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**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, DC 20549**

 

**FORM 10-Q**

 
| **x**                                                  | ** ** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934**  |
|--------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------|
| ** **                                             | ** ** | ** **                                                                                               |
| **For the Quarterly Period Ended March 31, 2010** |
| ** **                                             |
| **OR**                                                 |
| ** **                                             |
| **o**                                                  | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934** |

 

**For the transition period from            to**

 

**Commission File Number 1-14472**

 

**CORNELLCOMPANIES, INC.**

(Exact Name of Registrant as Specified in ItsCharter)

 

| **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’sTelephone Number, Including Area Code:  **(713) 623-0790**

 

Indicateby a check mark whether the registrant (1) has filed all reports requiredto be filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days. Yes  x  No o

 

Indicateby check mark whether the registrant has submitted electronically and posted onits corporate Web site, if any, every Interactive Data File required to besubmitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 ofthis chapter) during the preceding 12 months (or for such shorter period thatthe registrant was required to submit and post such files.)  Yes  ̈ No  ̈

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, a non-accelerated filer, or a smaller reporting company. Seedefinitions of “large accelerated filer,” “accelerated filer,” and “smallerreporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 
| Large accelerated filer  o                     |   | Accelerated filer x          |
|------------------------------------------------|--------|-----------------------------------|
|                                           |   |                              |
| Non-accelerated filer o                        |   | Smaller reporting  company o |
| (Do not check if a  smaller reporting company) |   |                              |

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act). Yes  o No x

 

At May 6, 2010, the registrant had 14,897,068 shares of commonstock outstanding.

 

 

 

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**Cornell Companies, Inc.**

** **

**Table of Contents**

 

**Form 10-Q**

** **
| ** **       | ** **                                                                                  | **Page**   |
|------------------|---------------------------------------------------------------------------------------------|------------|
| **Part I**  |                                                                                        |       |
| Item 1.          | Financial Statements (unaudited)                                                            | 5          |
| Item 2.          | Management’s  Discussion and Analysis of Financial Condition and Results of Operations | 27         |
| Item 3.          | Quantitative  and Qualitative Disclosures About Market Risk                                 | 39         |
| Item 4.          | Controls and  Procedures                                                                    | 40         |
|             |                                                                                        |       |
| **Part II** | ** **                                                                                  | ** ** |
| Item 1.          | Legal Proceedings                                                                           | 41         |
| Item 1A.         | Risk Factors                                                                                | 41         |
| Item 2.          | Unregistered  Sales of Equity Securities and Use of Proceeds                                | 43         |
| Item 3.          | Defaults Upon  Senior Securities                                                            | 43         |
| Item 4.          | Removed and  Reserved                                                                       | 43         |
| Item 5.          | Other Information                                                                           | 43         |
| Item 6.          | Exhibits                                                                                    | 43         |

 

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**Forward-Looking Information**

 

The statements included in this quarterlyreport regarding future financial performance and results of operations andother statements that are not historical facts are forward-looking statementswithin the meaning of Section 27A of the Securities Act of 1933 and Section 21Eof the Securities Exchange Act of 1934. Forward-looking statements in this quarterly report include, but are notlimited to, statements about the following subjects:

 

·                  revenues,

·                  revenue mix,

·                  expenses, including personnel and medical costs,

·                  results of operations,

·                  operating margins,

·                  supply and demand,

·                  market outlook in our various markets,

·                  our other expectations with regard to market outlook,

·                  utilization,

·                  parolee, detainee, inmate and youth offender trends,

·                  pricing and per diem rates,

·                  contract commencements,

·                  new contract opportunities,

·                  our proposed merger transaction with The GEO Group, Inc.(including, but not limited to, expected timing of completion of the transaction,ability to obtain required regulatory approvals, satisfaction of requiredclosing conditions),

·                  operations at, future contracts for, and results fromour Baker Community Correctional Facility and Mesa Verde Community CorrectionalFacility,

·                  operations at, future contracts for, and results fromour Regional Correctional Center,

·                  the timing (including ramp of facility population) andother aspects of our planned customer transition at our D. Ray James Prison,

·                  adequacy of insurance,

·                  debt levels,

·                  debt reduction,

·                  common stock repurchases,

·                  the effect of income tax positions and related assetsand liabilities,

·                  our effective tax rate,

·                  tax assessments,

·                  results and effects of legal proceedings andgovernmental audits and assessments,

·                  liquidity, including future liquidity and our abilityto obtain financing,

·                  financial markets,

·                  cash flow from operations,

·                  adequacy of cash flow for our obligations,

·                  capital requirements,

·                  capital expenditures,

·                  effects of accounting changes and adoption ofaccounting policies,

·                  changes in laws and regulations,

·                  adoption of accounting policies,

·                  benefit payments, and

·                  changes in laws and regulations.

 

Forward-lookingstatements in this quarterly report are identifiable by use of the followingwords and other similar expressions among others:

 

·               “anticipates”

·               “believes”

·               “budgets”

·               “could”

·               “estimates”

 

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·               “expects”

·               “forecasts”

·               “intends”

·               “may”

·               “might”

·               “plans”

·               “predicts”

·               “projects”

·               “scheduled”

·               “should”

 

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

 

·                  those described (in the Company’s 2009 Annual Reporton Form 10-K) under “Item 1A. Risk Factors,” as filed with the SEC,

·                  the adequacy of sources of liquidity,

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

·                  other factors discussed in this quarterly report andin the Company’s other filings with the SEC, which are available free of chargeon the SEC’s website at *www.sec.gov*.

 

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

 

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

 

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**PART I  FINANCIAL INFORMATION**

**ITEM 1.      Financial Statements.**

 

**CORNELL COMPANIES, INC.CONSOLIDATED BALANCE SHEETS(Unaudited)(in thousands, except share data)**

 
| ** **                                                                                                                                                            | ** ** | **March 31,  2010** | ** ** | **December 31,  2009** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| **ASSETS**                                                                                                                                                            | ** ** | ** **               | ** ** | ** **                  | ** ** |
| **CURRENT ASSETS:**                                                                                                                                                   | ** ** | ** **               | ** ** | ** **                  | ** ** |
| Cash and cash equivalents                                                                                                                                             |       | $                        | 18,061     |                        | $          | 27,724 |   |
| Accounts receivable —  trade (net of allowance for doubtful accounts of $4,459 and  $4,345, respectively)                                                   |       | 55,803                   |       | 59,496                      |       |
| Other receivables                                                                                                                                                     |       | 2,635                    |       | 1,587                       |       |
| Bond fund payment account  and other restricted assets                                                                                                                |       | 30,492                   |       | 29,978                      |       |
| Deferred tax assets                                                                                                                                                   |       | 9,754                    |       | 9,843                       |       |
| Prepaid expenses and other                                                                                                                                            |       | 10,533                   |       | 11,647                      |       |
| **Total current assets**                                                                                                                                              |       | 127,278                  |       | 140,275                     |       |
| **PROPERTY AND EQUIPMENT,  net**                                                                                                                                      |       | 457,274                  |       | 455,523                     |       |
| **OTHER ASSETS:**                                                                                                                                                     |       |                     |       |                        |       |
| Debt service reserve fund  and other restricted assets                                                                                                                |       | 29,884                   |       | 27,017                      |       |
| Goodwill                                                                                                                                                              |       | 13,308                   |       | 13,308                      |       |
| Intangible assets, net                                                                                                                                                |       | 1,053                    |       | 1,185                       |       |
| Deferred costs and other                                                                                                                                              |       | 14,968                   |       | 13,257                      |       |
| **Total assets**                                                                                                                                                      |       | $                        | 643,765    |                        | $          | 650,565 |   |
|                                                                                                                                                                  |       |                     |       |                        |       |
| **LIABILITIES AND EQUITY**                                                                                                                                            | ** ** | ** **               | ** ** | ** **                  | ** ** |
|                                                                                                                                                                  |       |                     |       |                        |       |
| **CURRENT LIABILITIES:**                                                                                                                                              | ** ** | ** **               | ** ** | ** **                  | ** ** |
| Accounts payable and  accrued liabilities                                                                                                                             |       | $                        | 58,574     |                        | $          | 62,287 |   |
| Current portion of  long-term debt                                                                                                                                    |       | 13,411                   |       | 13,413                      |       |
| **Total current  liabilities**                                                                                                                                        |       | 71,985                   |       | 75,700                      |       |
| **LONG-TERM DEBT, net of  current portion**                                                                                                                           |       | 287,286                  |       | 289,841                     |       |
| **DEFERRED TAX LIABILITIES**                                                                                                                                          |       | 24,984                   |       | 24,455                      |       |
| **OTHER LONG-TERM LIABILITIES**                                                                                                                                       |       | 1,845                    |       | 1,831                       |       |
| **Total liabilities**                                                                                                                                                 |       | 386,100                  |       | 391,827                     |       |
|                                                                                                                                                                  |       |                     |       |                        |       |
| **COMMITMENTS AND CONTINGENCIES**                                                                                                                                     | ** ** | ** **               | ** ** | ** **                  | ** ** |
|                                                                                                                                                                  |       |                     |       |                        |       |
| **EQUITY:**                                                                                                                                                           | ** ** | ** **               | ** ** | ** **                  | ** ** |
| Preferred stock, $.001 par  value, 10,000,000 shares authorized, none issued                                                                                          |       | —                   |       | —                      |       |
| Common stock, $.001 par  value, 30,000,000 shares authorized, 16,184,212 and 16,434,940 shares issued  and 14,787,032 and 14,947,054 shares outstanding, respectively |       | 16                       |       | 16                          |       |
| Additional paid-in capital                                                                                                                                            |       | 165,708                  |       | 168,852                     |       |
| Retained earnings                                                                                                                                                     |       | 101,224                  |       | 97,944                      |       |
| Accumulated other  comprehensive income                                                                                                                               |       | 1,358                    |       | 1,422                       |       |
| Treasury stock (1,397,180  and 1,487,886 shares of common stock, at cost, respectively)                                                                               |       | (11,163                  | )          | (11,888                     | )          |
| **Total Cornell Companies, Inc.  stockholders’ equity**                                                                                                     |       | 257,143                  |       | 256,346                     |       |
| Non-controlling interest                                                                                                                                              |       | 522                      |       | 2,392                       |       |
| **Total equity**                                                                                                                                                      |       | 257,665                  |       | 258,738                     |       |
| **Total liabilities and  equity**                                                                                                                                     |       | $                        | 643,765    |                        | $          | 650,565 |   |

 

The accompanyingnotes are an integral part of these consolidated financial statements.

 

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**CORNELL COMPANIES, INC.****CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVEINCOME****(Unaudited)(in thousands, except per share data)**

 
|                                                                      |   | **Three Months Ended  March 31,** |       |
|---------------------------------------------------------------------------|--------|--------------------------------------------------|------------|
|                                                                      |   | **2010**                                         | ** ** | **2009** |   |
|                                                                      |   |                                             |       |   |   |
| REVENUES                                                                  |   | $                                                | 100,006    |   | $ | 99,710 |   |
| OPERATING EXPENSES,  EXCLUDING DEPRECIATION AND AMORTIZATION              |   | 76,683                                           |       | 72,891 |   |
| DEPRECIATION AND  AMORTIZATION                                            |   | 4,699                                            |       | 4,893 |   |
| GENERAL AND ADMINISTRATIVE  EXPENSES                                      |   | 5,759                                            |       | 6,138 |   |
|                                                                      |   |                                             |       |   |   |
| INCOME FROM OPERATIONS                                                    |   | 12,865                                           |       | 15,788 |   |
|                                                                      |   |                                             |       |   |   |
| INTEREST EXPENSE                                                          |   | 6,314                                            |       | 6,199 |   |
| INTEREST INCOME                                                           |   | (129                                             | )          | (246 | ) |
|                                                                      |   |                                             |       |   |   |
| INCOME FROM OPERATIONS  BEFORE PROVISION FOR INCOME TAXES                 |   | 6,680                                            |       | 9,835 |   |
|                                                                      |   |                                             |       |   |   |
| PROVISION FOR INCOME TAXES                                                |   | 2,831                                            |       | 4,101 |   |
|                                                                      |   |                                             |       |   |   |
| NET INCOME                                                                |   | 3,849                                            |       | 5,734 |   |
|                                                                      |   |                                             |       |   |   |
| NON-CONTROLLING INTEREST                                                  |   | 569                                              |       | 477 |   |
|                                                                      |   |                                             |       |   |   |
| INCOME AVAILABLE TO  CORNELL COMPANIES, INC.                              |   | $                                                | 3,280      |   | $ | 5,257 |   |
|                                                                      |   |                                             |       |   |   |
| EARNINGS PER SHARE ATTRIBUTABLE TO CORNELL  COMPANIES, INC. STOCKHOLDERS: |   |                                             |       |   |   |
| BASIC                                                                     |   | $                                                | .22        |   | $ | .36 |   |
| DILUTED                                                                   |   | $                                                | .22        |   | $ | .36 |   |
|                                                                      |   |                                             |       |   |   |
| NUMBER OF SHARES USED IN PER SHARE COMPUTATION:                           |   |                                             |       |   |   |
| BASIC                                                                     |   | 14,756                                           |       | 14,572 |   |
| DILUTED                                                                   |   | 14,882                                           |       | 14,629 |   |
|                                                                      |   |                                             |       |   |   |
| COMPREHENSIVE INCOME:                                                     |   |                                             |       |   |   |
| Net income                                                                |   | $                                                | 3,849      |   | $ | 5,734 |   |
| Comprehensive income  attributable to non-controlling interest            |   | (569                                             | )          | (477 | ) |
| Comprehensive income  attributable to Cornell Companies, Inc.        |   | $                                                | 3,280      |   | $ | 5,257 |   |

 

The accompanyingnotes are an integral part of these consolidated financial statements.

 

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**CORNELL COMPANIES, INC.**

### ***CONSOLIDATEDSTATEMENT OF CHANGES IN EQUITY***

### ***ANDCOMPREHENSIVE INCOME***

**FOR THE THREE MONTHS ENDED MARCH 31, 2010**

**(Unaudited)**

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

 
| ** **                                                                | ** ** | **Common Stock** | ** ** | **Additional** | ** ** | ** **  | ** ** | ** **   | ** ** | ** **              | ** ** | **Accumulated  Other** | ** ** | **Non-**        | ** ** | **Total**              | ** ** | ** **        | ** ** |
|---------------------------------------------------------------------------|------------|-----------------------|------------|----------------|------------|-------------|------------|--------------|------------|-------------------------|------------|------------------------|------------|-----------------|------------|------------------------|------------|-------------------|------------|
| ** **                                                                | ** ** | ** **            | ** ** | **Par**        | ** ** | **Paid-In** | ** ** | **Retained** | ** ** | **Treasury Stock** | ** ** | **Comprehensive**      | ** ** | **Controlling** | ** ** | **Stockholders’** | ** ** | **Comprehensive** | ** ** |
| ** **                                                                | ** ** | **Shares**            | ** ** | **Value**      | ** ** | **Capital** | ** ** | **Earnings** | ** ** | **Shares**              | ** ** | **Cost**               | ** ** | **Income**      | ** ** | **Interest**           | ** ** | **Equity**        | ** ** | **Income** | ** ** |
| ** **                                                                | ** ** | ** **            | ** ** | ** **     | ** ** | ** **  | ** ** | ** **   | ** ** | ** **              | ** ** | ** **             | ** ** | ** **      | ** ** | ** **             | ** ** | ** **        | ** ** | ** ** | ** ** |
| BALANCES AT DECEMBER 31,  2009                                            |       | 16,434,940            |       | $              | 16         |        | $          | 168,852      |       | $                       | 97,944     |                   | 1,487,886  |            | $          | (11,888                | )          | $                 | 1,422      |   | $ | 2,392 |   | $ | 258,738 |   | $ | — |   |
|                                                                      |       |                  |       |           |       |        |       |         |       |                    |       |                   |       |            |       |                   |       |              |       |   |   |
| NET INCOME                                                                |       | —                |       | —         |       | —      |       | 3,280        |       | —                  |       | —                 |       | —          |       | 569                    |       | 3,849             |       | 3,280 |   |
| COMPREHENSIVE INCOME                                                      |       |                  |       |           |       |        |       |         |       |                    |       |                   |       |            |       |                   |       |              |       | $ | 3,280 |   |
| EXERCISE OF STOCK  OPTIONS                                                |       | 625                   |       | —         |       | 20          |       | —       |       | (2,132                  | )          | 17                     |       | —          |       | —                 |       | 37                |       |   |   |
| DISTRIBUTION TO MCF  PARTNERS                                             |       | —                |       | —         |       | —      |       | —       |       | —                  |       | —                 |       | —          |       | (2,439                 | )          | (2,439            | )          |   |   |
| REPURCHASE AND  RETIREMENT OF COMMON STOCK                                |       | (145,473              | )          | —         |       | (3,000      | )          | —       |       | —                  |       | —                 |       | —          |       | —                 |       | (3,000            | )          |   |   |
| DEFERRED AND  OTHER STOCK COMPENSATION                               |       | (105,880              | )          | —         |       | (438        | )          | —       |       | (61,035                 | )          | 489                    |       | —          |       | —                 |       | 51                |       |   |   |
| AMORTIZATION OF GAIN ON  TERMINATION OF DERIVATIVE                        |       | —                |       | —         |       | —      |       | —       |       | —                  |       | —                 |       | (64             | )          | —                 |       | (64               | )          |   |   |
| ISSUANCE OF  COMMON STOCK TO EMPLOYEE STOCK PURCHASE PLAN       |       | —                |       | —         |       | 169         |       | —       |       | (23,237                 | )          | 186                    |       | —          |       | —                 |       | 355               |       |   |   |
| ISSUANCE OF  COMMON STOCK UNDER 2000 DIRECTOR’S STOCK PLAN |       | —                |       | —         |       | 105         |       | —       |       | (4,302                  | )          | 33                     |       | —          |       | —                 |       | 138               |       |   |   |
|                                                                      |       |                  |       |           |       |        |       |         |       |                    |       |                   |       |            |       |                   |       |              |       |   |   |
| BALANCES AT MARCH 31,  2010                                          |       | 16,184,212            |       | $              | 16         |        | $          | 165,708      |       | $                       | 101,224    |                   | 1,397,180  |            | $          | (11,163                | )          | $                 | 1,358      |   | $ | 522 |   | $ | 257,665 |   |   |   |

 

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

 

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**CORNELL COMPANIES, INC.**

### ***CONSOLIDATEDSTATEMENT OF CHANGES IN EQUITY***

### ***ANDCOMPREHENSIVE INCOME***

**FOR THE THREE MONTHS ENDED MARCH 31, 2009**

**(Unaudited)**

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

 
| ** **                                                                | ** ** | **Common Stock** | ** ** | **Additional** | ** ** | ** **  | ** ** | ** **   | ** ** | ** **              | ** ** | **Accumulated  Other** | ** ** | **Non-**        | ** ** | **Total**              | ** ** | ** **        | ** ** |
|---------------------------------------------------------------------------|------------|-----------------------|------------|----------------|------------|-------------|------------|--------------|------------|-------------------------|------------|------------------------|------------|-----------------|------------|------------------------|------------|-------------------|------------|
| ** **                                                                | ** ** | ** **            | ** ** | **Par**        | ** ** | **Paid-In** | ** ** | **Retained** | ** ** | **Treasury Stock** | ** ** | **Comprehensive**      | ** ** | **Controlling** | ** ** | **Stockholders’** | ** ** | **Comprehensive** | ** ** |
| ** **                                                                | ** ** | **Shares**            | ** ** | **Value**      | ** ** | **Capital** | ** ** | **Earnings** | ** ** | **Shares**              | ** ** | **Cost**               | ** ** | **Income**      | ** ** | **Interest**           | ** ** | **Equity**        | ** ** | **Income** | ** ** |
| ** **                                                                | ** ** | ** **            | ** ** | ** **     | ** ** | ** **  | ** ** | ** **   | ** ** | ** **              | ** ** | ** **             | ** ** | ** **      | ** ** | ** **             | ** ** | ** **        | ** ** | ** ** | ** ** |
| BALANCES AT DECEMBER 31,  2008                                            |       | 16,238,685            |       | $              | 16         |        | $          | 164,746      |       | $                       | 73,318     |                   | 1,506,163  |            | $          | (12,034                | )          | $                 | 1,676      |   | $ | 445 |   | $ | 228,167 |   | $ | — |   |
|                                                                      |       |                  |       |           |       |        |       |         |       |                    |       |                   |       |            |       |                   |       |              |       |   |   |
| NET INCOME                                                                |       | —                |       | —         |       | —      |       | 5,257        |       | —                  |       | —                 |       | —          |       | 477                    |       | 5,734             |       | 5,257 |   |
| COMPREHENSIVE INCOME                                                      |       |                  |       |           |       |        |       |         |       |                    |       |                   |       |            |       |                   |       |              |       | $ | 5,257 |   |
| EXERCISE OF STOCK  OPTIONS                                                |       | 750                   |       | —         |       | 10          |       | —       |       | —                  |       | —                 |       | —          |       | —                 |       | 10                |       |   |   |
| INCOME TAX BENEFIT FROM  STOCK OPTION EXERCISES                           |       | —                |       | —         |       | (71         | )          | —       |       | —                  |       | —                 |       | —          |       | —                 |       | (71               | )          |   |   |
| DEFERRED AND  OTHER STOCK COMPENSATION                               |       | (293                  | )          | —         |       | 413         |       | —       |       | —                  |       | —                 |       | —          |       | —                 |       | 413               |       |   |   |
| AMORTIZATION OF GAIN ON  TERMINATION OF DERIVATIVE                        |       | —                |       | —         |       | —      |       | —       |       | —                  |       | —                 |       | (63             | )          | —                 |       | (63               | )          |   |   |
| ISSUANCE OF COMMON STOCK  TO EMPLOYEE STOCK PURCHASE PLAN       |       | —                |       | —         |       | 143         |       | —       |       | (18,277                 | )          | 146                    |       | —          |       | —                 |       | 289               |       |   |   |
| ISSUANCE OF  COMMON STOCK UNDER 2000 DIRECTOR’S STOCK PLAN |       | 3,459                 |       | —         |       | 115         |       | —       |       | —                  |       | —                 |       | —          |       | —                 |       | 115               |       |   |   |
|                                                                      |       |                  |       |           |       |        |       |         |       |                    |       |                   |       |            |       |                   |       |              |       |   |   |
| BALANCES AT MARCH 31,  2009                                          |       | 16,242,601            |       | $              | 16         |        | $          | 165,356      |       | $                       | 78,575     |                   | 1,487,886  |            | $          | (11,888                | )          | $                 | 1,613      |   | $ | 922 |   | $ | 234,594 |   |   |   |

 

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

 

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**CORNELL COMPANIES, INC.CONSOLIDATED STATEMENTS OF CASH FLOWS(Unaudited)(in thousands)**

 
| ** **                                                                                                    | ** ** | **Three Months Ended  March 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                                                    | ** ** | **2010**                                         | ** ** | **2009** | ** ** |
| CASH FLOWS FROM OPERATING ACTIVITIES:                                                                         |       |                                             |       |   |   |
| Net income                                                                                                    |       | $                                                | 3,849      |   | $ | 5,734 |   |
| Adjustments to reconcile  net income to net cash used in operating activities                                 |       |                                             |       |   |   |
| Depreciation                                                                                                  |       | 4,567                                            |       | 4,445 |   |
| Amortization of  intangibles                                                                                  |       | 132                                              |       | 448 |   |
| Amortization of deferred  financing costs                                                                     |       | 310                                              |       | 319 |   |
| Amortization of Senior  Notes discount                                                                        |       | 46                                               |       | 46 |   |
| Amortization of gain on  termination of derivative                                                            |       | (64                                              | )          | (64 | ) |
| Stock-based compensation                                                                                      |       | 729                                              |       | 594 |   |
| Provision for bad debts                                                                                       |       | 322                                              |       | 668 |   |
| (Gain)loss on property and  equipment                                                                         |       | (10                                              | )          | 14 |   |
| Change in assets and liabilities:                                                                             |       |                                             |       |   |   |
| Accounts receivable                                                                                           |       | 2,889                                            |       | (4,611 | ) |
| Other restricted assets                                                                                       |       | (3,173                                           | )          | (375 | ) |
| Deferred income taxes                                                                                         |       | 617                                              |       | 249 |   |
| Other assets                                                                                                  |       | (17                                              | )          | 854 |   |
| Accounts payable and  accrued liabilities                                                                     |       | (11,000                                          | )          | (10,555 | ) |
| Other liabilities                                                                                             |       | (214                                             | )          | 145 |   |
| Net cash used in operating  activities                                                                        |       | (1,017                                           | )          | (2,089 | ) |
|                                                                                                          |       |                                             |       |   |   |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                                                         |       |                                             |       |   |   |
| Capital expenditures                                                                                          |       | (3,227                                           | )          | (3,168 | ) |
| Payments to restricted  debt payment account, net                                                             |       | (208                                             | )          | (381 | ) |
| Net cash used in investing  activities                                                                        |       | (3,435                                           | )          | (3,549 | ) |
|                                                                                                          |       |                                             |       |   |   |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                                                         |       |                                             |       |   |   |
| Proceeds from line of  credit                                                                                 |       | —                                           |       | 2,000 |   |
| Payments of line of credit                                                                                    |       | (2,600                                           | )          | (1,000 | ) |
| Payments of capital lease  obligations                                                                        |       | (3                                               | )          | (3 | ) |
| Purchase and retirement of  common stock                                                                      |       | (3,000                                           | )          | — |   |
| Proceeds from exercise of  stock options and employee stock purchase plan                                     |       | 392                                              |       | 299 |   |
| Net cash provided by (used  in) financing activities                                                          |       | (5,211                                           | )          | 1,296 |   |
|                                                                                                          |       |                                             |       |   |   |
| NET DECREASE IN CASH AND  CASH EQUIVALENTS                                                                    |       | (9,663                                           | )          | (4,342 | ) |
| CASH AND CASH EQUIVALENTS  AT BEGINNING OF PERIOD                                                             |       | 27,724                                           |       | 14,613 |   |
| CASH AND CASH EQUIVALENTS  AT END OF PERIOD                                                                   |       | $                                                | 18,061     |   | $ | 10,271 |   |
|                                                                                                          |       |                                             |       |   |   |
| OTHER NON-CASH INVESTING AND FINANCING ACTIVITIES:                                                            |       |                                             |       |   |   |
| Common stock issued for  board of directors fees                                                              |       | $                                                | 140        |   | $ | 115 |   |
| Purchases and additions to  property and equipment included in accounts payable and  accrued liabilities |       | 3,081                                            |       | 1,557 |   |
| Tax expense of stock  option exercises                                                                        |       | —                                           |       | (71 | ) |

 

The accompanyingnotes are an integral part of these consolidated financial statements.

 

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**CORNELL COMPANIES, INC.**

**NOTES TO CONSOLIDATEDFINANCIAL STATEMENTS**

**(unaudited)**

** **

**1.****    ****Basis ofPresentation**

 

Theaccompanying unaudited consolidated financial statements have been prepared byCornell Companies, Inc. (collectively with its subsidiaries andconsolidated special purpose entities, unless the context requires otherwise,the “Company,” “we,” “us” or “our”) 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. The year-end consolidated balance sheet was derived from auditedfinancial statements but does not include all disclosures required by GAAP. Inthe opinion of management, adjustments and disclosures necessary for a fair presentationof 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 2009 AnnualReport on Form 10-K as filed with the Securities and Exchange Commission.

 

**2.****    ****AccountingPolicies**

 

Seea description of our accounting policies in the Notes to Consolidated FinancialStatements included in our 2009 Annual Report on Form 10-K.

 

**3.****    ****Stock-Based Compensation**

 

We have an employee stock purchase plan (“ESPP”) under whichemployees can make contributions to purchase our common stock. Participation inthe plan is elected annually by employees. The plan year typically begins each January 1st(the “Beginning Date”) and ends on December 31st (the “Ending Date”).Purchases of common stock are made at the end of the year using the lower ofthe fair market value on either the Beginning Date or Ending Date, less a 15%discount. Undercurrent authoritative guidance our employee-stock purchase plan is consideredto be a compensatory ESPP, and therefore, we recognize compensation expenseover the requisite service period for grants made under the ESPP. Compensationexpense of approximately $0.03 million was recognized in both the three monthsended March 31, 2010 and 2009, respectively.

 

Our stock incentive plansprovide for the granting of stock options (both incentive stock options andnonqualified stock options), stock appreciation rights, restricted stock sharesand other stock-based awards to officers, directors and employees of theCompany. Grants of stock options made to date under these plans vest overperiods up to seven years after the date of grant and expire no more than 10years after grant. Upon the occurrence of specified change of control events,those awards outstanding which have not previously vested will automaticallyvest.

 

At March 31, 2009,153,300 shares of restricted stock were outstanding subject toperformance-based vesting criteria (32,500 of these restricted shares wereconsidered market-based restricted stock under authoritative guidance). Therewere also 6,260 stock options outstanding subject to performance-based vestingcriteria. We recognized $0.04 million of expense associated with these sharesof restricted stock and stock options during the three months ended March 31,2009.

 

At March 31, 2010,273,769 shares of restricted stock were outstanding subject to performance-basedvesting criteria (32,500 of these restricted shares were consideredmarket-based restricted stock under authoritative guidance). There were alsostock options for 840 shares outstanding subject to performance-based vestingcriteria. We recognized $0.2 million of expense associated with these shares ofrestricted stock and stock options during the three months ended March 31,2010.

 

The amounts above relate to the impact of recognizingcompensation expense related to stock options and restricted stock.Compensation expense related to stock options (840 shares) and restricted stock(241,269 shares) that vest based upon performance conditions is not recordedfor such performance-based awards until it has been deemed probable that therelated performance targets allowing the vesting of these options andrestricted stock will be met. We are required to periodically re-assess theprobability that these options will vest and begin to record expense at thatpoint in time. During the three months ended March 31, 2010 it was deemedprobable that certain performance targets pertaining to certain restrictedstock and stock options would be achieved by their vesting date. Accordingly,compensation expense of approximately $0.1 million was recognized in the threemonths ended March 31, 2010 related to these performance-based awards.

 

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We recognize expense for our stock-based compensationover the vesting period, or in the case of performance-based awards, during theservice period for which the performance target becomes probable of being met,which represents the period in which an employee is required to provide servicein exchange for the award. We recognize compensation expense for stock-basedawards immediately if the award has immediate vesting.

 

***Assumptions***

 

Thefair values for the significant stock-based awards granted during the threemonths ended March 31, 2010 and 2009 were estimated at the date of grantusing a Black-Scholes option pricing model with the following weighted-averageassumptions:

 
| ** **                       | ** ** | **Three Months Ended  March 31,** | ** ** |
|----------------------------------|------------|--------------------------------------------------|------------|
| ** **                       | ** ** | **2010**                                         | ** ** | **2009** | ** ** |
|                             |       |                                             |       |   |   |
| Risk-free rate of return         |       | 3.04                                             | %          | 1.90 | % |
| Expected life of award           |       | 6.0 years                                        |       | 6.0 years |   |
| Expected dividend yield of stock |       | 0                                                | %          | 0 | % |
| Expected volatility of stock     |       | 41.89                                            | %          | 50.49 | % |
| Weighted-average fair value      |       | $                                                | 10.34      |   | $ | 8.89 |   |
|                                  |            |                                                  |            |  |  |  |  |

 

Theexpected volatility of stock assumption was derived by referring to changes inthe Company’s historical common stock prices over a timeframe similar to thatof the expected life of the award. We do not believe that future stockvolatility will significantly differ from historical stock volatility.Estimated forfeiture rates are derived from historical forfeiture patterns. Webelieve the historical experience method is the best estimate of forfeiturescurrently available.

 

Generallywe utilized the “simplified” method for “plain vanilla” options to estimate theexpected term of options granted during the periods noted (whereappropriate).  For those grants duringthese periods wherein we had sufficient historical or impartial data to betterestimate the expected term, we have done so.

 

Stock-basedoption activity during the three months ended March 31, 2010 was asfollows (aggregate intrinsic value in millions):

 
| ** **                                         | ** ** | **Number  of  Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Remaining  Contractual  Term** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|----------------------------------------------------|------------|------------------------|------------|----------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------|------------|
|                                               |       |                   |       |                                   |       |                                                |       |                            |       |
| Outstanding at December 31, 2009              |       | 496,247                |       | $                                      | 15.36      |                                                | 5.9        |                            | $          | 7.6 |   |
| Granted                                            |       | 40,000                 |       | 23.08                                  |       |                                                |       |                            |       |
| Exercised                                          |       | (8,425                 | )          | 13.61                                  |       |                                                |       |                            |       |
| Canceled                                           |       | (2,962                 | )          | 11.00                                  |       |                                                |       |                            |       |
|                                               |       |                   |       |                                   |       |                                                |       |                            |       |
| Outstanding at March 31, 2010                 |       | 524,860                |       | $                                      | 16.00      |                                                | 6.0        |                            | $          | 8.4 |   |
|                                               |       |                   |       |                                   |       |                                                |       |                            |       |
| Vested and expected to vest at March 31, 2010 |       | 523,135                |       | $                                      | 15.70      |                                                | 6.0        |                            | $          | 8.4 |   |
|                                               |       |                   |       |                                   |       |                                                |       |                            |       |
| Exercisable at March 31, 2010                 |       | 479,770                |       | $                                      | 15.45      |                                                | 5.7        |                            | $          | 7.4 |   |

 

Thetotal intrinsic value of stock options exercised during the three months ended March 31,2010 and 2009 was approximately $0.1 million in each period. Net cash proceedsfrom the exercise of stock options were approximately $0.04 million and $0.01million for each of the three months ended March 31, 2010 and 2009,respectively.

 

Werecognized $0.1 million of expense associated with time-based stock optionsduring the three months ended March 31, 2010. As of March 31, 2010,approximately $0.3 million of estimated expense with respect to time-basednonvested stock-based awards had yet to be recognized and will be amortizedinto expense over the employee’s remaining requisite service period ofapproximately four months.

 

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Thefollowing table summarizes information with respect to stock optionsoutstanding and exercisable at March 31, 2010.

 
| **Range of Exercise Prices** | ** ** | **Number  Outstanding** | ** ** | **Weighted  Average  Remaining  Life (Years)** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Number  Exercisable** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
|---------------------------------------------|------------|-------------------------|------------|-----------------------------------------------------|------------|----------------------------------------|------------|-------------------------|------------|----------------------------------------|------------|
|                                        |       |                    |       |                                                |       |                                   |       |                    |       |                                   |       |
| $3.75  to  $10.00       |       | 18,015                  |       | 1.6                                                 |       | $                                      | 5.76       |                    | 18,015     |                                   | $          | 5.76 |   |
| $10.01  to  $13.50      |       | 146,945                 |       | 4.5                                                 |       | 12.85                                  |       | 144,945                 |       | 12.85                                  |       |
| $13.51  to   $14.50          |       | 168,200                 |       | 5.5                                                 |       | 13.99                                  |       | 164,500                 |       | 13.98                                  |       |
| $14.51  to   $25.00          |       | 191,700                 |       | 8.0                                                 |       | 21.13                                  |       | 152,310                 |       | 20.65                                  |       |
|                                        |       | 524,860                 |       | 6.0                                                 |       | $                                      | 16.00      |                    | 479,770    |                                   | $          | 15.45 |   |

 

Stock-basedaward activity for nonvested awards during the three months ended March 31,2010 is as follows:

 
| ** **                          | ** ** | **Number  of  Shares** | ** ** | **Weighted Average  Grant Date  Fair Value** | ** ** |
|-------------------------------------|------------|------------------------|------------|-------------------------------------------------------------|------------|
| Nonvested at December 31, 2009 |       | 20,510                 |       | $                                                           | 20.32      |   |
| Granted                             |       | 40,000                 |       | 23.08                                                       |       |
| Vested                              |       | (15,420                | )          | 22.95                                                       |       |
| Canceled                            |       | —                 |       | —                                                      |       |
|                                |       |                   |       |                                                        |       |
| Nonvested at March 31, 2010    |       | 45,090                 |       | $                                                           | 21.87      |   |

 

***Restricted Stock***

 

We have previously issuedrestricted stock under certain employment agreements and stock incentive planswhich vests either over a specific period of time, generally three to fiveyears, or which will vest subject to certain market or performanceconditions.  Those shares of restrictedcommon stock issued are subject to restrictions on transfer and certainconditions to vesting. We issued no restricted stock under our 2006 IncentivePlan during the three months ended March 31, 2010.

 

Restricted stock activityfor the three months ended March 31, 2010 was as follows:

 
| ** **                          | ** ** | **Number  of  Shares** | ** ** | **Weighted Average  Grant Date  Fair Value** | ** ** |
|-------------------------------------|------------|------------------------|------------|-------------------------------------------------------------|------------|
| Nonvested at December 31, 2009 |       | 520,574                |       | $                                                           | 20.61      |   |
| Granted                             |       | —                 |       | —                                                      |       |
| Vested                              |       | (87,833                | )          | 22.12                                                       |       |
| Canceled                            |       | (6,875                 | )          | 23.15                                                       |       |
|                                |       |                   |       |                                                        |       |
| Nonvested at March 31, 2010    |       | 425,866                |       | $                                                           | 20.26      |   |

 

We recognized $0.4million of expense associated with nonvested time-based restricted stock awardsduring the three months ended March 31, 2010.  As of March 31, 2010, approximately $1.2million of estimated expense with respect to nonvested time-based restrictedstock awards had yet to be recognized and will be amortized over a weightedaverage period of 2.0 years. Approximately $4.2 million of estimatedexpense with respect to nonvested performance-based restricted stock optionawards had yet to be recognized as of March 31, 2010.

 

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**4.****    ****MergerAgreement**

 

OnApril 18, 2010, the Company entered into an Agreement and Plan of Merger (“Agreement”)with The GEO Group, Inc. (NYSE:GEO) (“GEO”), a private provider ofcorrectional, detention, and residential treatment services to federal, stateand local government agencies around the globe. Pursuant to the Agreement, GEOwill acquire Cornell for stock and/or cash at an estimated enterprise value of$685 million based on the closing prices of both companies’ stock on April 16,2010, including the assumption of approximately $300 million in Cornell debt,excluding cash.

 

Underthe terms of the definitive agreement, stockholders of Cornell will have theoption to elect to receive either (x) 1.3 shares of GEO common stock foreach share of Cornell common stock or (y) an amount of cash considerationequal to the greater of (i) the fair market value of one share of GEOcommon stock plus $6.00 or (ii) the fair market value of 1.3 shares of GEOcommon stock. In order to preserve the tax-deferred treatment of thetransaction, no more than 20% of the outstanding shares of Cornell Common Stockmay be exchanged for the cash consideration. If elections are made such thatthe aggregate cash consideration to be received by Cornell stockholders wouldexceed $100 million in the aggregate, such excess amount may be paid at theelection of GEO in shares of GEO common stock or in cash.

 

Themerger is expected to close in the third quarter of 2010, subject to theapproval of the issuance of GEO common stock by GEO’s shareholders, approval ofthe transaction by Cornell’s stockholders and federal regulatory agencies,including but not limited to the expiration or termination of the waiting periodunder the Hart-Scott-Rodino Antitrust Improvement Act of 1976, as well as thefulfillment of other customary conditions.

 

***LitigationRelating to the Merger***

 

On April 27, 2010, aputative stockholder class action was filed in the District Court for HarrisCounty, Texas by Todd Shelby against Cornell, members of the Cornell board ofdirectors, individually, and GEO. The complaint alleges, amongother things, that the Cornell directors breached their duties by entering intothe Agreement without first taking steps to obtain adequate, fair and maximumconsideration for Cornell’s stockholders by shopping the company or initiatingan auction process, by structuring the transaction to take advantage of Cornell’slow current stock valuation, and by structuring the transaction to benefit GEOwhile making an alternative transaction either prohibitively expensive orotherwise impossible, and that Cornell and GEO have aided and abetted suchbreaches by Cornell’s directors. Among other things, the complaint seeks to enjoinCornell, its directors and GEO from completing the merger and seeks aconstructive trust over any benefits improperly received by the defendants as aresult of their alleged wrongful conduct.

 

**5.****    ****Fair Value Measurements**

 

OnJanuary 1, 2008, we adopted a newly issued accounting standard for fairvalue measurements of financial assets and liabilities which did not have amaterial financial impact on our consolidated results of operations orfinancial condition.  On January 1,2009, we adopted the provisions of this new accounting pronouncement forapplying fair value to non-financial assets, liabilities and transactions on anon-recurring basis.  Adoption of theprovisions for the fair value measurements on a non-recurring basis did nothave a material effect on our financial position, results of operations or cashflows.

 

Asdefined in this accounting standard, fair value is the price that would bereceived to sell an asset or paid to transfer a liability in an orderlytransaction between market participants at the measurement date (“exit price”).  Additionally, this pronouncement requiresdisclosure that establishes a framework for measuring fair value and expandsdisclosures about fair value measurements. Additionally, it requires that fair value measurements be classified anddisclosed in one of the following categories:

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

 

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Asrequired, financial assets and liabilities are classified based on the lowestlevel of input that is significant for the fair value measurement.  The following table summarizes the valuationof our financial assets and liabilities by pricing levels as of March 31,2010:

 
| ** **         | ** ** | **Fair Value as of  March 31, 2010 (in thousands)** | ** ** |
|--------------------|------------|----------------------------------------------------------------------------------------|------------|
| ** **         | ** ** | **Level 1**                                                                       | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Total** | ** ** |
| Assets:            |       |                                                                                   |       |   |   |   |   |   |   |
| Corporate Bonds    |       | $                                                                                      | —     |   | $ | 12,317 |   | $ | — |   | $ | 12,317 |   |
| Money Market Funds |       | —                                                                                 |       | 43,922 |   | — |   | 43,922 |   |
|                    |            |                                                                                        |            |  |  |  |  |  |  |  |  |  |  |

 

Thecorporate bonds and money market funds are carried in debt service fund andother restricted assets and the debt service reserve fund in the accompanyingbalance sheet. The fair value measurements for corporate bonds and money-marketfunds are based upon the quoted price for similar assets in markets that arenot active, multiplied by the number of shares owned, exclusive of anytransaction costs and without any adjustments to reflect discounts that may beapplied to selling a large block of securities at one time.  We do not believe that the changes in fairvalue of these assets will materially differ from the amounts that could berealized upon settlement or that the changes in fair value will have a materialeffect on our results of operations, liquidity and capital resources.

 

Thisaccounting standard requires a reconciliation of the beginning and endingbalances for fair value measurements using Level 3 inputs. We had no suchassets or liabilities which were measured at fair value on a recurring basisusing significant unobservable inputs (level 3) during the three months ended March 31,2010.  We evaluated our long-lived assetsfor impairment using internally developed, unobservable inputs (Level 3 inputsin the fair value hierarchy of fair value accounting) based on the projectedcash flows of our idle facilities. Such inputs that may significantly influenceestimated future cash flows include the periods and levels of occupancy for thefacility, expected per diem or reimbursement rates, assumptions regarding thelevels of staffing, services and future operating and capital expendituresnecessary to generate forecasted revenues, related costs for these activitiesand future rate of increases or decreases associated with these factors.Information typically utilized will also include relevant terms of existingcontracts (for similar services and customers), market knowledge of customerdemand (both present and anticipated) and related pricing, market competitors,and our historical experience (as to areas including customer requirements,contract terms, operating requirements/costs, occupancy trends, etc.).

 

**6.****    ****Recent Accounting Standards**

 

InJanuary 2010, the FASB issued an amendment to the disclosure requirementrelated to Fair Value Measurements.  Theamendment requires new disclosures related to transfers in and out of Levels 1and 2 and activity in Level 3 fair value measurements.  A reporting entity is required to discloseseparately the amounts of significant transfers in and out of Level 1 and Level2 fair value measurements and describe the reasons for the transfers.  Additionally, in the reconciliation for fairvalue measurements in Level 3, a reporting entity must present separatelyinformation about purchases, sales, issuances and settlements (on a gross basisrather than a net number).  The newdisclosures are effective for interim and annual reporting periods beginningafter December 15, 2009, except for the disclosures about purchases,sales, issuances and settlements in the roll forward of activity in Level 3fair value measurements.  Thosedisclosures are effective for fiscal years beginning after December 15,2010 and for interim periods within those fiscal years.  Our adoption of this amendment did not have amaterial affect on our financial position, results of operations or cash flows.

 

In June 2009, theFASB issued an amendment to the accounting and disclosure requirements fortransfers of financial assets.  Thisamendment applies to the financial reporting of a transfer of financial assets;the effects of a transfer on an entity’s financial position, financialperformance and cash flows; and a transferor’s continuing involvement, if any,in transferred financial assets.  Iteliminates (1) the exceptions for qualifying special-purpose entities fromthe consolidation guidance and (2) the exception that permitted saleaccounting for certain mortgage securitizations when a transferor has notsurrendered control over the transferred financial assets.  The provisions of this amendment must beapplied as of the beginning of each reporting entity’s first annual reportingperiod that begins after November 15, 2009, for interim periods withinthat first annual reporting period and for interim and annual reporting periodsthereafter.  Earlier application wasprohibited.  The requirements in theamendment must be applied to transfers occurring on or after the effectivedate. Our adoption of this amendment as of January 1, 2010 did not have amaterial affect on our consolidated financial position, results of operationsor cash flows.

 

In June 2009, the FASBalso issued an amendment to the accounting and disclosure requirements for theconsolidation of variable interest entities (“VIEs”). This amendment requiresan enterprise to perform a qualitative analysis when determining whether or notit must consolidate a VIE.  The amendmentalso requires an enterprise to continuously reassess whether it mustconsolidate a VIE.  Additionally, theamendment requires enhanced disclosures about an enterprise’s involvement withVIEs and any significant change in risk exposure due to that involvement, aswell as how its involvement with VIEs impacts the enterprise’s financialstatements.  Finally, an enterprise willbe required to disclose significant judgments and assumptions used to determinewhether or not to 

 

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consolidate a VIE. Thisamendment is effective for financial statements issued for fiscal yearsbeginning after November 15, 2009. Earlier application was prohibited. Our adoption of this amendment as of January 1,2010 did not have a material affect on our consolidated financial position,results of operations or cash flows; however, we have included the applicabledisclosure requirements at Note 14 to the consolidated financial statements.

 

**7.****    ****Intangible Assets**

 

Intangibleassets at March 31, 2010 and December 31, 2009 consisted of thefollowing (in thousands):

 
| ** **                                              | ** ** | **March 31,  2010** | ** ** | **December 31,  2009** | ** ** |
|---------------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
|                                                    |       |                     |       |                        |       |
| Acquired contract value                                 |       | $                        | 6,240      |                        | $          | 6,240 |   |
| Accumulated amortization — acquired contract value |       | (5,187                   | )          | (5,055                      | )          |
| Identified intangibles, net                             |       | 1,053                    |       | 1,185                       |       |
| Goodwill                                                |       | 13,308                   |       | 13,308                      |       |
| Total intangibles, net                                  |       | $                        | 14,361     |                        | $          | 14,493 |   |

 

There were no changes in the carryingamount of our goodwill in the three months ended March 31, 2010.

 

Amortization expense for our acquired contract value was approximately$0.1 million and $0.3 million for the three months ended March 31, 2010and 2009, respectively.

 

Our non-compete agreements were fully amortized as of December 31,2009. Amortization expense for our non-compete agreements was approximately$0.2 million in the three months ended March 31, 2009.

 

**8.****    ****Credit Facilities**

 

Ourlong-term debt consisted of the following (in thousands):

 
| ** **                                                                                                                                                                            | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                            | ** ** | **2010**           | ** ** | **2009**              | ** ** |
| **Debt of Cornell  Companies, Inc.:**                                                                                                                                            |       |               |       |                  |       |
| Senior Notes, unsecured, due July 2012 with  an interest rate of 10.75%, net of discount                                                                               |       | $                  | 111,586    |                  | $          | 111,540 |   |
| Revolving Line of Credit due December 2011  with an interest rate of LIBOR plus 1.50% to 2.25% or prime plus 0.00%  to 0.75% (the “Amended Credit Facility”) |       | 67,400             |       | 70,000                |       |
| Capital lease obligations                                                                                                                                                             |       | 11                 |       | 14                    |       |
| Subtotal                                                                                                                                                                              |       | 178,997            |       | 181,554               |       |
|                                                                                                                                                                                  |       |               |       |                  |       |
| **Debt of Special Purpose Entity:**                                                                                                                                                   |       |               |       |                  |       |
| 8.47% Bonds due 2016                                                                                                                                                                  |       | 121,700            |       | 121,700               |       |
|                                                                                                                                                                                  |       |               |       |                  |       |
| Total consolidated debt                                                                                                                                                               |       | 300,697            |       | 303,254               |       |
|                                                                                                                                                                                  |       |               |       |                  |       |
| Less: current maturities                                                                                                                                                              |       | (13,411            | )          | (13,413               | )          |
|                                                                                                                                                                                  |       |               |       |                  |       |
| Consolidated long-term debt                                                                                                                                                           |       | $                  | 287,286    |                  | $          | 289,841 |   |

 

***Long-Term Credit Facilities.***  Our Amended CreditFacility provides for borrowings up to $100.0 million (including letters ofcredit) and matures in December 2011. At our election, outstandingborrowings bear interest at either the LIBOR rate plus a margin ranging from1.50% to 2.25% or a rate which ranges from 0.00% to 0.75% above the applicableprime rate. The applicable margins are subject to adjustments based on ourtotal leverage ratio. The available commitment under our Amended CreditFacility was approximately $20.5 million at March 31, 2010.  We had outstanding borrowings under ourAmended Credit Facility of $67.4 million and we had outstanding letters ofcredit of approximately $12.1 million at March 31, 2010.  Subject to certain requirements, we have theright to increase the commitments under our Amended Credit Facility up to$150.0 million, although the indenture for our Senior Notes limits our ability,subject to certain conditions, to expand the Amended Credit Facility beyond$100.0 million. We can provide no assurance that all of the banks that havemade commitments to us under our Amended Credit Facility would be willing to 

 

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participate in an expansion to the Amended Credit Facility should we desireto do so. The Amended Credit Facility iscollateralized by substantially all of our assets, including the assets andstock of all of our subsidiaries. The Amended Credit Facility is notcollateralized by the assets of Municipal Corrections Finance, L.P. (“MCF”).

 

Our Amended Credit Facilitycontains certain financial and other restrictive covenants that limit ourability to engage in certain activities. Our ability to borrow under theAmended Credit Facility is subject to compliance with certain financialcovenants, including bank leverage, total leverage and fixed charge coveragerates. At March 31, 2010, we were in compliance with all such covenants. Our Amended Credit Facility includesother restrictions that, among other things, limit our ability to: incurindebtedness; grant liens; engage in mergers, consolidations and liquidations;make investments, restricted payments and asset dispositions; enter intotransactions with affiliates; and engage in sale/leaseback transactions.

 

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

 

Thebonds are limited, nonrecourse obligations of MCF and secured by the propertyand equipment, bond reserves, assignment of subleases and substantially allassets related to the facilities included in the 2001 Sale and LeasebackTransaction (in which we sold eleven facilities to MCF).  The bonds are not guaranteed by Cornell.

 

InJune 2004, we issued $112.0 million in principal of 10.75% Senior Notesthe (“Senior Notes”) due July 1, 2012. The Senior Notes are unsecured senior indebtedness and are guaranteed byall of our existing and future subsidiaries (collectively, the “Guarantors”).  The Senior Notes are not guaranteed by MCF(the “Non-Guarantor”).  Interest on theSenior Notes is payable semi-annually on January 1 and July 1 of eachyear, commencing January 1, 2005. On or after July 1, 2008, we have the right to redeem all or aportion of the Senior Notes at the redemption prices (expressed as a percentageof the principal amount) listed below, plus accrued and unpaid interest, ifany, on the Senior Notes redeemed, to the applicable date of redemption, ifredeemed during the 12-month period commencing on July 1 of each of theremaining years indicated below:

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

 

As the Senior Notes are redeemable at our option(subject to the requirements noted) we anticipate we will monitor the capitalmarkets and continue to assess our capital needs and our capital structure,including a potential refinancing of the Senior Notes.

 

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

 

**9.****    ****Income Taxes**

 

At March 31, 2010,the total amount of our unrecognized tax benefits was approximately $2.8 million.

 

We are subject to incometax in the United States and many of the individual states we operate in.  We currently have significant operations inTexas, California, Colorado, Oklahoma, Georgia, Illinois and Pennsylvania.  State income tax returns are generallysubject to examination for a period of three to five years after filing.  The state impact of any changes made to thefederal return remains subject to examination by various states for a period upto one year after formal notification to the state.  We are open to United States Federal IncomeTax examinations for the tax years ended December 31, 2005 through December 31, 2008.

 

We do not anticipate asignificant change in the balance of our unrecognized tax benefits within thenext 12 months.

 

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**10.****      ****EarningsPer Share**

 

Basic earningsper share (“EPS”) are computed by dividing net income by the weighted averagenumber of shares of common stock outstanding during the period.  Diluted EPS is computed by dividing net income by the weightedaverage number of shares of common stock outstanding giving effect to allpotentially dilutive common shares outstanding during the period. Potentiallydilutive common shares include the dilutive effect of outstanding common stockoptions and restricted common stock granted under our various option and otherincentive plans. For the threemonths ended March 31, 2010 and 2009, there were 104,200 shares ($23.18average price) and 141,700 shares ($20.98 average price), respectively, ofstock options that were not included in the computation of diluted EPS becauseto do so would have been anti-dilutive. As of January 1, 2009, instruments with nonforfeitabledividend rights grantedin share-based payment transactions are participating securities prior tovesting and, therefore, need to be included in the earnings allocation incomputing EPS under the two-class method. For our fiscalyear beginning January 1, 2009, since our restricted common stock grants(including both vested and those unvested due to either time or performancerequirements) convey nonforfeitable rights to dividends while outstanding, theyare included in both basic and fully diluted ESP calculations. All prior-period EPS data has beenadjusted retrospectively to conform to the calculation of EPS.

 

The followingtable summarizes the calculation of net earnings and weighted average commonshares and common equivalent shares outstanding for purposes of the computationof earnings per share (in thousands, except per share data):

 
| ** **                                                               | ** ** | **Three Months Ended  March 31,** | ** ** |
|--------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                               | ** ** | **2010**                                         | ** ** | **2009** | ** ** |
|                                                                     |       |                                             |       |   |   |
| Income  available to stockholders                                        |       | $                                                | 3,280      |   | $ | 5,257 |   |
|                                                                     |       |                                             |       |   |   |
| Weighted  average common share outstanding                               |       | 14,756                                           |       | 14,572 |   |
| Weighted  average common share equivalents outstanding                   |       | 126                                              |       | 57 |   |
| Weighted  average common shares and common share equivalents outstanding |       | 14,882                                           |       | 14,629 |   |
|                                                                     |       |                                             |       |   |   |
| Basic income  per share                                                  |       | $                                                | .22        |   | $ | .36 |   |
|                                                                     |       |                                             |       |   |   |
| Diluted  income per share                                                |       | $                                                | .22        |   | $ | .36 |   |

 

**11.****      ****Commitmentsand Contingencies**

 

***FinancialGuarantees***

 

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

 

***Legal Proceedings***

 

We are party to various legal proceedings, includingthose noted below. While management presently believes that the ultimateoutcome of these proceedings will not have a material adverse effect on ourfinancial position, overall trends in results of operations or cash flows,litigation is subject to inherent uncertainties, and unfavorable rulings couldoccur. An unfavorable ruling could include monetary damages or equitablerelief, and could have a material adverse impact on the net income of theperiod in which the ruling occurs or in future periods.

 

***Valencia County Detention Center***

 

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

 

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InDecember 2008, the parties agreed to a proposed stipulation of settlementand, in July 2009, the Court granted final approval of thesettlement.  The settlement amount underthe terms of the agreement is $3.3 million. Cornell’sportion of the stipulated settlement, based on the number of inmates housed atVCDC during the time Cornell operated the facility in comparison to the numberof inmates housed at the facility during the time Valencia County operated thefacility, is $1.2 million and was funded principally through our generalliability and professional liability coverage. The claims administrationprocess is under way and we expect it to be completed in the first half of2010.

 

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

 

***LitigationRelating to the Merger***

 

On April 27, 2010, aputative stockholder class action was filed in the District Court for HarrisCounty, Texas by Todd Shelby against Cornell, members of the Cornell board ofdirectors, individually, and GEO. The complaint alleges, amongother things, that the Cornell directors breached their duties by entering intothe Agreement without first taking steps to obtain adequate, fair and maximumconsideration for Cornell’s stockholders by shopping the company or initiatingan auction process, by structuring the transaction to take advantage of Cornell’slow current stock valuation, and by structuring the transaction to benefit GEOwhile making an alternative transaction either prohibitively expensive orotherwise impossible, and that Cornell and GEO have aided and abetted suchbreaches by Cornell’s directors. Among other things, the complaint seeks to enjoinCornell, its directors and GEO from completing the merger and seeks aconstructive trust over any benefits improperly received by the defendants as aresult of their alleged wrongful conduct.

 

***Other***

 

Wehold insurance policies to cover potential director and officer liability, someof which may limit our cash outflows in the event of a decision adverse to usin the matter discussed above. However, if an adverse decision in the matterexceeds the insurance coverage or if the insurance coverage is deemed not toapply to the matter, it could have a material adverse effect on us, ourfinancial condition, results of operations and future cash flows.

 

Wecurrently and from time to time are subject to claims and suits arising in theordinary course of business, including claims for damages for personal injuriesor for wrongful restriction of or interference with offender privileges andemployment matters. If an adverse decision in these matters exceeds ourinsurance coverage, or if our coverage is deemed not to apply to these matters,or if the underlying insurance carrier was unable to fulfill its obligationunder the insurance coverage provided, it could have a material adverse effecton our financial condition, results of operations or cash flows.

 

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

 

**12.  FinancialInstruments**

 

Thecarrying amounts of our financial instruments, including cash and cashequivalents, investment securities, accounts receivable and accounts payableand accrued expenses, approximate fair value due to the short term maturitiesof these financial instruments.  At December 31,2009, the carrying amount of consolidated debt was $303.3 million, and theestimated fair value was $309.1 million. At March 31, 2010, the carrying amount was $300.7 million, and theestimated fair value was $304.2 million. The estimated fair value of long-term debt is based primarily on quotedmarket prices or discounted cash flow analysis for the same or similar assets.

 

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**13.***      ***Derivative Financial Instruments AndGuarantees**

 

***Debt Service Reserve Fund and Debt ServiceFund***

 

In August 2001, MCFcompleted a bond offering to finance the 2001 Sale and Leaseback Transaction inwhich we sold eleven facilities to MCF. In connection with this bond offering,two reserve fund accounts were established by MCF pursuant to the terms of theindenture: (1) MCF’s Debt Service Reserve Fund, aggregating $23.4 millionat March 31, 2010, was established to: (a) make payments on MCF’soutstanding bonds in the event we (as lessee) should fail to make the scheduledrental payments to MCF or (b) to the extent payments were not made under(a), then to make final debt service payments on the then outstanding bonds and(2) MCF’s Bond Fund Payment Account, (as reported in Bond Fund PaymentAccount and other restricted assets in our Consolidated Balance Sheet)aggregating $12.3 million at March 31, 2010, was established to accumulatethe monthly lease payments that MCF receives from us until such funds are usedto pay MCF’s semi-annual bond interest and annual bond principal payments, withany excess to pay certain other expenses and to make certain transfers. Thesereserve funds are invested in short-term money markets and commercial paper.Both reserve fund accounts were subject to agreements with the MCF EquityInvestors (Lehman Brothers, Inc. (“Lehman”)) whereby guaranteed rates ofreturn of 3.0% and 5.08%, respectively, were provided for in the balance of theDebt Service Reserve Fund and the Bond Fund Payment Account. The guaranteedrates of return were characterized as cash flow hedge derivative instruments.At inception, the derivative instruments had an aggregate fair value of $4.0million, which was recorded as a decrease to the equity investment in MCF madeby the MCF Equity Investors (MCF non-controlling interest) and is included inother long-term liabilities in our Consolidated Balance Sheets. Changes in thefair value of the derivative instruments were recorded as an adjustment toother long-term liabilities and reported as other comprehensive income in ourConsolidated Statements of Income and Comprehensive Income. Due to thebankruptcy of Lehman in 2008, the derivative instruments no longer qualified asa hedge and was de-designated. Amounts included in accumulated othercomprehensive income are reclassified into earnings during the same periods inwhich interest is earned on debt service funds (approximately $0.01 million was amortized andrecognized in earnings in the three months ended March 31, 2010). Changes inthe fair value of these derivatives after de-designation were recorded toearnings. The derivatives were terminated in the first quarter of 2009 with afair value of zero.

 

Inaccordance with the terms of its partnership agreement, MCF has accrued adistribution of $2.4 million to its partners as of March 31, 2010. Thedistribution was made in April 2010.

 

**14.****      ****Variable Interest Entity**

 

Inconnection with the 2001 Sale and Leaseback Transaction with MunicipalCorrections Finance, L.P. (“MCF”), the Company determined that MCF was avariable interest entity.  The Companyconcluded that it is the primary beneficiary of MCF’s activities becausesubstantially all of the operating assets of MCF are utilized by the Companyand the lease payments made by the Company are the main source of cashavailable to fund the debt obligations of MCF. As a result, our consolidated balance sheet includes the assets andliabilities of MCF.  The results ofoperations of MCF are reflected in non-controlling interest in our ConsolidatedStatements of Income and Comprehensive Income.

 

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**15.****      ****Segment Disclosure**

 

Our three operating divisions are our reportablesegments. The Adult Secure Services segment consists of the operations ofsecure adult incarceration facilities. The Abraxas Youth and Family Servicessegment consists of providing residential treatment and educational programsand non-residential community-based programs to juveniles between the ages of10 and 18 who have either been adjudicated or suffer from behavioral problems.The Adult Community-Based Services segment consists of providing pre-releaseand halfway house programs for adult offenders who are either on probation orserving the last three to six-months of their sentences on parole and preparingfor re-entry into society at large as well as community-based treatment andeducation programs as an alternative to incarceration. All of our customers andlong-lived assets are located in the United States of America. The accountingpolicies of our reportable segments are the same as those described in thesummary of significant accounting policies in Note 2 in our 2009 Annual Reporton Form 10-K. Intangible assets are not included in each segment’sreportable assets, and the amortization of intangible assets is not included inthe determination of a reportable segment’s operating income. We evaluateperformance based on income or loss from operations before general andadministrative expenses, incentive bonuses, amortization of intangibles,interest and income taxes. Corporate and other assets are comprised primarilyof cash, accounts receivable, debt service fund, deposits, property andequipment, deferred taxes, deferred costs and other assets. Corporate and otherexpense from operations primarily consists of depreciation and amortization onthe corporate office facilities and equipment and specific general andadministrative charges pertaining to corporate personnel and is presentedseparately as such charges cannot be readily identified for allocation to aparticular segment.

 
| ** **                          | ** ** | **Three  Months Ended  March 31,** | ** ** |
|-------------------------------------|------------|----------------------------------------------|------------|
| ** **                          | ** ** | **2010**                                     | ** ** | **2009** | ** ** |
|                                |       |                                         |       |   |   |
| Revenues:                           |       |                                         |       |   |   |
| Adult Secure Services               |       | $                                            | 58,819     |   | $ | 56,858 |   |
| Abraxas Youth and Family Services   |       | 23,475                                       |       | 25,689 |   |
| Adult Community-Based Services      |       | 17,712                                       |       | 17,163 |   |
| Total revenues                      |       | $                                            | 100,006    |   | $ | 99,710 |   |
|                                |       |                                         |       |   |   |
| Income (loss) from operations:      |       |                                         |       |   |   |
| Adult Secure Services               |       | $                                            | 13,500     |   | $ | 17,118 |   |
| Abraxas Youth and Family Services   |       | (175                                         | )          | 734 |   |
| Adult Community-Based Services      |       | 5,636                                        |       | 4,767 |   |
| Sub-total                           |       | 18,961                                       |       | 22,619 |   |
| General and administrative expenses |       | (5,759                                       | )          | (6,138 | ) |
| Amortization of intangibles         |       | (132                                         | )          | (448 | ) |
| Corporate and other expenses        |       | (205                                         | )          | (245 | ) |
| Total income from operations        |       | $                                            | 12,865     |   | $ | 15,788 |   |

 
| ** **                        | ** ** | **March 31,  2010** | ** ** | **December 31,  2009** | ** ** |
|-----------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| Assets:                           |       |                     |       |                        |       |
| Adult Secure Services             |       | $                        | 358,999    |                        | $          | 356,247 |   |
| Abraxas Youth and Family Services |       | 102,194                  |       | 103,276                     |       |
| Adult Community-Based Services    |       | 61,220                   |       | 62,251                      |       |
| Intangible assets, net            |       | 14,361                   |       | 14,498                      |       |
| Corporate and other               |       | 106,991                  |       | 114,298                     |       |
| Total assets                      |       | $                        | 643,765    |                        | $          | 650,565 |   |

 

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**16.****      ****Guarantor Disclosures**

 

Wecompleted an offering of $112.0 million of Senior Notes in June 2004. TheSenior Notes are guaranteed by each of our 100% owned subsidiaries (GuarantorSubsidiaries). MCF does not guarantee the Senior Notes (“Non-GuarantorSubsidiary”). These guarantees are full and unconditional and are joint andseveral obligations of the Guarantor Subsidiaries. The following condensedconsolidating financial information presents the financial condition, resultsof operations and cash flows for the Parent, the Guarantor Subsidiaries and theNon-Guarantor Subsidiary, together with the consolidating adjustments necessaryto present our results on a consolidated basis.

 

**CondensedConsolidating Balance Sheet as of March 31, 2010 (in thousands)(unaudited)**

 
| ** **                                                    | ** ** | ** ** | ** ** | ** **       | ** ** | **Non-**       | ** ** | ** **       | ** ** | ** **       | ** ** |
|---------------------------------------------------------------|------------|------------|------------|------------------|------------|----------------|------------|------------------|------------|------------------|------------|
| ** **                                                    | ** ** | ** ** | ** ** | **Guarantor**    | ** ** | **Guarantor**  | ** ** | ** **       | ** ** | ** **       | ** ** |
| ** **                                                    | ** ** | **Parent** | ** ** | **Subsidiaries** | ** ** | **Subsidiary** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| **Assets**                                                    |       |       |       |             |       |           |       |             |       |             |       |
|                                                          |       |       |       |             |       |           |       |             |       |             |       |
| Current assets:                                               |       |       |       |             |       |           |       |             |       |             |       |
| Cash and cash equivalents                                     |       | $          | 17,871     |             | $          | 175            |       | $                | 15         |             | $          | — |   | $ | 18,061 |   |
| Accounts receivable                                           |       | 1,978      |       | 56,390           |       | 70             |       | —           |       | 58,438           |       |
| Restricted assets                                             |       | —     |       | 4,136            |       | 26,356         |       | —           |       | 30,492           |       |
| Prepaids and other                                            |       | 18,714     |       | 1,573            |       | —         |       | —           |       | 20,287           |       |
| Total current assets                                          |       | 38,563     |       | 62,274           |       | 26,441         |       | —           |       | 127,278          |       |
|                                                          |       |       |       |             |       |           |       |             |       |             |       |
| Property and equipment, net                                   |       | 18         |       | 325,005          |       | 137,839        |       | (5,588           | )          | 457,274          |       |
| Other Assets:                                                 |       |       |       |             |       |           |       |             |       |             |       |
| Restricted assets                                             |       | —     |       | —           |       | 29,884         |       | —           |       | 29,884           |       |
| Deferred costs and other                                      |       | 70,193     |       | 21,844           |       | 4,613          |       | (67,321          | )          | 29,329           |       |
| Investments in subsidiaries                                   |       | 99,401     |       | 1,856            |       | —         |       | (101,257         | )          | —           |       |
| Total assets                                                  |       | $          | 208,175    |             | $          | 410,979        |       | $                | 198,777    |             | $          | (174,166 | ) | $ | 643,765 |   |
|                                                          |       |       |       |             |       |           |       |             |       |             |       |
| **Liabilities and Equity**                                    |       |       |       |             |       |           |       |             |       |             |       |
|                                                          |       |       |       |             |       |           |       |             |       |             |       |
| Current liabilities:                                          |       |       |       |             |       |           |       |             |       |             |       |
| Accounts payable and accrued liabilities                      |       | $          | 37,057     |             | $          | 16,842         |       | $                | 4,279      |             | $          | 396 |   | $ | 58,574 |   |
| Current portion of long-term debt                             |       | —     |       | 11               |       | 13,400         |       | —           |       | 13,411           |       |
| Total current liabilities                                     |       | 37,057     |       | 16,853           |       | 17,679         |       | 396              |       | 71,985           |       |
| Long-term debt, net of current portion                        |       | 178,986    |       | —           |       | 108,300        |       | —           |       | 287,286          |       |
| Deferred tax liabilities                                      |       | 22,283     |       | 94               |       | —         |       | 2,607            |       | 24,984           |       |
| Other long-term liabilities                                   |       | 5,681      |       | 14               |       | 67,506         |       | (71,356          | )          | 1,845            |       |
| Intercompany                                                  |       | (293,497   | )          | 294,659          |       | —         |       | (1,162           | )          | —           |       |
| Total liabilities                                             |       | (49,490    | )          | 311,620          |       | 193,485        |       | (69,515          | )          | 386,100          |       |
| Total Cornell Companies, Inc. stockholders’  equity |       | 257,143    |       | 99,359           |       | 5,292          |       | (104,651         | )          | 257,143          |       |
| Non-controlling interest                                      |       | 522        |       | —           |       | —         |       | —           |       | 522              |       |
| Total equity                                                  |       | 257,665    |       | 99,359           |       | 5,292          |       | (104,651         | )          | 257,665          |       |
| Total liabilities and equity                                  |       | $          | 208,175    |             | $          | 410,979        |       | $                | 198,777    |             | $          | (174,166 | ) | $ | 643,765 |   |

 

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**CondensedConsolidating Balance Sheet as of December 31, 2009 (in thousands)**

 
| ** **                                                   | ** ** | **Parent** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor****Subsidiary** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|--------------------------------------------------------------|------------|------------|------------|-----------------------------|------------|-----------------------------------|------------|------------------|------------|------------------|------------|
| **Assets**                                                   | ** ** | ** ** | ** ** | ** **                  | ** ** | ** **                        | ** ** | ** **       | ** ** | ** **       | ** ** |
| Current  assets:                                             |       |       |       |                        |       |                              |       |             |       |             |       |
| Cash and cash  equivalents                                   |       | $          | 27,386     |                        | $          | 317                               |       | $                | 21         |             | $          | — |   | $ | 27,724 |   |
| Accounts  receivable                                         |       | 1,471      |       | 59,561                      |       | 51                                |       | —           |       | 61,083           |       |
| Restricted  assets                                           |       | —     |       | 3,831                       |       | 26,147                            |       | —           |       | 29,978           |       |
| Prepaids and  other                                          |       | 20,024     |       | 1,466                       |       | —                            |       | —           |       | 21,490           |       |
| Total current  assets                                        |       | 48,881     |       | 65,175                      |       | 26,219                            |       | —           |       | 140,275          |       |
| Property and  equipment, net                                 |       | 7          |       | 322,396                     |       | 138,719                           |       | (5,599           | )          | 455,523          |       |
| Other assets:                                                |       |       |       |                        |       |                              |       |             |       |             |       |
| Restricted  assets                                           |       | —     |       | —                      |       | 27,017                            |       | —           |       | 27,017           |       |
| Deferred  costs and other                                    |       | 66,623     |       | 20,029                      |       | 4,758                             |       | (63,660          | )          | 27,750           |       |
| Investment in  subsidiaries                                  |       | 98,003     |       | 1,856                       |       | —                            |       | (99,859          | )          | —           |       |
| Total assets                                                 |       | $          | 213,514    |                        | $          | 409,456                           |       | $                | 196,713    |             | $          | (169,118 | ) | $ | 650,565 |   |
|                                                         |       |       |       |                        |       |                              |       |             |       |             |       |
| **Liabilities and Equity**                                   | ** ** | ** ** | ** ** | ** **                  | ** ** | ** **                        | ** ** | ** **       | ** ** | ** **       | ** ** |
|                                                         |       |       |       |                        |       |                              |       |             |       |             |       |
| Current  liabilities:                                        |       |       |       |                        |       |                              |       |             |       |             |       |
| Accounts  payable and accrued liabilities                    |       | $          | 42,192     |                        | $          | 15,725                            |       | $                | 4,370      |             | $          | — |   | $ | 62,287 |   |
| Current  portion of long-term debt                           |       | —     |       | 13                          |       | 13,400                            |       | —           |       | 13,413           |       |
| Total current  liabilities                                   |       | 42,192     |       | 15,738                      |       | 17,770                            |       | —           |       | 75,700           |       |
| Long-term  debt, net of current portion                      |       | 181,540    |       | 1                           |       | 108,300                           |       | —           |       | 289,841          |       |
| Deferred tax  liabilities                                    |       | 21,710     |       | 94                          |       | —                            |       | 2,651            |       | 24,455           |       |
| Other  long-term liabilities                                 |       | 5,766      |       | —                      |       | 63,750                            |       | (67,685          | )          | 1,831            |       |
| Intercompany                                                 |       | (296,432   | )          | 297,594                     |       | —                            |       | (1,162           | )          | —           |       |
| Total  liabilities                                           |       | (45,224    | )          | 313,427                     |       | 189,820                           |       | (66,196          | )          | 391,827          |       |
| Total Cornell Companies, Inc. stockholders’ equity |       | 256,346    |       | 96,029                      |       | 6,893                             |       | (102,922         | )          | 256,346          |       |
| Non-controlling  interest                                    |       | 2,392      |       | —                      |       | —                            |       | —           |       | 2,392            |       |
| Total equity                                                 |       | 258,738    |       | 96,029                      |       | 6,893                             |       | (102,922         | )          | 258,738          |       |
| Total liabilities and equity                                 |       | $          | 213,514    |                        | $          | 409,456                           |       | $                | 196,713    |             | $          | (169,118 | ) | $ | 650,565 |   |

 

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# **CondensedConsolidating Statement of Income for the three months ended March 31,2010**(in thousands) (unaudited)

 
| ** **                                                  | ** ** | **Parent** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor****Subsidiary** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-------------------------------------------------------------|------------|------------|------------|-----------------------------|------------|-----------------------------------|------------|------------------|------------|------------------|------------|
|                                                        |       |       |       |                        |       |                              |       |             |       |             |       |
| Revenues                                                    |       | $          | 4,502      |                        | $          | 115,149                           |       | $                | 4,502      |             | $          | (24,147 | ) | $ | 100,006 |   |
| Operating expenses, excluding depreciation and amortization |       | 4,040      |       | 96,660                      |       | 45                                |       | (24,062          | )          | 76,683           |       |
| Depreciation and amortization                               |       | —     |       | 3,830                       |       | 880                               |       | (11              | )          | 4,699            |       |
| General and administrative expenses                         |       | 5,740      |       | —                      |       | 19                                |       | —           |       | 5,759            |       |
| Income (loss) from operations                               |       | (5,278     | )          | 14,659                      |       | 3,558                             |       | (74              | )          | 12,865           |       |
| Overhead allocations                                        |       | (7,828     | )          | 7,828                       |       | —                            |       | —           |       | —           |       |
| Interest, net                                               |       | 166        |       | 3,500                       |       | 2,720                             |       | (201             | )          | 6,185            |       |
| Equity earnings in subsidiaries                             |       | 3,331      |       | —                      |       | —                            |       | (3,331           | )          | —           |       |
| Income before provision for income taxes                    |       | 5,715      |       | 3,331                       |       | 838                               |       | (3,204           | )          | 6,680            |       |
| Provision for income taxes                                  |       | 2,435      |       | —                      |       | —                            |       | 396              |       | 2,831            |       |
| Net income                                                  |       | 3,280      |       | 3,331                       |       | 838                               |       | (3,600           | )          | 3,849            |       |
| Non-controlling interest                                    |       | —     |       | —                      |       | —                            |       | 569              |       | 569              |       |
| Income available to Cornell Companies, Inc.            |       | $          | 3,280      |                        | $          | 3,331                             |       | $                | 838        |             | $          | (4,169 | ) | $ | 3,280 |   |

 

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# **CondensedConsolidating Statement of Income for the three months ended March 31,2009**(in thousands) (unaudited)

 
| ** **                                                  | ** ** | **Parent** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor****Subsidiary** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-------------------------------------------------------------|------------|------------|------------|-----------------------------|------------|-----------------------------------|------------|------------------|------------|------------------|------------|
|                                                        |       |       |       |                        |       |                              |       |             |       |             |       |
| Revenues                                                    |       | $          | 4,502      |                        | $          | 117,820                           |       | $                | 4,502      |             | $          | (27,114 | ) | $ | 99,710 |   |
| Operating expenses, excluding depreciation and amortization |       | 4,138      |       | 95,739                      |       | 42                                |       | (27,028          | )          | 72,891           |       |
| Depreciation and amortization                               |       | —     |       | 4,006                       |       | 881                               |       | 6                |       | 4,893            |       |
| General and administrative expenses                         |       | 6,119      |       | —                      |       | 19                                |       | —           |       | 6,138            |       |
| Income (loss) from operations                               |       | (5,755     | )          | 18,075                      |       | 3,560                             |       | (92              | )          | 15,788           |       |
| Overhead allocations                                        |       | (8,377     | )          | 8,377                       |       | —                            |       | —           |       | —           |       |
| Interest, net                                               |       | 1,954      |       | 1,337                       |       | 2,882                             |       | (220             | )          | 5,953            |       |
| Equity earnings in subsidiaries                             |       | 8,360      |       | —                      |       | —                            |       | (8,360           | )          | —           |       |
| Income before provision for income taxes                    |       | 9,028      |       | 8,361                       |       | 678                               |       | (8,232           | )          | 9,835            |       |
| Provision for income taxes                                  |       | 3,771      |       | —                      |       | —                            |       | 330              |       | 4,101            |       |
| Net income                                                  |       | 5,257      |       | 8,361                       |       | 678                               |       | (8,562           | )          | 5,734            |       |
| Non-controlling interest                                    |       | —     |       | —                      |       | —                            |       | 477              |       | 477              |       |
| Income available to Cornell Companies, Inc.            |       | $          | 5,257      |                        | $          | 8,361                             |       | $                | 678        |             | $          | (9,039 | ) | $ | 5,257 |   |

 

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**Condensed Consolidating Statement of Cash Flows for the three monthsended March 31, 2010 (in thousands) (unaudited)**

 
| ** **                                                                | ** ** | **Parent** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor****Subsidiary** | ** ** | **Consolidated** | ** ** |
|---------------------------------------------------------------------------|------------|------------|------------|-----------------------------|------------|-----------------------------------|------------|------------------|------------|
| **Cash flows from operating activities:**                                 | ** ** | ** ** | ** ** | ** **                  | ** ** | ** **                        | ** ** | ** **       | ** ** |
| Net cash provided by (used in) operating activities                       |       | $          | (4,307     | )                           | $          | 3,088                             |       | $                | 202        |   | $ | (1,017 | ) |
| ** **                                                                | ** ** | ** ** | ** ** | ** **                  | ** ** | ** **                        | ** ** | ** **       | ** ** |
| **Cash flows from investing activities:**                                 | ** ** | ** ** | ** ** | ** **                  | ** ** | ** **                        | ** ** | ** **       | ** ** |
| Capital expenditures                                                      |       | —     |       | (3,227                      | )          | —                            |       | (3,227           | )          |
| Payments to restricted debt payment account, net                          |       | —     |       | —                      |       | (208                              | )          | (208             | )          |
| Net cash provided by (used in) investing activities                       |       | —     |       | (3,227                      | )          | (208                              | )          | (3,435           | )          |
|                                                                      |       |       |       |                        |       |                              |       |             |       |
| **Cash flows from financing activities:**                                 | ** ** | ** ** | ** ** | ** **                  | ** ** | ** **                        | ** ** | ** **       | ** ** |
| Payments of  line of  credit                                         |       | (2,600     | )          | —                      |       | —                            |       | (2,600           | )          |
| Purchase and retirement of common stock                                   |       | (3,000     | )          | —                      |       | —                            |       | (3,000           | )          |
| Payments on capital lease obligations                                     |       | —     |       | (3                          | )          | —                            |       | (3               | )          |
| Proceeds from exercise of stock options and employee stock  purchase plan |       | 392        |       | —                      |       | —                            |       | 392              |       |
| Net cash used in financing activities                                     |       | (5,208     | )          | (3                          | )          | —                            |       | (5,211           | )          |
|                                                                      |       |       |       |                        |       |                              |       |             |       |
| **Net decrease in cash and  cash equivalents**                            |       | (9,515     | )          | (142                        | )          | (6                                | )          | (9,663           | )          |
|                                                                      |       |       |       |                        |       |                              |       |             |       |
| **Cash and cash  equivalents at beginning of period**                     |       | 27,386     |       | 317                         |       | 21                                |       | 27,724           |       |
|                                                                      |       |       |       |                        |       |                              |       |             |       |
| **Cash and cash  equivalents at end of period**                           |       | $          | 17,871     |                        | $          | 175                               |       | $                | 15         |   | $ | 18,061 |   |

 

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# **CondensedConsolidating Statement of Cash Flows for the three months ended March 31,2009 (in thousands) (unaudited)**

 
| ** **                                                | ** ** | **Parent** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor****Subsidiary** | ** ** | **Consolidated** | ** ** |
|-----------------------------------------------------------|------------|------------|------------|-----------------------------|------------|-----------------------------------|------------|------------------|------------|
| **Cash flows from operating activities:**                 | ** ** | ** ** | ** ** | ** **                  | ** ** | ** **                        | ** ** | ** **       | ** ** |
| Net cash provided by (used in) operating activities       |       | $          | (5,727     | )                           | $          | 3,276                             |       | $                | 362        |   | $ | (2,089 | ) |
| ** **                                                | ** ** | ** ** | ** ** | ** **                  | ** ** | ** **                        | ** ** | ** **       | ** ** |
| **Cash flows from investing activities:**                 | ** ** | ** ** | ** ** | ** **                  | ** ** | ** **                        | ** ** | ** **       | ** ** |
| Capital expenditures                                      |       | —     |       | (3,168                      | )          | —                            |       | (3,168           | )          |
| Payments to restricted debt payment account, net          |       | —     |       | —                      |       | (381                              | )          | (381             | )          |
| Net cash used in investing activities                     |       | —     |       | (3,168                      | )          | (381                              | )          | (3,549           | )          |
|                                                      |       |       |       |                        |       |                              |       |             |       |
| **Cash flows from financing activities:**                 | ** ** | ** ** | ** ** | ** **                  | ** ** | ** **                        | ** ** | ** **       | ** ** |
| Proceeds from line of credit                              |       | 2,000      |       | —                      |       | —                            |       | 2,000            |       |
| Payments on line of credit                                |       | (1,000     | )          | —                      |       | —                            |       | (1,000           | )          |
| Payments on capital lease obligations                     |       | —     |       | (3                          | )          | —                            |       | (3               | )          |
| Proceeds from exercise of stock options                   |       | 299        |       | —                      |       | —                            |       | 299              |       |
| Net cash provided by (used in) financing activities       |       | 1,299      |       | (3                          | )          | —                            |       | 1,296            |       |
|                                                      |       |       |       |                        |       |                              |       |             |       |
| **Net increase (decrease)  in cash and cash equivalents** |       | (4,428     | )          | 105                         |       | (19                               | )          | (4,342           | )          |
| ** **                                                |       |       |       |                        |       |                              |       |             |       |
| **Cash and cash  equivalents at beginning of period**     |       | 14,291     |       | 265                         |       | 57                                |       | 14,613           |       |
| ** **                                                |       |       |       |                        |       |                              |       |             |       |
| **Cash and cash  equivalents at end of period**           |       | $          | 9,863      |                        | $          | 370                               |       | $                | 38         |   | $ | 10,271 |   |

 

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

 

**General**

** **

CornellCompanies, Inc. is a leading provider of correctional, detention,educational, rehabilitation and treatment services outsourced by federal, stateand local government agencies. We provide a diversified portfolio of servicesfor adults and juveniles through our three operating divisions: (1) AdultSecure Services; (2) Abraxas Youth and Family Services and (3) AdultCommunity-Based Services. At March 31, 2010, we operated 63 facilitieswith a total service capacity of 20,531 beds and had five facilities witha combined service capacity of 861 beds that were vacant. Our facilitiesare located in 15 states and the District of Columbia.

 

The following table sets forth for the periods indicated totalresidential service capacity and contracted beds in operation at the end of theperiods shown, average contract occupancy percentages and total non-residentialservice capacity.

 
| ** **                                                                     | ** ** | **Three Months Ended  March 31,** | ** ** |
|--------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                     | ** ** | **2010**                                    | ** ** | **2009** | ** ** |
|                                                                           |       |                                        |       |   |   |
| **Residential**                                                                |       |                                        |       |   |   |
| Service  capacity (1)                                                          |       | 19,284                                      |       | 17,634 |   |
| Contracted  beds in operation (end of period) (2)                              |       | 17,639                                      |       | 16,780 |   |
| Average contract  occupancy based on contracted beds in operation (3) (4) |       | 87.8                                        | %          | 93.2 | % |
| **Non-Residential**                                                            |       |                                        |       |   |   |
| Service  capacity (5)                                                          |       | 2,108                                       |       | 2,558 |   |

 

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| (1) |   | Residential service  capacity is comprised of the number of beds currently available for service  in our residential facilities.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |
|-----|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) |   | At  certain residential facilities, the contracted capacity is lower than the  facility’s service capacity. We could increase a facility’s contracted  capacity by obtaining additional contracts or by renegotiating existing  contracts to increase the number of beds covered. However, we may not be able  to obtain contracts that provide occupancy levels at a facility’s service  capacity or be able to maintain current contracted capacities in future  periods.                                                                                                                                                |
| (3) |   | Occupancy  percentages reflect less than normalized occupancy during the start-up phase  of any applicable facility, resulting in a lower average occupancy in periods  when we have substantial start-up activities.                                                                                                                                                                                                                                                                                                                                                                                                                     |
| (4) |   | Average  contract occupancy percentages are calculated based on actual occupancy for  the period as a percentage of the contracted capacity for residential  facilities in operation. These percentages do not reflect the operations of  non-residential community-based programs. At certain residential facilities,  our contracted capacity is lower than the facility’s service capacity.  Additionally, certain facilities have and are currently operating above the  contracted capacity. As a result, average contract occupancy percentages can  exceed 100% if the average actual occupancy exceeded contracted capacity. |
| (5) |   | Service  capacity for non-residential programs is based on either contractual terms or  an estimate of the number of clients to be served. We update these estimates  at least annually based on the program’s budget and other factors.                                                                                                                                                                                                                                                                                                                                                                                             |

 

During the threemonths ended March 31, 2010 we initiated the transition plan at our D. RayJames Prison from our current customer, the Georgia Department of Corrections (“GDOC”),to the Federal Bureau of Prisons (“BOP”) (anticipated to take through thefourth quarter of 2010). This will include the ramp-down of the currentpopulation, preparation of the facility for the new customer and subsequentramp-up of the BOP population.

 

Although we believe wewill continue to see steady demand across our various business segments andcustomer base (federal, state and local) in 2010, we are monitoring thedeclining economic trends (which began in 2008) and the related impact ongovernment budget plans and the effect tightened spending plans could have onour business (with respect to possible areas including current utilization andper diem rates, among others.) We expect key areas of focusfor our performance in 2010 to include the transition of the customer at our D.Ray James Prison from GDOC to the BOP (by the fourth quarter of 2010). Asnoted, this will include the ramp-down of the current population, preparationof the facility for the new customer and subsequent ramp-up of the BOPpopulation.  We also intend to focus onthe options for our Great Plains Correctional Facility, including the continuedutilization by the Arizona Department of Corrections of the facility or thepotential utilization by other customers. We also plan to remain focused on our operating margins, on increasingutilization (particularly in the Abraxas Youth and Family Services division andin our Adult Secure division) and improving customer mix as we believe thoseinitiatives are the key elements of our financial performance.

 

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# **Management Overview**

# ** **

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

 

The federal governmentcontracts with private providers for the incarceration of adults, whether theyare serving prison sentences, detained as illegal aliens, detained inanticipation of pending judicial administration or transitioning from prison tosociety.  Chief among the federalagencies which use private providers are the BOP, U.S. Immigration and CustomsEnforcement (“ICE”) and United States Marshalls Service (“USMS”). We provideadult secure and adult community-based services to the federal government. Mostof the federal involvement in juvenile administration in the federal system ishandled via Medicare and Medicaid assistance to state governments. Althoughthere are circumstances in which we may contract with a federal agency on asole source basis, the primary means by which we secure a contract with afederal agency is via the RFP bidding process. From time to time, we contract to provide management services to a localgovernmental unit who then bids on a federal contract.

 

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

 

Private juvenile andcommunity-based programs are utilized by states and local governmental unitsand are organized on a profit and not-for-profit basis.  We monitor opportunities in these segmentsvia our corporate and business division development officers.  Many opportunities are not published in any mannerand, accordingly, we believe that taking the initiative at the state and locallevels is key in developing sole source opportunities.

 

***Performance*****.**  We track a number of factors as we monitorfinancial performance.  Chief among themare:

 

·      capacity (thenumber of beds within each business segment’s facilities),

·      occupancy(utilization),

·      per diemreimbursement rates,

·      revenues,

·      operatingmargins, and

·      operatingexpenses.

 

*Capacity. *Capacity, commonly expressedin terms of number of beds, is primarily impacted by the number and size of thefacilities we own or lease and the facilities we operate on behalf of a thirdparty owner or lessee.  We view capacityas one of the measures of our development efforts, through which we may increasecapacity by adding new projects or by expanding existing projects (as we havedone in 2007 through 2009 at several of our facilities including Great PlainsCorrectional Facility, D. Ray James Prison and the Hudson CorrectionalFacility).  As part of the evaluation ofour development efforts, we will assess (a) whether a given developmentproject was brought into service in accordance with our expectation as to timeand expense; and (b) the number of projects in development or underconsideration at the relevant point in time. In addition to the focus on new projects, capacity will reflect oursuccess in renewing and maintaining existing contracts and facilities.  It will also reflect any closure of programsor facilities due to underutilization or failure to earn an adequaterisk-adjusted rate of return.  We mustalso be cognizant of the possibility that state or local budgetary limitationsmay cause the contractual commitment to a given facility to be reduced or eveneliminated, which would require us to either secure an alternate customer orclose the operation.

 

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*Occupancy. *Occupancy is typicallyexpressed in terms of percentage of contract capacity utilized.  We look at occupancy to assess the efficacyof both our efforts to market our facilities and our efforts to retain existingcustomers or contracts.  Because revenuevaries directly with occupancy, occupancy is a driver of our revenues. Ourindustry experiences significant economies of scale, whereby as occupancyrises, operating costs per resident decline. Some of our contracts are “take-or-pay,”meaning that the agency making use of the facility is obligated to pay for bedseven though they are not used. Historically, occupancy percentages in many of our facilities have beenhigh and we are mindful of the need to maintain such occupancy levels.  As new development projects are brought intoservice, occupancy percentages may decline until the projects reach fullutilization (as, for example, with the activation of the 1,100 bed expansion atGreat Plains Correctional Facility during the fourth quarter of 2008, the 700bed expansion at D. Ray James Prison during the second quarter of 2009 and the1,250 bed Hudson Correctional Facility during the fourth quarter of 2009).Where we have commitments for utilization before the commencement ofoperations, occupancy percentages reflect the speed at which a facilityachieves full service/implementation. However, we may decide to undertakedevelopment projects without written commitments to make full use of afacility. In these instances, we have performed our own assessment, based ondiscussions with local government or other potential customer representativesand analysis of other factors, of the demand for services at the facility.  There is no assurance that we would recoverour initial investment in these projects. We will monitor occupancy as a measure of the accuracy of our estimationof the demand for the services of a development facility, and will incorporatethis information in future assessments of potential projects. In addition, the ramp phase for our youthfacilities is typically longer than that experienced in our adult facilities,which will impact our occupancy in the Abraxas Youth and Family Servicesdivision in a given period.

 

*Per Diem ReimbursementRates. *Per diem reimbursement ratesare another key element of our gross revenue and operating margin since perdiem contracts represent a majority of our revenues (59.3% for the three monthsended March 31, 2010).  Per diemrates are a function of negotiation between management and a governmental unitat the inception of a contract or through the bidding process.  Actual per diem rates vary dramaticallyacross our business segments, and within each business segment depending uponthe particular service or program provided. The initial per diem rates oftenchange during the term of a contract in accordance with a schedule.  The amount of the change can be a fixedamount set forth within the contract, an amount determined by formulas setforth within the contract or an amount determined by negotiations betweenmanagement and the governmental unit (often these negotiations are along thesame lines as the original per diem negotiation — a review of expenses andapproval of an amount to recompense for expenses and assure the potential of anoperating profit).  In recent years, asbudgetary pressures on governmental units have increased, some of our customershave negotiated relief from formulaic increase provisions within theiragreements or have declined to include in their appropriation legislationamounts that would increase the per diem rates payable under the contract.Based on the economic turmoil which began in the second half of 2008, we areexpecting such pressures to continue in 2010 for many of our customers. Insimilar prior situations we have attempted to mitigate the impact of thesedevelopments by negotiating services provided, obtaining commitments forincreased volume and other measures. Customers may choose to reduce per diem rates throughthe reduction of contract services we may provide. We may also choose toconsider terminating an existing relationship at a given facility and replacingit with a new customer (as was done with our Great Plains Correctional Facilityin 2007 and as weintend to do with the D. Ray James Prison in 2010).

 

*Revenues. *We derivesubstantially all of our revenues from providing adult corrections andtreatment and juvenile justice, educational and treatment services outsourcedby federal, state and local government agencies in the United States. Revenuesfor our services are generally recognized on a per diem rate based upon thenumber of occupant days or hours served for the period, on a guaranteedtake-or-pay basis or on a cost-plus reimbursement basis. For the three monthsended March 31, 2010, our revenue base consisted of 59.3% for servicesprovided under per diem contracts, 35.5% for services provided undertake-or-pay and management contracts, 3.5% for services provided undercost-plus reimbursement contracts and 1.7% for services provided underfee-for-service contracts.  For the threemonths ended March 31, 2009, our revenue base consisted of 61.1% forservices provided under per diem contracts, 33.5% for services provided undertake-or-pay and management contracts, 3.4% for services provided undercost-plus reimbursement contracts, 1.8% for services provided underfee-for-service contracts and 0.2% from other miscellaneous sources.

 

Revenues can fluctuate fromperiod to period due to changes in government funding policies, changes in thenumber or types of clients referred to our facilities by governmental agencies,changes in the types of services delivered to our customers, the opening of newfacilities or the expansion of existing facilities and the termination ofcontracts for a facility or the closure (or temporary program consolidation) ofa facility.

 

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

 

*Revenues-Adult SecureServices. *Revenues forour Adult Secure Services division are primarily generated from per diem,take-or-pay and management contracts. For the three months ended March 31, 2010, and 2009, we realizedaverage per diem rates on our adult secure facilities of approximately $55.64and $53.75, respectively. The 2010 average per diem rate benefited from theactivation 

 

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of our Hudson Correctional Facility duringthe fourth quarter of 2009. We periodically have experienced pressure fromcontracting governmental agencies to limit or even reduce per diem rates. Manyof these governmental entities are under severe budget pressures and weanticipate that governmental agencies may periodically approach us in 2010about per diem rate concessions (or decline to provide funding for contractualrate increases).  Decreases in, or thelack of anticipated increases in, per diem rates could adversely impact ouroperating margin.

 

*Revenues-Abraxas Youth and FamilyServices. *Revenues forour Abraxas Youth and Family Services division are primarily generated from perdiem, fee-for-service and cost-plus reimbursement contracts.  For the three months ended March 31,2010 and 2009, we realized average per diem rates on our residential youth andfamily services facilities of approximately $194.65 and $197.51, respectively.For the three months ended March 31, 2010 and 2009, we realized averagefee-for-service rates for our non-residential community-based Abraxas Youth andFamily Services facilities and programs, including rates that are limited byMedicaid and other private insurance providers, of approximately $48.47 and$45.04, respectively. The changes in the average fee-for-service rates are dueto changes in the mix of services provided at our non-residential facilities.The majority of our Abraxas Youth and Family Services contracts renew annually.

 

*Revenues-Adult Community-BasedServices. *Revenues forour Adult Community-Based Services division are primarily generated from perdiem and fee-for-service contracts. For the three months ended March 31,2010 and 2009, we realized average per diem rates on our residential adultcommunity-based facilities of approximately $70.29 and $67.25, respectively.For the three months ended March 31, 2010 and 2009, we realized averagefee-for-service rates on our non-residential Adult Community-Based Servicesfacilities and programs of approximately $9.42 and $9.07, respectively.  Our average fee-for-service rates fluctuatefrom period to period principally due to changes in the mix of servicesprovided by our various Adult Community-Based Services programs and facilities.

 

*Operating Margins. *We have historicallyexperienced higher operating margins in our Adult Secure Services and AdultCommunity-Based Services divisions as compared to our Abraxas Youth and FamilyServices division. Our operating margin, in a given period, will be impacted byboth utilization at active facilities as well as by those facilities which maybe either dormant or have been reactivated during the period. As previouslydiscussed, we have expanded several of our Adult Secure facilities (D. RayJames Prison, Great Plains Correctional Facility and Walnut Grove Youth CorrectionalFacility, for example), which provides the opportunity to leverage existinginfrastructure. Additionally, our operating margins within a division can varyfrom facility to facility based on whether a facility is owned or leased, thelevel of competition for the contract award, the proposed length of thecontract, the mix of services provided, the occupancy levels for a facility,the level of capital commitment required with respect to a facility, theanticipated changes in operating costs over the term of the contract and ourability to increase a facility’s contract revenue. Under take-or-pay contracts,such as the contract at the Moshannon Valley Correctional Center, operatingmargins are typically higher during the early stages of the contract as the facility’spopulation ramps up (as revenues are received at contract percentagesregardless of actual occupancy). As the variable costs (primarilyresident-related and certain facility costs) increase with the growth inpopulation, operating margins will generally decline to a stabilized level. Such an impact is anticipated at our D.Ray James Prison upon the activation of its transition to the BOP in the fourthquarter of 2010. A decline in occupancy at our Abraxas Youth andFamily Services facilities can have a more significant impact on operatingmargins than our Adult Secure Services division due to the longer periodstypically required to ramp resident population at a youth facility.

 

We have experienced andexpect to continue to experience interim period operating margin fluctuationsdue to factors such as the number of calendar days in the period, higherpayroll taxes (generally in the first half of the year) and salary and wageincreases and insurance cost increases that are incurred prior to certain contractrate increases. Periodically, many of the governmental agencies with whom wecontract may experience budgetary pressures and may approach us to limit orreduce per diem rates (including contractual price increases as well). Weexperienced such behavior in 2009 and we anticipate such customer behavior willcontinue in 2010. Decreases in, or the lack of anticipated increases in, perdiem rates could adversely impact our operating margin. Additionally, adecrease in per diem rates without a corresponding decrease in operatingexpenses could also adversely impact our operating margin. Furthermore, our margins may benegatively impacted during a customer transition at a facility due to requiredpopulation ramp patterns and timing as we change customers.

 

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

 

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We are responsible for all facility operatingcosts, except for certain debt service and interest or lease payments forfacilities where we have a management contract only. At these facilities, thefacility owner is responsible for all debt service and interest or leasepayments related to the facility. We are responsible for all other operatingexpenses at these facilities. We operated 11 and 14 facilities under managementcontracts at March 31, 2010 and 2009, respectively. Included in the 11facilities under management contracts at March 31, 2010 were the WalnutGrove Youth Correctional Facility and the eight Los Angeles County Jails, whichrepresented 1,714 beds of service capacity, or approximately 96.5%, of theresidential service capacity represented by management contracts.

 

A majority of our facilityoperating costs consists of fixed costs. These fixed costs include lease andrental expense, insurance, utilities and depreciation.  As a result, when we commence operation ofnew or expanded facilities, fixed operating costs may increase. The amount ofour variable operating costs, including food, medical services, supplies andclothing, depend on occupancy levels at the facilities. Our largest singleoperating cost, facility payroll expense and related employment taxes andexpenses, has both a fixed and a variable component. We can adjust a facility’sstaffing levels and the related payroll expense to a certain extent based onoccupancy at a facility; however a minimum fixed number of employees isrequired to operate and maintain any facility regardless of occupancy levels.Personnel costs are subject to increases in tightening labor markets based onlocal economic environments and other conditions.

 

We incur pre-opening andstart-up expenses including payroll, benefits, training and other operatingcosts prior to opening a new or expanded facility (including customertransitions) and during the period of operation while occupancy is ramping up.These costs vary by contract (and the pace/scale of the activation and relatedpopulation ramp). Weincurred such costs at our Hudson Correctional Facility in conjunction with itsactivation during the fourth quarter of 2009 and would also expect to incursimilar costs in conjunction with the planned customer transition at our D. RayJames Prison in the second half of 2010. Since pre-opening andstart-up costs are generally factored into the revenue per diem rate that ischarged to the contracting agency, we typically expect to recover these upfrontcosts over the life of the contract. Because occupancy rates during a facility’sstart-up phase typically result in capacity under-utilization for at least 90to 180 days, we may incur additional post-opening start-up costs. We do notanticipate post-opening start-up costs at any adult secure facilities operatedunder any future contracts with the BOP which are take-or-pay contracts,meaning that the BOP will generally pay a certain percentage of the contractualmonthly revenue once the facility opens, regardless of actual occupancy (withan adjusted percentage level (up to 90%) as the population achieves certainthresholds).

 

Newly opened facilities arestaffed according to applicable regulatory or contractual requirements when webegin receiving offenders or clients. Offenders or clients are typicallyassigned to a newly opened facility on a phased-in basis over a one- tosix-month period. Our start-up period for new juvenile operations is generallyup to 12 months from the date we begin recognizing revenue unless break-evenoccupancy levels are achieved before then. The actual time required to ramp ajuvenile facility (with an approximate capacity, for example, of 100 to 200beds) may be a period of one to three years. Our start-up period for new adultoperations is generally up to nine months from the date we begin recognizingrevenue unless break-even occupancy levels are achieved before then.  The approximate time to ramp an adultfacility of approximately 1,000 beds may be a period of three to six months,depending upon the customer requirements. Although we typically recover these upfront costs over the life of thecontract, quarterly results can be substantially affected by the timing of thecommencement of operations as well as the development and construction of newfacilities.

 

Working capital requirementsgenerally increase immediately prior to commencing management of a new orexpanded facility as we incur start-up costs and purchase necessary equipmentand supplies before facility management revenue is realized.

 

General and administrative expenses consistprimarily of costs for corporate and administrative personnel who providesenior management, legal, finance, accounting, human resources, investorrelations, payroll and information systems, costs of business development andoutside professional and consulting fees.

 

#### **Recent Developments**

 

***Merger Agreement***

#### ** **

On April 18, 2010,the Company entered into an Agreement and Plan of Merger (“Agreement”) with TheGEO Group (NYSE:GEO) (“GEO”), a private provider of correctional, detention,and residential treatment services to federal, state and local governmentagencies around the globe. Pursuant to the Agreement, The GEO Group willacquire Cornell for stock and/or cash at an estimated enterprise value of $685million based on the closing prices of both companies’ stock on April 16,2010, including the assumption of approximately $300 million in Cornell debt,excluding cash.

 

Under the terms of thedefinitive agreement, stockholders of Cornell will have the option to elect toreceive either (x) 1.3 shares of GEO common stock for each share ofCornell common stock or (y) an amount of cash consideration equal to thegreater of (i) the 

 

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fair market value of oneshare of GEO common stock plus $6.00 or (ii) the fair market value of 1.3shares of GEO common stock. In order to preserve the tax-deferred treatment ofthe transaction, no more than 20% of the outstanding shares of Cornell CommonStock may be exchanged for the cash consideration. If elections are made suchthat the aggregate cash consideration to be received by Cornell stockholderswould exceed $100 million in the aggregate, such excess amount may be paid atthe election of GEO in shares of GEO common stock or in cash.

 

The merger is expected toclose in the third quarter of 2010, subject to the approval of the issuance ofGEO common stock by GEO’s shareholders, approval of the transaction by Cornell’sstockholders and federal regulatory agencies including but not limited to theexpiration or termination of the waiting period under the Hart-Scott-RodinoAntitrust Improvements Act of 1976, as well as the fulfillment of othercustomary terms and conditions. The Merger Agreement also contains covenantswith respect to the operation of the Company’s business between signing of theMerger Agreement and closing of the Merger.

 

***LitigationRelating to the Merger***

 

On April 27, 2010, aputative stockholder class action was filed in the District Court for HarrisCounty, Texas by Todd Shelby against Cornell, members of the Cornell board ofdirectors, individually, and GEO. The complaint alleges, amongother things, that the Cornell directors breached their duties by entering intothe Agreement without first taking steps to obtain adequate, fair and maximumconsideration for Cornell’s stockholders by shopping the company or initiatingan auction process, by structuring the transaction to take advantage of Cornell’slow current stock valuation, and by structuring the transaction to benefit GEOwhile making an alternative transaction either prohibitively expensive orotherwise impossible, and that Cornell and GEO have aided and abetted suchbreaches by Cornell’s directors. Among other things, the complaint seeks to enjoinCornell, its directors and GEO from completing the merger and seeks aconstructive trust over any benefits improperly received by the defendants as aresult of their alleged wrongful conduct.

 

***D. Ray James Prison***

 

InJanuary 2010, we received a contract award from the BOP to house up to2,507 low-security adult males at the facility. The contract has an anticipatedeffective date of October 1, 2010 and has an initial four-year term withthree two-year option periods. We anticipate we will spend approximately $8.0million prior to the effective date of the BOP contract in order to prepare thefacility for the BOP inmates. In conjunction with the preparations for the BOPpopulation during 2010, we will be transitioning from the Georgia Department ofCorrections’ inmates currently housed at this facility.

 

## **Liquidity and CapitalResources**

## ** **

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

 

***Cash Flows FromOperating Activities.*** Cash flows used in operating activities wereapproximately $1.0 million for the three months ended March 31, 2010compared to cash used in operating activities of approximately $2.1 million forthe three months ended March 31, 2009, principally due to: (1) areduction in net income during the first quarter of 2010 as compared to thefirst quarter of 2009 of approximately $1.9 million, (2) an increase inother restricted assets of approximately $3.2 million, and (3) a decreasein accounts receivable-trade due to the timing and receipt of customerpayments.

 

***Cash Flows From Investing Activities*****.** Cash used ininvesting activities was approximately $3.4 million for the three months ended March 31,2010, due primarily to capital expenditures of $3.2 million related to ourHudson Correctional Facility and D. Ray James Prison. There were also netpayments for the three months ended March 31, 2010 to the restricted debtpayment account of $0.2 million. Cash used in investing activities was approximately $3.5 million for thethree months ended March 31, 2009, due primarily to capital expendituresof approximately $3.2 million, primarily related to the facility expansionprojects at the D. Ray James Prison and the Great Plains Correctional Facility.There were also net payments to the restricted debt payment account ofapproximately $0.4 million.

 

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***Cash Flows FromFinancing Activities*****.**Cash used in financing activities was approximately $5.2 million for thethree months ended March 31, 2010, due to payments on our Amended CreditFacility of $2.6 million and the purchase of $3.0 million of our commonstock.  Additionally, we had proceedsfrom the exercise of stock options and employee stock purchase plan ofapproximately $0.4 million.  Cashprovided by financing activities was approximately $1.3 million for the threemonths ended March 31, 2009, due primarily to net borrowings on ourAmended Credit Facility of $1.0 million and proceeds from the exercise of stockoptions of $0.3 million.

 

***Treasury StockRepurchases.*** We repurchased 145,473 shares of ourcommon stock in the three months ended March 31, 2010. See Part II,Item 2. All of these shares were retired. We did not repurchase any of our common stock in the three months ended March 31,2009. Under the terms of our Senior Notes and our Amended Credit Facility, wecan purchase shares of our stock subject to certain cumulative restrictions.

 

***Long-Term Credit Facilities.***  Our Amended CreditFacility provides for borrowings up to $100.0 million (including letters ofcredit) and matures in December 2011. At our election, outstandingborrowings bear interest at either the LIBOR rate plus a margin ranging from1.50% to 2.25%, or a rate which ranges from 0.00% to 0.75% above the applicableprime rate. The applicable margins are subject to adjustments based on ourtotal leverage ratio. The available commitment under our Amended CreditFacility was approximately $20.5 million at March 31, 2010.  We had outstanding borrowings under ourAmended Credit Facility of $67.4 million and we had outstanding letters ofcredit of approximately $12.1 million at March 31, 2010.  Subject to certain requirements, we have theright to increase the commitments under our Amended Credit Facility up to$150.0 million, although the indenture for our Senior Notes limits our ability,subject to certain conditions, to expand the Amended Credit Facility beyond$100.0 million. We can provide no assurance that all of the banks that havemade commitments to us under our Amended Credit Facility would be willing toparticipate in an expansion to the Amended Credit Facility should we desire todo so. The Amended Credit Facility iscollateralized by substantially all of our assets, including the assets andstock of all of our subsidiaries. The Amended Credit Facility is notcollateralized by the assets of MCF.

 

Our Amended Credit Facility containscertain financial and other restrictive covenants that limit our ability to engagein certain activities. Our ability to borrow under the Amended Credit Facilityis subject to compliance with certain financial covenants, including bankleverage, total leverage and fixed charge coverage rates. At March 31,2010, we were in compliance with all such covenants. Our Amended Credit Facility includesother restrictions that, among other things, limit our ability to: incurindebtedness; grant liens; engage in mergers, consolidations and liquidations;make investments, restricted payments and asset dispositions; enter intotransactions with affiliates; and engage in sale/leaseback transactions.

 

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

 

Thebonds are limited, nonrecourse obligations of MCF and secured by the propertyand equipment, bond reserves, assignment of subleases and substantially allassets related to the facilities included in the 2001 Sale and LeasebackTransaction (in which we sold eleven facilities to MCF).  The bonds are not guaranteed by Cornell.

 

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

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

 

As the Senior Notes are redeemable at our option(subject to the requirements noted) we anticipate we will monitor the capitalmarkets and continue to assess our capital needs and our capital structure,including a potential refinancing of the Senior Notes.

 

Upon the occurrence ofspecified change of control events, unless we have exercised our option toredeem all the Senior Notes as described above, each holder will have the rightto require us to repurchase all or a portion of such holder’s Senior Notes at apurchase price in cash equal to 101% of the aggregate principal amount of thenotes repurchased plus accrued and unpaid interest, if any, on the 

 

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Senior Notes repurchased, to the applicabledate of purchase.  The Senior Notes wereissued under an indenture which limits our ability and the ability of ourGuarantors to, among other things, incur additional indebtedness, pay dividendsor make other distributions, make other restricted payments and investments,create liens, incurrestrictions on the ability of the Guarantors to pay dividends or otherpayments to us, enter into transactions with affiliates, and engagein mergers, consolidations and certain sales of assets.

 

***Future Liquidity***

 

Our shelf registration statement under Form S-3for potential offerings from time to time of up to $75.0 million in grossproceeds of debt securities, common stock, preferred stock, warrants or certainother securities was declared effective by the Securities and ExchangeCommission in September 2008.

 

We expect to use existing cash balances, internallygenerated cash flows and borrowings from our Amended Credit Facility to fulfillanticipated obligations such as capital expenditures, working-capital needs andscheduled debt maturities over at least the next twelve months.  As of March 31, 2010, we hadapproximately $20.5 million of available capacity under our Amended CreditFacility.  We will continue to analyze ourcapital structure, including a potential refinancing of our Senior Notes andfinancing for our expected future capital expenditures, including any potentialacquisitions.  We will consider potentialacquisitions from time to time.  Ourprincipal focus for acquisitions is anticipated to be in our Adult Secure andAdult Community-Based divisions, although we would also pursue attractivelypriced acquisitions in our Abraxas Youth and Family Services division.  We may decide to use internally generatedfunds, bank financing, equity issuances, debt issuances or a combination of anyof the foregoing to finance our future capital needs. We may also seek, from time to time, toretire or purchase some of our common stock and/or outstanding debt throughopen market purchases, privately negotiated transactions or otherwise.  Such repurchases, if any, will depend onprevailing market conditions, our liquidity requirements, contractualrestrictions and other factors.  In July 2009,our Board of Directors authorized a stock repurchase program which provides forup to $10.0 million in purchases through December 2010.  In September 2009, we adopted a 10b5-1Plan to facilitate purchases of our common stock pursuant to such stockrepurchase plan. As noted, we purchased approximately $3.0 million of ourcommon stock during the three months ended March 31, 2010. The Company mayalso repurchase our common stock in open market purchases. As a result of theproposed Merger with GEO, we terminated the 10B5-1 Plan and we do not intend torepurchase further shares of our common stock pending the Merger.  At March 31, 2010, we believe we havesufficient liquidity necessary to complete those projects (including thefacility maintenance improvements to be performed in association with thecontract transition preparation at D. Ray James Prison) for which we haveoutstanding commitments.

 

Our internally generated cash flow is directlyrelated to our business. Should the private corrections and juvenile businessesdeteriorate, or should we experience poor results in our operations, cash flowfrom operations may be reduced. We have, however, continued to generatepositive cash flow from operating activities over recent years and expect thatcash flow will continue to be positive over the next year. Our access to debtand equity markets may be reduced or closed to us due to a variety of events,including, among others, industry conditions, general economic conditions,market conditions, credit rating agency downgrades of our debt and/or market perceptionsof us and our industry.  The volatilityseen in the financial markets beginning in the third quarter of 2008 andcontinuing throughout 2009 is expected to be present (at some level) for thenear term.  Such volatility could resultin decreased availability of capital at economical terms (or at various times)and could also put additional financial and budgetary pressure on ourcustomers.  Such conditions couldpotentially result in our inability to pursue additional future growthopportunities (such as facility expansions or new facility construction) and,if coupled with unexpected client, operational or other issues affecting ourcash flow, in a need to seek additional financing at terms we would otherwisenot accept.

 

Inaddition, our accounts receivable are with federal, state, county and localgovernment agencies, which we believe generally reduces our credit risk. However, it is possible that situations such as continuing budget resolutions,delayed passage of budgets or budget pressures may increase the length ofrepayment of certain of these receivables. For example, during 2009 the Stateof California notified vendors providing services to the state that it wouldtemporarily issue IOU’s. We received IOU’s from the State of California which weresubsequently paid in full during the third quarter of 2009. We do not currentlyhold any IOU’s from the State of California. In addition, delays in the passageof budgets (such as experienced in the State of Pennsylvania in 2009) may leadto temporary delays in the repayment of our receivables from operations in suchstates. This would lead to a temporary increase in our receivables, asevidenced by the increase in our accounts receivable-trade in the third quarterof 2009. As the State of Pennsylvania did not pass a fiscal 2010 budget untilmid-October 2009, the majority of the cities and counties in Pennsylvaniachose to defer their payments (during the state budget impasse present throughthe third quarter of 2009) until the state budget had been adopted. Subsequentto the passage of the state’s fiscal 2010 budget, our various Pennsylvaniacustomers returned to their historic payment patterns. While we will closelymonitor such situations, we do not currently expect this to have a significantnegative impact on the repayment of our receivables related to our facilitiesin such locations.

 

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**Results of Operations**

 

The following table sets forth for the periods indicated thepercentages of revenues represented by certain items in our consolidated statementsof operations.

 
| ** **                                                   | ** ** | **Three Months  Ended March 31,** | ** ** |
|--------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                   | ** ** | **2010**                                    | ** ** | **2009** | ** ** |
|                                                         |       |                                        |       |   |   |
| Revenues                                                     |       | 100.0                                       | %          | 100.0 | % |
| Operating expenses, excluding depreciation and  amortization |       | 76.6                                        |       | 73.1 |   |
| Depreciation and amortization                                |       | 4.7                                         |       | 4.9 |   |
| General and administrative expenses                          |       | 5.8                                         |       | 6.2 |   |
| Income from operations                                       |       | 12.9                                        |       | 15.8 |   |
| Interest expense, net                                        |       | 6.2                                         |       | 5.9 |   |
| Income from operations before provision for income  taxes    |       | 6.7                                         |       | 9.9 |   |
| Provision for income taxes                                   |       | 2.8                                         |       | 4.1 |   |
| Net income                                                   |       | 3.9                                         |       | 5.8 |   |
| Non-controlling interest                                     |       | 0.6                                         |       | 0.5 |   |
| Income available to shareholders                             |       | 3.3                                         | %          | 5.3 | % |

 

##### ***Three Months Ended March 31,2010 Compared to Three Months Ended March 31, 2009***

##### *** ***

***Revenues***.  Revenues increased approximately $0.3million, or 0.3%, to $100.0 million for the three months ended March 31,2010 from approximately $99.7 million for the three months ended March 31,2009.

 

*Adult Secure Services*. Adult SecureServices revenues increased approximately $1.9 million, or 3.3%, to $58.8million for the three months ended March 31, 2010, from approximately $56.9million for the three months ended March 31, 2009, due primarily torevenues of $4.6 million at the Hudson Correctional Facility which beganoperations in November 2009.  Thisincrease in revenue was offset by (1) a decrease in revenues of $1.2million and $1.5 million, respectively, due to the termination of our contractsat the Baker Community Correctional Facility (“Baker”) and the Mesa VerdeCommunity Correctional Facility (“Mesa Verde”) in December 2009.

 

At March 31, 2010, we operated nineadult secure facilities with an aggregate service capacity of 14,169.  Additionally, we had two vacant facilitieswith a combined service capacity of 622 beds at March 31, 2010.  Average contract occupancy was 83.2% for thethree months ended March 31, 2010 compared to 91.9% for the three monthsended March 31, 2009. The decrease in the average contract occupancy isprimarily due to the under-utilization at our two facilities in California as aresult of the termination of our management contracts for these facilities in October 2009.The average per diem rate was $55.64 and $53.75 for the three months ended March 31,2010 and 2009, respectively. The average per diem rate in the three monthsended March 31, 2010 reflected the activation of our Hudson CorrectionalFacility in November 2009.

 

*Abraxas Youth and FamilyServices*. Abraxas Youth and Family Services revenuesdecreased approximately $2.2 million, or 8.6%, to $23.5 million for the threemonths ended March 31, 2010, from $25.7 million for the three months endedMarch 31, 2009, due primarily to (1) a decrease in revenues of $1.5million due to the consolidation of the Texas Adolescent Treatment Center (“TATC”)operations with our Hector Garza Residential Treatment Center (“Hector Garza”)in late November 2009 and (2) a decrease in revenues of $0.8 millionat the Cornell Abraxas Academy due to a reduction in occupancy.  The remaining net increase in revenues of$0.1 million was due to various fluctuations in revenues at our other AbraxasYouth and Family Services facilities and programs.

 

***At March 31,2010, we operated 15 residential Abraxas Youth and Family Services facilitiesand nine non-residential community-based programs and facilities with an aggregateservice capacity of 2,804. Additionally, we had three vacant facilities with acombined service capacity of 239 beds. Average contract occupancy for the threemonths ended March 31, 2010 was 86.8% compared to 83.9% for the threemonths ended March 31, 2009.***

*** ***

***The average perdiem rate for our residential Abraxas Youth and Family Services facilities was$194.65 for the three months ended March 31, 2010 compared to $197.51 forthe three months ended March 31, 2009. Our average fee-for-service rate for our non-residential Abraxas Youthand Family Services community-based facilities and programs was $48.47 for thethree months ended March 31, 2010 compared to $45.04 for the three monthsended March 31, 2009.  Our averagefee-for-service rate can fluctuate from period-to-period depending on the mixof services provided at our various non-residential Abraxas Youth and FamilyServices facilities and programs.***

 

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*Adult Community-Based*. AdultCommunity-Based Services revenues increased approximately $0.5 million, or2.9%, to $17.7 million for the three months ended March 31, 2010, from$17.2 million for the three months ended March 31, 2009, due an increasein revenues of $0.5 million at the Reid Community Residential Facility(principally due to its reactivation in the first quarter of 2009 aftersuffering damage from Hurricane Ike in 2008). Revenues decreased approximately $1.0 million due to our termination ofour management contract for the Dallas County Judicial Treatment Center (“Dallas”)in late November 2009.  Theremaining net increase in revenues of approximately $1.0 million was due tovarious fluctuations in revenues at our other Adult Community-Based Servicesfacilities and programs.

 

AtMarch 31, 2010, we operated 27 residential Adult Community-Based Servicesfacilities and three non-residential community-based programs with an aggregateservice capacity of 3,558. Average contract occupancy for the threemonths ended March 31, 2010 was 116.2% compared to 104.3% for the threemonths ended March 31, 2009.

 

Theaverage per diem rate for our residential Adult Community-Based Servicesfacilities was $70.29 for the three months ended March 31, 2010 comparedto $67.25 for the three months ended March 31, 2009. The averagefee-for-service rate for our non-residential Adult Community-Based Servicesprograms was $9.42 for the three months ended March 31, 2010 compared to$9.07 for the three months ended March 31, 2009.  Our average fee-for-service rates fluctuateas a result of changes in the mix of services provided by our various AdultCommunity-Based Services programs and facilities.

 

***Operating Expenses excludingdepreciation and amortization****.*Operatingexpenses, excluding depreciation and amortization increased approximately $3.8million, or 5.2%, to $76.7 million for the three months ended March 31,2010 from $72.9 million for the three months ended March 31, 2009.

 

*Adult Secure Services*. Adult SecureServices operating expenses increased approximately $5.3 million, or 14.4%, to$42.0 million for the three months ended March 31, 2010 from $36.7 millionfor the three months ended March 31, 2009. The increase was dueprimarily to operating expenses of $5.8 million at the Hudson CorrectionalFacility which began operations in November 2009.  This increase in operating expenses wasoffset, in part, by a combined decrease in operating expense of $0.8 milliondue to the termination of our contracts for Baker and Mesa Verde in December 2009.  The remaining net increase in operatingexpenses of $0.3 million was due to various fluctuations in operating expensesat our other Adult Secure Services facilities.

 

Asa percentage of segment revenues, Adult Secure Services operating expenses were71.5% for the three months ended March 31, 2010 compared to 64.5% for thethree months ended March 31, 2009. The decrease in our operating margin in the three months ended March 31,2010 was due primarily to (1) the activation of our Hudson Correctional Facilityin November 2009 (which is currently operating with available capacity),and (2) those expenses related to our closed Baker and Mesa Verdefacilities.

 

*Abraxas Youth and FamilyServices*.** **Abraxas Youth and Family Services operating expenses decreasedapproximately $1.2 million, or 5.0%, to $23.0 million for the three monthsended March 31, 2010 from $24.2 million for the three months ended March 31,2009, due primarily to the consolidation of TATC operations with our HectorGarza facility in late November 2009 which decreased operating expensesapproximately $1.4 million. The remaining net increase in operating expenses of$0.2 million was due to various fluctuations in operating expenses at our otherAbraxas Youth and Family Services facilities and programs.

 

Asa percentage of segment revenues, Abraxas Youth and Family Services divisionoperating expenses were 97.8% for the three months ended March 31, 2010compared to 94.4% for the three months ended March 31, 2009. The decreasein our operating margin in the three months ended March 31, 2010 was dueprimarily to the decrease in revenues as noted above (reflective of occupancyand customer mix at certain facilities).

 

*Adult Community-Based Services*. Adult Community-Based Servicesoperating expenses decreased approximately $0.3 million, or 2.5%, to $11.7million for the three months ended March 31, 2010 from $12.0 million forthe three months ended March 31, 2009, due primarily to the termination ofour management contract for Dallas in late November 2009 which decreasedoperating expenses approximately $0.6 million. The remaining net increase in operating expenses of approximately $0.3million was due to various fluctuations in operating expenses at our other AdultCommunity-Based facilities and programs.

 

As a percentage ofsegment revenues, Adult Community-Based Services operating expenses were 66.0%for the three months ended March 31, 2010 compared to 69.8% for the threemonths ended March 31, 2009. The decrease in our operating margin in thethree months ended March 31, 2010 was primarily due to the reduction ofrevenue previously noted which were not offset by operating expense reductionsdue to contractual staffing requirements.

 

***Pre-opening and start-up expenses.***** **There were no pre-openingand start-up expenses for the three months ended March 31, 2010 and 2009.

 

***Depreciation and Amortization*****. **Depreciation and amortization was approximately $4.7million and $4.9 million for the three months ended March 31, 2010 and2009, respectively.  Amortization ofintangibles was approximately $0.1 million and $0.4 million for the threemonths ended March 31, 2010 and 2009, respectively.  The decrease in amortization expense in thethree months ended 

 

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March 31, 2010 was due to the fullamortization of our non-compete agreements as of December 2009.

 

***General and Administrative Expenses. ***General and administrative expenses decreasedapproximately $0.3 million, or 4.9%, to approximately $5.8 million for thethree months ended March 31, 2010, from $6.1 million for the three monthsended March 31, 2009 due primarily to lower legal and other professionalexpenses in the three months ended March 31, 2010 as compared to the threemonths ended March 31, 2009.

 

***Interest. ***Interest expense, net of interest income,increased approximately $0.2 million, or 3.3%, to $6.2 million for the threemonths ended March 31, 2010 from $6.0 million for the three months ended March 31,2009. We did not capitalize any interest in the three months ended March 31,2010, whereas we capitalized interest of approximately $0.7 million in thethree months ended March 31, 2009 related to the 700 bed facilityexpansion project at the D. Ray James Prison. This increase was largely offsetby (1) a decrease in interest expense of approximately $0.3 million as aresult of a lower outstanding principal balance on MCF’s debt and (2) adecrease in interest expense on our Amended Credit Facility of approximately$0.3 million due primarily to lower interest rates in the 2010 period.

 

***Income Taxes.***For the three months ended March 31, 2010, werecognized a provision for income taxes at an estimated effective rate of42.4%.  For the three months ended March 31,2009, we recognized a provision for income taxes at an estimated effective rateof 41.7%.

 

***Contractual Uncertainties Related toCertain Facilities***

 

***Regional Correctional Center.***  The Office of Federal Detention Trustee (“OFDT”)holds the contract for the use of the RCC on behalf of ICE, USMS and the BOPwith Bernalillo County, New Mexico (the “County”) through an intergovernmentalservices agreement, and we have an operating and management agreement with theCounty.  In July 2007, we werenotified by ICE that it was removing all ICE detainees from the RCC and theremoval was completed in early August 2007.  The facility is stillbeing utilized by the USMS and since May 2008 by the BOP, but not at itsfull capacity.  In February 2008,ICE informed us that it would not resume use of the facility.  In February 2008, OFDT attempted tounilaterally amend its agreement with the County to reduce the number ofminimum annual guaranteed mandays under the agreement from 182,500 to66,300.  Neither we nor the County believe OFDT has the right tounilaterally amend the contract in this manner, and OFDT has been informed ofour position. Although either party to the intergovernmental services agreementhas the right to terminate upon 180 days notice, neither party has exercisedsuch right as of March 31, 2010. During the third quarter of 2009, we filed a claim against the UnitedStates, acting through the United States Department of Justice, OFDT and ICE(collectively, “Defendants”) for breach of contract and breach of the duty ofgood faith and fair dealing, arising out of the Defendants’ impropermodification of the intergovernmental services agreement (the “Contract”) andsubsequent failure to pay for the shortfalls in the 2007-2008 and 2008-2009minimum annual guaranteed mandays specified in the Contract.

 

Thereis a pending lawsuit against the County concerning the County jail system, knowas the “McClendon” case.  In 1994,plaintiffs sued the County in federal district court in the District of NewMexico over conditions at the county jail, which was then located at what isnow the RCC and run by the Company.  TheCounty subsequently built their new Metropolitan Detention Center to house theCounty inmates and also negotiated two stipulated agreements in 2004 designedto end the McClendon lawsuit.  Thesestipulated settlements covered the Metropolitan Detention Facility and wereapproved by the Court in 2005 (the “2005 settlement agreements”).

 

InMarch 2009, the Federal Judge presiding over the case issued an Orderbased on motions filed by Plaintiffs class counsel asking the Judge to reformthe 2005 settlement agreements to allow for access to the RCC.  In those motions, the Plaintiffs alsorequested alternative relief in the form of withdrawal of the Court’s approvalof the 2005 settlement agreements.  Basedon our interpretation of the Order, the Judge denied Plaintiffs’ request foraccess to the RCC, granted the alternative relief requested, withdrew herapproval of the 2005 settlement agreements and granted the option to Plaintiffsto rescind their 2005 settlement agreements. The Plaintiffs chose to rescind the 2005 settlement agreements.  In the Order, the Judge concluded that theRCC, at least to the extent it is used to house detainees by Bernalillo Countypursuant to the intergovernmental services agreement, is part of the countyjail system.  The County has informed usthat it does not believe McClendon should apply to the RCC and the County hasfiled an appeal of the Order to the U.S. Court of Appeals for the TenthCircuit.  We are not party to thislawsuit and the ramifications of the Court’s Order to our operation of the RCCare unclear.

 

The2005 settlement agreements imposed various conditions on the Metropolitan DetentionCenter that resulted in material increases to its operating costs.  The effect of the rescission of the 2005settlement agreements is unclear since those settlement agreements replacedprior settlement agreements approved in 1996. We do not believe we are contractually obligated to bear any incrementalcosts of complying with any settlement agreements in the McClendon casealthough the County has expressed to us that it 

 

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may want us to absorb a portion of any coststhat would be incurred.  We currentlyplan to continue to operate the facility and also continue with our marketingplans for the RCC.

 

Revenuesfor this facility were approximately $3.6 million and $3.0 million for thethree months ended March 31, 2010 and 2009, respectively.  The net carrying value of the leaseholdimprovements for this facility was approximately $0.3 million and $0.6 millionat March 31, 2010 and December 31, 2009, respectively. Our lease forthis facility requires monthly rent payments of approximately $0.13 million forthe remaining term of the lease (which was extended through June 2010). Todate, although we have several federal agencies using the RCC, the facilitystill has available capacity.  Ourinability to expand the existing population with current or new customers orany disruption of our operations due to activity in the McClendon case couldhave an adverse effect on our financial condition, results of operations andcash flows.  We believe there has been noimpairment to the carrying value of the leasehold improvements at thisfacility.

 

***California Facilities.***In October 2009,we were notified by the CDCR that they were terminating our contracts at ourtwo small California male community correctional facilities, (Baker CommunityCorrectional Facility (“Baker”) and Mesa Verde Community Correctional Facility(“Mesa Verde”)) which represent a combined 622 beds of service capacity.

 

Revenuesfor Baker were approximately $1.2 million for the three months ended March 31,2009.  There were no revenues in thethree months ended March 31, 2010. The net carrying value of this ownedfacility was approximately $2.8 million at March 31, 2010 and December 31,2009.  We are considering potentialalternate customers for this facility (including the pending procurement forfemale low-security beds by the CDCR (for which this facility would qualify)),but we can make no assurances as to who the customer will be or what thepossible timing might be. We believe that there has been no impairment to thecarrying value of this facility.

 

Revenuesfor Mesa Verde were $1.5 million for the three months ended March 31,2009.  There were no revenues for thethree months ended March 31, 2010. The net carrying value of the leaseholdimprovements for this facility was approximately $0.6 million at March 31,2010 and December 31, 2009. Our lease for this facility requires monthlyrent payments ranging from approximately $0.14 million to $0.16 million overthe remaining term of the lease through June 2015. We are consideringpotential alternate customers for this facility (including the pendingprocurement for female low-security beds by the CDCR (for which this facilitywould qualify)), which we believe will ultimately result in the recovery of ourinvestment in this facility. However, we can make no assurances as to who thecustomer will be (or what the possible timing might be). We believe that therehas been no impairment to the carrying value of the leasehold improvements atthis facility.

 

***Realization of long-lived assets***

 

We review our long-livedassets (including our facilities at a facility-by-facility level) forimpairment at least annually or when changes in circumstances or a triggeringevent indicates that the carrying amount of the asset may not be recoverable inaccordance GAAP.  GAAP requires thatlong-lived assets to be held and used recognize an impairment loss only if thecarrying amount of the long-lived asset is not recoverable from its estimatedfuture undiscounted cash flows and to measure an impairment loss as thedifference between the carrying value and the fair value of the asset. Assetsto be disposed of by sale are recorded at the lower of their carrying amount orfair value less estimated selling costs. We estimate projections ofundiscounted cash flows, and also fair value, based upon the best informationavailable, which may include expected future discounted cash flows to beproduced by the asset and/or available market prices. Factors thatsignificantly influence estimated future cash flows include the periods andlevels of occupancy for the facility, expected per diem or reimbursement rates,assumptions regarding the levels of staffing, services and future operating andcapital expenditures necessary to generate forecasted revenues, related costsfor these activities and future rate of increases or decreases associated withthese factors. Information typically utilized will also include relevant termsof existing contracts (for similar services and customers), market knowledge ofcustomer demand (both present and anticipated) and related pricing, marketcompetitors, and our historical experience (as to areas including customerrequirements, contract terms, operating requirements/costs, occupancy trends,etc.). We may also consider the results of any appraisals if a fair value isnecessary. Estimates for factors such as per diem or reimbursement rates may behighly subjective, particularly in circumstances where there is no currentoperating contract in place and changes in the assumptions and estimates couldresult in the recognition of impairment charges.

 

We may be required torecord an impairment charge in the future if we are unable to successfullynegotiate a replacement contract on any of our facilities for which wecurrently have an operating contract.

 

###### ***ContractualObligations and Commercial Commitments***

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

We have assumed various financial obligations andcommitments in the ordinary course of conducting our business.  We have contractual obligations requiringfuture cash payments, such as management, consulting and non-competitionagreements.

 

We maintain operating leases in the ordinary course ofour business activities.  These leasesinclude those for operating facilities, 

 

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office space and office and operatingequipment, and the agreements expire between 2010 and 2075. As of March 31,2010, our total commitment under these operating leases was approximately$129.8 million.

 

The following table details the known future cashpayments (on an undiscounted basis) related to our various contractualobligations as of March 31, 2010 (in thousands):

 
| ** **                              | ** ** | **Payments Due by Period** | ** ** |
|-----------------------------------------|------------|-------------------------------------------|------------|
| ** **                              | ** ** | ** **                                | ** ** | ** ** | ** ** | **2011 -** | ** ** | **2013 -** | ** ** | ** ** | ** ** |
| ** **                              | ** ** | **Total**                                 | ** ** | **2010** | ** ** | **2012** | ** ** | **2014** | ** ** | **Thereafter** | ** ** |
|                                    |       |                                      |       |   |   |   |   |   |   |   |   |
| **Contractual Obligations:**            |       |                                      |       |   |   |   |   |   |   |   |   |
| Long-term debt — principal         |       |                                      |       |   |   |   |   |   |   |   |   |
| · Cornell  Companies, Inc.    |       | $                                         | 112,000    |   | $ | — |   | $ | 112,000 |   | $ | — |   | $ | — |   |
| · Special Purpose Entity           |       | 121,700                                   |       | 13,400 |   | 30,400 |   | 35,800 |   | 42,100 |   |
| Long-term debt — interest          |       |                                      |       |   |   |   |   |   |   |   |   |
| · Cornell  Companies, Inc.    |       | 27,090                                    |       | 9,030 |   | 18,060 |   | — |   | — |   |
| · Special Purpose Entity           |       | 39,424                                    |       | 5,154 |   | 17,110 |   | 11,740 |   | 5,420 |   |
| Revolving line of credit-principal      |       |                                      |       |   |   |   |   |   |   |   |   |
| · Cornell  Companies, Inc.    |       | 67,400                                    |       | — |   | 67,400 |   | — |   | — |   |
| Revolving line of credit-interest       |       |                                      |       |   |   |   |   |   |   |   |   |
| · Cornell  Companies, Inc.    |       | 2,467                                     |       | 1,026 |   | 1,441 |   | — |   | — |   |
| Capital lease obligations               |       |                                      |       |   |   |   |   |   |   |   |   |
| · Cornell  Companies, Inc.    |       | 11                                        |       | 11 |   | — |   | — |   | — |   |
| Construction commitments                |       | 7,817                                     |       | 7,817 |   | — |   | — |   | — |   |
| Operating leases                        |       | 129,840                                   |       | 13,096 |   | 29,521 |   | 27,541 |   | 59,682 |   |
| Consultative and non-compete agreements |       | 10                                        |       | 10 |   | — |   | — |   | — |   |
| Total contractual cash obligations      |       | $                                         | 507,759    |   | $ | 49,544 |   | $ | 275,932 |   | $ | 75,081 |   | $ | 107,202 |   |

 

Approximately$2.8 million of unrecognized tax benefits have been recorded as liabilities asof March 31, 2010 but are not included in the contractual obligationstable above because we are uncertain as to if or when such amounts may besettled.  Related to the unrecognized taxbenefits not included in the table above, we have also recorded a liability forpotential penalties of approximately $0.1 million and for interest ofapproximately $0.2 million as of March 31, 2010.

 

Weenter into letters of credit in the ordinary course of operating and financingactivities.  As of March 31, 2010,we had outstanding letters of credit of approximately $12.1 million primarilyfor certain workers’ compensation insurance and other operatingobligations.  The following table detailsour letters of credit commitments as of March 31, 2010 (in thousands):

 
| ** **                | ** ** | **Total**     | ** ** | **Amount of Commitment Expiration Per Period** | ** ** |
|---------------------------|------------|---------------|------------|-------------------------------------------------------------------------|------------|
| ** **                | ** ** | **Amounts**   | ** ** | **Less than**                                                      | ** ** | ** ** | ** ** | ** ** | ** ** | **More Than** | ** ** |
| ** **                | ** ** | **Committed** | ** ** | **1 Year**                                                         | ** ** | **1-3 Years** | ** ** | **3-5 Years** | ** ** | **5 Years** | ** ** |
| Commercial Commitments:   |       |          |       |                                                                    |       |   |   |   |   |   |   |
| Standby letters of credit |       | $             | 12,101     |                                                                    | $          | 12,101 |   | $ | — |   | $ | — |   | $ | — |   |
|                           |            |               |            |                                                                         |            |  |  |  |  |  |  |  |  |  |  |  |

 

**ITEM 3.**                       QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

** **

Inthe normal course of business, we are exposed to market risk, primarily fromchanges in interest rates. We continually monitor exposure to market risk anddevelop appropriate strategies to manage this risk. We are not exposed to anyother significant market risks, including commodity price risk or, foreigncurrency exchange risk or interest rate risks from the use of derivativefinancial instruments.

 

**Credit Risk**

 

Dueto the short duration of our investments, changes in market interest rateswould not have a significant impact on their fair value.  In addition, ouraccounts receivables are with federal, state, county and local governmentagencies, which we believe reduces our credit risk. However, it is possiblethat such situations as continuing budget resolutions, delayed passage ofbudgets or budget pressures may increase the length of repayment of certainreceivables.  During the third quarter of2009 the State of California notified vendors providing services to the statethat it would temporarily issue IOU’s. We received IOU’s from the State of California which were subsequentlyrepaid prior to September 30, 2009, and we do not presently hold any IOU’sfrom the State of California as of 

 

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December 31, 2009.  In addition, delays in the passage of budgets(such as experienced in the State of Pennsylvania in 2009) may lead totemporary delays in the repayment of our receivables from operations in suchstates. As the State of Pennsylvania did not pass a fiscal 2010 budget untilmid-October 2009, the majority of the cities and counties in Pennsylvaniachose to defer their payments (during the state budget impasse through thethird quarter 2009) until the state budget had been adopted. Subsequent to thepassage of the state’s fiscal 2010 budget, our various Pennsylvania customersreturned to their historic payment patterns. While we closely monitor suchsituations, we do not currently expect this to have a permanent impact on therepayment of our receivables related to our facilities.

 

**Interest Rate Exposure**

 

Ourexposure to changes in interest rates primarily results from our Amended CreditFacility, as these borrowings have floating interest rates.  The debt on our consolidated financialstatements at March 31, 2010 with fixed interest rates consist of the8.47% Bonds issued by MCF, in August 2001 in connection with the 2001 Saleand Leaseback Transaction and $112.0 million of Senior Notes.  The detrimental effect of a hypothetical 100basis point increase in interest rates on our current borrowings under ourAmended Credit Facility would be to reduce income before provision for incometaxes by approximately $0.2 million for the three months ended March 31,2010.  At March 31, 2010, the fairvalue of our consolidated debt was approximately $304.2 million based uponquoted market prices or discounted future cash flows using the same or similarsecurities.

 

**Inflation**

 

Other than personnel, offender medical costsat certain facilities, and employee medical and worker’s compensation insurancecosts, we believe that inflation has not had a material effect on our resultsof operations during the past two years. We have experienced significant increases in resident/inmate medicalcosts and employee medical and worker’s compensation insurance costs, and wehave also experienced higher personnel costs during the past two years. Most ofour facility management contracts provide for payments of either fixed per diemfees or per diem fees that increase by only small amounts during the term ofthe contracts. Inflation could substantially increase our personnel costs (thelargest component of our operating expenses), medical and insurance costs orother operating expenses at rates faster than any increases in contractrevenues.  Food costs (part of ourresident/inmate care costs) were also subject to rising prices in 2009 and2010.  We believe we have limited ourexposure through long-term contracts with fixed term pricing.

 

**ITEM 4.**                       Controls and Procedures.

** **

**Evaluationof Disclosure Controls and Procedures**

 

Wemaintain disclosure controls and procedures designed to provide reasonableassurance that information disclosed in our annual and periodic reports isrecorded, processed, summarized and reported, within the time periods specifiedin the Securities and Exchange Commission’s rules and forms. In addition,we designed these disclosure controls and procedures to ensure that thisinformation is accumulated and communicated to management, including the chiefexecutive officer (“CEO”) and chief financial officer (“CFO”), to allow timelydecisions regarding required disclosures. SEC rules require that wedisclose the conclusions of our CEO and CFO about the effectiveness of ourdisclosure controls and procedures.

 

We do not expect that our disclosure controls and procedures willprevent all errors or fraud. A control system, no matter how well conceived andoperated, can provide only reasonable, not absolute, assurance that theobjectives of the control system are met. In addition, the design of disclosure controls and procedures mustreflect the fact that there are resource constraints, and the benefits ofcontrols must be considered relative to their costs. Because of the inherentlimitation in a cost-effective control system, misstatements due to error orfraud could occur and not be detected.

 

Underthe supervision and with the participation of our management, including ourprincipal executive officer and principal financial officer, and as required byparagraph (b) of Rules 13a-15 and 15d-15 of the Exchange Act, we haveevaluated the effectiveness of the design and operation of our disclosurecontrols and procedures (as defined in Rules 13a-15(e) and 15d-15(e) ofthe Exchange Act) as of the end of the period required by this report. Based onthat evaluation, our principal executive officer and principal financialofficer have concluded that these controls and procedures are effective at areasonable assurance level as of that date.

 

**Changesin Internal Control over Financial Reporting**

 

In connection with the evaluation as requiredby paragraph (d) of Rules 13a-15 and 15d-15 of the Exchange Act, wehave not identified any change in our internal control over financial reporting(as such term is defined in Rules 13a-15(f) and 15d-15(f) underExchange Act) that occurred during our fiscal quarter ended March 31, 2010that has materially affected, or is reasonably likely to materially affect, ourinternal control over financial reporting.

 

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**PART II**     OTHERINFORMATION

 

**ITEM 1.****                        ****Legal Proceedings.**

** **

SeePart I, Item 1. Note 9 to the Consolidated Financial Statements, which isincorporated herein by reference.

 

**ITEM 1A.****                     ****Risk Factors.**

 

Therisk factors as previously discussed in our Form 10-K for the fiscal yearended December 31, 2009 are incorporated herein by this reference.

 

**Risks Related to the Merger**

 

***Therecan be no assurance that the proposed merger of The GEO Group and Cornell willbe consummated.  The announcement andpendency of the Merger, or the failure of the Merger to be consummated, couldhave an adverse effect on Cornell’s stock price, business, financial condition,results of operations or prospects.***

 

***We have entered into an Agreement and Plan of Merger with The GEO Group, Inc.(“GEO”) and GEO Acquisition III, Inc. (“Merger Sub”), dated April 18,2010 (the “Merger Agreement”), pursuant to which GEO will acquire the Company(the “Merger”). The Merger is subject to a number of conditions to closing,including (i) the approval of the issuance of shares of GEO common stockin accordance with the terms of the merger agreement, (ii) the adoption ofthe Merger Agreement by the Cornell stockholders, (iii) the expiration ortermination of the waiting period (and any extension thereof) or the resolutionof any litigation instituted applicable to the Merger under the Hart-Scott-RodinoAntitrust Improvements Act of 1976, as amended (the “HSR Act”) or any otherapplicable federal or state statute or regulation, (iv) no temporaryrestraining order, preliminary or permanent injunction or other order shallhave been issued (and remain in effect) by a court or other governmental entityhaving the effect of making the merger illegal or otherwise prohibiting theconsummation of the Merger, and (v) the approval for listing on the NewYork Stock Exchange of the shares of GEO common stock issuable in connectionwith the Merger, (vi) the receipt of certain third party contractualapprovals that are required as a result of the Merger.***

*** ***

***If the stockholders of GEO fail to approve the GEO share issuance or ifCornell stockholders fail to adopt the Merger Agreement, we will not be able tocomplete the Merger.  Additionally, ifthe other closing conditions are not met or waived, we will not be able tocomplete the Merger.  As a result, therecan be no assurance that the Merger will be completed in a timely manner or atall.***

*** ***

***Further, the announcement and pendency of the Merger could disrupt ourbusinesses, in any of the following ways, among others:***

*** ***

·      Ouremployees may experience uncertainty about their future roles with the combinedcompany, which might adversely affect our ability to retain and hire keymanagers and other employees;

 

·      theattention of our management may be directed toward the completion of the mergerand transaction-related considerations and may be diverted from the day-to-daybusiness operations of Cornell; and

 

·      customers,suppliers or others may seek to modify or terminate their businessrelationships with us.

 

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***We may face additional challenges in competing for new business andretaining or renewing business.  Thesedisruptions could be exacerbated by a delay in the completion of the Merger ortermination of the Merger Agreement.***

*** ***

***For the foregoing reasons, there can be no assurance that theannouncement and pendency of the Merger, or the failure of the Merger to beconsummated, will not have an adverse effect on our stock price, business,financial condition, results of operations or prospects.***

*** ***

***TheMerger Agreement limits our ability to pursue an alternative acquisitionproposal and requires us to pay a termination fee of $12 million, plusexpenses, if it does.***

 

***The Merger Agreement prohibits us from soliciting, initiating orencouraging alternative merger or acquisition proposals with any thirdparty.  The Merger Agreement alsoprovides for the payment by us to GEO of a termination fee of $12 million, plusup to $2 million in fees and expenses, if the Merger Agreement is terminated incertain circumstances in connection with a competing acquisition proposal forus or the withdrawal by our board of directors of its recommendation that ourstockholders vote in favor of the proposals required to consummate the Merger,as the case may be.***

*** ***

***Theremay be a long delay between GEO and Cornell each receiving the necessarystockholder approvals for the Merger and the closing of the transaction, duringwhich time we will lose the ability to consider and pursue alternativeacquisition proposals, which might otherwise be superior to the Merger.***

 

***Following the GEO shareholder and Cornell stockholder approvals, theMerger Agreement prohibits us from taking any actions to review, consider orrecommend any alternative acquisition proposals, including those that could besuperior to our stockholders when compared to the Merger.  Given that there could be a delay betweenstockholder approval and closing, the time during which we could be preventedfrom reviewing, considering or recommending such proposals could besignificant.***

*** ***

***A lawsuit has been filed against Cornell, members of Cornell’sboard of directors and GEO challenging the Merger, and an unfavorable judgmentor ruling in this lawsuit could prevent or delay the consummation of theMerger, result in substantial costs or both.***

*** ***

***Cornell, its directors and GEO have been named in a purportedstockholder class action complaint filed in Texas state court. The complaintalleges, among other things, that Cornell’s directors breached their fiduciaryduties by entering into the Merger Agreement without first taking steps toobtain adequate, fair and maximum consideration for Cornell’s stockholders byshopping the company or initiating an auction process, by structuring thetransaction to take advantage of Cornell’s current low stock valuation, and bystructuring the transaction to benefit GEO while making an alternativetransaction either prohibitively expensive or otherwise impossible, and thatthe corporate defendants have aided and abetted such breaches by Cornell’sdirectors.  The plaintiffs are seeking,among other things, both an injunction prohibiting the Merger and aconstructive trust in an unspecified amount.***

*** ***

One of the conditions to the closing of the Merger isthat there not be any legal prohibition preventing the consummation of theMerger, which would include the injunction sought by the plaintiffs in thiscase if it were to be granted.  As aresult, if any of the plaintiffs are successful in obtaining the injunctionthey seek, the Merger may be blocked or delayed, or there could be substantialcosts to GEO and/or Cornell.  It ispossible that other similar lawsuits may be filed in the future.  Cornell cannot estimate any possible lossfrom this or similar future litigation at this time.  Cornell has obligations under certaincircumstances to hold harmless and indemnify each of the defendant directorsagainst judgments, fines, settlements and expenses related to claims againstsuch directors and otherwise to the fullest extent permitted under Delaware lawand Cornell’s certificate of incorporation, bylaws and contractual agreementswith its directors.

 

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**ITEM 2.****                        ****Unregistered Sales of Equity Securities and Use of Proceeds.**

 

**IssuerPurchases of Equity Securities**

 

The following tablepresents information related to our repurchases of common stock for the periodsindicated.

 
| ** **                                            | ** ** | ** **            | ** ** | ** **           | ** ** | **Total Number** | ** ** | **Approximate**       | ** ** |
|-------------------------------------------------------|------------|-----------------------|------------|----------------------|------------|-----------------------|------------|-----------------------|------------|
| ** **                                            | ** ** | ** **            | ** ** | ** **           | ** ** | **of Shares**         | ** ** | **Dollar Value**      | ** ** |
| ** **                                            | ** ** | ** **            | ** ** | ** **           | ** ** | **Purchased**         | ** ** | **of Shares**         | ** ** |
| ** **                                            | ** ** | ** **            | ** ** | ** **           | ** ** | **as Part**           | ** ** | **that May Yet** | ** ** |
| ** **                                            | ** ** | **Total Number** | ** ** | **Average**          | ** ** | **of Publicly**       | ** ** | **Be Purchased** | ** ** |
| ** **                                            | ** ** | **of Shares**         | ** ** | **Price  Paid** | ** ** | **Announced**         | ** ** | **Under the**         | ** ** |
| **Period**                                            | ** ** | **Purchased**         | ** ** | **per Share**        | ** ** | **Programs (1)**      | ** ** | **Programs (2)**      | ** ** |
| **(In  millions, except share and per   share data)** | ** ** | ** **            | ** ** | ** **           | ** ** | ** **            | ** ** | ** **            | ** ** |
| * *                                              | ** ** | ** **            | ** ** | ** **           | ** ** | ** **            | ** ** |                  | ** ** |
| January 1, 2010 to January 31, 2010         | ** ** | ** **            | ** ** | ** **           | ** ** | ** **            | ** ** |                  | ** ** |
| February 1, 2010 to February 28, 2010       | ** ** | ** **            | ** ** | ** **           | ** ** | ** **            | ** ** |                  | ** ** |
| March 1, 2010 to March 31, 2010             |       | 145,473               |       | $                    | 20.60      |                  | 145,473    |                  | $          | 7.0 |   |
|                                                  | ** ** | ** **            | ** ** | ** **           | ** ** | ** **            | ** ** |                  | ** ** |
|                                                  |       | 145,473               | ** ** | ** **           |       | 145,473               | ** ** |                  | ** ** |
|                                                       |            |                       |            |                      |            |                       |            |                       |            |  |  |

 

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| (1) | Represents  the number of shares repurchased through our repurchase program authorized by  our Board of Directors in July 2009. During the three months ended  March 31, 2010, we repurchased approximately 145,473 shares at a cost of  $3 million under the program |
|-----|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| (2) | We  do not intend to repurchase any more shares of our common stock under our  repurchase program pending the completion of the merger with GEO.                                                                                                                                |

 

**ITEM 3.****                        ****Defaults Upon Senior Securities.**

 

None.

 

## **ITEM 4.**                         Removed andReserved.

## ** **

None.

 

## **ITEM 5.**                         OtherInformation.

## ** **

None.

 

**ITEM 6.**                         Exhibits.

** **

2.1           Agreement and Plan of Mergerdated as of April 18, 2010, by and among Cornell Companies, Inc., TheGEO Group and GEO Acquisition III, Inc. (incorporated by reference from Exhibit 2.1to the Company’s Current Report on Form 8-K filed with the SEC on April 19,2010).

3.1           Third Amended and RestatedBylaws of Cornell Companies, Inc. (incorporated by reference from exhibit3.2 to the Company’s Current Report on Form 8-K filed with the SEC on February 24,2010).

10.1         Amendment No. 2 toEmployment/Separation Agreement between Cornell Companies, Inc. and JohnR. Nieser dated effective as of April 16, 2010 (incorporated by referencefrom Exhibit 10.1 to the Company’s Current Report on Form 8-K filedwith the SEC on April 22, 2010).

31.1*       Section 302Certification of Chief Executive Officer

31.2*       Section 302Certification of Chief Financial Officer

32.1**    Section 906Certification of Chief Executive Officer

32.2**    Section 906Certification of Chief Financial Officer

 

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| *  | Filed herewith      |
|----|---------------------|
| ** | Furnished  herewith |

 

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**SIGNATURES**

 

Pursuantto the requirements of Section 13 or 15(d) of the Securities ExchangeAct of 1934, the Registrant has duly caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized.

 
| ** **                        | ** ** | **CORNELL COMPANIES, INC.**                                                                                              |
|-----------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------|
|                              |       |                                                                                                                          |
|                              |       |                                                                                                                          |
| Date:  May 7, 2010 | By:        | /s/ James E. Hyman                                                                                                            |
|                              |       | JAMES E. HYMAN                                                                                                                |
|                              |       | Chief Executive Officer, President and Chairman  of the Board (Principal Executive Officer)                                   |
|                              |       |                                                                                                                          |
|                              |       |                                                                                                                          |
| Date:  May 7, 2010 | By:        | /s/ John R. Nieser                                                                                                            |
|                              |       | JOHN R. NIESER                                                                                                                |
|                              |       | Senior Vice President, Chief Financial Officer  and Treasurer (Principal Financial Officer and  Principal Accounting Officer) |

 

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