Table ofContents

 

 

 

**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**Washington, DC 20549**

 

**FORM 10-Q**

 

**x****      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES EXCHANGE ACT OF 1934**

 

**For the Quarterly Period Ended September 30, 2009**

 

**OR**

 

**o****         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES 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’s Telephone 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 o No o

 

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

 

AtNovember 6, 2009, the registrant had 14,928,619 shares of common stockoutstanding.

 

 

 

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**Cornell Companies, Inc.**

 

**Table ofContents**

 

**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 | 29       |
| Item 3.          | Quantitative  and Qualitative Disclosures About Market Risk                                 | 44       |
| Item 4.          | Controls and  Procedures                                                                    | 46       |
|             |                                                                                        |     |
| **Part II** |                                                                                        |     |
| Item 1.          | Legal Proceedings                                                                           | 47       |
| Item 1A.         | Risk Factors                                                                                | 47       |
| Item 2.          | Unregistered  Sales of Equity Securities and Use of Proceeds                                | 47       |
| Item 3.          | Defaults  Upon Senior Securities                                                            | 47       |
| Item 4.          | Submission  of Matters to a Vote of Security Holders                                        | 47       |
| Item 5.          | Other Information                                                                           | 47       |
| Item 6.          | Exhibits                                                                                    | 47       |

 

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**Forward-Looking Information**

 

Thestatements included in this quarterly report regarding future financialperformance and results of operations and other statements that are nothistorical facts are forward-looking statements within the meaning of Section 27Aof the Securities Act of 1933 and Section 21E of the Securities ExchangeAct of 1934.  Forward-looking statementsin this quarterly report include, but are not limited to, statements about thefollowing subjects:

 

·                  revenues,

·                  revenue mix,

·                  expenses, including personnel and medicalcosts,

·                  results of operations,

·                  operating margins,

·                  supply and demand,

·                  market outlook in our various markets,

·                  our other expectations with regard tomarket outlook,

·                  utilization,

·                  parolee, detainee, inmate and youthoffender trends,

·                  pricing and per diem rates,

·                  contract commencements,

·                  new contract opportunities,

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

·                  the timing (including ramp of facilitypopulation) and other aspects of planned expansions, including withoutlimitation the D. Ray James Prison and Walnut Grove Youth Correctional Facilityexpansions, and client contracts for such facilities,

·                  the construction and lease of the new facility in Hudson,Colorado and our contract with the Alaska Department of Corrections, includingthe timing of the ramp of facility population,

·                  adequacy of insurance,

·                  debt levels,

·                  debt reduction,

·                  common stock repurchases,

·                  the effect of FIN No. 48,

·                  our effective tax rate,

·                  tax assessments,

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

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

·                  financial markets,

·                  cash flow from operations,

·                  adequacy of cash flow for ourobligations,

·                  capital requirements,

·                  capital expenditures,

·                  effects of accounting changes andadoption of accounting policies,

·                  changes in laws and regulations,

·                  adoption of accounting policies,

·                  benefit payments, and

·                  changes in laws and regulations.

 

Forward-lookingstatements in this quarterly report are identifiable by, but not limited to,the use of the following words and other similar expressions among others:

 

·               “anticipates”

·               “believes”

·               “budgets”

·               “could”

·               “estimates”

·               “expects”

·               “forecasts”

 

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·               “intends”

·               “may”

·               “might”

·               “plans”

·               “predicts”

·               “projects”

·               “scheduled”

·               “should”

 

Such statementsare subject to numerous risks, uncertainties and assumptions, including, butnot limited to:

 

·                  those described (in the Company’s 2008Annual Report on Form 10-K) under “Item 1A. Risk Factors,” as filed withthe SEC,

·                  the adequacy of sources of liquidity,

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

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

 

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

 

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

 

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**PART I FINANCIAL INFORMATION**

**ITEM 1.****                ****FinancialStatements.**

 

**CORNELL COMPANIES, INC.**

**CONSOLIDATED BALANCE SHEETS**

**(Unaudited)**

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

 
| ** **                                                                                                                                                            | ** ** | **September 30,  2009** | ** ** | **December 31,  2008** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| **ASSETS**                                                                                                                                                            | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| **CURRENT ASSETS:**                                                                                                                                                   | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Cash and cash equivalents                                                                                                                                             |       | $                            | 4,972      |                        | $          | 14,613 |   |
| Accounts receivable — trade (net of allowance for  doubtful accounts of $4,899 and $4,272, respectively)                                                    |       | 74,971                       |       | 64,622                      |       |
| Other receivables                                                                                                                                                     |       | 4,523                        |       | 4,766                       |       |
| Bond fund payment account and other restricted  assets                                                                                                                |       | 26,904                       |       | 31,370                      |       |
| Deferred tax assets                                                                                                                                                   |       | 10,562                       |       | 9,151                       |       |
| Prepaid expenses and other                                                                                                                                            |       | 5,702                        |       | 6,368                       |       |
| **Total current assets**                                                                                                                                              |       | 127,634                      |       | 130,890                     |       |
| **PROPERTY AND EQUIPMENT, net**                                                                                                                                       |       | 451,944                      |       | 450,354                     |       |
| **OTHER ASSETS:**                                                                                                                                                     |       |                         |       |                        |       |
| Debt service reserve fund                                                                                                                                             |       | 23,370                       |       | 23,750                      |       |
| Goodwill, net                                                                                                                                                         |       | 13,308                       |       | 13,308                      |       |
| Intangible assets, net                                                                                                                                                |       | 1,374                        |       | 2,320                       |       |
| Deferred costs and other                                                                                                                                              |       | 18,318                       |       | 16,299                      |       |
| **Total assets**                                                                                                                                                      |       | $                            | 635,948    |                        | $          | 636,921 |   |
|                                                                                                                                                                  |       |                         |       |                        |       |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**                                                                                                                        | ** ** | ** **                   | ** ** | ** **                  | ** ** |
|                                                                                                                                                                  |       |                         |       |                        |       |
| **CURRENT LIABILITIES:**                                                                                                                                              | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Accounts payable and accrued liabilities                                                                                                                              |       | $                            | 57,432     |                        | $          | 69,093 |   |
| Current portion of long-term debt                                                                                                                                     |       | 13,413                       |       | 12,412                      |       |
| **Total current liabilities**                                                                                                                                         |       | 70,845                       |       | 81,505                      |       |
| **LONG-TERM DEBT, net of current  portion**                                                                                                                           |       | 292,798                      |       | 308,070                     |       |
| **DEFERRED TAX LIABILITIES**                                                                                                                                          |       | 18,854                       |       | 17,491                      |       |
| **OTHER LONG-TERM LIABILITIES**                                                                                                                                       |       | 1,973                        |       | 1,688                       |       |
| **Total liabilities**                                                                                                                                                 |       | 384,470                      |       | 408,754                     |       |
|                                                                                                                                                                  |       |                         |       |                        |       |
| **COMMITMENTS AND CONTINGENCIES**                                                                                                                                     | ** ** | ** **                   | ** ** | ** **                  | ** ** |
|                                                                                                                                                                  |       |                         |       |                        |       |
| **STOCKHOLDERS’ EQUITY:**                                                                                                                                        | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Preferred stock, $.001 par value, 10,000,000  shares authorized, none issued                                                                                          |       | —                       |       | —                      |       |
| Common stock, $.001 par value, 30,000,000 shares  authorized, 16,412,802 and 16,238,685 shares issued and 14,924,916 and  14,732,522 shares outstanding, respectively |       | 16                           |       | 16                          |       |
| Additional paid-in capital                                                                                                                                            |       | 167,534                      |       | 164,746                     |       |
| Retained earnings                                                                                                                                                     |       | 92,500                       |       | 73,318                      |       |
| Accumulated other comprehensive income                                                                                                                                |       | 1,485                        |       | 1,676                       |       |
| Treasury stock (1,487,886 and 1,506,163 shares of  common stock, at cost, respectively)                                                                               |       | (11,888                      | )          | (12,034                     | )          |
| **Total Cornell  Companies, Inc.**                                                                                                                               |       | 249,647                      |       | 227,722                     |       |
| Non-controlling interest                                                                                                                                              |       | 1,831                        |       | 445                         |       |
| **Total stockholders’ equity**                                                                                                                                   |       | 251,478                      |       | 228,167                     |       |
| **Total liabilities and  stockholders’ equity**                                                                                                                  |       | $                            | 635,948    |                        | $          | 636,921 |   |

 

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

 

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**CORNELL COMPANIES,INC.**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME**

**(Unaudited)**

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

 
| ** **                                                                                                                         | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                                                         | ** ** | **2009**                                             | ** ** | **2008**                                            | ** ** | **2009** | ** ** | **2008** | ** ** |
|                                                                                                                               |       |                                                 |       |                                                |       |   |   |   |   |
| REVENUES                                                                                                                           |       | $                                                    | 103,279    |                                                | $          | 95,187 |   | $ | 308,323 |   | $ | 285,225 |   |
| OPERATING  EXPENSES, EXCLUDING DEPRECIATION AND AMORTIZATION                                                                       |       | 74,419                                               |       | 71,234                                              |       | 222,044 |   | 209,723 |   |
| DEPRECIATION  AND AMORTIZATION                                                                                                     |       | 4,460                                                |       | 4,466                                               |       | 14,093 |   | 12,843 |   |
| GENERAL AND  ADMINISTRATIVE EXPENSES                                                                                               |       | 5,806                                                |       | 5,450                                               |       | 18,214 |   | 19,217 |   |
|                                                                                                                               |       |                                                 |       |                                                |       |   |   |   |   |
| INCOME FROM  OPERATIONS                                                                                                            |       | 18,594                                               |       | 14,037                                              |       | 53,972 |   | 43,442 |   |
|                                                                                                                               |       |                                                 |       |                                                |       |   |   |   |   |
| INTEREST  EXPENSE                                                                                                                  |       | 6,500                                                |       | 6,162                                               |       | 19,435 |   | 19,074 |   |
| INTEREST  INCOME                                                                                                                   |       | (124                                                 | )          | (408                                                | )          | (530 | ) | (1,459 | ) |
|                                                                                                                               |       |                                                 |       |                                                |       |   |   |   |   |
| INCOME BEFORE  PROVISION FOR INCOME TAXES AND NON-CONTROLLING INTEREST                                                             |       | 12,218                                               |       | 8,283                                               |       | 35,067 |   | 25,827 |   |
|                                                                                                                               |       |                                                 |       |                                                |       |   |   |   |   |
| PROVISION FOR  INCOME TAXES                                                                                                        |       | 5,012                                                |       | 3,368                                               |       | 14,499 |   | 10,931 |   |
|                                                                                                                               |       |                                                 |       |                                                |       |   |   |   |   |
| NET INCOME                                                                                                                         |       | 7,206                                                |       | 4,915                                               |       | 20,568 |   | 14,896 |   |
|                                                                                                                               |       |                                                 |       |                                                |       |   |   |   |   |
| NON-CONTROLLING  INTEREST                                                                                                          |       | 513                                                  |       | 87                                                  |       | 1,386 |   | 87 |   |
|                                                                                                                               |       |                                                 |       |                                                |       |   |   |   |   |
| INCOME  AVAILABLE TO STOCKHOLDERS                                                                                                  |       | $                                                    | 6,693      |                                                | $          | 4,828 |   | $ | 19,182 |   | $ | 14,809 |   |
|                                                                                                                               |       |                                                 |       |                                                |       |   |   |   |   |
| EARNINGS PER  SHARE:                                                                                                               |       |                                                 |       |                                                |       |   |   |   |   |
| BASIC                                                                                                                              |       | $                                                    | .45        |                                                | $          | .33 |   | $ | 1.29 |   | $ | 1.01 |   |
| DILUTED                                                                                                                            |       | $                                                    | .45        |                                                | $          | .32 |   | $ | 1.28 |   | $ | 1.00 |   |
|                                                                                                                               |       |                                                 |       |                                                |       |   |   |   |   |
| NUMBER OF  SHARES USED IN PER SHARE COMPUTATION:                                                                                   |       |                                                 |       |                                                |       |   |   |   |   |
| BASIC                                                                                                                              |       | 14,886                                               |       | 14,734                                              |       | 14,880 |   | 14,715 |   |
| DILUTED                                                                                                                            |       | 14,995                                               |       | 14,915                                              |       | 14,968 |   | 14,867 |   |
|                                                                                                                               |       |                                                 |       |                                                |       |   |   |   |   |
| COMPREHENSIVE  INCOME:                                                                                                             |       |                                                 |       |                                                |       |   |   |   |   |
| Net income                                                                                                                         |       | $                                                    | 7,206      |                                                | $          | 4,915 |   | $ | 20,568 |   | $ | 14,896 |   |
| Other  comprehensive income, net of tax: Unrealized gain on derivative instruments,  net of tax provision of $324 and $406 in 2008 |       | —                                               |       | 467                                                 |       | — |   | 584 |   |
| Total other comprehensive  income, net of tax                                                                                      |       | 7,206                                                |       | 5,382                                               |       | 20,568 |   | 15,480 |   |
| Comprehensive  income attributable to non-controlling interest                                                                     |       | 513                                                  |       | 87                                                  |       | 1,386 |   | 87 |   |
| Comprehensive  income attributable to Cornell Companies, Inc.                                                                      |       | $                                                    | 6,693      |                                                | $          | 5,295 |   | $ | 19,182 |   | $ | 15,393 |   |

 

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

 

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**CORNELL COMPANIES, INC.**

### ***CONSOLIDATED STATEMENT OFSTOCKHOLDERS’ EQUITY***

### ***AND COMPREHENSIVE INCOME***

**FOR THE NINE MONTHS ENDED SEPTEMBER 30, 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                                                               |       | —                |       | —         |       | —      |       | 19,182       |       | —                  |       | —                 |       | —          |       | 1,386                  |       | 20,568            |       | 19,182 |   |
| COMPREHENSIVE  INCOME                                                     |       | —                |       | —         |       | —      |       | —       |       | —                  |       | —                 |       | —          |       | —                 |       | —            |       | $ | 19,182 |   |
| EXERCISE  OF STOCK OPTIONS                                                |       | 2,550                 |       | —         |       | 32          |       | —       |       | —                  |       | —                 |       | —          |       | —                 |       | 32                |       |   |   |
| INCOME  TAX BENEFIT/(EXPENSE) FROM STOCK OPTION EXERCISES                 |       | —                |       | —         |       | (71         | )          | —       |       | —                  |       | —                 |       | —          |       | —                 |       | (71               | )          |   |   |
| DEFERRED  AND OTHER STOCK COMPENSATION                               |       | 158,783               |       | —         |       | 2,347       |       | —       |       | —                  |       | —                 |       | —          |       | —                 |       | 2,347             |       |   |   |
| AMORTIZATION  OF GAIN ON TERMINATION OF DERIVATIVE                        |       | —                |       | —         |       | —      |       | —       |       | —                  |       | —                 |       | (191            | )          | —                 |       | (191              | )          |   |   |
| ISSUANCE  OF COMMON STOCK TO EMPLOYEE STOCK PURCHASE PLAN       |       | —                |       | —         |       | 143         |       | —       |       | (18,277                 | )          | 146                    |       | —          |       | —                 |       | 289               |       |   |   |
| ISSUANCE  OF COMMON STOCK UNDER 2000 DIRECTOR’S STOCK PLAN |       | 12,784                |       | —         |       | 337         |       | —       |       | —                  |       | —                 |       | —          |       | —                 |       | 337               |       |   |   |
|                                                                      |       |                  |       |           |       |        |       |         |       |                    |       |                   |       |            |       |                   |       |              |       |   |   |
| BALANCES  AT SEPTEMBER 30, 2009                                           |       | 16,412,802            |       | $              | 16         |        | $          | 167,534      |       | $                       | 92,500     |                   | 1,487,886  |            | $          | (11,888                | )          | $                 | 1,485      |   | $ | 1,831 |   | $ | 251,478 |   |   |   |

 

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

 

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**CORNELL COMPANIES, INC.**

### ***CONSOLIDATED STATEMENT OFSTOCKHOLDERS’ EQUITY***

### ***AND COMPREHENSIVE INCOME***

**FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2008**

**(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, 2007                                             |       | 16,068,677            |       | $              | 16         |        | $          | 160,319      |       | $                       | 51,127     |                   | 1,515,046  |            | $          | (12,105                | )          | $                 | 1,092      |   | $ | — |   | $ | 200,449 |   | $ | — |   |
|                                                                      |       |                  |       |           |       |        |       |         |       |                    |       |                   |       |            |       |                   |       |              |       |   |   |
| NET INCOME                                                                |       | —                |       | —         |       | —      |       | 14,896       |       | —                  |       | —                 |       | —          |       | 87                     |       | 14,809            |       | 14,809 |   |
| UNREALIZED GAIN ON DERIVATIVE INSTRUMENTS, NET OF  TAXES OF $406          |       | —                |       | —         |       | —      |       | —       |       | —                  |       | —                 |       | 584             |       | —                 |       | 584               |       | 584 |   |
| COMPREHENSIVE INCOME                                                      |       | —                |       | —         |       | —      |       | —       |       | —                  |       | —                 |       | —          |       | —                 |       | —            |       | $ | 15,393 |   |
| EXERCISE OF STOCK OPTIONS                                                 |       | 36,390                |       | —         |       | 444         |       | —       |       | —                  |       | —                 |       | —          |       | —                 |       | 444               |       |   |   |
| INCOME TAX BENEFIT/(EXPENSE) FROM STOCK OPTION  EXERCISES                 |       | —                |       | —         |       | 140         |       | —       |       | —                  |       | —                 |       | —          |       | —                 |       | 140               |       |   |   |
| DEFERRED AND OTHER STOCK COMPENSATION                                |       | 144,637               |       | —         |       | 2,220       |       | —       |       | —                  |       | —                 |       | —          |       | —                 |       | 2,220             |       |   |   |
| ISSUANCE OF COMMON STOCK TO EMPLOYEE  STOCK PURCHASE PLAN       |       | —                |       | —         |       | 82          |       | —       |       | (8,883                  | )          | 71                     |       | —          |       | —                 |       | 153               |       |   |   |
| ISSUANCE OF COMMON STOCK UNDER 2000 DIRECTOR’S  STOCK PLAN |       | 10,761                |       | —         |       | 380         |       | —       |       | —                  |       | —                 |       | —          |       | —                 |       | 380               |       |   |   |
|                                                                      |       |                  |       |           |       |        |       |         |       |                    |       |                   |       |            |       |                   |       |              |       |   |   |
| BALANCES AT SEPTEMBER 30, 2008                                            |       | 16,260,465            |       | $              | 16         |        | $          | 163,585      |       | $                       | 66,023     |                   | 1,506,163  |            | $          | (12,034                | )          | $                 | 1,676      |   | $ | 87 |   | $ | 219,179 |   |   |   |

 

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

 

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**CORNELLCOMPANIES, INC.**

# **CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(Unaudited)**

**(in thousands)**

 
| ** **                                                                                               | ** ** | **Nine Months Ended** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                                               | ** ** | **September 30,**          | ** ** |
| ** **                                                                                               | ** ** | **2009**                        | ** ** | **2008** | ** ** |
| CASH FLOWS  FROM OPERATING ACTIVITIES:                                                                   |       |                            |       |   |   |
| Net income                                                                                               |       | $                               | 20,568     |   | $ | 14,896 |   |
| Adjustments  to reconcile net income to net cash provided by operating activities -                      |       |                            |       |   |   |
| Depreciation                                                                                             |       | 13,147                          |       | 11,386 |   |
| Amortization  of intangibles and other assets                                                            |       | 946                             |       | 1,593 |   |
| Impairment of  long-lived assets                                                                         |       | —                          |       | 250 |   |
| Amortization  of deferred financing costs                                                                |       | 950                             |       | 952 |   |
| Amortization  of Senior Notes discount                                                                   |       | 138                             |       | 138 |   |
| Amortization  of gain on termination of derivative                                                       |       | (191                            | )          | — |   |
| Stock-based  compensation                                                                                |       | 2,618                           |       | 2,519 |   |
| Provision for  bad debts                                                                                 |       | 702                             |       | 1,638 |   |
| (Gain)loss on  sale/disposals of property and equipment                                                  |       | (1,046                          | )          | 82 |   |
| Deferred  income taxes                                                                                   |       | (119                            | )          | 341 |   |
| Change in  assets and liabilities:                                                                       |       |                            |       |   |   |
| Accounts  receivable                                                                                     |       | (11,021                         | )          | (12,569 | ) |
| Other restricted  assets                                                                                 |       | 223                             |       | (806 | ) |
| Other assets                                                                                             |       | (1,558                          | )          | (4,747 | ) |
| Accounts  payable and accrued liabilities                                                                |       | (13,969                         | )          | 5,531 |   |
| Other  long-term liabilities                                                                             |       | 285                             |       | (238 | ) |
| Net cash  provided by operating activities                                                               |       | 11,673                          |       | 20,966 |   |
|                                                                                                     |       |                            |       |   |   |
| CASH FLOWS  FROM INVESTING ACTIVITIES:                                                                   |       |                            |       |   |   |
| Capital  expenditures                                                                                    |       | (14,456                         | )          | (59,282 | ) |
| Sales of  investment securities                                                                          |       | —                          |       | 250 |   |
| Proceeds from  insurance recoveries and proceeds from sale of property and equipment                     |       | 2,608                           |       | 791 |   |
| Withdrawals  from restricted debt payment account, net                                                   |       | 4,623                           |       | 3,702 |   |
| Net cash used  in investing activities                                                                   |       | (7,225                          | )          | (54,539 | ) |
|                                                                                                     |       |                            |       |   |   |
| CASH FLOWS  FROM FINANCING ACTIVITIES:                                                                   |       |                            |       |   |   |
| Proceeds from  line of credit                                                                            |       | 2,000                           |       | 43,000 |   |
| Payments of  line of credit                                                                              |       | (4,000                          | )          | — |   |
| Payment of  MCF bonds                                                                                    |       | (12,400                         | )          | (11,400 | ) |
| Tax benefit  of stock option exercises                                                                   |       | —                          |       | 140 |   |
| Payments of  capital lease obligations                                                                   |       | (10                             | )          | (8 | ) |
| Proceeds from  exercise of stock options and employee stock purchase plan contributions                  |       | 321                             |       | 597 |   |
| Net cash  provided by (used in) financing activities                                                     |       | (14,089                         | )          | 32,329 |   |
|                                                                                                     |       |                            |       |   |   |
| NET DECREASE IN  CASH AND CASH EQUIVALENTS                                                               |       | (9,641                          | )          | (1,244 | ) |
| CASH AND CASH  EQUIVALENTS AT BEGINNING OF PERIOD                                                        |       | 14,613                          |       | 3,028 |   |
| CASH AND CASH  EQUIVALENTS AT END OF PERIOD                                                              |       | $                               | 4,972      |   | $ | 1,784 |   |
|                                                                                                     |       |                            |       |   |   |
| OTHER  NON-CASH INVESTING AND FINANCING ACTIVITIES:                                                      |       |                            |       |   |   |
| Other  comprehensive income, net of tax                                                                  |       | $                               | —     |   | $ | 584 |   |
| Common stock  issued for board of directors fees                                                         |       | 337                             |       | 380 |   |
| Purchases and  additions to property and equipment included in accounts payable and accrued  liabilities |       | 1,844                           |       | 10,322 |   |
| Tax  benefit/(expense) of stock option exercises                                                         |       | (71                             | )          | — |   |

 

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

 

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**CORNELL COMPANIES, INC.****NOTES TO CONSOLIDATED FINANCIAL 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 audited financialstatements but does not include all disclosures required by GAAP. In theopinion of management, adjustments and disclosures necessary for a fairpresentation of these financial statements have been included.  Estimates were used in the preparation of thesefinancial statements.  Actual resultscould differ from those estimates.  Thesefinancial statements should be read in conjunction with the financialstatements and notes thereto included in the Company’s 2008 Annual Report on Form 10-Kas filed with the Securities and Exchange Commission.

 

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

 

Seea description of our accounting policies in the Notes to Consolidated FinancialStatements included in our 2008 Annual Report on Form 10-K.

 

**3.****             ****Stock-BasedCompensation**

 

We have an employee stock purchase plan (“ESPP”) under whichemployees can make contributions to purchase our common stock. Participation inthe plan is elected annually by employees. The plan year 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. Ouremployee-stock purchase plan is considered to be a compensatory ESPP, andtherefore, we recognize compensation expense over the requisite service periodfor grants made under the ESPP. Compensation expense of approximately $0.08million was recognized in each of the nine months ended September 30, 2009 and2008.

 

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 the Company.Grants of stock options made to date under these plans vest over periods up toseven years after the date of grant and expire no later than 10 years aftergrant.

 

At September 30,2008, 202,000 shares of restricted stock were outstanding subject toperformance-based vesting criteria (32,500 of these restricted shares wereconsidered market-based restricted stock). There were also 52,700 stock optionsoutstanding subject to performance-based vesting criteria. We recognized $0.04million and $0.6 million of expense associated with these shares of restrictedstock and stock options during the three and nine months ended September 30,2008, respectively.

 

At September 30,2009, 317,227 shares of restricted stock were outstanding subject toperformance-based vesting criteria (32,500 of these restricted shares wereconsidered market-based restricted stock). There were also 6,260 stock optionsoutstanding subject to performance-based vesting criteria. We recognized $0.4million and $0.9 million of expense associated with these shares of restrictedstock and stock options during the three and nine months ended September 30,2009, respectively.

 

The amounts above relate to the impact of recognizingcompensation expense related to stock options and restricted stock.Compensation expense related to stock options (6,260 shares) and restrictedstock (284,727 shares) that vest based upon performance conditions is notrecorded for such performance-based awards until it has been deemed probablethat the related performance targets allowing the vesting of these options andrestricted stock will be met. We are required to periodically re-assess theprobability that these performance-based awards will vest and record expense atthat point in time. During the nine months ended September 30, 2009, itwas deemed probable that certain performance targets pertaining to certainrestricted stock and stock options would be achieved by their vesting date.Accordingly, compensation expense of approximately $0.8 million was recognizedin the nine months ended September 30, 2009 related to these stock-basedawards.

 

We recognizeexpense for our stock-based compensation over the vesting period, or in thecase of performance-based awards, during the service period for which theperformance target becomes probable of being met, which represents the periodin which an employee is required to provide service in exchange for the award.We recognize compensation expense for stock-based awards immediately if theaward has immediate vesting.

 

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***Assumptions***

 

The fair values for thesignificant stock-based awards granted during the nine months ended September 30,2009 and 2008 were estimated at the date of grant using a Black-Scholes optionpricing model with the following weighted-average assumptions:

 
| ** **                       | ** ** | **Nine Months Ended  September 30,** | ** ** |
|----------------------------------|------------|-----------------------------------------------------|------------|
| ** **                       | ** ** | **2009**                                            | ** ** | **2008** | ** ** |
|                             |       |                                                |       |   |   |
| Risk-free rate of return         |       | 1.90                                                | %          | 3.35 | % |
| Expected life of award           |       | 6.0 years                                           |       | 5.7 years |   |
| Expected dividend yield of stock |       | 0                                                   | %          | 0 | % |
| Expected volatility of stock     |       | 50.49                                               | %          | 38.74 | % |
| Weighted-average fair value      |       | $                                                   | 8.89       |   | $ | 9.46 |   |
|                                  |            |                                                     |            |  |  |  |  |

 

Theexpected volatility of stock assumption was derived by referring to changes inthe Company’s historical common stock prices over a timeframe similar to that of the expected lifeof the award. We do not believe that future stock volatility will significantlydiffer from historical stock volatility. Estimated forfeiture rates are derivedfrom historical forfeiture patterns. We believe the historical experiencemethod is the best estimate of forfeitures currently available.

 

Generally we consideredthe “simplified” method for “plain vanilla” options to estimate the expectedterm of options granted during 2009 and 2008 (where appropriate).  For those grants during these periods whereinwe had sufficient historical or impartial data to better estimate the expectedterm, we have done so.

 

Stock-based options awardactivity during the nine months ended September 30, 2009 was as follows(aggregate intrinsic value in millions):

 
| ** **                                              | ** ** | **Number  of  Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Remaining  Contractual  Term** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|---------------------------------------------------------|------------|------------------------|------------|----------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------|------------|
|                                                    |       |                   |       |                                   |       |                                                |       |                            |       |
| Outstanding at December 31, 2008                   |       | 485,699                |       | $                                      | 15.03      |                                                | 6.5        |                            | $          | 7.3 |   |
| Granted                                                 |       | 40,000                 |       | 17.98                                  |       |                                                |       |                            |       |
| Exercised                                               |       | (2,550                 | )          | 12.71                                  |       |                                                |       |                            |       |
| Canceled                                                |       | (8,467                 | )          | 14.11                                  |       |                                                |       |                            |       |
|                                                    |       |                   |       |                                   |       |                                                |       |                            |       |
| Outstanding at September 30, 2009                  |       | 514,682                |       | $                                      | 15.29      |                                                | 6.1        |                            | $          | 7.9 |   |
|                                                    |       |                   |       |                                   |       |                                                |       |                            |       |
| Vested and expected to vest at September 30,  2009 |       | 513,090                |       | $                                      | 15.27      |                                                | 6.1        |                            | $          | 7.7 |   |
|                                                    |       |                   |       |                                   |       |                                                |       |                            |       |
| Exercisable at September 30, 2009                  |       | 483,912                |       | $                                      | 15.02      |                                                | 6.0        |                            | $          | 7.3 |   |

 

Thetotal intrinsic value of stock options exercised during the nine months ended September 30,2009 and 2008 was $0.01 million and $0.5 million, respectively. Net cashproceeds from the exercise of stock options were approximately $0.03 and $0.6million for the nine months ended September 30, 2009 and 2008,respectively.

 

Werecognized $0.1 million and $0.4 million of expense associated with stockoptions during the three and nine months ended September 30, 2009. As of September 30,2009, approximately $0.1 million of estimated expense with respect totime-based nonvested stock-based options awards has yet to be recognized andwill be amortized into expense over the employee’s remaining requisite serviceperiod of approximately 6.6 months.

 

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Thefollowing table summarizes information with respect to stock optionsoutstanding and exercisable at September 30, 2009.

 
| **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                   |       | 18,865                  |       | 2.0                                                 |       | $                                      | 5.72       |                    | 18,865     |                                   | $          | 5.72 |   |
| $10.01 to $13.50                  |       | 150,917                 |       | 4.9                                                 |       | 12.83                                  |       | 148,917                 |       | 12.82                                  |       |
| $13.51 to $14.50                  |       | 193,200                 |       | 5.9                                                 |       | 13.95                                  |       | 189,240                 |       | 13.94                                  |       |
| $14.51 to $25.00                  |       | 151,700                 |       | 8.1                                                 |       | 20.62                                  |       | 126,890                 |       | 20.58                                  |       |
|                                        |       | 514,682                 |       | 6.1                                                 |       | $                                      | 15.29      |                    | 483,912    |                                   | $          | 15.02 |   |

 

Stock-basedaward activity for nonvested awards during the nine months ended September 30,2009 is as follows:

 
| ** **                           | ** ** | **Number  of  Shares** | ** ** | **Weighted Average  Grant Date  Fair Value** | ** ** |
|--------------------------------------|------------|------------------------|------------|-------------------------------------------------------------|------------|
| Nonvested at December 31, 2008  |       | 95,118                 |       | $                                                           | 16.09      |   |
| Granted                              |       | 40,000                 |       | 17.98                                                       |       |
| Vested                               |       | (104,348               | )          | 15.81                                                       |       |
| Canceled                             |       | —                 |       | —                                                      |       |
|                                 |       |                   |       |                                                        |       |
| Nonvested at September 30, 2009 |       | 30,770                 |       | $                                                           | 19.51      |   |

 

***Restricted Stock***

 

We have previously issuedrestricted stock under certain employment agreements and stock incentive planswhich vests either over a specific period of time, generally three to fiveyears, or which will vest subject to certain market or performanceconditions.  During the nine months endedSeptember 30, 2009, we issued restricted stock as part of our normalequity awards under our 2006 Incentive Plan. These shares of restricted common stock are subject to restrictions ontransfer and certain conditions to vesting.

 

Restricted stock activityfor the nine months ended September 30, 2009 was as follows:

 
| ** **                           | ** ** | **Number  of  Shares** | ** ** | **Weighted Average  Grant Date  Fair Value** | ** ** |
|--------------------------------------|------------|------------------------|------------|-------------------------------------------------------------|------------|
| Nonvested at December 31, 2008  |       | 403,124                |       | $                                                           | 22.44      |   |
| Granted                              |       | 176,800                |       | 16.81                                                       |       |
| Vested                               |       | (55,693                | )          | 21.95                                                       |       |
| Canceled                             |       | (657                   | )          | 22.27                                                       |       |
|                                 |       |                   |       |                                                        |       |
| Nonvested at September 30, 2009 |       | 523,574                |       | $                                                           | 20.59      |   |

 

We recognized $0.4million and $1.2 million of expense associated with nonvested time-basedrestricted stock awards during the three and nine months ended September 30,2009, respectively.  As of September 30,2009, approximately $2.0 million of estimated expense with respect to nonvestedtime-based restricted stock awards had yet to be recognized and will beamortized over a weighted average period of 2.0 years. Approximately$5.0 million of estimated expense with respect to nonvested performance-basedrestricted stock option awards had yet to be recognized as of September 30,2009.

 

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**4.****             ****IntangibleAssets**

 

Intangibleassets at September 30, 2009 and December 31, 2008 consisted of thefollowing (in thousands):

 
| ** **                                             | ** ** | **September 30,  2009** | ** ** | **December 31,  2008** | ** ** |
|--------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
|                                                   |       |                         |       |                        |       |
| Non-compete agreements                                 |       | $                            | 8,200      |                        | $          | 8,200 |   |
| Accumulated amortization — non-compete agreements |       | (8,142                       | )          | (7,595                      | )          |
| Acquired contract value                                |       | 6,240                        |       | 6,240                       |       |
| Accumulated amortization — contract value         |       | (4,924                       | )          | (4,525                      | )          |
| Identified intangibles, net                            |       | 1,374                        |       | 2,320                       |       |
| Goodwill                                               |       | 13,308                       |       | 13,308                      |       |
| Total intangibles                                      |       | $                            | 14,682     |                        | $          | 15,628 |   |

 

There were no changes in the carryingamount of goodwill in the nine months ended September 30, 2009.

 

Amortizationexpense for our non-compete agreements was approximately $0.2 million for eachof the three months ended September 30, 2009 and 2008 and approximately$0.5 million and $0.6 million for the nine months ended September 30, 2009and 2008, respectively.

 

Amortizationexpense for our acquired contract value was approximately $0.1 million and $0.3million for the three months ended September 30, 2009 and 2008,respectively, and approximately $0.4 million and $0.8 million for the ninemonths ended September 30, 2009 and 2008, respectively.

 

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

 

On January 1, 2008we adopted a newly issued accounting standard for fair value measurements offinancial assets and liabilities which did not have a material financial impacton our consolidated results of operations or financial condition.  On January 1, 2009, we adopted theprovisions of this new accounting pronouncement for applying fair value tonon-financial assets, liabilities and transactions on a non-recurringbasis.  Adoption of the provisions forfair value measurements on a non-recurring basis did not have a material effecton our financial position, results of operations or cash flows.

 

As defined in thisaccounting standard, fair value is the price that would be received to sell anasset or paid to transfer a liability in an orderly transaction between marketparticipants 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). |

 

As required, financialassets and liabilities are classified based on the lowest level of input thatis significant for the fair value measurement. The following table summarizes the valuation of our financial assets andliabilities by pricing levels as of September 30, 2009:

 
| ** **         | ** ** | **Fair Value as of September 30, 2009 (in thousands)** | ** ** |
|--------------------|------------|------------------------------------------------------------------------------------------------|------------|
| ** **         | ** ** | **Level 1**                                                                               | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Total** | ** ** |
| Assets:            |       |                                                                                           |       |   |   |   |   |   |   |
| Corporate Bonds    |       | $                                                                                              | —     |   | $ | 3,907 |   | $ | — |   | $ | 3,907 |   |
| Money Market Funds |       | —                                                                                         |       | 42,778 |   | — |   | 42,778 |   |
|                    |            |                                                                                                |            |  |  |  |  |  |  |  |  |  |  |

 

The corporate bonds andmoney market funds are carried in debt service fund and other restricted assetsand the debt service reserve fund in the accompanying balance sheet. The fairvalue measurements for corporate bonds and money-market funds are based uponthe quoted price for similar assets in markets that are not active, multipliedby the number of shares owned, exclusive of any 

 

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transaction costs and withoutany adjustments to reflect discounts that may be applied to selling a largeblock of the securities at one time. The Company does not believe that thechanges in fair value of these assets will materially differ from the amountsthat could be realized upon settlement or that the changes in fair value willhave a material effect on the Company’s results of operations, liquidity andcapital resources.

 

This accounting standard requires a reconciliationof the beginning and ending balances for fair value measurements using Level 3inputs.  We had no such assets orliabilities which were measured at fair value on a recurring basis usingsignificant unobservable inputs (level 3) during the three and nine months endedSeptember 30, 2009.

 

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

 

In December 2007,the FASB revised the authoritative guidance for business combinations whichestablishes principles and requirements for how the acquirer in a businesscombination (1) recognizes and measures in its financial statements the identifiableassets acquired, the liabilities assumed and any noncontrolling interest in theacquiree, (2) recognizes and measures the goodwill acquired in thebusiness combination or a gain from a bargain purchase and (3) determineswhat information to disclose to enable users of the financial statements toevaluate the nature and financial effects of the business combination. Thisguidance applies prospectively to business combinations for which theacquisition date is on or after the beginning of the first annual reportingperiod beginning on or after December 15, 2008.  Our adoption of this revised guidance on January 1,2009 did not have any impact on our consolidated results of operations orfinancial condition as we did not have any business combination activity in thenine months ended September 30, 2009.

 

Additionally, the FASBamended the factors that should be considered in developing renewal orextension assumptions used to determine the useful life of a recognizedintangible asset to improve the consistency between the useful life of arecognized intangible asset and the period of expected cash flows used tomeasure the fair value of the asset under the current guidance concerningbusiness combinations and other U.S. generally accepted accounting principles.  This new guidance is effective for financialstatements issued for fiscal years beginning after December 15, 2008, andinterim periods within those fiscal years. Our adoption of the new guidance on January 1, 2009 did not have asignificant impact on our consolidated financial position, results ofoperations or cash flows.

 

In December 2007,the FASB issued authoritative guidance which established new accounting andreporting standards for the noncontrolling interest in a subsidiary and for thedeconsolidation of a subsidiary.  The newguidance requires the recognition of a noncontrolling interest (minorityinterest) as equity in the consolidated financial statements and separate fromthe parent’s equity.  The amount of netincome attributable to the noncontrolling interest will be included inconsolidated net income on the face of the income statement.  This guidance clarifies that changes in aparent’s ownership interest in a subsidiary that do not result indeconsolidation are equity transactions if the parent retains its controllingfinancial interest.  In addition, itrequires that a parent recognize a gain or loss in net income when a subsidiaryis deconsolidated.  Such gain or losswill be measured using the fair value of the noncontrolling equity investmenton the deconsolidation date. Additionally, there are expanded disclosure requirements regarding theinterests of the parent and its noncontrolling interest.  This guidance is effective for fiscal years,and interim periods within those fiscal years, beginning on or after December 15,2008.  We adopted the new guidance on January 1,2009 and applied the provisions to our 2009 financial statements andretroactively to all prior periods presented.

 

In March 2008, theFASB issued new authoritative guidance to improve financial reporting aboutderivatives and hedging activities by requiring enhanced qualitative andquantitative disclosures regarding derivative instruments, gains and losses onsuch instruments and their effects on an entity’s financial position, financialperformance and cash flows.  Our adoptionof this new guidance on January 1, 2009 did not have a significant impacton our consolidated financial position, results of operations or cash flows.

 

In May 2008, theFASB issue new authoritative guidance which establishes general standards ofaccounting and disclosure of events that occur after the balance sheet date butbefore the financial statements are issued. This guidance sets forth (1) the period after the balance sheetdate during which management should evaluate events or transactions that mayoccur for potential recognition or disclosure in the financial statements, (2) thecircumstances under which an entity should recognize events or transactionsoccurring after the balance sheet date and (3) the disclosures an entityshould make about such events or transactions. Management has performed a review of our subsequent events andtransactions through November 6, 2009, which is the date the financialstatements are issued.

 

In June 2009, theFASB issued the FASB Accounting Standards Codification (“Codification”).  The Codification became the single source forall authoritative GAAP recognized by the FASB to be applied for financialstatements issued for periods ending after September 15, 2009.  The Codification does not change GAAP and didnot have an affect on our financial position, results of operations or cashflows.

 

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**7.****             ****Future Accounting Requirements**

 

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 isprohibited.  The requirements in theamendment must be applied to transfers occurring on or after the effectivedate. We are currently evaluating the impact, if any, that such requirementsmay have on our financial statements once adopted.

 

In June 2009, theFASB also issued an amendment to the accounting and disclosure requirements forthe consolidation of variable interest entities (“VIEs”). This amendmentrequires an enterprise to perform a qualitative analysis when determiningwhether or not it must consolidate a VIE. The amendment also requires an enterprise to continuously reassesswhether it must consolidate a VIE. Additionally, the amendment requires enhanced disclosures about anenterprise’s involvement with VIEs and any significant change in risk exposuredue to that involvement, as well as how its involvement with VIEs impacts theenterprise’s financial statements. Finally, an enterprise will be required to disclose significantjudgments and assumptions used to determine whether or not to consolidate aVIE.  This amendment is effective forfinancial statements issued for fiscal years beginning after November 15,2009.  Earlier application is prohibited.We are currently evaluating the impact, if any, that this amendment may have onour financial statements once adopted.

 

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

 

At September 30,2009 and December 31, 2008, our long-term debt consisted of the following(in thousands):

 
| ** **                                                                                                                                                                  | ** ** | **September 30,  2009** | ** **    | **December 31,  2008** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|---------------|-----------------------------|------------|
| ** **                                                                                                                                                                  | ** ** | ** **                   | ** **    | ** **                  | ** ** |
| **Debt of Cornell Companies, Inc.:**                                                                                                                                   | ** ** | ** **                   | ** **    | ** **                  | ** ** |
| Senior Notes, unsecured, due July 2012 with  an interest rate of 10.75%, net of discount                                                                               |       | $                            |  111,494 |                        | $          | 111,356 |   |
| 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”) |       | 73,000                       |          | 75,000                      |       |
| Capital lease obligations                                                                                                                                                   |       | 17                           |          | 26                          |       |
| Subtotal                                                                                                                                                                    |       | 184,511                      |          | 186,382                     |       |
|                                                                                                                                                                        |       |                         |          |                        |       |
| **Debt of Special Purpose Entity:**                                                                                                                                         | ** ** | ** **                   | ** **    | ** **                  | ** ** |
| 8.47% Bonds due 2016                                                                                                                                                        |       | 121,700                      |          | 134,100                     |       |
|                                                                                                                                                                        |       |                         |          |                        |       |
| Total consolidated debt                                                                                                                                                     |       | 306,211                      |          | 320,482                     |       |
|                                                                                                                                                                        |       |                         |          |                        |       |
| Less: current maturities                                                                                                                                                    |       | (13,413                      | )             | (12,412                     | )          |
|                                                                                                                                                                        |       |                         |          |                        |       |
| Consolidated long-term debt                                                                                                                                                 |       | $                            |  292,798 |                        | $          | 308,070 |   |

 

***Long-Term Credit Facilities.*** Our Amended Credit Facility provides for borrowingsup to $100.0 million (including letters of credit) and matures in December 2011.At our election, outstanding borrowings bear interest at either the LIBOR rateplus a margin ranging from 1.50% to 2.25% or a rate which ranges from 0.00% to0.75% above the applicable prime rate. The applicable margins are subject to adjustments based on our totalleverage ratio. Theavailable commitment under our Amended Credit Facility was approximately $12.1million at September 30, 2009.  Wehad outstanding borrowings under our Amended Credit Facility of $73.0 millionand we had outstanding letters of credit of approximately $14.9 million at September 30,2009.  Subject to certain requirements,we have the right to increase the commitments under our Amended Credit Facilityup to $150.0 million, although the indenture for our Senior Notes limits ourability, subject to certain conditions, to expand the Amended Credit Facilitybeyond $100.0 million.  We can provide noassurance that all of the banks that have made commitments to us under ourAmended Credit Facility would be willing to participate in an expansion to theAmended Credit Facility should we desire to do so. The Amended Credit 

 

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Facility iscollateralized by substantially all of our assets, including the assets andstock of all of our subsidiaries. The Amended Credit Facility is not secured bythe assets of Municipal Corrections Finance, LP, a special purpose entity (“MCF”).

 

Our Amended CreditFacility contains financial and other restrictive covenants that limit ourability to engage in certain activities. Our ability to borrow under the Amended Credit Facility is subject tocompliance with certain financial covenants, including bank leverage, totalleverage and fixed charge coverage ratios. At September 30, 2009, we werein 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 payment and asset dispositions; enter intotransactions with affiliates; and engage in sale/leaseback transactions.

 

MCF is obligated for the outstanding balance of its 8.47% TaxableRevenue Bonds, Series 2001.  Thebonds bear interest at a rate of 8.47% per annum and are payable in semi-annualinstallments of interest and annual installments of principal.  All unpaid principal and accrued interest onthe bonds is due on the earlier of August 1, 2016 (maturity) or as notedunder the bond documents.

 

The bonds are limited, nonrecourse obligations of MCF and securedby the property and equipment, bond reserves, assignment of subleases andsubstantially all assets related to the facilities included in the 2001 Saleand Leaseback Transaction (in which we sold eleven facilities to MCF).  The bonds are not guaranteed by Cornell.

 

In June 2004, we issued $112.0 million in principal of10.75% Senior Notes the (“Senior Notes”) due July 1, 2012.  The Senior Notes are unsecured seniorindebtedness and are guaranteed by all of our existing and future subsidiaries(collectively, the “Guarantors”).  TheSenior Notes are not guaranteed by MCF (the “Non-Guarantor”).  Interest on the Senior Notes is payablesemi-annually on January 1 and July 1 of each year, commencing January 1,2005.  On or after July 1, 2008, wemay redeem all or a portion of the Senior Notes at the redemption prices(expressed as a percentage of the principal amount) listed below, plus accruedand unpaid interest, if any, on the Senior Notes redeemed, to the applicabledate of redemption, if redeemed during the 12-month period commencing on July 1of each of the years indicated below:

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

 

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

 

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

 

At December 31,2008, the total amount of our unrecognized tax benefits was approximately $2.5million.  There were no material changesto the total amount of our unrecognized tax benefits in the three and ninemonths ended September 30, 2009.

 

Estimated interest and penaltiesrelated to the underpayment of income taxes are classified as a component ofincome tax expense in the accompanying Consolidated Statements of Income andComprehensive Income.  There were nomaterial changes to our accrued interest and penalties in the three and ninemonths ended September 30, 2009. Accrued interest and penalties were approximately $0.2 million at September 30,2009 and December 31, 2008.

 

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, 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 December 31, 2005 through December 31, 2008.  The audit of our 2006 federal income taxreturn by the Internal Revenue Service was recently concluded without materialfindings.

 

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We have state operatingloss carryforwards of approximately $34.4 million on which we have provided avaluation allowance of $3.0 million. These net operating losses expire beginning in 2008 through 2032.

 

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

 

**10.****      ****Earnings Per Share**

 

Basic earnings per share (“EPS”) are computed by dividing netincome by the weighted average number of shares of common stock outstandingduring the period.  Diluted EPS iscomputed by dividing net income by the weighted average number of shares ofcommon stock outstanding after giving effect to all potentially dilutive commonshares outstanding during the period. Potentially dilutive common shares include the dilutive effect ofoutstanding common stock options and restricted common shares granted under ourvarious option and other incentive plans. 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.

 

For the three months ended September 30, 2009, there were 101,700shares ($22.16 average price) of stock options that were not included in thecomputation of diluted EPS because to do so would have been anti-dilutive. Forthe three months ended September 30, 2008, there were no anti-dilutiveshares. For the nine months ended September 30, 2009 and 2008, there were141,700 shares ($20.98 average price) and 19,200 shares ($24.56 average price),respectively, of stock options that were not included in the computation ofdiluted EPS because to do so would have been anti-dilutive.

 

The following table summarizes the calculation of net earningsand weighted average common shares and common equivalent shares outstanding forpurposes of the computation of earnings per share (in thousands, except pershare data):

 
| ** **                                                                       | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|----------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                       | ** ** | **2009**                                             | ** ** | **2008**                                            | ** ** | **2009** | ** ** | **2008** | ** ** |
|                                                                             |       |                                                 |       |                                                |       |   |   |   |   |
| Income  available to stockholders                                                |       | $                                                    | 6,693      |                                                | $          | 4,828 |   | $ | 19,182 |   | $ | 14,809 |   |
|                                                                             |       |                                                 |       |                                                |       |   |   |   |   |
| Weighted  average basic common shares outstanding                                |       | 14,886                                               |       | 14,734                                              |       | 14,880 |   | 14,715 |   |
| Weighted  average common share equivalents outstanding                           |       | 109                                                  |       | 181                                                 |       | 88 |   | 152 |   |
|                                                                             |       |                                                 |       |                                                |       |   |   |   |   |
| Weighted  average diluted common shares and common share equivalents outstanding |       | 14,995                                               |       | 14,915                                              |       | 14,968 |   | 14,867 |   |
|                                                                             |       |                                                 |       |                                                |       |   |   |   |   |
| Basic income  per share                                                          |       | $                                                    | .45        |                                                | $          | .33 |   | $ | 1.29 |   | $ | 1.01 |   |
|                                                                             |       |                                                 |       |                                                |       |   |   |   |   |
| Diluted  income per share                                                        |       | $                                                    | .45        |                                                | $          | .32 |   | $ | 1.28 |   | $ | 1.00 |   |

 

**11.****      ****Commitments and Contingencies**

 

***Financial Guarantees***

 

During the normal courseof business, we enter into contracts that contain a variety of representationsand warranties and provide general indemnifications. Our maximum exposure underthese arrangements is unknown as this would involve future claims that may bemade against us that have not yet occurred. However, based on experience, webelieve the risk of loss to be remote.

 

***Legal Proceedings***

 

We are party to variouslegal proceedings, including those noted below. While management presentlybelieves that the ultimate outcome of these proceedings will not have amaterial adverse effect on our financial position, overall trends in results ofoperations or cash flows, litigation is subject to inherent uncertainties, andunfavorable rulings could occur. An unfavorable ruling could include 

 

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monetary damages orequitable relief and could have a material adverse impact on the net income ofthe period in which the ruling occurs or in future periods.

 

***Valencia County Detention Center***

 

In April 2007,a lawsuit was filed against the Company in the Federal District Court inAlbuquerque, New Mexico, by Joe Torres and Eufrasio Armijo, who each allegedthat he was strip searched at the Valencia County Detention Center (“VCDC”) inNew Mexico in violation of his federal rights under the Fourth, Fourteenth andEighth amendments to the U.S. Constitution.  The claimants also allegedviolation of their rights under state law and sought to bring the case as aclass action on behalf of themselves and all detainees at VCDC during theapplicable statutes of limitation.  The plaintiffs sought damages anddeclaratory and injunctive relief.  Valencia County is also a nameddefendant in the case and operated the VCDC for a significantly greater portionof the period covered by the lawsuit.

 

In December 2008,the parties agreed to a proposed stipulation of settlement and, in July 2009,the Court granted final approval of the settlement.  The settlement amount under the terms of theagreement 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 administration process is underway and we expect it to becompleted in the fourth quarter of 2009.

 

In the year ended December 31,2007, we previously provided insurance reserves for this matter (as part of ourregular review of reported and unreported claims) totaling approximately $0.5million. During the fourth quarter of 2008, we recorded an additionalsettlement charge of approximately $0.7 million and the related reimbursementfrom our general liability and professional liability insurance. The charge andreimbursement were recognized in general and administrative expenses for theyear ended December 31, 2008. The reimbursement was funded by theinsurance carrier in the first quarter of 2009 into a settlement account, whereit will remain until payments are made to the settlement class members.

 

**12.  FINANCIAL INSTRUMENTS**

 

The carrying amounts ofour financial instruments, including cash and cash equivalents, investmentsecurities, accounts receivable and accounts payable and accrued expenses,approximate fair value due to the short term maturities of these financialinstruments.  At December 31, 2008,the carrying amount of consolidated debt was $320.5 million, and the estimatedfair value was $308.0 million.  At September 30,2009, the carrying amount was $306.2 million, and the estimated fair value was$313.2 million.  The estimated fair valueof long-term debt is based primarily on quoted market prices or discounted cashflow analysis for the same or similar assets.

 

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

 

***Debt Service Reserve Fund and Bond Fund Payment Account***

 

In August 2001, MCF,a special purpose entity, completed a bond offering to finance the 2001 Saleand Leaseback Transaction in which we sold eleven facilities to MCF.  In connection with this bond offering, tworeserve fund accounts were established by MCF pursuant to the terms of theindenture: (1) MCF’s Debt Service Reserve Fund, aggregating approximately$23.4 million at September 30, 2009, was established to: (a) makepayments on MCF’s outstanding bonds in the event we (as lessee) should fail tomake the scheduled rental payments to MCF or (b) to the extent paymentswere not made under (a), then to make final debt service payments on the thenoutstanding bonds and (2) MCF’s Bond Fund Payment Account (as reported inBond Fund Payment Account and other restricted assets in our ConsolidatedBalance Sheet) aggregating approximately $3.9 million at September 30,2009, was established to accumulate the monthly lease payments that MCFreceives from us until such funds are used to pay MCF’s semi-annual bondinterest payments and annual bond principal payments, with any excess to paycertain other expenses and to make certain transfers.  These reserve funds are invested inshort-term money markets and commercial paper. Both reserve fund accounts were subject to agreements with the MCFEquity Investors (Lehman Brothers, Inc. (“Lehman”)) whereby guaranteedrates of return of 3.0% and 5.08%, respectively, were provided for the balancesin the Debt Service Reserve Fund and the Bond Fund Payment Account.  The guaranteed rates of return werecharacterized as cash flow hedge derivative instruments.  At inception, the derivatives instruments hadan aggregate fair value of $4.0 million, which was recorded as a decrease tothe equity investment in MCF made by the MCF Equity Investors (MCF minorityinterest) and as a liability 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 (loss)in our Consolidated Statements of Operations and Comprehensive Income.  Due to the bankruptcy of Lehman in 2008, thederivative instruments no longer qualified as a hedge and werede-designated.  Amounts included inaccumulated other comprehensive income are reclassified into earnings duringthe same periods in which interest is earned on debt service reserve funds.  Changes in the fair 

 

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value of thesederivatives after de-designation were recorded to earnings.  At December 31, 2008, the fair value wasdetermined to be zero.  The derivativeswere terminated by MCF in the first quarter of 2009 with a fair value of zero.

 

In connection with MCF’sbond offering, Lehman also provided a guarantee of the Debt Service Reserve Fundif a bankruptcy of the Company were to occur and a trustee for the estate ofthe Company were to include the Debt Service Reserve Fund as an asset of theCompany’s estate.  This guarantee wascharacterized as an insurance contract and its fair value was being amortizedto expenses over the life of the debt. Due to the bankruptcy of Lehman in 2008, the full carrying value of theinsurance guarantee was determined to be unrecoverable.  Accordingly, we recorded a charge of $1.3million in the year ended December 31, 2008.

 

**14.****      ****Segment Disclosure**

 

Our three operatingdivisions are our reportable segments. The Adult Secure Services segmentconsists of the operations of secure adult incarceration facilities. TheAbraxas Youth and Family Services segment consists of providing residentialtreatment and educational programs and non-residential community-based programsto juveniles between the ages of 10 and 17 who have either been adjudicated orsuffer from behavioral problems. The Adult Community-Based Services segmentconsists of providing pre-release and halfway house programs for adultoffenders who are either on probation or serving the last three to six-monthsof their sentences on parole and preparing for re-entry into society at largeas well as community-based treatment and education programs as an alternativeto incarceration. All of our customers and long-lived assets are located in theUnited States of America. The accounting policies of our reportable segmentsare the same as those described in the summary of significant accountingpolicies in Note 2 in our 2008 Annual Report on Form 10-K. Intangibleassets are not included in each segment’s reportable assets, and theamortization of intangible assets is not included in the determination of areportable segment’s operating income. We evaluate performance based on incomeor loss from operations before general and administrative expenses,amortization of intangibles, interest and income taxes. Corporate and otherassets are comprised primarily of cash, investment securities available forsale, accounts receivable, debt service and debt service reserve funds,deposits, property and equipment, deferred taxes, deferred costs and otherassets. Corporate and other expense from operations primarily consists of depreciationand amortization on the corporate office facilities and equipment and specificgeneral and administrative charges pertaining to corporate personnel. Suchexpenses are presented separately, as they cannot be readily identified forallocation to a particular segment.

 

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The only significant non-cash item reported in the respectivesegment’s income from operations is depreciation and amortization (excludingintangibles) (in thousands).

 
| ** **                          | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                          | ** ** | **2009**                                             | ** ** | **2008**                                            | ** ** | **2009** | ** ** | **2008** | ** ** |
|                                |       |                                                 |       |                                                |       |   |   |   |   |
| Revenues:                           |       |                                                 |       |                                                |       |   |   |   |   |
| Adult secure services               |       | $                                                    | 57,686     |                                                | $          | 51,470 |   | $ | 173,819 |   | $ | 151,673 |   |
| Abraxas youth  and family services  |       | 26,679                                               |       | 26,231                                              |       | 80,075 |   | 80,891 |   |
| Adult  community-based services     |       | 18,914                                               |       | 17,486                                              |       | 54,429 |   | 52,661 |   |
| Total  revenues                     |       | $                                                    | 103,279    |                                                | $          | 95,187 |   | $ | 308,323 |   | $ | 285,225 |   |
|                                |       |                                                 |       |                                                |       |   |   |   |   |
| Income from  operations:            |       |                                                 |       |                                                |       |   |   |   |   |
| Adult secure services               |       | $                                                    | 15,932     |                                                | $          | 13,896 |   | $ | 50,545 |   | $ | 44,782 |   |
| Abraxas youth  and family services  |       | 2,289                                                |       | 1,696                                               |       | 6,216 |   | 5,831 |   |
| Adult  community-based services     |       | 6,469                                                |       | 4,603                                               |       | 17,099 |   | 14,090 |   |
| Subtotal                            |       | 24,690                                               |       | 20,195                                              |       | 73,860 |   | 64,703 |   |
| General and  administrative expense |       | (5,806                                               | )          | (5,450                                              | )          | (18,214 | ) | (19,217 | ) |
| Amortization  of intangibles        |       | (50                                                  | )          | (484                                                | )          | (946 | ) | (1,458 | ) |
| Corporate and  other                |       | (240                                                 | )          | (224                                                | )          | (728 | ) | (586 | ) |
| Total income  from operations       |       | $                                                    | 18,594     |                                                | $          | 14,037 |   | $ | 53,972 |   | $ | 43,442 |   |

 
| ** **                         | ** ** | ** ** | ** ** | **September 30,** | ** ** | **December 31,** | ** ** | ** ** | ** ** | ** ** |
|------------------------------------|------------|------------|------------|------------------------|------------|-----------------------|------------|------------|------------|------------|
| ** **                         | ** ** | ** ** | ** ** | **2009**               | ** ** | **2008**              | ** ** | ** ** | ** ** | ** ** |
| Assets:                            |       |       |       |                   |       |                  |       |       |       |       |
| Adult secure services              |       |       |       | $                      | 364,906    |                  | $          | 358,406    |       |       |   |   |
| Abraxas youth  and family services |       |       |       | 113,941                |       | 105,991               |       |       |       |       |
| Adult  community-based services    |       |       |       | 62,484                 |       | 60,170                |       |       |       |       |
| Intangible  assets, net            |       |       |       | 14,682                 |       | 15,628                |       |       |       |       |
| Corporate and  other               |       |       |       | 79,935                 |       | 96,726                |       |       |       |       |
| Total assets                       |       |       |       | $                      | 635,948    |                  | $          | 636,921    |       |       |   |   |

 

**15.****      ****Guarantor Disclosures**

 

We completed an offering of $112.0million in principal of 10.75% Senior Notes in June 2004 that are due July 1,2012.  The Senior Notes are guaranteed byeach of our subsidiaries (the Guarantor Subsidiaries which are 100% owned).  These guarantees are joint and severalobligations of the Guarantor Subsidiaries. MCF does not guarantee the SeniorNotes (Non-Guarantor Subsidiary). The following condensed consolidatingfinancial information presents the financial condition, results of operationsand cash flows of the Guarantor Subsidiaries and the Non-Guarantor Subsidiary,together with the consolidating adjustments necessary to present our results ona consolidated basis.

 

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**Condensed Consolidating Balance Sheet as of September 30,2009 (in thousands)**

 
| ** **                                                   | ** ** | **Parent** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor****Subsidiary** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|--------------------------------------------------------------|------------|------------|------------|-----------------------------|------------|-----------------------------------|------------|------------------|------------|------------------|------------|
| **Assets**                                                   |       |       |       |                        |       |                              |       |             |       |             |       |
| Current  assets:                                             |       |       |       |                        |       |                              |       |             |       |             |       |
| Cash and cash  equivalents                                   |       | $          | 4,773      |                        | $          | 170                               |       | $                | 29         |             | $          | — |   | $ | 4,972 |   |
| Accounts  receivable                                         |       | 1,504      |       | 77,950                      |       | 40                                |       | —           |       | 79,494           |       |
| Restricted  assets                                           |       | —     |       | 3,589                       |       | 23,315                            |       | —           |       | 26,904           |       |
| Prepaids and  other                                          |       | 14,608     |       | 1,656                       |       | —                            |       | —           |       | 16,264           |       |
| Total current  assets                                        |       | 20,885     |       | 83,365                      |       | 23,384                            |       | —           |       | 127,634          |       |
| Property and  equipment, net                                 |       | 48         |       | 317,908                     |       | 139,600                           |       | (5,612           | )          | 451,944          |       |
| Other assets:                                                |       |       |       |                        |       |                              |       |             |       |             |       |
| Debt service  reserve fund                                   |       | —     |       | —                      |       | 23,370                            |       | —           |       | 23,370           |       |
| Deferred  costs and other                                    |       | 64,793     |       | 25,053                      |       | 4,866                             |       | (61,712          | )          | 33,000           |       |
| Investment in  subsidiaries                                  |       | 97,670     |       | 1,856                       |       | —                            |       | (99,526          | )          | —           |       |
| Total assets                                                 |       | $          | 183,396    |                        | $          | 428,182                           |       | $                | 191,220    |             | $          | (166,850 | ) | $ | 635,948 |   |
|                                                         |       |       |       |                        |       |                              |       |             |       |             |       |
| **Liabilities and Stockholders’ Equity**                |       |       |       |                        |       |                              |       |             |       |             |       |
|                                                         |       |       |       |                        |       |                              |       |             |       |             |       |
| Current  liabilities:                                        |       |       |       |                        |       |                              |       |             |       |             |       |
| Accounts  payable and accrued liabilities                    |       | $          | 39,648     |                        | $          | 14,760                            |       | $                | 1,741      |             | $          | 1,283 |   | $ | 57,432 |   |
| Current  portion of long-term debt                           |       | —     |       | 13                          |       | 13,400                            |       | —           |       | 13,413           |       |
| Total current  liabilities                                   |       | 39,648     |       | 14,773                      |       | 15,141                            |       | 1,283            |       | 70,845           |       |
| Long-term  debt, net of current portion                      |       | 184,492    |       | 6                           |       | 108,300                           |       | —           |       | 292,798          |       |
| Deferred tax  liabilities                                    |       | 17,740     |       | 94                          |       | —                            |       | 1,020            |       | 18,854           |       |
| Other  long-term liabilities                                 |       | 5,916      |       | 76                          |       | 61,750                            |       | (65,769          | )          | 1,973            |       |
| Intercompany                                                 |       | (315,878   | )          | 317,040                     |       | —                            |       | (1,162           | )          | —           |       |
| Total  liabilities                                           |       | (68,082    | )          | 331,989                     |       | 185,191                           |       | (64,628          | )          | 384,470          |       |
| Total Cornell Companies, Inc. stockholders’ equity |       | 249,647    |       | 96,193                      |       | 6,029                             |       | (102,222         | )          | 249,647          |       |
| Non-controlling interest                                     |       | 1,831      |       | —                      |       | —                            |       | —           |       | 1,831            |       |
| Total  stockholders’ equity                             |       | 251,478    |       | 96,193                      |       | 6,029                             |       | (102,222         | )          | 251,478          |       |
| Total liabilities and stockholders’ equity              |       | $          | 183,396    |                        | $          | 428,182                           |       | $                | 191,220    |             | $          | (166,850 | ) | $ | 635,948 |   |

 

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**CondensedConsolidating Balance Sheet as of December 31, 2008 (in thousands)**

 
| ** **                                                    | ** ** | **Parent** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiary** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|---------------------------------------------------------------|------------|------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
| **Assets**                                                    |       |       |       |                        |       |                            |       |             |       |             |       |
|                                                          |       |       |       |                        |       |                            |       |             |       |             |       |
| Current Assets:                                               |       |       |       |                        |       |                            |       |             |       |             |       |
| Cash and cash equivalents                                     |       | $          | 14,291     |                        | $          | 265                             |       | $                | 57         |             | $          | — |   | $ | 14,613 |   |
| Accounts receivable                                           |       | 2,045      |       | 66,921                      |       | 422                             |       | —           |       | 69,388           |       |
| Restricted assets                                             |       | —     |       | 3,432                       |       | 27,938                          |       | —           |       | 31,370           |       |
| Prepaids and other                                            |       | 13,875     |       | 1,644                       |       | —                          |       | —           |       | 15,519           |       |
| Total current assets                                          |       | 30,211     |       | 72,262                      |       | 28,417                          |       | —           |       | 130,890          |       |
| Property and equipment, net                                   |       | 101        |       | 312,446                     |       | 141,975                         |       | (4,168           | )          | 450,354          |       |
| Other assets:                                                 |       |       |       |                        |       |                            |       |             |       |             |       |
| Debt service reserve fund                                     |       | —     |       | —                      |       | 23,750                          |       | —           |       | 23,750           |       |
| Deferred costs and other                                      |       | 60,322     |       | 23,267                      |       | 5,367                           |       | (57,029          | )          | 31,927           |       |
| Investments in subsidiaries                                   |       | 73,642     |       | 1,856                       |       | —                          |       | (75,498          | )          | —           |       |
| Total assets                                                  |       | $          | 164,276    |                        | $          | 409,831                         |       | $                | 199,509    |             | $          | (136,695 | ) | $ | 636,921 |   |
|                                                          |       |       |       |                        |       |                            |       |             |       |             |       |
| **Liabilities and  stockholders’ equity**                |       |       |       |                        |       |                            |       |             |       |             |       |
|                                                          |       |       |       |                        |       |                            |       |             |       |             |       |
| Current liabilities:                                          |       |       |       |                        |       |                            |       |             |       |             |       |
| Accounts payable and accrued liabilities                      |       | $          | 48,373     |                        | $          | 15,515                          |       | $                | 4,883      |             | $          | 322 |   | $ | 69,093 |   |
| Current portion of long-term debt                             |       | —     |       | 12                          |       | 12,400                          |       | —           |       | 12,412           |       |
| Total current liabilities                                     |       | 48,373     |       | 15,527                      |       | 17,283                          |       | 322              |       | 81,505           |       |
| Long-term debt, net of current portion                        |       | 186,356    |       | 14                          |       | 121,700                         |       | —           |       | 308,070          |       |
| Deferred tax liabilities                                      |       | 16,246     |       | 94                          |       | —                          |       | 1,151            |       | 17,491           |       |
| Other long-term liabilities                                   |       | 5,851      |       | 113                         |       | 56,733                          |       | (61,009          | )          | 1,688            |       |
| Intercompany                                                  |       | (320,717   | )          | 320,722                     |       | —                          |       | (5               | )          | —           |       |
| Total liabilities                                             |       | (63,891    | )          | 336,470                     |       | 195,716                         |       | (59,541          | )          | 408,754          |       |
| Total Cornell Companies, Inc. stockholders’  equity |       | 227,722    |       | 73,361                      |       | 3,793                           |       | (77,154          | )          | 227,722          |       |
| Non-controlling interest                                      |       | 445        |       | —                      |       | —                          |       | —           |       | 445              |       |
| Total stockholders’ equity                               |       | 228,167    |       | 73,361                      |       | 3,793                           |       | (77,154          | )          | 228,167          |       |
| Total liabilities and stockholders’ equity               |       | $          | 164,276    |                        | $          | 409,831                         |       | $                | 199,509    |             | $          | (136,695 | ) | $ | 636,921 |   |

 

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**Condensed Consolidating Statement of Operations forthe three months ended September 30, 2009****(in thousands) (unaudited)**

 
| ** **                                                             | ** ** | **Parent** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiary** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|------------------------------------------------------------------------|------------|------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
| ** **                                                             | ** ** | ** ** | ** ** | ** **                  | ** ** | ** **                      | ** ** | ** **       | ** ** | ** **       | ** ** |
| Revenues                                                               |       | $          | 4,505      |                        | $          | 118,658                         |       | $                | 4,502      |             | $          | (24,386 | ) | $ | 103,279 |   |
| Operating  expenses, excluding depreciation and amortization           |       | 4,226      |       | 94,459                      |       | 34                              |       | (24,300          | )          | 74,419           |       |
| Depreciation  and amortization                                         |       | —     |       | 3,580                       |       | 880                             |       | —           |       | 4,460            |       |
| General and  administrative expenses                                   |       | 5,788      |       | —                      |       | 18                              |       | —           |       | 5,806            |       |
| Income (loss)  from operations                                         |       | (5,509     | )          | 20,619                      |       | 3,570                           |       | (86              | )          | 18,594           |       |
| Overhead  allocations                                                  |       | (8,672     | )          | 8,672                       |       | —                          |       | —           |       | —           |       |
| Interest, net                                                          |       | 2,430      |       | 1,331                       |       | 2,832                           |       | (217             | )          | 6,376            |       |
| Equity  earnings in subsidiaries                                       |       | 10,616     |       | —                      |       | —                          |       | (10,616          | )          | —           |       |
| Income before  provision for income taxes and non-controlling interest |       | 11,349     |       | 10,616                      |       | 738                             |       | (10,485          | )          | 12,218           |       |
| Provision for  income taxes                                            |       | 4,656      |       | —                      |       | —                          |       | 356              |       | 5,012            |       |
| Net income                                                             |       | 6,693      |       | 10,616                      |       | 738                             |       | (10,841          | )          | 7,206            |       |
| Non-controlling  interest                                              |       | —     |       | —                      |       | —                          |       | 513              |       | 513              |       |
| Income  available to stockholders                                      |       | $          | 6,693      |                        | $          | 10,616                          |       | $                | 738        |             | $          | (11,354 | ) | $ | 6,693 |   |

 

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**Condensed Consolidating Statement of Operations forthe three months ended September 30, 2008****(in thousands) (unaudited)**

 
| ** **                                                           | ** ** | **Parent** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiary** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|----------------------------------------------------------------------|------------|------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
| ** **                                                           | ** ** | ** ** | ** ** | ** **                  | ** ** | ** **                      | ** ** | ** **       | ** ** | ** **       | ** ** |
| Revenues                                                             |       | $          | 4,502      |                        | $          | 108,050                         |       | $                | 4,502      |             | $          | (21,867 | ) | $ | 95,187 |   |
| Operating  expenses, excluding depreciation and amortization         |       | 4,976      |       | 87,989                      |       | 11                              |       | (21,742          | )          | 71,234           |       |
| Depreciation  and amortization                                       |       | —     |       | 3,570                       |       | 1,056                           |       | (160             | )          | 4,466            |       |
| General and  administrative expenses                                 |       | 5,429      |       | —                      |       | 21                              |       | —           |       | 5,450            |       |
| Income (loss)  from operations                                       |       | (5,903     | )          | 16,491                      |       | 3,414                           |       | 35               |       | 14,037           |       |
| Overhead  allocations                                                |       | (8,760     | )          | 8,760                       |       | —                          |       | —           |       | —           |       |
| Interest, net                                                        |       | 1,811      |       | 1,274                       |       | 2,732                           |       | (63              | )          | 5,754            |       |
| Equity  earnings in subsidiaries                                     |       | 6,849      |       | —                      |       | —                          |       | (6,849           | )          | —           |       |
| Income from  provision for income taxes and non-controlling interest |       | 7,895      |       | 6,457                       |       | 682                             |       | (6,751           | )          | 8,283            |       |
| Provision for  income taxes                                          |       | 3,067      |       | —                      |       | —                          |       | 301              |       | 3,368            |       |
| Net income                                                           |       | 4,828      |       | 6,457                       |       | 682                             |       | (7,052           | )          | 4,915            |       |
| Non-controlling  interest                                            |       | —     |       | —                      |       | —                          |       | 87               |       | 87               |       |
| Income  available to stockholders                                    |       | $          | 4,828      |                        | $          | 6,457                           |       | $                | 682        |             | $          | (7,139 | ) | $ | 4,828 |   |

 

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**Condensed Consolidating Statement of Operations forthe nine months ended September 30, 2009****(in thousands) (unaudited)**

 
| ** **                                                             | ** ** | **Parent** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiary** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|------------------------------------------------------------------------|------------|------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
| ** **                                                             | ** ** | ** ** | ** ** | ** **                  | ** ** | ** **                      | ** ** | ** **       | ** ** | ** **       | ** ** |
| Revenues                                                               |       | $          | 13,509     |                        | $          | 354,461                         |       | $                | 13,506     |             | $          | (73,153 | ) | $ | 308,323 |   |
| Operating  expenses, excluding depreciation and amortization           |       | 14,574     |       | 280,170                     |       | 187                             |       | (72,887          | )          | 222,044          |       |
| Depreciation  and amortization                                         |       | —     |       | 11,442                      |       | 2,641                           |       | 10               |       | 14,093           |       |
| General and  administrative expenses                                   |       | 18,158     |       | —                      |       | 56                              |       | —           |       | 18,214           |       |
| Income (loss)  from operations                                         |       | (19,223    | )          | 62,849                      |       | 10,622                          |       | (276             | )          | 53,972           |       |
| Overhead  allocations                                                  |       | (28,270    | )          | 28,270                      |       | —                          |       | —           |       | —           |       |
| Interest, net                                                          |       | 6,903      |       | 4,005                       |       | 8,652                           |       | (655             | )          | 18,905           |       |
| Equity  earnings in subsidiaries                                       |       | 30,574     |       | —                      |       | —                          |       | (30,574          | )          | —           |       |
| Income before  provision for income taxes and non-controlling interest |       | 32,718     |       | 30,574                      |       | 1,970                           |       | (30,195          | )          | 35,067           |       |
| Provision for  income taxes                                            |       | 13,536     |       | —                      |       | —                          |       | 963              |       | 14,499           |       |
| Net income                                                             |       | 19,182     |       | 30,574                      |       | 1,970                           |       | (31,158          | )          | 20,568           |       |
| Non-controlling  interest                                              |       | —     |       | —                      |       | —                          |       | 1,386            |       | 1,386            |       |
| Income  available to stockholders                                      |       | $          | 19,182     |                        | $          | 30,574                          |       | $                | 1,970      |             | $          | (32,544 | ) | $ | 19,182 |   |

 

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**Condensed Consolidating Statement of Operations forthe nine months ended September 30, 2008****(in thousands) (unaudited)**

 
| ** **                                                             | ** ** | **Parent** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiary** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|------------------------------------------------------------------------|------------|------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
| ** **                                                             | ** ** | ** ** | ** ** | ** **                  | ** ** | ** **                      | ** ** | ** **       | ** ** | ** **       | ** ** |
| Revenues                                                               |       | $          | 13,506     |                        | $          | 324,295                         |       | $                | 13,506     |             | $          | (66,082 | ) | $ | 285,225 |   |
| Operating expenses,  excluding depreciation and amortization           |       | 12,165     |       | 263,302                     |       | 41                              |       | (65,785          | )          | 209,723          |       |
| Depreciation  and amortization                                         |       | —     |       | 10,154                      |       | 3,167                           |       | (478             | )          | 12,843           |       |
| General and  administrative expenses                                   |       | 19,161     |       | —                      |       | 56                              |       | —           |       | 19,217           |       |
| Income (loss)  from operations                                         |       | (17,820    | )          | 50,839                      |       | 10,242                          |       | 181              |       | 43,442           |       |
| Overhead  allocations                                                  |       | (26,419    | )          | 26,419                      |       | —                          |       | —           |       | —           |       |
| Interest, net                                                          |       | 5,698      |       | 3,820                       |       | 8,284                           |       | (187             | )          | 17,615           |       |
| Equity  earnings in subsidiaries                                       |       | 21,904     |       | —                      |       | —                          |       | (21,904          | )          | —           |       |
| Income before  provision for income taxes and non-controlling interest |       | 24,805     |       | 20,600                      |       | 1,958                           |       | (21,536          | )          | 25,827           |       |
| Provision for  income taxes                                            |       | 9,996      |       | —                      |       | —                          |       | 935              |       | 10,931           |       |
| Net income                                                             |       | 14,809     |       | 20,600                      |       | 1,958                           |       | (22,471          | )          | 14,896           |       |
| Non-controlling  interest                                              |       | —     |       | —                      |       | —                          |       | 87               |       | 87               |       |
| Income  available to stockholders                                      |       | $          | 14,809     |                        | $          | 20,600                          |       | $                | 1,958      |             | $          | (22,558 | ) | $ | 14,809 |   |

 

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**Condensed Consolidating Statement of Cash Flows forthe nine months ended September 30, 2009 (in thousands) (unaudited)**

 
| ** **                                                    | ** ** | **Parent** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiary** | ** ** | **Consolidated** | ** ** |
|---------------------------------------------------------------|------------|------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|
| **Cash flows from operating activities:**                     |       |       |       |                        |       |                            |       |             |       |
| Net cash  provided by (used in) operating activities          |       | $          | (7,839     | )                           | $          | 11,763                          |       | $                | 7,749      |   | $ | 11,673 |   |
| ** **                                                    | ** ** | ** ** | ** ** | ** **                  | ** ** | ** **                      | ** ** | ** **       | ** ** |
| **Cash flows from investing activities:**                     |       |       |       |                        |       |                            |       |             |       |
| Capital  expenditures                                         |       | —     |       | (14,456                     | )          | —                          |       | (14,456          | )          |
| Proceeds from  insurance recoveries on property and equipment |       | —     |       | 2,608                       |       | —                          |       | 2,608            |       |
| Withdrawals  from restricted debt payment account, net        |       | —     |       | —                      |       | 4,623                           |       | 4,623            |       |
| Net cash  provided by (used in) investing activities          |       | $          | —     |                        | $          | (11,848                         | )          | $                | 4,623      |   | $ | (7,225 | ) |
| ** **                                                    | ** ** | ** ** | ** ** | ** **                  | ** ** | ** **                      | ** ** | ** **       | ** ** |
| **Cash flows from financing activities:**                     |       |       |       |                        |       |                            |       |             |       |
| Proceeds from  line of credit                                 |       | 2,000      |       | —                      |       | —                          |       | 2,000            |       |
| Payments of  line of credit                                   |       | (4,000     | )          | —                      |       | —                          |       | (4,000           | )          |
| Payment of  MCF bonds                                         |       | —     |       | —                      |       | (12,400                         | )          | (12,400          | )          |
| Payments on  capital lease obligations                        |       | —     |       | (10                         | )          | —                          |       | (10              | )          |
| Proceeds from  exercise of stock options                      |       | 321        |       | —                      |       | —                          |       | 321              |       |
| Net cash used  in financing activities                        |       | $          | (1,679     | )                           | $          | (10                             | )          | $                | (12,400    | ) | $ | (14,089 | ) |
| ** **                                                    | ** ** | ** ** | ** ** | ** **                  | ** ** | ** **                      | ** ** | ** **       | ** ** |
| **Net decrease in cash and cash equivalents**                 |       | (9,518     | )          | (95                         | )          | (28                             | )          | (9,641           | )          |
| ** **                                                    | ** ** | ** ** | ** ** | ** **                  | ** ** | ** **                      | ** ** | ** **       | ** ** |
| **Cash and cash equivalents at beginning of period**          |       | 14,291     |       | 265                         |       | 57                              |       | 14,613           |       |
| ** **                                                    | ** ** | ** ** | ** ** | ** **                  | ** ** | ** **                      | ** ** | ** **       | ** ** |
| **Cash and cash equivalents at end of period**                |       | $          | 4,773      |                        | $          | 170                             |       | $                | 29         |   | $ | 4,972 |   |

 

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**Condensed Consolidating Statement of Cash Flows forthe nine months ended September 30, 2008 (in thousands) (unaudited)**

 
| ** **                                             | ** ** | **Parent** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiary** | ** ** | **Consolidated** | ** ** |
|--------------------------------------------------------|------------|------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|
| **Cash flows from operating activities:**              |       |       |       |                        |       |                            |       |             |       |
| Net cash  provided by (used in) operating activities   |       | $          | (44,986    | )                           | $          | 58,271                          |       | $                | 7,681      |   | $ | 20,966 |   |
| ** **                                             | ** ** | ** ** | ** ** | ** **                  | ** ** | ** **                      | ** ** | ** **       | ** ** |
| **Cash flows from investing activities:**              |       |       |       |                        |       |                            |       |             |       |
| Capital  expenditures                                  |       | —     |       | (59,282                     | )          | —                          |       | (59,282          | )          |
| Sales of  investment securities                        |       | 250        |       | —                      |       | —                          |       | 250              |       |
| Proceeds from  the sale of fixed assets                |       | —     |       | 791                         |       | —                          |       | 791              |       |
| Withdrawals  from restricted debt payment account, net |       | —     |       | —                      |       | 3,702                           |       | 3,702            |       |
| Net cash  provided by (used in) investing activities   |       | $          | 250        |                        | $          | (58,491                         | )          | $                | 3,702      |   | $ | (54,539 | ) |
| ** **                                             | ** ** | ** ** | ** ** | ** **                  | ** ** | ** **                      | ** ** | ** **       | ** ** |
| **Cash flows from financing activities:**              |       |       |       |                        |       |                            |       |             |       |
| Proceeds from  line of credit                          |       | 43,000     |       | —                      |       | —                          |       | 43,000           |       |
| Payment of  MCF bonds                                  |       | —     |       | —                      |       | (11,400                         | )          | (11,400          | )          |
| Tax benefit  of stock option exercises                 |       | 140        |       | —                      |       | —                          |       | 140              |       |
| Payments on  capital lease obligations                 |       | —     |       | (8                          | )          | —                          |       | (8               | )          |
| Proceeds from  exercise of stock options               |       | 597        |       | —                      |       | —                          |       | 597              |       |
| Net cash  provided by (used in) financing activities   |       | $          | 43,737     |                        | $          | (8                              | )          | $                | (11,400    | ) | $ | 32,329 |   |
| ** **                                             | ** ** | ** ** | ** ** | ** **                  | ** ** | ** **                      | ** ** | ** **       | ** ** |
| **Net decrease in cash and cash equivalents**          |       | (999       | )          | (228                        | )          | (17                             | )          | (1,244           | )          |
| ** **                                             | ** ** | ** ** | ** ** | ** **                  | ** ** | ** **                      | ** ** | ** **       | ** ** |
| **Cash and cash equivalents at beginning of period**   |       | 2,565      |       | 408                         |       | 55                              |       | 3,028            |       |
| ** **                                             | ** ** | ** ** | ** ** | ** **                  | ** ** | ** **                      | ** ** | ** **       | ** ** |
| **Cash and cash equivalents at end of period**         |       | $          | 1,566      |                        | $          | 180                             |       | $                | 38         |   | $ | 1,784 |   |

 

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**ITEM2.****                       ****Management’s Discussion and Analysis of Financial Conditionand Results of Operations**

 

**General**

 

Cornell Companies, Inc.is a leading provider of correctional, detention, educational, rehabilitationand treatment services outsourced by federal, state, county and localgovernment agencies. We provide a diversified portfolio of services for adultsand juveniles through our three operating divisions: (1) Adult SecureServices; (2) Abraxas Youth and Family Services and (3) AdultCommunity-Based Services. At September 30, 2009, we operated 68 facilitieswith a total service capacity of 20,597 and had one vacant facility with aservice capacity of 70 beds. Our facilities are located in 15 states and theDistrict of Columbia.

 

The following table sets forth for the periodsindicated total residential service capacity and contracted beds in operationat the end of the periods shown, average contract occupancy percentages andtotal non-residential service capacity.

 
| ** **                                                                     | ** ** | **September 30,** | ** ** | **September 30,** | ** ** |
|--------------------------------------------------------------------------------|------------|------------------------|------------|------------------------|------------|
| ** **                                                                     | ** ** | **2009**               | ** ** | **2008**               | ** ** |
| **Residential**                                                                | ** ** | ** **             | ** ** | ** **             | ** ** |
| Service  capacity (1)                                                          |       | 18,334                 |       | 17,788                 |       |
| Contracted  beds in operation (end of period) (2)                              |       | 17,480                 |       | 17,017                 |       |
| Average  contract occupancy based on contracted beds in operation (3) (4) |       | 91.6                   | %          | 92.7                   | %          |
| **Non-Residential**                                                            | ** ** | ** **             | ** ** | ** **             | ** ** |
| Service  capacity (5)                                                          |       | 2,333                  |       | 2,403                  |       |

 

----

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

(2)         At certain residential facilities, the contractedcapacity is lower than the facility’s service capacity.  We could increase a facility’s contractedcapacity by obtaining additional contracts or by renegotiating existingcontracts to increase the number of beds covered.  However, we may not be able to obtaincontracts that provide occupancy levels at a facility’s service capacity or beable to maintain current contracted capacities in future periods.

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

(4)         Average contract occupancy percentages are calculatedbased on actual occupancy for the period as a percentage of the contractedcapacity for residential facilities in operation.  These percentages do not reflect theoperations of non-residential community-based programs.  At certain residential facilities, ourcontracted capacity is lower than the facility’s service capacity.  Additionally, certain facilities have and arecurrently operating above the contracted capacity.  As a result, average contract occupancypercentages can exceed 100% if the average actual occupancy exceeded contractedcapacity.

(5)         Service capacity for non-residential programs is basedon either contractual terms or an estimate of the number of clients to beserved.  We update these estimates atleast annually based on the program’s budget and other factors.

 

Our operating results forthe nine months ended September 30, 2009 were impacted by a fewsignificant events.  We completed the 700 bed expansion at D. Ray JamesPrison at the beginning of April 2009 and continued construction on a new1,250 bed facility in Hudson, Colorado. Our 2008 results of operation were positively affected by a 300 bedexpansion at the D. Ray James Prison which we activated in February 2008.  In addition, in the nine months ended September 30,2008, we recorded a contract-based revenue adjustment of approximately $1.5million at the Regional Correctional Center (“RCC”) for the contract year endedMarch 2008.

 

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 on ourbusiness (with respect to possible areas including utilization, per diem rates,etc.)  We expect one of the key areas offocus for our performance for the remainder of 2009 to be our ability to manageour facility construction currently in process in Hudson, Colorado and therelated activation of this facility in the fourth quarter of 2009 (for ourcontract with the State of Alaska Department of Corrections (“Alaska DOC”)).  We also plan to remain focused on ouroperating margins, on increasing utilization (particularly in the Abraxasdivision) and improving customer mix as we believe those initiatives are keyelements of our financial performance.

 

# **Management Overview**

 

***Demand*****.** Our business is driven generally bydemand for incarceration or treatment services, and specifically by demand forprivate incarceration or treatment services, within our three primary businesssegments: Adult Secure Services; Abraxas Youth and Family Services; and AdultCommunity-Based Services. The demand for adult and juvenile corrections andtreatment services has 

 

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generally increased at a steady rate over the past ten years, largelyas a result of increasing sentence terms and/or mandatory sentences forcriminals and as well a greater range of criminal acts, increasing demand forincarceration of illegal aliens and a public recognition of the need to provideservices to juveniles that will improve the possibility that they will leadproductive lives. Moreover, demand for our services is also affected by theamount of available capacity in the government systems to enable governments toprovide the services themselves, as well as desire and ability of these systemsto add additional capacity. In addition, the balance between community-basedcorrections treatment of adults as an alternative to traditional incarcerationcontinues to be analyzed by many political and societal parties.  Among other things, we monitor federal, stateand industry communications and statistics relative to trends in prisonpopulations, juvenile justice statistics and initiatives, and developments inalternatives to traditional incarceration or detention of adults foropportunities to expand our scope or delivery of services.

 

The federal government contracts with private providers for theincarceration of adults, whether they are serving prison sentences, detained asillegal aliens, detained in anticipation of pending judicial administration ortransitioning from prison to society. Chief among the federal agencies which use private providers are theFederal Bureau of Prisons (“BOP”), U.S. Immigration and Customs Enforcement (“ICE”)and United States Marshalls Service (“USMS”). We provide adult secure and adultcommunity-based services to the federal government. Most of the federalinvolvement in juvenile administration in the federal system is handled viaMedicare and Medicaid assistance to state governments. Although there arecircumstances in which we may contract with a federal agency on a sole sourcebasis, the primary means by which we secure a contract with a federal agency isvia the RFP bidding process.  From timeto time, we contract to provide management services to a local governmentalunit who then bids on a federal contract.

 

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

 

Private juvenile and community-based programs are utilized by states andlocal governmental units and are organized on a profit and not-for-profitbasis.  We monitor opportunities in thesesegments via our corporate and business division development officers.  Many opportunities are typically notpublished in any formal manner and, accordingly, we believe that taking theinitiative at the state and local levels is key in developing sole sourceopportunities.

 

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

 

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

·      occupancy(utilization),

·      perdiem reimbursement rates,

·      revenues,

·      operatingmargins, and

·      operatingexpenses.

 

*Capacity. *Capacity, commonly expressed in terms of number of beds,is primarily impacted by the number and size of the facilities we own or leaseand the facilities we operate on behalf of a third party owner or lessee.  We view capacity as one of the measures ofour development efforts, through which we may increase capacity by adding newprojects or by expanding existing projects (as we have done in 2007 through2009 at several of our facilities including Great Plains Correctional Facilityand D. Ray James Prison).  As part of theevaluation of our development efforts, we will assess (a) whether a givendevelopment project was brought into service in accordance with our expectationas to time and expense; and (b) the number of projects in development orunder consideration at the relevant point in time.  In addition to the focus on new projects,capacity will reflect our success in renewing and maintaining existingcontracts and facilities.  It will alsoreflect any closure of programs or facilities due to underutilization or failureto earn an adequate risk-adjusted rate of return.  We must also be cognizant of the possibilitythat state or local budgetary limitations may cause the contractual commitmentto a given facility to be reduced or even eliminated, which would require us toeither secure an alternate customer or close the operation.

 

*Occupancy. *Occupancy is typically expressed in termsof percentage of contract capacity utilized. We look at occupancy to assess the efficacy of both our efforts tomarket our facilities and our efforts to retain existing customers orcontracts.  Because revenue variesdirectly with occupancy, occupancy is a principal 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 

 

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development projects are brought into service, occupancy percentagesmay decline until the projects reach full utilization (as, for example, withthe activation of the 1,100 bed expansion at Great Plains Correctional Facilityduring the fourth quarter of 2008 and the 700 bed expansion at D. Ray JamesPrison during the second quarter of 2009). Where we have commitments forutilization before the commencement of operations, occupancy percentagesreflect the speed at which a facility achieves full service/implementation.However, we may decide to undertake development projects without writtencommitments to make full use of a facility. In these instances, we haveperformed our own assessment of the existing or anticipated demand, based ondiscussions with local government or other potential customer representativesand our analysis of other factors, of the demand for services at thefacility.  There is no assurance that wewould recover our initial investment in these projects.  We will monitor occupancy as a measure of theaccuracy of our estimation of the demand for the services of a developmentfacility and will incorporate this information in future assessments ofpotential projects. In addition, the ramp phase for our youth facilities istypically longer than that experienced in our adult facilities, which willimpact our occupancy in the Abraxas Youth and Family Services division in agiven period.

 

*Per DiemReimbursement Rates. *Per diem reimbursement rates are anotherkey element of our gross revenue and operating margin since per diem contractsrepresent a majority of our revenues (approximately 61.0% and 61.2% for thethree and nine months ended September 30, 2009, respectively).  Per diem rates are a function of negotiationbetween management and a governmental unit at the inception of a contract orthrough the bidding process.  Actual perdiem rates vary dramatically across our business segments, as well as withineach business segment, depending upon the particular service or programprovided. The initial per diem rates often change during the term of a contractin accordance with a schedule.  Theamount of the change can be a fixed amount set forth within the contract, anamount determined by formulas set forth within the contract or an amountdetermined by negotiations between management and the governmental unit (oftenthese negotiations are along the same lines as the original per diemnegotiation — a review of expenses and approval of an amount to recompense forexpenses and assure the potential of an operating profit).  In recent years, as budgetary pressures ongovernmental units have increased, some of our customers have negotiated relieffrom formulaic increase provisions within their agreements or have declined toinclude in their appropriation legislation amounts that would increase the perdiem rates payable under the contract. Based on the economic turmoil whichbegan in the second half of 2008, we are expecting such pressures to continuethrough the remainder of 2009 and likely into 2010 for many of our customers.In similar prior situations we have attempted to mitigate the impact of thesedevelopments by negotiating services provided, obtaining commitments forincreased volume and other measures.  Wemay also choose to consider terminating an existing relationship at a given facilityand replacing it with a new customer (as was done with our Great PlainsCorrectional Facility in 2007).

 

*Revenues. *We derive substantially all of our revenues fromproviding adult corrections and treatment and juvenile justice, educational andtreatment services outsourced by federal, state and local government agenciesin the United States. Revenues for our services are generally recognized on aper diem rate based upon the number of occupant days or hours served for theperiod, on a guaranteed take-or-pay basis or on a cost-plus reimbursementbasis. For the three months ended September 30, 2009, our revenue baseconsisted of 61.0% for services provided under per diem contracts, 34.0% forservices provided under take-or-pay and management contracts, 2.9% for servicesprovided under cost-plus reimbursement contracts, 1.9% for services providedunder fee-for-service contracts and 0.2% from other miscellaneous sources.  For the three months ended September 30,2008, our revenue base consisted of 54.3% for services provided under per diemcontracts, 40.2% for services provided under take-or-pay and managementcontracts, 3.4% for services provided under cost-plus reimbursement contracts,1.9% for services provided under fee-for-service contracts and 0.2% from othermiscellaneous sources. For the nine months ended September 30, 2009 ourrevenue base consisted of 61.2% for services provided under per diem contracts,33.5% for services provided under take-or-pay and management contracts, 3.3%for services provided under cost-plus reimbursement contracts, 1.8% forservices provided under fee-for-service contracts and 0.2% from othermiscellaneous sources.  For the ninemonths ended September 30, 2008 our revenue base consisted of 52.4% forservices provided under per diem contracts, 41.6% for services provided undertake-or-pay and management contracts, 3.8% for services provided undercost-plus reimbursement contracts, 2.0% for services provided underfee-for-service contracts and 0.2% from other miscellaneous sources.  The increase in revenues in the respective2009 periods provided under per diem contracts (and the corresponding decreasein revenues provided under take-or-pay and management contracts) primarilyreflects the transition of our contract with the Arizona Department ofCorrections from a take-or-pay contract to a per diem contract upon theactivation (and subsequent ramp in the fourth quarter of 2008) of its 1,100 bedexpansion. In addition, we also terminated several management contracts in 2008(including Salt Lake Valley Detention Center and Lincoln County DetentionCenter in September 2008 and February 2008, respectively).

 

Revenues canfluctuate from year to year due to changes in government funding policies,changes in the number or types of clients referred to our facilities by governmentalagencies, changes in the types of services delivered to our customers, theopening of new facilities or the expansion of existing facilities and thetermination of contracts for a facility or the closure of a facility.

 

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

 

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*Revenues-Adult Secure Services. *Revenues for our Adult Secure Services division areprimarily generated from per diem, take-or-pay and management contracts.  For the three months ended September 30,2009 and 2008, we realized average per diem rates on our adult securefacilities of approximately $53.72 and $53.12, respectively.  For the nine months ended September 30,2009 and 2008, we realized average per diem rates of approximately $54.25 and$54.00, respectively.  The averageper diem rate for the nine months ended September 30, 2008 benefited froma contract-based revenue adjustment for the contract year ended March 2008in the amount of approximately $1.5 million at the RCC. We periodically haveexperienced pressure from contracting governmental agencies to limit or evenreduce per diem rates. Many of these governmental entities are under severebudget pressures and we anticipate that these agencies may periodicallyapproach us in the remainder of 2009 and likely in 2010 about per diem rateconcessions (or decline to provide funding for contractual rateincreases).  Decreases in, or the lack ofanticipated increases in, per diem rates could adversely impact our operatingmargin.

 

*Revenues-Abraxas Youth and Family Services. *Revenues for our Abraxas Youth and Family Servicesdivision are primarily generated from per diem, fee-for-service and cost-plusreimbursement contracts.  For the threemonths ended September 30, 2009 and 2008, we realized average per diemrates on our residential youth and family services facilities of approximately$195.74 and $193.89, respectively.  Forthe nine months ended September 30, 2009 and 2008, we realized average perdiem rates of approximately $195.88 and $191.03, respectively.  The increase in the average per diem rate for2009 reflects the continued ramp-up of the Abraxas Academy (reactivated in thefourth quarter of 2006), the reactivation of the Hector Garza ResidentialTreatment Center in August 2007 as well as changes in the mix of servicesprovided and customers served at our other facilities.  For the three months ended September 30,2009 and 2008, we realized average fee-for-service rates for ournon-residential community-based Abraxas Youth and Family Services facilitiesand programs, including rates that are limited by Medicaid and other privateinsurance providers, of approximately $45.91 and $45.32, respectively. For thenine months ended September 30, 2009 and 2008, we realized average fee forservice rates of approximately $45.36 and $47.85, respectively.  The fluctuation in the averagefee-for-service rates for 2009 and 2008 is due to changes in the mix ofservices provided at our non-residential facilities. The majority of our AbraxasYouth and Family Services contracts renew annually.

 

*Revenues-Adult Community-Based Services. *Revenues for our Adult Community-Based Servicesdivision are primarily generated from per diem and fee-for-service contracts.For the three months ended September 30, 2009 and 2008, we realized averageper diem rates on our residential adult community-based facilities ofapproximately $66.47 and $68.46, respectively. For the nine months ended September 30,2009 and 2008, we realized average per diem rates on our residential AdultCommunity-Based Services facilities of approximately $66.97 and $66.44,respectively.  For the three months endedSeptember 30, 2009 and 2008, we realized average fee-for-service rates onour non-residential Adult Community-Based Services facilities and programs ofapproximately $12.22 and $11.90, respectively. For the nine months ended September 30, 2009 and 2008, we realizedaverage fee-for-service rates on our non-residential Adult Community-BasedServices facilities and programs of approximately $9.93 and $13.71, respectively.  Our average fee-for-service rates fluctuatefrom year to year principally due to changes in the mix of services provided byour various Adult Community-Based Services programs and facilities.

 

*OperatingMargins. *We have historically experienced higher operatingmargins in our Adult Secure Services and Adult Community-Based Servicesdivisions as compared to our Abraxas Youth and Family Services division. Ouroperating margin, in a given period, will be impacted by those facilities whichmay either be underutilized, dormant or have been reactivated during theperiod. As previously discussed, we have reactivated several facilities,including the Abraxas Academy and the Hector Garza Residential Treatment Centerin 2006 and 2007, respectively. We have also expanded several of our AdultSecure facilities during 2008 and 2009 (D. Ray James Prison, Great PlainsCorrectional Facility and Walnut Grove Youth Correctional Facility, forexample), which provides the opportunity to leverage existing infrastructure.Additionally, our operating margins within a division can vary from facility tofacility based on whether a facility is owned or leased, the level ofcompetition for the contract award, the proposed length of the contract, themix of services provided, the occupancy levels for a facility, the level ofcapital commitment required with respect to a facility, the anticipated changesin operating costs over the term of the contract and our ability to increase afacility’s contract revenue. Under take-or-pay contracts, such as the contractat the Moshannon Valley Correctional Center, operating margins are typicallyhigher during the early stages of the contract as the facility’s populationramps up (as revenues are received at contract percentages regardless of actualoccupancy). As the variable costs (primarily resident-related and certainfacility costs) increase with the growth in population, operating margins willgenerally decline to a stabilized level. Following its activation in April 2006,we experienced such operating margin impact pertaining to the Moshannon ValleyCorrectional Center in the third and fourth quarters of 2006. A decline inoccupancy at our Abraxas Youth and Family Services facilities can have a moresignificant negative impact on operating margins than a decline in occupancy inour Adult Secure Services division due to the longer periods typically requiredto ramp resident population at a youth facility (given the relative facilityscale influences present in these divisions).

 

We have experienced and expect to continue to experience interim periodoperating margin fluctuations due to factors such as the number of calendardays in the period, higher payroll taxes (generally in the first half of theyear) and salary and wage increases and insurance cost increases that areincurred prior to certain contract rate increases. Periodically, many of thegovernmental agencies with

 

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whom we contract may experience budgetary pressures and may approach usto limit or reduce per diem rates (including contractual price increases aswell). We have seen indications of such customer behavior in 2009 and believeit will continue into 2010. Decreases in, or the lack of anticipated increasesin, per diem 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.

 

*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 effecton our financial performance.  Operatingexpenses are also impacted by decisions to close or terminate a particular programor facility.  Such decisions are based onour assessments of operating results, operating efficiency and risk-adjustedreturns 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.

 

We are responsible for all facility operating costs, except for certaindebt service and interest or lease payments for facilities where we have amanagement contract only. At these facilities, the facility owner isresponsible for all debt service and interest or lease payments related to thefacility. We are responsible for all other operating expenses at thesefacilities. We operated 13 and 16 facilities under management contracts at September 30,2009 and 2008, respectively. Included in the facilities under managementcontracts at September 30, 2009 were the Walnut Grove Youth CorrectionalFacility and the eight Los Angeles County Jails, which represented 1,714 bedsof service capacity, or approximately 82.5%, of the residential servicecapacity represented by management contracts.

 

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

 

We incur pre-opening and start-up expenses including payroll, benefits,training and other operating costs prior to opening a new or expanded facilityand during the period of operation while occupancy is ramping up. These costsvary by contract (and also the pace/scale of the activation and relatedpopulation ramp). Since pre-opening and start-up costs are generally factoredinto the revenue per diem rate that is charged to the contracting agency, wetypically expect to recover these upfront costs over the life of the contract.Because occupancy rates during a facility’s start-up phase typically result incapacity under-utilization for at least 90 to 180 days, we may incur additionalpost-opening start-up costs.  The ramp phasefor our youth facilities is typically longer than that experienced in adultfacilities. We do not anticipate post-opening start-up costs at any adultsecure facilities operated under any future contracts with the BOP which aretake-or-pay contracts, meaning that the BOP will pay at least 80.0% of thecontractual monthly revenue once the facility opens, regardless of actualoccupancy.

 

Newly opened facilitiesare staffed according to applicable regulatory or contractual requirements whenwe begin 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 12 monthsfrom the date we begin recognizing revenue unless break-even occupancy levelsare achieved before then. The actual time required to ramp a juvenile facility(with an approximate capacity, for example, of 100 to 200 beds) may be a periodof one to three years. Our start-up period for new adult operations is ninemonths from the date we begin recognizing revenue unless break-even occupancylevels are achieved before then.  Theapproximate time to ramp an adult facility of approximately 1,000 beds may be aperiod of three to six months, depending upon the customer requirements.Acceleration of the ramp pace may also increase the pre-opening start-up costs(primarily related to costs such as personnel, training, etc.). Although wetypically recover these upfront costs over the life of the contract, quarterlyresults can be substantially affected by the timing of the commencement ofoperations as well as the development and construction of new facilities.

 

Working capital requirements generally increase immediately prior tocommencing management of a new or expanded facility as we incur start-up costsand purchase necessary equipment and supplies before facility managementrevenue is realized.

 

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

 

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#### **Recent Developments**

 

***D. Ray James Prison***

 

In August 2007, weannounced that we were initiating a second expansion of the D. Ray JamesPrison. This expansion project increased the facility’s service capacity by anadditional 700 beds for a total service capacity of approximately 2,800 beds.This expansion project began in the first quarter of 2008 and was completed inthe second quarter of 2009.  We arecurrently marketing this additional expansion to multiple customers, but we canmake no assurances as to who the customer will be (or what the possible timingmight be).

 

***Hudson, Colorado***

 

In August 2008, weentered into an agreement pursuant to which we will lease a new 1,250 male bedadult secure facility in Hudson, Colorado. The facility is owned by a thirdparty and is being built on land we sold to the third party. We retainedapproximately 270 acres out of the original 320 acres we acquired in 2007. Weanticipate the construction, which began in the third quarter of 2008, to becompleted in November 2009. We have entered into a contract with theAlaska DOC to house up to 1,000 state prisoners at the facility. The contractbecame effective on September 16, 2009 and has an initial term through June 30,2012, with annual renewal options for the period July 1, 2012 through October 31,2019. Under the contract, the Alaska DOC will house up to 1,000 adult maleinmates at the Facility, with an agreed-upon 800-bed guarantee. The intake ofapproximately 850 inmates is expected to commence in late November 2009and be completed by late December 2009.

 

**Liquidity and Capital Resources**

 

***General*****.**Our primary capital requirements are for (1) purchases,construction or renovation of new facilities, (2) expansions of existingfacilities, (3) working capital, (4) pre-opening and start-up costsrelated to new operating contracts, (5) acquisitions, (6) informationsystems hardware and software, and (7) furniture, fixtures andequipment.  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.

 

***Cash Flows From OperatingActivities.***  Cash provided by operations was approximately$11.7 million for the nine months ended September 30, 2009 compared to$21.0 million for the nine months ended September 30, 2008.  The decrease from the prior period wasprincipally due (1) an increase of approximately $5.7 million in net income inthe nine months ended September 30, 2009, (2) a decrease in accounts payableand accrued liabilities in the nine months ended September 30, 2009 due tothe timing and amount of vendor payments and (3) an increase in accounts receivable-trade(refer to “Management’s Discussion and Analysis of Operations - Liquidity andCapital Resources - Future Liquidity” for more information concerning thisincrease).

 

***Cash Flows From InvestingActivities*****. **Cash used in investing activities was approximately $7.2 million for thenine months ended September 30, 2009 due to capital expenditures of $14.5million related to the facility expansion projects at the D. Ray James Prison,as well as certain infrastructure work at our Hudson, Colorado facility, offsetby insurance proceeds of $2.6 million (related to damages sustained at the ReidCommunity Residential Facility during Hurricane Ike in September 2008 anddamages sustained at our disaster recovery site in 2009). Additionally, we hadnet withdrawals from the restricted debt payment account of $4.6 million. ** **Cash used ininvesting activities was approximately $54.5 million for the nine months ended September 30,2008 due to capital expenditures of $59.3 million related primarily to theexpansion projects at the D. Ray James Prison and the Great Plains CorrectionalFacility.  These payments were partiallyoffset by net withdrawals from the restricted debt payment account of $3.7million and proceeds of $0.8 million from the sale of certain property.  Additionally, we had sales of investmentsecurities of $0.3 million.

 

***Cash Flows From FinancingActivities*****. **Cash used in financing activities was approximately $14.1 million for thenine months ended September 30, 2009 due primarily to MCF’s annual bondprincipal payment of $12.4 million in July 2009.  Additionally, we had borrowings of $2.0million and payments of $4.0 million on our Amended Credit Facility, andproceeds of $0.3 million from the exercise of stock options and employee stockpurchase plan contributions.  Cash providedby financing activities was approximately $32.3 million for the nine monthsended September 30, 2008 due primarily to borrowings on our Amended CreditFacility of $43.0 million and proceeds from the exercise of stock options of$0.6 million.  These were partiallyoffset by MCF’s annual principal payment of $11.4 million in July 2008.

 

***Treasury Stock Repurchases.***  We did not purchase any of our common stockin the nine months ended September 30, 2009 and 2008.

 

***Long-Term Credit Facilities.*** Our Amended Credit Facility provides for borrowingsup to $100.0 million (including letters of credit) and matures in December 2011.At our election, outstanding borrowings bear interest, at either the LIBOR rateplus a margin ranging from 1.50% to 2.25% or a rate which ranges from 0.00% to0.75% above the applicable prime rate. The applicable margins are subject to adjustments based on our totalleverage ratio. Theavailable commitment under our Amended Credit Facility was 

 

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approximately $12.1million at September 30, 2009.  Wehad outstanding borrowings under our Amended Credit Facility of $73.0 millionand we had outstanding letters of credit of approximately $14.9 million at September 30,2009.  Subject to certain requirements,we have the right to increase the commitments under our Amended Credit Facilityup to $150.0 million, although the indenture for our Senior Notes limits ourability, subject to certain conditions, to expand the Amended Credit Facilitybeyond $100.0 million.  We can provide noassurance that all of the banks that have made commitments to us under ourAmended Credit Facility would be willing to participate in an expansion to theAmended Credit Facility should we desire to do so. The Amended Credit Facility iscollateralized by substantially all of our assets, including the assets andstock of all of our subsidiaries. The Amended Credit Facility is not secured bythe assets of MCF, a special purpose entity.

 

Our Amended CreditFacility contains financial and other restrictive covenants that limit ourability to engage in certain activities. Our ability to borrow under the Amended Credit Facility is subject tocompliance with certain financial covenants, including bank leverage, totalleverage and fixed charge coverage ratios. At September 30, 2009, we werein 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 payment and asset dispositions; enter intotransactions with affiliates; and engage in sale/leaseback transactions.

 

MCF is obligated for the outstanding balance of its 8.47% TaxableRevenue Bonds, Series 2001.  Thebonds bear interest at a rate of 8.47% per annum and are payable in semi-annualinstallments of interest and annual installments of principal.  All unpaid principal and accrued interest onthe bonds is due on the earlier of August 1, 2016 (maturity) or as notedunder the bond documents.

 

The bonds are limited, nonrecourse obligations of MCF and securedby the property and equipment, bond reserves, assignment of subleases andsubstantially all assets related to the facilities included in the 2001 Saleand Leaseback Transaction (in which we sold eleven facilities to MCF).  The bonds are not guaranteed by Cornell.

 

In June 2004, we issued $112.0 million in principal of10.75% Senior Notes the (“Senior Notes”) due July 1, 2012.  The Senior Notes are unsecured seniorindebtedness and are guaranteed by all of our existing and future subsidiaries(collectively, the “Guarantors”).  TheSenior Notes are not guaranteed by MCF (the “Non-Guarantor”).  Interest on the Senior Notes is payablesemi-annually on January 1 and July 1 of each year, commencing January 1,2005.  On or after July 1, 2008, wemay redeem all or a portion of the Senior Notes at the redemption prices(expressed as a percentage of the principal amount) listed below, plus accruedand unpaid interest, if any, on the Senior Notes redeemed, to the applicabledate of redemption, if redeemed during the 12-month period commencing on July 1of each of the years indicated below:

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

 

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

 

***Future Liquidity***

 

Our shelf registrationstatement under Form S-3 for potential offerings from time to time of upto $75.0 million in gross proceeds of debt securities, common stock, preferredstock, warrants or certain other securities was declared effective by theSecurities and Exchange Commission in September 2008.

 

We expect to use existingcash balances, internally generated cash flows and borrowings from our AmendedCredit Facility to fulfill anticipated obligations such as capitalexpenditures, working-capital needs and scheduled debt maturities over at leastthe next twelve months.  As of September 30, 2009, we hadapproximately $12.1 million of available capacity under our Amended CreditFacility.  We will continue to analyze our capital structure, including apotential refinancing of our Senior Notes and financing for our expected futurecapital expenditures, including any potential acquisitions.  We willconsider potential acquisitions from time to time.  Our principal focusfor acquisitions is anticipated to be in our Adult Secure and AdultCommunity-Based divisions, although we 

 

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would also considerattractively priced acquisitions in our Abraxas Youth and Family Servicesdivision.  We may decide to use internally generated funds, bankfinancing, equity issuances, debt issuances or a combination of any of theforegoing to finance our future capital needs. We may also seek, from time totime, to retire or purchase some of our common stock and/or outstanding debtthrough cash purchases in open market purchases, privately negotiatedtransactions or otherwise. Such repurchases, if any, will depend on prevailingmarket conditions, our liquidity requirements, contractual restrictions andother factors. In September 2009 we adopted a stock repurchase plan under rule 10b5-1of the Securities Exchange Act of 1934 (“the Company 10b5-1 Plan”) tofacilitate the repurchase of our common stock pursuant to the stock repurchaseprogram authorized by our Board of Directors in July 2009. The Company10b5-1 Plan, which provides for up to $10.0 million in purchases, will be ineffect through December 2010, subject to certain price, volume and timingconstraints as specified in the Company 10b5-1 Plan. At September 30,2009, we believe we have sufficient liquidity necessary to complete thoseprojects for which we have outstanding commitments.

 

Our internally generatedcash flow is directly related to our business. Should the private correctionsand juvenile businesses deteriorate, or should we experience poor results inour operations, cash flow from operations may be reduced. We have, however,continued to generate positive cash flow from operating activities over recentyears and expect that cash flow will continue to be positive over the nextyear. Our access to debt and equity markets may be reduced or closed to us dueto a variety of events, including, among others, industry conditions, generaleconomic conditions, market conditions, credit rating agency downgrades of ourdebt and/or market perceptions of us and our industry.  The volatilityseen in the financial markets beginning in the third quarter of 2008 hascontinued into the third quarter of 2009 and is expected to be present (at somelevel) for the near term.  Such volatility could result in decreasedavailability of capital at economical terms (or at various times) and couldalso put additional financial and budgetary pressure on our customers. Such conditions could potentially result in our inability to pursue additionalfuture growth opportunities (such as facility expansions or new facilityconstruction) and, if coupled with unexpected client, operational or otherissues affecting our cash flow, in a need to seek additional financing at termswe would otherwise not accept.

 

In addition, our accountsreceivable are with federal, state, county and local government agencies, whichwe believe generally reduces our credit risk.  However, it is possiblethat situations such as continuing budget resolutions, delayed passage ofbudgets or budget pressures may increase the length of repayment of certain ofthese receivables. For example, during 2009 the State of California notifiedvendors providing services to the state that it would temporarily issue IOU’s.We received IOU’s from the State of California which were subsequently paid infull during the third quarter of 2009. We do not currently hold any IOU’s fromthe State of California. In addition, delays in the passage of budgets (such asexperienced in the State of Pennsylvania in 2009) may lead to temporary delaysin the repayment of our receivables from operations in such states. This wouldlead to a temporary increase in our receivables, as evidenced by the increasein our accounts receivable-trade at September 30, 2009. As the State ofPennsylvania did not pass a fiscal 2010 budget until mid-October 2009, themajority of the cities and counties in Pennsylvania chose to defer theirpayments (during the state budget impasse present through the third quarter of2009) until the state budget had been adopted. While we will closely monitorsuch situations, we do not currently expect this to have a significant negativeimpact on the repayment of our receivables related to our facilities in suchlocations.

 

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**Results of Operations**

 

The following table sets forth for the periods indicated thepercentages of revenue represented by certain items in our historicalconsolidated statements of operations.

 
| ** **                                                   | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|--------------------------------------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                                                   | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                                                   | ** ** | **2009**                         | ** ** | **2008**                        | ** ** | **2009** | ** ** | **2008** | ** ** |
|                                                         |       |                             |       |                            |       |   |   |   |   |
| Revenues                                                     |       | 100.0                            | %          | 100.0                           | %          | 100.0 | % | 100.0 | % |
| Operating  expenses, excluding depreciation and amortization |       | 72.1                             |       | 74.9                            |       | 72.1 |   | 73.5 |   |
| Depreciation  and amortization                               |       | 4.3                              |       | 4.7                             |       | 4.6 |   | 4.5 |   |
| General and  administrative expenses                         |       | 5.6                              |       | 5.7                             |       | 5.9 |   | 6.7 |   |
| Income from  operations                                      |       | 18.0                             |       | 14.7                            |       | 17.4 |   | 15.3 |   |
| Interest  expense, net                                       |       | 6.2                              |       | 6.0                             |       | 6.1 |   | 6.2 |   |
| Income before  provision for income taxes                    |       | 11.8                             |       | 8.7                             |       | 11.3 |   | 9.1 |   |
| Provision for  income taxes                                  |       | 4.8                              |       | 3.5                             |       | 4.7 |   | 3.9 |   |
| Net income                                                   |       | 7.0                              |       | 5.2                             |       | 6.6 |   | 5.2 |   |
| Non-controlling  interest                                    |       | 0.5                              |       | 0.1                             |       | 0.4 |   | — |   |
| Income  available to stockholders                            |       | 6.5                              | %          | 5.1                             | %          | 6.2 | % | 5.2 | % |

 

***Three Months Ended September 30,2009 Compared to Three Months Ended September 30, 2008***

 

***Revenues*****.** Revenues increased approximately $8.1 million, or 8.5%, to $103.3million for the three months ended September 30, 2009 from $95.2 millionfor the three months ended September 30, 2008.

 

*Adult SecureServices.*****AdultSecure Services revenues increased approximately $6.2 million, or 12.0%, to $57.7million for the three months ended September 30, 2009 from $51.5 millionfor the three months ended September 30, 2008 due primarily to (1) anincrease in revenues of $4.1 million at the Great Plains Correctional Facilitydue to increased occupancy as a result of a facility expansion completed in September 2008,(2) an increase in revenues of $1.1 million at the RCC due to improvedoccupancy and (3) an increase in revenues of $0.7 million at the WalnutGrove Youth Correctional Facility due to a facility expansion completed in thethird quarter of 2008.  The remaining netincrease in revenues of $0.3 million was due to various insignificant fluctuationsin revenues at our other Adult Secure Services facilities.

 

At September 30, 2009, we operated ten Adult Secure Servicesfacilities with an aggregate service capacity of 13,541.  Average contract occupancy was 86.5% for thethree months ended September 30, 2009 compared to 89.9% for the threemonths ended September 30, 2008. The decrease in the average contractoccupancy is primarily due to (1) the additional capacity brought intooperations in September 2008 at Walnut Grove, which we began rampingduring the fourth quarter of 2008, (2) under-utilization at certainCalifornia facilities and (3) the activation of the second expansion atthe D. Ray James Prison in April 2009. The average per diem rate for ourAdult Secure Services facilities was approximately $53.72 and $53.12 for thethree months ended September 30, 2009 and 2008, respectively.

 

*Abraxas Youth andFamily Services.** ***Abraxas Youth andFamily Services revenues increased approximately $0.5 million, or 1.9%, to $26.7million for the three months ended September 30, 2009 from $26.2 millionfor the three months ended September 30, 2008 due primarily to (1) an increase in revenues of $1.0 millionat the Cornell Abraxas 1 facility (“A-1”) due to improved occupancy, (2) anincrease in revenues of $0.7 million at the Texas Adolescent Treatment Center (“TATC”)due to improved occupancy and (3) an increase in revenues of $0.6 millionat the Hector Garza Residential Treatment Center due to improvedoccupancy.  The increase in revenues dueto the above was offset, in part, by a decrease in revenues of $0.8 million dueto the termination of our management contract for the Salt Lake ValleyDetention Center as of September 2008. The remaining net decrease in revenues of $1.0 million was due tovarious immaterial fluctuations in revenues at our other Abraxas Youth andFamily Services facilities and programs.

 

At September 30,2009, we operated 17 residential Abraxas Youth andFamily Servicesfacilities and 10 non-residential Abraxas Youth andFamily Servicescommunity-based programs with an aggregate service capacity of 3,096.Additionally, we had one facility that was vacant at September 30, 2009with a service capacity of 70 beds. Average contract occupancy for the three months ended September 30,2009 was 87.4% compared to 74.6% for the three months ended September 30,2008.  The increase in the averagecontract occupancy in 2009 was due to increased occupancy/higher utilization atsuch facilities as TATC, A-1 and the Hector Garza Residential Treatment Center.

 

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The average per diem ratefor our residential Abraxas Youth and Family Services facilities was approximately $195.74 forthe three months ended September 30, 2009 compared to $193.89 for thethree months ended September 30, 2008. Our average fee-for-service rate for our non-residential AbraxasYouth and Family Services community-based facilities and programs was approximately $45.91 for thethree months ended September 30, 2009 compared to $45.32 for the threemonths ended September 30, 2008. Our average fee-for-service rate canfluctuate from period-to-period depending on the mix of services provided atour various Abraxas Youth and Family Services facilities and programs.

 

*Adult Community-BasedServices.***AdultCommunity-Based Services revenues increased approximately $1.4 million, or8.0%, to $18.9 million for the three months ended September 30, 2009 from $17.5million for the three months ended September 30, 2008 due to variousimmaterial fluctuations in revenues spread across our Adult Community-BasedServices facilities and programs.

 

At September 30, 2009, we operated 28 residential AdultCommunity-Based Services facilities and three non-residential AdultCommunity-Based Services programs with an aggregate service capacity of3,960.  Average contract occupancy was 113.6%for the three months ended September 30, 2009 compared to 99.6% for the threemonths ended September 30, 2008. The average per diem rate for our residential Adult Community-Based Services facilitieswas approximately $66.47 for the three months ended September 30, 2009compared to $68.46 for the three months ended September 30, 2008.  The average fee-for-service rate for ournon-residential Adult Community-Based Services programs was approximately$12.22 for the three months ended September 30, 2009 compared to $11.90for the three months ended September 30, 2008. Our average fee-for-servicerates fluctuate as a result of changes in the mix of services provided by ourvarious Adult Community-Based Services programs and facilities.

 

***Operating Expenses******.*****Operating expenses, excluding depreciation and amortization, increasedapproximately $3.2 million, or 4.5%, to $74.4 million for the three monthsended September 30, 2009 from $71.2 million for the three months ended September 30,2008.

 

*Adult SecureServices.*****AdultSecure Services operating expenses increased approximately $3.8 million, or10.9%, to $38.7 million for the three months ended September 30, 2009 from$34.9 million for the three months ended September 30, 2008 due primarilyto (1) anincrease in operating expenses of $2.2 million at the Great Plains CorrectionalFacility due to increased occupancy as a result of a facility expansioncompleted in September 2008 and (2) an increase in operating expensesof $0.7 million at RCC due to increased occupancy. The remaining net increasein operating expenses of approximately $0.9 million was due to variousimmaterial fluctuations in operating expenses at our other Adult SecureServices facilities as well as a decrease in divisional operating expenses inthe 2009 period.

 

As a percentage ofsegment revenues, Adult Secure Services operating expenses were 67.2% for thethree months ended September 30, 2009 compared to 67.8% for the threemonths ended September 30, 2008.

 

*Abraxas Youth andFamily Services.** ***Abraxas Youth andFamily Services division operating expenses decreased approximately $0.1million, or 0.4%, to $23.7 million for the three months ended September 30,2009 from $23.8 million for the three months ended September 30, 2008 dueprimarily to a decrease in operating expense of $1.0 million due to thetermination of our management contract for the Salt Lake Valley DetentionCenter as of September 2008.  Thisdecrease was offset, in part, by (1) an increase in operating expenses of$0.6 million at the Hector Garza Residential Treatment Center due to improvedoccupancy and (2) an increase in operating expenses of $0.4 million atTATC due to increased occupancy. The remaining net decrease in operating expenses ofapproximately $0.1 million was due to various immaterial fluctuations inoperating expenses at our other Abraxas Youth and Family Services facilitiesand programs.

 

As a percentage of segment revenues, Abraxas Youth and FamilyServices operating expenses were 88.7% for the three months ended September 30,2009 compared to 90.8% for the three months ended September 30, 2008.  The reduction in the operating expense ratioin 2009 was principally due to the increased utilization at those facilitiesnoted.

 

*Adult Community-BasedServices.* Adult Community-Based Services operatingexpenses decreased approximately $0.5 million, or 4.0%, to $12.0 million forthe three months ended September 30, 2009 from $12.5 million for the threemonths ended September 30, 2008. The decrease in operating expenses was due primarily to a gain of $0.2million related to final insurance recoveries in excess of property carryingvalues at the Reid Community Residential Facility damaged in Hurricane Ike in September 2008.This gain is reflected in operating expenses for the three months ended September 30,2009.  The remaining decrease inoperating expenses of approximately $0.3 million was due to immaterialfluctuations in operating expenses at our various Adult Community-BasedServices facilities and programs between the two periods.

 

As a percentage of segment revenues, Adult Community-BasedServices operating expenses were 63.5% for the three months ended September 30,2009 compared to 71.5% for the three months ended September 30, 2008. Theimprovement in the operating 

 

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margin was primarily due to the increased utilization across thevarious facilities and programs during the period as well as the gain oninsurance recovery recognized in the three months ended September 30, 2009as discussed above.

 

***Depreciation and Amortization*****. **Depreciationand amortization expense was approximately $4.5 million and $4.5 million forthe three months ended September 30, 2009 and 2008, respectively.  Depreciation expense increased approximately$0.4 million primarily due to the facility expansions at the Great PlainsCorrectional Facility and the D. Ray James Prison.  Amortization of intangibles was approximately$0.1 million and $0.5 million for the three months ended September 30,2009 and 2008, respectively.

 

***General and AdministrativeExpenses.*** General and administrative expensesincreased approximately $0.3 million, or 5.5%, to $5.8 million for the threemonths ended September 30, 2009 compared to $5.5 million for the threemonths ended September 30, 2008. The increase was due primarily to increased stock-based compensationexpense in the three months ended September 30, 2009 as compared to thesame period of 2008.

 

***Interest.***Interest expense, net of interest income, increased to approximately $6.4 millionfor the three months ended September 30, 2009 from $5.8 million for thethree months ended September 30, 2008. The increase in net interestexpense was primarily due to a reduction in capitalized interest in the threemonths ended September 30, 2009. Capitalized interest for the three months ended September 30, 2008was approximately $1.0 million and related to the facility expansion projectsat the Great Plains Correctional Facility and the D. Ray James Prison. Therewas no interest capitalized during the three months ended September 30,2009. This increase in net interest expense was offset by lower interestexpense of approximately $0.3 million on our Amended Credit Facility due tolower average interest rates in the 2009 period.  Additionally, MCF made an annual bondprincipal payment of $12.4 million on July 31, 2009 which reduced bondinterest expense for the three months ended September 30, 2009 byapproximately $0.3 million as compared to the same period of 2008.

 

***Income Taxes.*** Forthe three months ended September 30, 2009, we recognized a provision forincome taxes at an estimated effective rate of 41.0%.  For the three months ended September 30,2008, we recognized a provision for income taxes at an estimated effective rateof 40.7%.  The change in our estimatedeffective tax rate in 2009 was related to an increase in operating incomeacross certain of our business segments, the decreased impact of certainnon-deductible expenses and the utilization of various tax credits.

 

***Nine Months Ended September 30,2009 Compared to Nine Months Ended September 30, 2008***

 

***Revenues*****.** Revenues increased approximately $23.1million, or 8.1%, to $308.3 million for the nine months ended September 30,2009 from $285.2 million for the nine months ended September 30, 2008.

 

*Adult SecureServices.*****AdultSecure Services revenues increased approximately $22.1 million, or 14.6%, to $173.8million for the nine months ended September 30, 2009 from $151.7 millionfor the nine months ended September 30, 2008 due primarily to (1) an increase in revenues of approximately$14.3 million at the Great Plains Correctional Facility due to increasedoccupancy as a result of a facility expansion completed in September 2008,(2) an increase in revenues of $3.5 million at RCC due to improvedoccupancy, (3) an increase in revenues of $2.3 million at Walnut Grove dueto a facility expansion completed in the third quarter of 2008, and (4) anincrease in revenues of $1.4 million at the Big Spring Correctional Center dueto increased occupancy.  The increase inrevenues due to the above was offset, in part, by a decrease in revenues of$0.9 million at the Mesa Verde Community Correctional Center due to a decreasein occupancy.  The remaining net increasein revenues of approximately $1.5 million was due to various insignificantfluctuations in revenues at our other Adult Secure Services facilities.

 

Average contractoccupancy for the nine months ended September 30, 2009 was 88.5% comparedto 92.5% for the nine months ended September 30, 2008.  The average per diem rate for our AdultSecure Services facilities was approximately $54.25 and $54.00 for the ninemonths ended September 30, 2009 and 2008, respectively. The decrease inthe average contract occupancy is primarily due to (1) the additionalcapacity brought into operations in September 2008 at Walnut Grove, whichwe began ramping during the fourth quarter of 2008, (2) under-utilizationat certain California facilities and (3) the activation of the secondexpansion at D. Ray James Prison in April 2009.

 

*Abraxas Youth andFamily Services.** ***Abraxas Youth andFamily Services revenues decreased approximately $0.8 million, or 1.0%, to $80.1million for the nine months ended September 30, 2009 from $80.9 millionfor the nine months ended September 30, 2008 due to (1) a decrease in revenues of $2.7million due to the termination of our management contract for the Salt LakeValley Detention Center as of September 2008, (2) a decrease inrevenues of $1.2 million due to the termination of our management contract for theReading Alternative Education School Program as of June 2008 and(3) a decrease in revenues of $0.6 million due to the termination of ourmanagement contract for the State Reintegration Program as of June 30,2009.  The decrease in revenues due tothe above was offset by (1) an increase in revenues of $1.0 million at theAbraxas Academy due to increased occupancy, (2) an increase in revenues of$1.7 million at TATC due to improved occupancy, (3) an increase inrevenues of $1.0 million at the Hector Garza Residential Treatment Center dueto increased occupancy and (4) an increase in revenues of $1.0 million atA-1 due to improved occupancy. The remaining 

 

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net decrease in revenuesof $1.0 million was due to various insignificant fluctuations at our otherAbraxas Youth and Family Services facilities and programs.

 

Average contractoccupancy was 86.9% and 80.5% for the nine months ended September 30, 2009and 2008, respectively. The increase in the 2009 average contract occupancy wasprimarily a result of higher utilization of the Hector Garza ResidentialTreatment Center, the Abraxas Academy and TATC facilities.  The average per diem rate for our residentialAbraxas Youth and Family Services facilities was approximately $195.88 and$191.03 for the nine months ended September 30, 2009 and 2008,respectively. The increase in the 2009 average per diem rate reflects the continuedramp-up of the Abraxas Academy, increased utilization at A-1 and our SanAntonio facilities, as well as changes in the mix of services provided at otherfacilities. The average fee-for-service rate for our non-residential AbraxasYouth and Family Services community-based facilities and programs wasapproximately $45.36 and $47.85 for the nine months ended September 30,2009 and 2008, respectively. The decrease in the average fee-for-service ratefor 2009 was due to changes in the mix of services provided by our variousnon-residential Abraxas Youth and Family Services facilities and programs.

 

*Adult Community-BasedServices.* Adult Community-Based Services revenues increasedapproximately $1.7 million, or 3.2%, to $54.4 million for the nine months endedSeptember 30, 2009 from $52.7 million for the nine months ended September 30,2008 due to various immaterial fluctuations in revenues among our various AdultCommunity-Based Services facilities and programs.

 

Average contractoccupancy was 109.4% and 100.4% for the nine months ended September 30,2009 and 2008.  The average per diem ratefor our residential Adult Community-Based Services facilities was $66.97 and$66.44 for the nine months ended September 30, 2009 and 2008,respectively.  The average fee-for-servicerate for our non-residential Adult Community-Based Services programs was $9.93and $13.71 for the nine months ended September 30, 2009 and 2008,respectively. The decrease in the average fee-for-service rate for 2009 was dueto changes in the mix of services provided by our various non-residential AdultCommunity-Based Services facilities and programs.

 

***Operating Expenses.***Operating expenses, excluding depreciation and amortization, increasedapproximately $12.3 million, or 5.9%, to $222.0 million for the nine monthsended September 30, 2009 from $209.7 million for the nine months ended September 30,2008.

 

*Adult SecureServices.*****AdultSecure Services operating expenses increased approximately $14.9 million, or15.0%, to $114.3 million for the nine months ended September 30, 2009 from$99.4 million for the nine months ended September 30, 2008 due to (1) anincrease in operating expenses of $6.7 million at the Great Plains CorrectionalFacility due to increased occupancy as a result of a facility expansioncompleted in September 2008, (2) an increase in operating expenses of$1.2 million at the D. Ray James Prison due to increased occupancy as a resultof facility expansions completed in February 2008 and April 2009, (3) anincrease in operating expenses of $2.5 million at the Big Spring CorrectionalCenter due to improved occupancy, (4) an increase in operating expenses of$1.1 million at Walnut Grove due to increased occupancy as a result of afacility expansion completed in third quarter of 2008 and (5) an increasein operating expenses of $1.5 million at RCC due to improved occupancy. The remaining net increase in operatingexpenses of $1.9 million was due to various insignificant fluctuations inoperating expenses at our other Adult Secure Services facilities as well as anincrease in divisional operating expenses of approximately $1.0 million in the2009 period.

 

As a percentage of segment revenues, Adult Secure Services operatingexpenses were 65.8% for the nine months ended September 30, 2009 comparedto 65.5% for the nine months ended September 30, 2008. The 2008 operatingmargin was favorably impacted by a $1.5 million contract-based revenueadjustment at the RCC for the contract year ended March 2008 (which werecognized in March 2008).

 

*Abraxas Youth andFamily Services.** ***Abraxas Youth andFamily Services operating expenses decreased approximately $1.2 million, or1.6%, to $71.7 million for the nine months ended September 30, 2009 from $72.9million for the nine months ended September 30, 2008 due primarily to (1) adecrease in operating expenses of $2.8 million due to the termination of ourmanagement contract for the Salt Lake Valley Detention Center as of September 2008and (2) a decrease in operating expenses of $0.9 million due to the terminationof our management contract for the Reading Alternative Education School Programas of June 2008. The decrease in operating expenses due to the above wasoffset, in part, by (1) an increase in operating expenses of $1.3 millionat the Abraxas Academy due to improved occupancy, (2) an increase inoperating expenses of $1.6 million at the Hector Garza Residential TreatmentCenter due to improved occupancy and (3) an increase in operating expensesof $1.2 million at TATC due to improved occupancy.  The remaining net decrease in operating expenses ofapproximately $1.6 million was due to various immaterial fluctuations inoperating expenses at our other Abraxas Youth and Family Services facilitiesand programs.

 

As a percentage of segment revenues, Abraxas Youth and FamilyServices operating expenses were 89.5% and 90.1% for the nine months ended September 30,2009 and 2008, respectively.

 

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*Adult Community-BasedServices.* Adult Community-Based Services operatingexpenses decreased approximately $1.4 million, or 3.7%, to $36.0 million forthe nine months ended September 30, 2009 from $37.4 million for the ninemonths ended September 30, 2008 due to (1) a decrease in operating expenses of $0.6million due to the termination of our management contract for the LincolnCounty Detention Center in May 2008 and (2) a decrease in operatingexpenses of $0.5 million due to the termination of our management contracts forseveral county jails in California. Additionally, we recorded a gain of $0.6 million related to insurancerecoveries in excess of property carrying values at the Reid CommunityResidential Facility damaged in Hurricane Ike in September 2008.  This gain is reflected in operating expensesfor the nine months ended September 30, 2009.  The remaining net increase in operatingexpenses of $0.9 million was due to immaterial fluctuations in operatingexpenses at our other Adult Community-Based Services facilities and programs.As a percentage of segment revenues, Adult Community-Based Services operatingexpenses were 66.2% for the nine months ended September 30, 2009 comparedto 71.0% for the nine months ended September 30, 2008.

 

***Impairmentof Long-Lived Assets.***  We evaluate the realization ofour long-lived assets at least annually or when changes in circumstances or aspecific triggering event indicates that the carrying value of the asset maynot be recoverable.  As part of ourevaluation, we make judgments regarding such factors as estimated market valuesand the potential future operating results and undiscounted cash flowsassociated with individual facilities or assets.  Additionally, should we decide to sell afacility or other such asset, realization is evaluated based on the estimatedsales price based on the best market information available.  In conjunction with our review of certain ofour long-lived assets based on estimated market values associated with theseassets, we determined that our carrying value for a currently vacant site ofland was not fully recoverable and exceeded its fair value and, as a result, werecorded an impairment charge of $0.3 million in the nine months ended September 30,2008.  This charge is reflected ingeneral and administrative expenses in the accompanying financial statementsfor the 2008 period. We did not have any impairment charges in the nine monthsended September 30, 2009.

 

***Depreciation and Amortization*****.** Depreciation and amortization expense wasapproximately $14.1 million and $12.8 million for the nine months ended September 30,2009 and 2008, respectively. Depreciation of property and equipment increased approximately $1.8million due primarily to depreciation expense related to the facilityexpansions at the Great Plains Correctional Facility and the D. Ray JamesPrison.  Amortization of intangibles wasapproximately $0.9 million and $1.5 million for the nine months ended September 30,2009 and 2008, respectively.

 

***General and AdministrativeExpenses.*** General and administrative expenses decreasedapproximately $1.0 million, or 5.2%, to approximately $18.2 million for the ninemonths ended September 30, 2009 from $19.2 million for the nine monthsended September 30, 2008 due primarily to lower legal and other professionalexpenses in the 2009 period.

 

***Interest.***Interest expense, net of interest income, increased to approximately $18.9million for the nine months ended September 30, 2009 from $17.6 millionfor the nine months ended September 30, 2008. The net increase in interestexpense was primarily due to lower capitalized interest in the nine monthsended September 30, 2009 as compared to the same period of 2008.  Capitalized interest was approximately $0.7million in the nine months ended September 30, 2009 and related to the 700bed facility expansion project at the D. Ray James Prison.  For the nine months ended September 30,2008, we capitalized interest of approximately $2.3 million related to theexpansion projects at the D. Ray James Prison and the Great Plains CorrectionalFacility. Additionally, interest income decreased by approximately $0.8 millionin the 2009 period due to lower investment balances and decreased interestrates. This increase in net interest expense was offset by lower interestexpense of approximately $0.2 million on our Amended Credit Facility due tolower average interest rates in the 2009 period.  Additionally, MCF made annual bond principalpayments of $11.4 million in July 2008 and $12.4 million on July 31,2009 which reduced bond interest expense for the nine months ended September 30,2009 by approximately $0.7 million as compared to the same period of 2008.

 

***Income Taxes.*** Forthe nine months ended September 30, 2009, we recognized a provision forincome taxes at an estimated effective rate of 41.3%.  For the nine months ended September 30,2008, we recognized a provision for income taxes at an estimated effective rateof 42.3%.  The change in our estimatedeffective tax rate in 2009 was related to an increase in operating incomeacross certain of our business segments, the decreased impact of certainnon-deductible expenses and the utilization of various tax credits.

 

***Contractual Uncertainties Related to Certain Facilities***

 

***Regional Correctional Center.*** The Office of Federal Detention Trustee (“OFDT”) holds the contract forthe use of the RCC on behalf of ICE, USMS and the BOP with Bernalillo County,New Mexico (the “County”) through an intergovernmental services agreement, andwe have an operating and management agreement with the County.  In July 2007, we were notified by ICEthat it was removing all ICE detainees from the RCC and the removal wascompleted in early August 2007.  The facility is still being utilizedby the USMS, and since May 2008 by the BOP, but not at its fullcapacity.  In February 2008, ICEinformed 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 

 

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right to unilaterallyamend the contract in this manner, and OFDT has been informed of our position.Although either party to the intergovernmental services agreement has the rightto terminate upon 180 days notice, neither party has exercised such right as ofSeptember 30, 2009. During the third quarter 2009, we filed aclaim against the United States, acting through the United States Department ofJustice, OFDT and ICE (collectively “Defendants”) for breach of contract andbreach of the duty of good faith and fair dealing, arising out ofthe Defendants’ improper modification of the intergovernmental servicesagreement (the “Contract”) and subsequent failure to pay for the shortfalls inthe 2007-2008 and 2008-2009 minimum annual guaranteed mandays specified in theContract.

 

There is a pendinglawsuit against the County concerning the County jail system, known as the “McClendon”case. In 1994, plaintiffs sued the County in federal district court in theDistrict of New Mexico over conditions at the county jail, which was thenlocated at what is now the Regional Correctional Center and run by theCounty.  The County subsequently built their new Metropolitan DetentionCenter to house the County inmates and also negotiated two stipulatedagreements in 2004 designed to end the McClendon lawsuit.   These stipulated settlements covered theMetropolitan Detention Facility and were approved by the Court in 2005 (the “2005settlement agreements”).

 

In March 2009, theFederal Judge presiding over the case issued an Order based on motions filed byPlaintiffs class counsel asking the Judge to reform the 2005 settlementagreements to allow for access to the RCC. In those motions, the Plaintiffs also requested alternative relief inthe form of withdrawal of the Court’s approval of the 2005 settlementagreements.  Based on our interpretationof the Order, the Judge denied Plaintiffs’ request for access to the RCC,granted the alternative relief requested, withdrew her approval of the 2005settlement agreements and granted the option to Plaintiffs to rescind their2005 settlement agreements.   ThePlaintiffs 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 a party to this lawsuit and the ramifications of theCourt’s Order to our operation of the RCC are unclear.

 

The 2005 settlementagreements imposed various conditions on the Metropolitan Detention Center thatresulted 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 may want us to absorb aportion of any costs that would be incurred.  We currently plan to continue to operate the facility and also continuewith our marketing plans for the RCC.

 

Revenues for thisfacility were approximately $10.1 million and $6.6 million (including a $1.5million contract-based revenue adjustment for the contract year ended March 31,2008, for which the related receivable is carried in accounts receivable-tradeat September 30, 2009) for the nine months ended September 30, 2009and 2008, respectively. The net carrying value of the leasehold improvementsfor this facility was approximately $0.8 million and $1.1 million at September 30,2009 and December 31, 2008, respectively. Our lease for this facilityrequires monthly rent payments of approximately $0.13 million for the remainingterm of the lease (which was extended through June 2010). To date,although we have several federal agencies using the RCC, the facility still hasavailable capacity. Our inability to expand the existing population withcurrent or new customers or any disruption of our operations due to activity inthe McClendon case could have an adverse effect on our financial condition,results of operations and cash flows.  We believe no impairment to thecarrying value of the leasehold improvements for this facility has occurred.

 

***Hector Garza Residential Treatment Center.*********In October 2005, we initiated thetemporary closure of this MCF leased facility in San Antonio, Texas. Wereactivated the facility during the third quarter of 2007. The net carryingvalue for this facility was approximately $3.9 and $4.0 million at September 30,2009 and December 31, 2008, respectively. We believe that no impairment to the carrying value of this facility hasoccurred due to existing (and increasing) demand from current customers(including the Texas Youth Commission) and anticipated incremental demand fromadditional multiple customers to whom the facility is being marketed (includingseveral current and anticipated requests for proposal).

 

***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 that long-livedassets to be held and used recognize an impairment loss only if the carryingamount of the long-lived asset is not recoverable from its estimated futureundiscounted cash flows and to measure an impairment loss as the differencebetween the carrying value and the fair value of the asset. Assets to bedisposed of by sale are recorded at the lower of their carrying amount or fairvalue less estimated selling costs. We estimate projections of undiscountedcash flows, and also fair value, based upon the best information available,which may include expected future discounted cash flows to be produced by theasset

 

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and/or available marketprices. Factors that significantly influence estimated future cash flowsinclude the periods and levels of occupancy for the facility, expected per diemor reimbursement rates, assumptions regarding the levels of staffing, servicesand future operating and capital expenditures necessary to generate forecastedrevenues, related costs for these activities and future rate of increases ordecreases associated with these factors. Information typically utilized willalso include relevant terms of existing contracts (for similar services andcustomers), market knowledge of customer demand (both present and anticipated)and related pricing, market competitors, and our historical experience (as toareas including customer requirements, contract terms, operatingrequirements/costs, occupancy trends, etc.). We may also consider the resultsof any appraisals if a fair value is necessary. Estimates for factors such asper diem or reimbursement rates may be highly subjective, particularly incircumstances where there is no current operating contract in place and changesin the assumptions and estimates could result in the recognition of impairmentcharges.

 

The most subjectiveestimates made in our impairment analysis for 2008 related to Cornell Abraxas 1and the Hector Garza Residential Treatment Center, particularly with respect toestimated occupancy. The approximate carrying values at December 31, 2008for Cornell Abraxas 1 and the Hector Garza Residential Treatment Center were$10.4 million and $4.0 million, respectively. The estimated undiscounted futurecash flow values exceeded the carrying values noted for the facilities, and allfacilities had operating contracts in place. During 2009, there were nosignificant events that caused us to believe that an impairment of thesefacilities during the current period had occurred.

 

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.

 

***Contractual Obligations andCommercial Commitments*****.** Wehave assumed various financial obligations and commitments in the ordinarycourse of conducting our business. We have contractual obligations requiringfuture cash payments under our existing contractual arrangements, such asmanagement, consultative and non-competition agreements.

 

We maintain operating leases in the ordinary course of ourbusiness activities.  These leasesinclude those for operating facilities, office space and office and operatingequipment, and the terms of these agreements range from 2008 until 2075.  As of September 30, 2009, our totalcommitment under these operating leases was approximately $116.6 million.

 

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The following table details our known future cash payments (on anundiscounted basis) related to various contractual obligations as of September 30,2009 (in thousands):

 
| ** **                              | ** ** | **Payments Due by Period** | ** ** |
|-----------------------------------------|------------|-------------------------------------------|------------|
| ** **                              | ** ** | ** **                                | ** ** | ** ** | ** ** | **2010 -** | ** ** | **2012 -** | ** ** | ** ** | ** ** |
| ** **                              | ** ** | **Total**                                 | ** ** | **2009** | ** ** | **2011** | ** ** | **2013** | ** ** | **Thereafter** | ** ** |
|                                    |       |                                      |       |   |   |   |   |   |   |   |   |
| **Contractual Obligations:**            |       |                                      |       |   |   |   |   |   |   |   |   |
| Long-term debt — principal         |       |                                      |       |   |   |   |   |   |   |   |   |
| · Cornell Companies, Inc.     |       | $                                         | 112,000    |   | $ | — |   | $ | — |   | $ | 112,000 |   | $ | — |   |
| · Special Purpose Entity           |       | 121,700                                   |       | — |   | 28,000 |   | 33,000 |   | 60,700 |   |
| Long-term debt — interest          |       |                                      |       |   |   |   |   |   |   |   |   |
| · Cornell Companies, Inc.     |       | 33,110                                    |       | 3,010 |   | 24,080 |   | 6,020 |   | — |   |
| · Special Purpose Entity           |       | 44,578                                    |       | — |   | 19,482 |   | 14,534 |   | 10,562 |   |
| Revolving line of credit-principal      |       |                                      |       |   |   |   |   |   |   |   |   |
| · Cornell Companies, Inc.     |       | 73,000                                    |       | — |   | 73,000 |   | — |   | — |   |
| Revolving line of credit-interest       |       |                                      |       |   |   |   |   |   |   |   |   |
| · Cornell Companies, Inc.     |       | 700                                       |       | 490 |   | 210 |   | — |   | — |   |
| Capital lease obligations               |       |                                      |       |   |   |   |   |   |   |   |   |
| · Cornell Companies, Inc.     |       | 17                                        |       | 3 |   | 14 |   | — |   | — |   |
| Construction commitments                |       | 3,483                                     |       | 3,483 |   | — |   | — |   | — |   |
| Operating leases                        |       | 116,570                                   |       | 1,850 |   | 25,689 |   | 21,876 |   | 67,155 |   |
| Consultative and non-compete agreements |       | 120                                       |       | 110 |   | 10 |   | — |   | — |   |
| Total contractual cash obligations      |       | $                                         | 505,278    |   | $ | 8,946 |   | $ | 170,485 |   | $ | 187,430 |   | $ | 138,417 |   |

 

Approximately$2.8 million of unrecognized tax benefits have been recorded as liabilities asof September 30, 2009 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 $0.1 million as of September 30, 2009.

 

We enter into letters ofcredit in the ordinary course of operating and financing activities.  As of September 30, 2009, we hadoutstanding letters of credit of approximately $14.9 million primarily forcertain workers’ compensation insurance and other operating obligations.  The following table details our letters ofcredit commitments as of September 30, 2009 (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 |       | $             | 14,949     |                                                                    | $          | 14,199 |   | $ | 750 |   | $ | — |   | $ | — |   |
|                           |            |               |            |                                                                         |            |  |  |  |  |  |  |  |  |  |  |  |

 

**ITEM 3.****                        ****Quantitative and Qualitative Disclosures about Market Risk**

 

In the normalcourse of business, we are exposed to market risk, primarily from changes ininterest rates.  We continually monitorexposure to market risk and develop appropriate strategies to manage thisrisk.  We are not exposed to any othersignificant market risks, including commodity price risk or, foreign currencyexchange risk or interest rate risks from the use of derivative financialinstruments.

 

**CreditRisk**

 

Due to the short durationof our investments, changes in market interest rates would not have asignificant impact on their fair value. In addition, our accounts receivables are with federal, state, countyand local government agencies, which we believe reduces our credit risk.However, it is possible that such situations as continuing budget resolutions,delayed passage of budgets or budget pressures may increase the length ofrepayment of certain receivables. During the third quarter of 2009 the State ofCalifornia notified vendors providing services to the state that it wouldtemporarily issue IOU’s. We received IOU’s from the State of California whichwere subsequently repaid prior to September 30, 2009, and we do notpresently hold any IOU’s from the State of California. In addition, delays inthe passage of budgets (such as experienced in the State of Pennsylvania in2009) may lead to temporary delays in 

 

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the repayment of ourreceivables from operations in such states. This would lead to a temporaryincrease in our receivables, as evidenced by the increase in our accountsreceivable-trade at September 30, 2009. As the State of Pennsylvania didnot pass a fiscal 2010 budget until mid-October 2009, the majority of thecities and counties in Pennsylvania chose to defer their payments (during thestate budget impasse present through the third quarter of 2009) until the statebudget had been adopted. While we closely monitor such situations, we do notcurrently expect such this to have a permanent impact on the repayment of ourreceivables related to our facilities.

 

**InterestRate Exposure**

 

Our exposure to changes in interest rates primarily results from ourAmended Credit Facility, as these borrowings have floating interest rates.  The debt on our consolidated financialstatements at September 30, 2009 with fixed interest rates consist of the8.47% Bonds issued by MCF, a special purpose entity, in August 2001 inconnection with the 2001 Sale and Leaseback Transaction and $112.0 million of SeniorNotes.  The detrimental effect of ahypothetical 100 basis point increase in interest rates on our currentborrowings under our Amended Credit Facility would be to reduce income beforeprovision for income taxes by approximately $0.5 million for the nine months endedSeptember 30, 2009.  At September 30,2009, the fair value of our consolidated fixed rate debt was approximately $313.2million based upon quoted market prices or discounted future cash flows using thesame or similar securities.

 

**Inflation**

 

Other than personnel, offender medical costs at certain facilities, andemployee medical and worker’s compensation insurance costs, we believe thatinflation has not had a material effect on our results of operations during thepast two years.  We have experiencedsignificant increases in offender medical costs and employee medical and worker’scompensation insurance costs, and we have also experienced higher personnelcosts during the past two years. Most of our facility management contractsprovide for payments of either fixed per diem fees or per diem fees thatincrease by only small amounts during the term of the contracts. Inflationcould substantially increase our personnel costs (the largest component of ouroperating expenses), medical and insurance costs or other operating expenses atrates faster than any increases in contract revenues.  Food costs (part of our resident/inmate carecosts) have also been subject to rising prices in 2008 and 2009. We believe wehave limited our exposure through long-term contracts with fixed term pricing.

 

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**ITEM 4.****           ****Controls and Procedures**

 

**Evaluation of Disclosure Controls and Procedures**

 

We maintain disclosurecontrols and procedures designed to provide reasonable assurance thatinformation disclosed in our annual and periodic reports is recorded,processed, summarized and reported within the time periods specified in the Securitiesand Exchange Commission’s rules and forms. In addition, we designed thesedisclosure controls and procedures to ensure that this information isaccumulated and communicated to management, including the chief executiveofficer (CEO) and chief financial officer (CFO), to allow timely decisionsregarding required disclosures. SEC rules require that we disclose theconclusions of our CEO and CFO about the effectiveness of our disclosurecontrols 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 disclosurecontrols and procedures must reflect the fact that there are resourceconstraints, and the benefits of controls must be considered relative to theircosts. Because of the inherent limitation in a cost-effective control system,misstatements due to error or fraud could occur and not be detected.

 

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

 

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**Changesin Internal Control over Financial Reporting**

 

In connection withthe evaluation as required by paragraph (d) of Rules 13a-15 and15d-15 of the Exchange Act, we have not identified any change in our internalcontrol over financial reporting (as such term is defined in Rules 13a-15(f) and15d-15(f) under Exchange Act) during our fiscal quarter ended September 30,2009 that has materially affected, or is reasonably likely to materiallyaffect, our internal control over financial reporting.

 

**PART II****                       ****OTHER INFORMATION**

 

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

 

See Part I, Item 1. Note 9 to the ConsolidatedFinancial Statements, which is incorporated herein by reference.

 

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

 

The risk factors as previously disclosed in our Form 10-Kfor the fiscal year ended December 31, 2008 are incorporated herein bythis reference. There are no material changes to such risk factors.

 

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

 

None.

 

**ITEM 3.****                                            ****Defaults Upon SeniorSecurities.**

 

None.

 

## **ITEM 4.**                                             Submission of Matters to a Vote ofSecurity Holders.

 

None.

 

## **ITEM 5.**                                             OtherInformation.

 

None.

 

**ITEM 6.**                                             **Exhibits.**

 
| 31.1*  |   | Section 302  Certification of Chief Executive Officer |
|--------|--------|------------------------------------------------------------|
| 31.2*  |   | Section 302  Certification of Chief Financial Officer |
| 32.1** |   | Section 906  Certification of Chief Executive Officer |
| 32.2** |   | Section 906  Certification of Chief Financial Officer |

 

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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: November 6,  2009 | By:    | /s/ James  E. Hyman                         |
|                              |   | JAMES  E. HYMAN                                  |
|                              |   | Chief  Executive Officer, President and Chairman |
|                              |   | of  the Board (Principal Executive Officer)      |
|                              |   |                                             |
|                              |   |                                             |
| Date: November 6,  2009 | 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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