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** **

 

** **

**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, DC 20549**

 

**FORM 10-Q**

 
| **x**                                                 | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT  OF 1934**  |
|-------------------------------------------------------|----------------------------------------------------------------------------------------------------------|
|                                                  |                                                                                                     |
| **For the Quarterly Period Ended June 30, 2009** |
|                                                  |                                                                                                     |
| **OR**                                                |
|                                                  |                                                                                                     |
| **o**                                                 | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934** |

 

**For the transition period from           to           **

 

**Commission File Number 1-14472**

 

**CORNELLCOMPANIES, INC.**

(Exact Name of Registrant as Specified in ItsCharter)

 

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

 

Registrant’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  ̈ No  ̈

 

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

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

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act).

 

Yes  o No x

 

At August 5, 2009, the registrant had 16,412,802 shares of commonstock outstanding.

 

 

 

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**Cornell Companies, Inc.**

 

**Table of Contents**

 

**Form 10-Q**

 
| ** **       | ** **                                                                                  | **Page**   |
|------------------|---------------------------------------------------------------------------------------------|------------|
| **Part I**  | ** **                                                                                  | ** ** |
| Item 1.          | Financial  Statements (unaudited)                                                           | 5          |
| Item 2.          | Management’s  Discussion and Analysis of Financial Condition and Results of Operations | 30         |
| Item 3.          | Quantitative  and Qualitative Disclosures About Market Risk                                 | 44         |
| Item 4.          | Controls and  Procedures                                                                    | 45         |
|             |                                                                                        |       |
| **Part II** |                                                                                        | ** ** |
| Item 1.          | Legal Proceedings                                                                           | 46         |
| Item 1A.         | Risk Factors                                                                                | 46         |
| Item 2.          | Unregistered  Sales of Equity Securities and Use of Proceeds                                | 46         |
| Item 3.          | Defaults  Upon Senior Securities                                                            | 46         |
| Item 4.          | Submission  of Matters to a Vote of Security Holders                                        | 46         |
| Item 5.          | Other Information                                                                           | 47         |
| Item 6.          | Exhibits                                                                                    | 47         |

 

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**Forward-Looking Information**

 

The statements included in this quarterly report regarding futurefinancial performance and results of operations and other statements that arenot historical 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 contracts with the Colorado Department of Corrections,

·                  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 statements are subject to numerous risks,uncertainties and assumptions, including, but not 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.      Financial Statements.**

 

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

 
| ** **                                                                                                                                                            | ** ** | **June 30,  2009** | ** ** | **December 31,  2008** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| **ASSETS**                                                                                                                                                            | ** ** | ** **              | ** ** | ** **                  | ** ** |
| **CURRENT ASSETS:**                                                                                                                                                   | ** ** | ** **              | ** ** | ** **                  | ** ** |
| Cash and cash equivalents                                                                                                                                             |       | $                       | 16,620     |                        | $          | 14,613 |   |
| Accounts receivable — trade (net of allowance for  doubtful accounts of $5,527 and $4,272, respectively)                                                    |       | 64,565                  |       | 64,622                      |       |
| Other receivables (net of allowance for doubtful  accounts of $4,926)                                                                                                 |       | 1,681                   |       | 4,766                       |       |
| Bond fund payment account and other restricted  assets                                                                                                                |       | 38,299                  |       | 31,370                      |       |
| Deferred tax assets                                                                                                                                                   |       | 10,097                  |       | 9,151                       |       |
| Prepaid expenses and other                                                                                                                                            |       | 5,886                   |       | 6,368                       |       |
| **Total current assets**                                                                                                                                              |       | 137,148                 |       | 130,890                     |       |
| **PROPERTY AND EQUIPMENT, net**                                                                                                                                       |       | 450,850                 |       | 450,354                     |       |
| **OTHER ASSETS:**                                                                                                                                                     |       |                    |       |                        |       |
| Debt service reserve fund                                                                                                                                             |       | 24,195                  |       | 23,750                      |       |
| Goodwill, net                                                                                                                                                         |       | 13,308                  |       | 13,308                      |       |
| Intangible assets, net                                                                                                                                                |       | 1,423                   |       | 2,320                       |       |
| Deferred costs and other                                                                                                                                              |       | 17,022                  |       | 16,299                      |       |
| **Total assets**                                                                                                                                                      |       | $                       | 643,946    |                        | $          | 636,921 |   |
|                                                                                                                                                                  |       |                    |       |                        |       |
| **LIABILITIES AND  STOCKHOLDERS’ EQUITY**                                                                                                                        | ** ** | ** **              | ** ** | ** **                  | ** ** |
|                                                                                                                                                                  |       |                    |       |                        |       |
| **CURRENT LIABILITIES:**                                                                                                                                              | ** ** | ** **              | ** ** | ** **                  | ** ** |
| Accounts payable and accrued liabilities                                                                                                                              |       | $                       | 61,575     |                        | $          | 69,093 |   |
| Current portion of long-term debt                                                                                                                                     |       | 12,413                  |       | 12,412                      |       |
| **Total current liabilities**                                                                                                                                         |       | 73,988                  |       | 81,505                      |       |
| **LONG-TERM DEBT, net of current  portion**                                                                                                                           |       | 306,156                 |       | 308,070                     |       |
| **DEFERRED TAX LIABILITIES**                                                                                                                                          |       | 18,649                  |       | 17,491                      |       |
| **OTHER LONG-TERM LIABILITIES**                                                                                                                                       |       | 1,912                   |       | 1,688                       |       |
| **Total liabilities**                                                                                                                                                 |       | 400,705                 |       | 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, 16,403,637 and 16,238,685 shares issued and 14,915,751 and  14,732,522 shares outstanding, respectively |       | 16                      |       | 16                          |       |
| Additional paid-in capital                                                                                                                                            |       | 166,441                 |       | 164,746                     |       |
| Retained earnings                                                                                                                                                     |       | 85,805                  |       | 73,318                      |       |
| Accumulated other comprehensive income                                                                                                                                |       | 1,549                   |       | 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.**                                                                                                                               |       | 241,923                 |       | 227,722                     |       |
| Non-controlling interest                                                                                                                                              |       | 1,318                   |       | 445                         |       |
| **Total stockholders’ equity**                                                                                                                                   |       | 243,241                 |       | 228,167                     |       |
| **Total liabilities and  stockholders’ equity**                                                                                                                  |       | $                       | 643,946    |                        | $          | 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  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                                                                                           | ** ** | **2009**                                        | ** ** | **2008**                                      | ** ** | **2009** | ** ** | **2008** | ** ** |
|                                                                                                                                                 |       |                                            |       |                                          |       |   |   |   |   |
| REVENUES                                                                                                                                             |       | $                                               | 105,334    |                                          | $          | 94,646 |   | $ | 205,044 |   | $ | 190,038 |   |
| OPERATING EXPENSES, EXCLUDING DEPRECIATION AND AMORTIZATION                                                                                          |       | 74,734                                          |       | 68,280                                        |       | 147,627 |   | 138,491 |   |
| DEPRECIATION AND AMORTIZATION                                                                                                                        |       | 4,740                                           |       | 4,220                                         |       | 9,633 |   | 8,377 |   |
| GENERAL AND ADMINISTRATIVE EXPENSES                                                                                                                  |       | 6,270                                           |       | 7,232                                         |       | 12,408 |   | 13,766 |   |
|                                                                                                                                                 |       |                                            |       |                                          |       |   |   |   |   |
| INCOME FROM OPERATIONS                                                                                                                               |       | 19,590                                          |       | 14,914                                        |       | 35,376 |   | 29,404 |   |
|                                                                                                                                                 |       |                                            |       |                                          |       |   |   |   |   |
| INTEREST EXPENSE                                                                                                                                     |       | 6,736                                           |       | 6,307                                         |       | 12,935 |   | 12,912 |   |
| INTEREST INCOME                                                                                                                                      |       | (160                                            | )          | (740                                          | )          | (406 | ) | (1,050 | ) |
|                                                                                                                                                 |       |                                            |       |                                          |       |   |   |   |   |
| INCOME FROM OPERATIONS BEFORE PROVISION FOR INCOME TAXES AND  NON-CONTROLLING INTEREST                                                               |       | 13,014                                          |       | 9,347                                         |       | 22,847 |   | 17,542 |   |
|                                                                                                                                                 |       |                                            |       |                                          |       |   |   |   |   |
| PROVISION FOR INCOME TAXES                                                                                                                           |       | 5,386                                           |       | 4,002                                         |       | 9,487 |   | 7,563 |   |
|                                                                                                                                                 |       |                                            |       |                                          |       |   |   |   |   |
| NET INCOME                                                                                                                                           |       | 7,628                                           |       | 5,345                                         |       | 13,360 |   | 9,979 |   |
|                                                                                                                                                 |       |                                            |       |                                          |       |   |   |   |   |
| NON-CONTROLLING INTEREST                                                                                                                             |       | 398                                             |       | —                                        |       | 873 |   | — |   |
|                                                                                                                                                 |       |                                            |       |                                          |       |   |   |   |   |
| INCOME AVAILABLE TO STOCKHOLDERS                                                                                                                     |       | $                                               | 7,230      |                                          | $          | 5,345 |   | $ | 12,487 |   | $ | 9,979 |   |
|                                                                                                                                                 |       |                                            |       |                                          |       |   |   |   |   |
| EARNINGS PER SHARE:                                                                                                                                  |       |                                            |       |                                          |       |   |   |   |   |
| BASIC                                                                                                                                                |       | $                                               | .49        |                                          | $          | .36 |   | $ | .84 |   | $ | .68 |   |
| DILUTED                                                                                                                                              |       | $                                               | .48        |                                          | $          | .36 |   | $ | .84 |   | $ | .67 |   |
|                                                                                                                                                 |       |                                            |       |                                          |       |   |   |   |   |
| NUMBER OF SHARES USED IN PER SHARE COMPUTATION:                                                                                                      |       |                                            |       |                                          |       |   |   |   |   |
| BASIC                                                                                                                                                |       | 14,881                                          |       | 14,707                                        |       | 14,878 |   | 14,700 |   |
| DILUTED                                                                                                                                              |       | 14,970                                          |       | 14,854                                        |       | 14,952 |   | 14,840 |   |
|                                                                                                                                                 |       |                                            |       |                                          |       |   |   |   |   |
| COMPREHENSIVE INCOME:                                                                                                                                |       |                                            |       |                                          |       |   |   |   |   |
| Net income                                                                                                                                           |       | $                                               | 7,628      |                                          | $          | 5,345 |   | $ | 13,360 |   | $ | 9,979 |   |
| Other comprehensive income, net of tax: Unrealized gain (loss)  on derivative instruments, net of tax (benefit) provision of ($429) and $83  in 2008 |       | —                                          |       | (618                                          | )          | — |   | 117 |   |
| Total other comprehensive income, net of tax                                                                                                         |       | 7,628                                           |       | 4,727                                         |       | 13,360 |   | 10,096 |   |
| Comprehensive income attributable to non-controlling interest                                                                                        |       | (398                                            | )          | —                                        |       | (873 | ) | — |   |
| Comprehensive income attributable to Cornell Companies, Inc.                                                                                         |       | $                                               | 7,230      |                                          | $          | 4,727 |   | $ | 12,487 |   | $ | 10,096 |   |

 

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

 

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**CORNELL COMPANIES, INC.**

### ***CONSOLIDATEDSTATEMENT OF STOCKHOLDERS’ EQUITY***

### ***ANDCOMPREHENSIVE INCOME***

**FOR THE SIX MONTHS ENDED JUNE 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                                                               |       | ––          |       | ––   |       | –– |       | 12,487       |       | ––            |       | ––           |       | ––    |       | 873                    |       | 13,360            |       | 12,487 |   |
| COMPREHENSIVE  INCOME                                                     |       | ––          |       | ––   |       | –– |       | –– |       | ––            |       | ––           |       | ––    |       | ––           |       | ––      |       | $ | 12,487 |   |
| EXERCISE  OF STOCK OPTIONS                                                |       | 2,550                 |       | ––   |       | 32           |       | –– |       | ––            |       | ––           |       | ––    |       | ––           |       | 32                |       |   |   |
| INCOME  TAX BENEFIT FROM STOCK OPTION EXERICES                            |       | ––          |       |           |       | (71          | )          |         |       |                    |       |                   |       |            |       |                   |       | (71               | )          |   |   |
| DEFERRED  AND OTHER STOCK COMPENSATION                               |       | 153,983               |       | ––   |       | 1,363        |       | –– |       | ––            |       | ––           |       | ––    |       | ––           |       | 1,363             |       |   |   |
| AMORTIZATION  OF GAIN ON TERMINATION OF DERIVATIVE                        |       | ––          |       | —         |       | –– |       | —       |       | —                  |       | —                 |       | (127            | )          | ––           |       | (127              | )          |   |   |
| ISSUANCE  OF COMMON STOCK TO EMPLOYEE STOCK PURCHASE PLAN       |       | ––          |       | ––   |       | 143          |       | –– |       | (18,277                 | )          | 146                    |       | ––    |       | ––           |       | 289               |       |   |   |
| ISSUANCE  OF COMMON STOCK UNDER 2000 DIRECTOR’S STOCK PLAN |       | 8,419                 |       | ––   |       | 228          |       | –– |       | ––            |       | ––           |       | ––    |       | ––           |       | 228               |       |   |   |
|                                                                      |       |                  |       |           |       |         |       |         |       |                    |       |                   |       |            |       |                   |       |              |       |   |   |
| BALANCES  AT JUNE 30, 2009                                                |       | 16,403,637            |       | $              | 16         |         | $          | 166,441      |       | $                       | 85,805     |                   | 1,487,886  |            | $          | (11,888                | )          | $                 | 1,549      |   | $ | 1,318 |   | $ | 243,241 |   |   |   |

 

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

 

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**CORNELL COMPANIES, INC.**

### ***CONSOLIDATEDSTATEMENT OF STOCKHOLDERS’ EQUITY***

### ***ANDCOMPREHENSIVE INCOME***

**FOR THE SIX MONTHS ENDED JUNE 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                                                               |       | ––          |       | ––   |       | –– |       | 9,979        |       | ––            |       | ––           |       | ––    |       | ––           |       | 9,979             |       | 9,979 |   |
| UNREALIZED  GAIN ON DERIVATIVE INSTRUMENTS, NET OF TAXES OF $83           |       | ––          |       | ––   |       | –– |       | –– |       | ––            |       | ––           |       | 117             |       | ––           |       | 117               |       | 117 |   |
| COMPREHENSIVE  INCOME                                                     |       | ––          |       | ––   |       | –– |       | –– |       | ––            |       | ––           |       | ––    |       | ––           |       | ––      |       | $ | 10,096 |   |
| EXERCISE  OF STOCK OPTIONS                                                |       | 2,325                 |       | ––   |       | 29           |       | –– |       | ––            |       | ––           |       | ––    |       | ––           |       | 29                |       |   |   |
| INCOME  TAX BENEFIT FROM STOCK OPTION EXERCISES                           |       | ––          |       | ––   |       | 3            |       | –– |       | ––            |       | ––           |       | ––    |       | ––           |       | 3                 |       |   |   |
| DEFERRED  AND OTHER STOCK COMPENSATION                               |       | 139,637               |       | ––   |       | 1,712        |       | –– |       | ––            |       | ––           |       | ––    |       | ––           |       | 1,712             |       |   |   |
| ISSUANCE  OF COMMON STOCK TO EMPLOYEE STOCK PURCHASE PLAN       |       | ––          |       | ––   |       | 83           |       | –– |       | (8,883                  | )          | 71                     |       | ––    |       | ––           |       | 154               |       |   |   |
| ISSUANCE  OF COMMON STOCK UNDER 2000 DIRECTOR’S STOCK PLAN |       | 7,595                 |       | ––   |       | 268          |       | –– |       | ––            |       | ––           |       | ––    |       | ––           |       | 268               |       |   |   |
|                                                                      |       |                  |       |           |       |         |       |         |       |                    |       |                   |       |            |       |                   |       |              |       |   |   |
| BALANCES  AT JUNE 30, 2008                                                |       | 16,218,234            |       | $              | 16         |         | $          | 162,414      |       | $                       | 61,106     |                   | 1,506,163  |            | $          | (12,034                | )          | $                 | 1,209      |   | $ | –– |   | $ | 212,711 |   |   |   |

 

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

 

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**CORNELLCOMPANIES, INC.**

# **CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Unaudited)**

**(in thousands)**

 
| ** **                                                                                               | ** ** | **Six Months Ended** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                                               | ** ** | **June 30,**              | ** ** |
| ** **                                                                                               | ** ** | **2009**                       | ** ** | **2008** | ** ** |
| CASH FLOWS  FROM OPERATING ACTIVITIES:                                                                   |       |                           |       |   |   |
| Net income                                                                                               |       | $                              | 13,360     |   | $ | 9,979 |   |
| Adjustments  to reconcile net income to net cash provided by operating activities -                      |       |                           |       |   |   |
| Depreciation                                                                                             |       | 8,737                          |       | 7,404 |   |
| Amortization  of intangibles and other assets                                                            |       | 896                            |       | 973 |   |
| Impairment of  long-lived assets                                                                         |       | —                         |       | 250 |   |
| Amortization  of deferred financing costs                                                                |       | 635                            |       | 725 |   |
| Amortization  of Senior Notes discount                                                                   |       | 92                             |       | 92 |   |
| Amortization  of gain on termination of derivative                                                       |       | (127                           | )          | — |   |
| Stock-based  compensation                                                                                |       | 1,634                          |       | 1,888 |   |
| Provision for  bad debts                                                                                 |       | 1,265                          |       | 1,651 |   |
| (Gain)loss on  sale/disposals of property and equipment                                                  |       | (349                           | )          | 33 |   |
| Deferred  income taxes                                                                                   |       | 141                            |       | 692 |   |
| Change in  assets and liabilities, net of effects of acquisitions:                                       |       |                           |       |   |   |
| Accounts  receivable                                                                                     |       | (354                           | )          | 2,176 |   |
| Other restricted  assets                                                                                 |       | (594                           | )          | (362 | ) |
| Other assets                                                                                             |       | 1,759                          |       | (476 | ) |
| Accounts  payable and accrued liabilities                                                                |       | (9,041                         | )          | 1,450 |   |
| Other  long-term liabilities                                                                             |       | 224                            |       | (8 | ) |
| Net cash  provided by operating activities                                                               |       | 18,278                         |       | 26,467 |   |
|                                                                                                     |       |                           |       |   |   |
| CASH FLOWS  FROM INVESTING ACTIVITIES:                                                                   |       |                           |       |   |   |
| Capital  expenditures                                                                                    |       | (9,493                         | )          | (38,996 | ) |
| Sales of  investment securities                                                                          |       | —                         |       | 250 |   |
| Proceeds from  the sale/disposals of fixed assets                                                        |       | 1,688                          |       | 17 |   |
| Payments to restricted  debt payment account, net                                                        |       | (6,780                         | )          | (7,425 | ) |
| Net cash used  in investing activities                                                                   |       | (14,585                        | )          | (46,154 | ) |
|                                                                                                     |       |                           |       |   |   |
| CASH FLOWS  FROM FINANCING ACTIVITIES:                                                                   |       |                           |       |   |   |
| Proceeds from  line of credit                                                                            |       | 2,000                          |       | 17,500 |   |
| Payments of  line of credit                                                                              |       | (4,000                         | )          | — |   |
| Tax benefit  of stock option exercises                                                                   |       | —                         |       | 3 |   |
| Payments of  capital lease obligations                                                                   |       | (7                             | )          | (5 | ) |
| Proceeds from  exercise of stock options                                                                 |       | 321                            |       | 182 |   |
| Net cash  provided by (used in) financing activities                                                     |       | (1,686                         | )          | 17,680 |   |
|                                                                                                     |       |                           |       |   |   |
| NET INCREASE  (DECREASE) IN CASH AND CASH EQUIVALENTS                                                    |       | 2,007                          |       | (2,007 | ) |
| CASH AND CASH  EQUIVALENTS AT BEGINNING OF PERIOD                                                        |       | 14,613                         |       | 3,028 |   |
| CASH AND CASH  EQUIVALENTS AT END OF PERIOD                                                              |       | $                              | 16,620     |   | $ | 1,021 |   |
|                                                                                                     |       |                           |       |   |   |
| OTHER  NON-CASH INVESTING AND FINANCING ACTIVITIES:                                                      |       |                           |       |   |   |
| Other  comprehensive income, net of tax                                                                  |       | $                              | —     |   | $ | 117 |   |
| Common stock  issued for board of directors fees                                                         |       | 228                            |       | 268 |   |
| Purchases and  additions to property and equipment included in accounts payable and accrued  liabilities |       | 1,253                          |       | 9,392 |   |

 

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

 

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**CORNELLCOMPANIES, 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 auditedfinancial statements but does not include all disclosures required by GAAP. Inthe opinion of management, adjustments and disclosures necessary for a fairpresentation of these financial statements have been included.  Estimates were used in the preparation ofthese financial statements.  Actualresults could differ from those estimates. These financial statements should be read in conjunction with thefinancial statements and notes thereto included in the Company’s 2008 AnnualReport on Form 10-K as filed with the Securities and Exchange Commission.

 

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

 

Seea description of our accounting policies in the Notes to Consolidated FinancialStatements included in our 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. Under SFAS No. 123Rour employee-stock purchase plan is considered to be a compensatory ESPP, andtherefore, we recognize compensation expense over the requisite service periodfor grants made under the ESPP.

 

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

 

At June 30, 2008,200,000 shares of restricted stock were outstanding subject toperformance-based vesting criteria (32,500 of these restricted shares wereconsidered market-based restricted stock under SFAS No. 123R). There werealso 52,700 stock options outstanding subject to performance-based vestingcriteria. We recognized $0.14 million and $0.6 million of expense associatedwith these shares of restricted stock and stock options during the three andsix months ended June 30, 2008, respectively.

 

At June 30, 2009,317,602 shares of restricted stock were outstanding subject toperformance-based vesting criteria (32,500 of these restricted shares wereconsidered market-based restricted stock under SFAS No. 123R). There werealso 6,260 stock options outstanding subject to performance-based vestingcriteria. We recognized $0.4 million and $0.5 million of expense associatedwith these shares of restricted stock and stock options during the three andsix months ended June 30, 2009, respectively.

 

The amounts above relate to the impact of recognizingcompensation expense related to stock options and restricted stock. Compensationexpense related to stock options (6,260 shares) and restricted stock (285,102shares) that vest based upon performance conditions is not recorded for suchperformance-based awards until it has been deemed probable that the relatedperformance targets allowing the vesting of these options and restricted stockwill be met. We are required to periodically re-assess the probability thatthese performance-based awards will vest and record expense at that point intime. During the six months ended June 30, 2009 it was deemed probablethat certain performance targets pertaining to certain restricted stock andstock options would be achieved by their vesting date. Accordingly,compensation expense of approximately $0.4 million was recognized in the six monthsended June 30, 2009 related to these stock-based awards.

 

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We recognize expense forour stock-based compensation over the vesting period, or in the case ofperformance-based awards, over the remaining vesting period once 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.

 

***Assumptions***

 

Thefair values for the significant stock-based awards granted during the sixmonths ended June 30, 2009 and 2008 were estimated at the date of grantusing a Black-Scholes option pricing model with the following weighted-averageassumptions:

 
| ** **                       | ** ** | **Six Months Ended  June 30,** | ** ** |
|----------------------------------|------------|-----------------------------------------------|------------|
| ** **                       | ** ** | **2009**                                      | ** ** | **2008** | ** ** |
|                             |       |                                          |       |   |   |
| Risk-free rate of return         |       | 1.90                                          | %          | 3.35 | % |
| Expected life of award           |       | 6.0 years                                     |       | 5.67 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 thatof the expected life of the award. We do not believe that future stockvolatility will significantly differ from historical stock volatility.Estimated forfeiture rates are derived from historical forfeiture patterns. Webelieve the historical experience method is the best estimate of forfeiturescurrently available.

 

Inaccordance with SAB 107, we generally considered the “simplified” method for “plainvanilla” options to estimate the expected term of options granted during 2009and 2008 (where appropriate).  For thosegrants during these periods wherein we had sufficient historical or impartialdata to better estimate the expected term, we have done so.

 

Stock-basedaward activity during the six months ended June 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 June 30, 2009                 |       | 514,682                |       | $                                      | 15.29      |                                                | 6.4        |                            | $          | 7.9 |   |
|                                              |       |                   |       |                                   |       |                                                |       |                            |       |
| Vested and expected to vest at June 30, 2009 |       | 512,679                |       | $                                      | 15.26      |                                                | 6.4        |                            | $          | 7.6 |   |
|                                              |       |                   |       |                                   |       |                                                |       |                            |       |
| Exercisable at June 30, 2009                 |       | 467,467                |       | $                                      | 14.96      |                                                | 6.2        |                            | $          | 7.0 |   |

 

Thetotal intrinsic value of stock options exercised during the six months ended June 30,2009 and 2008 was $0.01 million and $0.03 million, respectively. Net cash proceedsfrom the exercise of stock options were approximately $0.03 million for the sixmonths ended June 30, 2009 and 2008.

 

Asof June 30, 2009, approximately $0.1 million of estimated expense withrespect to time-based nonvested stock-based awards has yet to be recognized andwill be amortized into expense over the employee’s remaining requisite serviceperiod of approximately 6.2 months.

 

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Thefollowing table summarizes information with respect to stock optionsoutstanding and exercisable at June 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                  |       | 2.3                                                 |       | $                                      | 5.72       |                    | 18,865     |                                   | $          | 5.72 |   |
| $10.01  to  $13.50      |       | 150,917                 |       | 5.2                                                 |       | 12.83                                  |       | 146,697                 |       | 12.83                                  |       |
| $13.51  to $14.50            |       | 193,200                 |       | 6.2                                                 |       | 13.95                                  |       | 185,540                 |       | 13.93                                  |       |
| $14.51  to $25.00            |       | 151,700                 |       | 8.3                                                 |       | 20.62                                  |       | 116,365                 |       | 20.79                                  |       |
|                                        |       | 514,682                 |       | 6.4                                                 |       | $                                      | 15.29      |                    | 467,467    |                                   | $          | 14.96 |   |

 

Stock-basedaward activity for nonvested awards during the six months ended June 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                              |       | (87,903                | )          | 15.67                                                       |       |
| Canceled                            |       | —                 |       | —                                                      |       |
|                                |       |                   |       |                                                        |       |
| Nonvested at June 30, 2009     |       | 47,215                 |       | $                                                           | 18.48      |   |

 

***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 six months ended June 30,2009, we issued restricted stock as part of our normal equity awards under our2006 Incentive Plan.  These shares ofrestricted common stock are subject to restrictions on transfer and certainconditions to vesting.

 

Restricted stock activityfor the six months ended June 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                            |       | —                 |       | —                                                      |       |
|                                |       |                   |       |                                                        |       |
| Nonvested at June 30, 2009     |       | 524,231                |       | $                                                           | 20.59      |   |

 

We recognized $0.4million and $0.8 million of expense associated with nonvested time-basedrestricted stock awards during the three and six months ended June 30,2009, respectively.  As of June 30,2009, approximately $2.4 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 2.1 years. Approximately$5.4 million of estimated expense with respect to nonvested performance-basedrestricted stock option awards had yet to be recognized as of June 30,2009.

 

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

 

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

 
| ** **                                             | ** ** | **June 30,  2009** | ** ** | **December 31,  2008** | ** ** |
|--------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
|                                                   |       |                    |       |                        |       |
| Non-compete agreements                                 |       | $                       | 8,200      |                        | $          | 8,200 |   |
| Accumulated amortization — non-compete agreements |       | (7,970                  | )          | (7,595                      | )          |
| Acquired contract value                                |       | 6,240                   |       | 6,240                       |       |
| Accumulated amortization — contract value         |       | (5,047                  | )          | (4,525                      | )          |
| Identified intangibles, net                            |       | 1,423                   |       | 2,320                       |       |
| Goodwill, net                                          |       | 13,308                  |       | 13,308                      |       |
| Total intangibles, net                                 |       | $                       | 14,731     |                        | $          | 15,628 |   |

 

There were no changes in the carryingamount of goodwill in the six months ended June 30, 2009.

 

Amortizationexpense for our non-compete agreements was approximately $0.2 million for thethree months ended June 30, 2009 and 2008 and approximately $0.4 millionfor the six months ended June 30, 2009 and 2008.

 

Amortizationexpense for our acquired contract value was approximately $0.3 million for eachof the three months ended June 30, 2009 and 2008 and approximately $0.5million for each of the six months ended June 30, 2009 and 2008.

 

**5.****             ****NewAccounting Pronouncements**

 

***Statementof Financial Accounting Standards (“SFAS”) No. 157***

 

In September 2006,the Financial Accounting Standards Board (“FASB”) issued SFAS No. 157, “FairValue Measurements” (“SFAS No. 157”). SFAS No. 157 defines fair value, establishes a framework formeasuring fair value within generally accepted accounting principles andexpands disclosures about fair value measurements for financial assets andliabilities, as well as for any other assets and liabilities that are carriedat fair value on a recurring basis in the financial statements. SFAS No. 157became effective for financial statements issued for fiscal years beginningafter November 15, 2007, and interim periods within those fiscalyears.  This statement appliesprospectively to financial assets and liabilities. In February 2008, theFASB issued (“FSP”) 157-2, which delayed the effective date of SFAS No. 157by one year for nonfinancial assets and liabilities.  Our adoption of SFAS No. 157 on January 1,2008 with respect to financial assets and liabilities did not have a materialfinancial impact on our consolidated results of operations or financialcondition.  Our adoption of SFAS No. 157on January 1, 2008 with respect to financial assets and liabilities didnot have a material financial impact on our consolidated results of operationsor financial condition.  On January 1,2009, we adopted the provisions of SFAS No. 157 for applying fair value toassets, liabilities and transactions on a non-recurring basis.  Adoption of SFAS No. 157 for fair valuemeasurements on a non-recurring basis did not have a material effect on theCompany’s financial position, results of operations or cash flows.

 

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

 

Level 1                                  Unadjustedquoted prices in active markets that are accessible at the measurement date foridentical, unrestricted assets or liabilities;

 

Level 2                                  Quoted pricesin markets that are not active, or inputs that are observable, either directlyor indirectly, for substantially the full term of the asset or liability; and

 

Level 3                                  Prices orvaluation techniques that require inputs that are both significant to the fairvalue measurement and unobservable (i.e., supported by little or no marketactivity).

 

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Asrequired by SFAS No. 157, financial assets and liabilities are classifiedbased on the lowest level of input that is significant for the fair valuemeasurement.  The following tablesummarizes the valuation of our financial assets and liabilities by pricinglevels, as defined by the provisions of SFAS No. 157, as of June 30,2009:

 
| ** **         | ** ** | **Fair Value as of June 30, 2009 (in thousands)** | ** **   |
|--------------------|------------|-------------------------------------------------------------------------------------------|--------------|
| ** **         | ** ** | **Level 1**                                                                          | ** **   | **Level 2** | ** ** | **Level 3** | ** ** | **Total** | ** ** |
| Assets:            |       |                                                                                      |         |   |   |   |   |   |   |
| Cash Equivalents   |       | $                                                                                         | –– |   | $ | –– |   | $ | –– |   | $ | –– |   |
| Corporate Bonds    |       | ––                                                                              |         | 15,881 |   | –– |   | 15,881 |   |
| Money Market Funds |       | ––                                                                              |         | 43,032 |   | –– |   | 43,032 |   |
|                    |            |                                                                                           |              |  |  |  |  |  |  |  |  |  |  |

 

Thecorporate bonds and money market funds are carried in debt service fund andother restricted assets and the debt service reserve fund in the accompanyingbalance sheet. The fair value measurements for corporate bonds and money-marketfunds are based upon the quoted price for similar assets in markets that arenot active, multiplied by the number of shares owned, exclusive of anytransaction costs and without any adjustments to reflect discounts that may beapplied to selling a large block of the securities at one time. The Companydoes not believe that the changes in fair value of these assets will materiallydiffer from the amounts that could be realized upon settlement or that thechanges in fair value will have a material effect on the Company’s results ofoperations, liquidity and capital resources.

 

SFAS No. 157 requires a reconciliation of thebeginning 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 six months endedJune 30, 2009.

 

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

 

In December 2007,the FASB issued SFAS No. 141 (Revised 2007), “Business Combinations” (“SFASNo. 141R”).  SFAS No. 141Rsignificantly changes the accounting for business combinations.  Under SFAS No. 141R, an acquiring entitywill be required to recognize all the assets acquired and liabilities assumedin a transaction at the acquisition-date fair value with limitedexceptions.  SFAS No. 141R changesthe accounting treatment for certain specific items, including acquisitioncosts, noncontrolling interests, acquired contingent liabilities, in-processresearch and development costs, restructuring costs and changes in deferred taxasset valuation allowances and income tax uncertainties subsequent to theacquisition date.  SFAS No. 141Rapplies prospectively to business combinations for which the acquisition dateis on or after the beginning of the first annual reporting period beginning onor after December 15, 2008.  Ouradoption of SFAS No. 141 on January 1, 2009 did not have any impacton our consolidated results of operations or financial condition as we did nothave any business combination activity in the six months ended June 30,2009.

 

***FASB Staff Position No. FAS 142-3***

 

ThisFSP amends the factors that should be considered in developing renewal orextension assumptions used to determine the useful life of a recognizedintangible asset under SFAS No. 142, “Goodwill and Other Intangible Assets”.  The intent of this FSP is to improve theconsistency between the useful life of a recognized intangible asset under SFASNo. 142 and the period of expected cash flows used to measure the fairvalue of the asset under SFAS No. 141 (Revised 2007), “BusinessCombinations” and other U.S. generally accepted accounting principles.  This FSP is effective for financialstatements issued for fiscal years beginning after December 15, 2008, andinterim periods within those fiscal years. Our adoption of this FSP on January 1, 2009 did not have a significantimpact on our consolidated financial position, results of operations or cashflows.

 

***Statement of Financial Accounting Standards No. 160***

 

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

 

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interest.  SFAS No. 160 is effective for fiscalyears, and interim periods within those fiscal years, beginning on or after December 15,2008.  We adopted SFAS No. 160 on January 1,2009 and applied the provisions to our 2009 financial statements andretroactively to all prior periods presented.

 

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

 

InMarch 2008, the FASB issued SFAS No. 161, “Disclosures aboutDerivative Instruments and Hedging Activities — an Amendment of FASB Statement133” (“SFAS No. 161”).  SFAS No. 161is intended to improve financial reporting about derivatives and hedgingactivities by requiring enhanced qualitative and quantitative disclosuresregarding derivative instruments, gains and losses on such instruments andtheir effects on an entity’s financial position, financial performance and cashflows.  SFAS No. 161 is effectivefor fiscal years and interim periods beginning after November 15, 2008.Our adoption of SFAS No. 161 on January 1, 2009 did not have asignificant impact on our consolidated financial position, results ofoperations or cash flows.

 

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

 

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

 

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

 

ThisFSP addresses whether instruments granted in share-based payment transactionsare participating securities prior to vesting and, therefore, need to beincluded in the earnings allocation in computing earnings per share (“EPS”)under the two-class method described in FASB Statement No. 128, “EarningsPer Share”.  This FSP is effective forfinancial statements issued for fiscal years beginning after December 15,2008, and the interim periods within those years.  All prior-period EPS data is adjustedretrospectively (including interim financial statements, summaries of earnings,and selected financial data) to conform to the provisions of this FSP.  Our adoption of this FSP in January 2009did not have a significant impact on our earnings per share.

 

***Statement of Financial Accounting Standards No. 165***

 

InMay 2008, the FASB issued SFAS No. 165, “Subsequent Events” (“SFAS No165”).  SFAS No. 165 establishesgeneral standards of accounting and disclosure of events that occur after thebalance sheet date but before the financial statements are issued.  SFAS No. 165 sets forth (1) theperiod after the balance sheet date during which management should evaluateevents or transactions that may occur for potential recognition or disclosurein the financial statements, (2) the circumstances under which an entityshould recognize events or transactions occurring after the balance sheet dateand (3) the disclosures an entity should make about such events ortransactions.  SFAS No. 165 isapplicable to both interim and annual financial statements ending after June 15,2009. Management has performed a review of our subsequent events andtransactions through August 7, 2009, which is the date the financial statementsare issued.

 

**New Accounting Pronouncement Not Yet Adopted**

 

***Statement of Financial Accounting Standards No. 166***

 

InJune 2009, the FASB issued SFAS No. 166, “Accounting for Transfers ofFinancial Assets an amendment of FASB Statement No. 140” (“SFAS No. 166”).  SFAS No. 166 applies to the financialreporting of a transfer of financial assets; the effects of a transfer on anentity’s financial position, financial performance and cash flows; and atransferor’s continuing involvement, if any, in transferred financialassets.  SFAS No. 166 eliminates (1) theexceptions for qualifying special-purpose entities from the consolidation guidanceand (2) the exception that permitted sale accounting for certain mortgagesecuritizations when a transferor has not surrendered control over thetransferred financial assets.  SFAS No. 166must be applied as of the beginning of each reporting entity’s first annualreporting period that begins after November 15, 2009, for interim periodswithin that first annual reporting period and for interim and annual

 

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reportingperiods thereafter.  Earlier applicationis prohibited.  SFAS No. 166 must beapplied to transfers occurring on or after the effective date. We are currentlyevaluating the impact, if any, that such statement may have on our financialstatements once adopted.

 

***Statement of Financial Accounting Standards No. 167***

 

InJune 2009, the FASB issued SFAS No. 167, “Amendments to FASBInterpretation No. 46(R)” (“SFAS No. 167”).  SFAS No. 167 amends Interpretation 46(R) toreplace the quantitative-based risks and rewards calculation for determiningwhich enterprise, if any, has a controlling financial interest in a variableinterest entity with an approach focused on identifying which enterprise hasthe power to direct the activities of a variable interest entity that mostsignificantly impact the entity’s economic performance and (1) theobligation to absorb losses of the entity and (2) the right to receivebenefits from the entity.  SFAS No. 167requires an additional reconsideration event when determining whether an entityis a variable interest entity when changes in facts and circumstances occursuch that the holders of the equity investment at risk, as a group, lose thepower from voting rights or similar rights of those investments to direct theactivities of the entity that most significantly impact the entity’s economicperformance.  It also requires ongoingassessments of whether an enterprise is the primary beneficiary of a variableinterest entity.  SFAS No. 167 iseffective 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 reportingperiods thereafter.  Earlier applicationis prohibited. We are currently evaluating the impact, if any, that suchstatement may have on our financial statements once adopted.

 

***Statement of Financial Accounting Standards No. 168***

 

InJune 2009, the FASB issued SFAS No. 168, “The ‘FASB AccountingStandards Codification’ and the Hierarchy of Generally Accepted AccountingPrinciples” (“SFAS No. 168”).  SFAS No. 168establishes the FASB Accounting Standards Codification (“Codification”), whichofficially commenced July 1, 2009, to become the source of authoritativeUS GAAP recognized by the FASB to be applied by nongovernmental entities.  Rules and interpretive releases of theSecurities and Exchange Commission (‘SEC”) under authority of federalsecurities laws are also sources of authoritative US GAAP for SECregistrants.  The subsequent issuances ofnew standards will be in the form of Accounting Standards Updates that will beincluded in the Codification.  Generally,the Codification is not expected to change US GAAP.  All other accounting literature excluded fromthe Codification will be considered nonauthoritative.  SFAS No. 168 is effective for financialstatements issued for interim and annual periods ending after September 15,2009.  We will adopt SFAS No. 168for our quarter ending September 30, 2009. We are currently evaluating the effect on our financial statementdisclosures as all future references to authoritative accounting literaturewill be referenced in accordance with the Codification.

 

**6.****             ****CreditFacilities**

 

AtJune 30, 2009 and December 31, 2008, our long-term debt consisted ofthe following (in thousands):

 
| ** **                                                                                                                                                                  | ** ** | **June 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                                                                               |       | $                       | 111,448    |                        | $          | 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                                                                                                                                                   |       | 21                      |       | 26                          |       |
| Subtotal                                                                                                                                                                    |       | 184,469                 |       | 186,382                     |       |
|                                                                                                                                                                        |       |                    |       |                        |       |
| **Debt of Special Purpose Entity:**                                                                                                                                         | ** ** | ** **              | ** ** | ** **                  | ** ** |
| 8.47% Bonds due 2016                                                                                                                                                        |       | 134,100                 |       | 134,100                     |       |
|                                                                                                                                                                        |       |                    |       |                        |       |
| Total consolidated debt                                                                                                                                                     |       | 318,569                 |       | 320,482                     |       |
|                                                                                                                                                                        |       |                    |       |                        |       |
| Less: current maturities                                                                                                                                                    |       | (12,413                 | )          | (12,412                     | )          |
|                                                                                                                                                                        |       |                    |       |                        |       |
| Consolidated long-term debt                                                                                                                                                 |       | $                       | 306,156    |                        | $          | 308,070 |   |

 

***Long-Term Credit Facilities.***  Our Amended CreditFacility provides for borrowings up to $100.0 million (including letters ofcredit) and matures in December 2011. At our election, outstandingborrowings bear interest at either the LIBOR rate plus a margin ranging from1.50% to 2.25% or a rate which ranges from 0.00% to 0.75% above the applicableprime rate.  The applicable margins aresubject to adjustments based on our total leverage ratio. The availablecommitment under our Amended Credit Facility was approximately $11.6 million atJune 30, 2009.  We had outstandingborrowings under our Amended Credit Facility of $73.0 million and we hadoutstanding letters of credit of approximately $15.4 million at June 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 limitsour ability, subject to certain conditions, to expand the Amended CreditFacility beyond $100.0 million.  We canprovide no assurance that all of the banks that have made commitments to usunder our Amended Credit Facility would be willing to participate in anexpansion to the Amended Credit Facility should we desire to do so. The AmendedCredit 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”).

 

OurAmended Credit Facility contains financial and other restrictive covenants thatlimit our ability to engage in certain activities.  Our ability to borrow under the AmendedCredit Facility is subject to compliance with certain financial covenants,

 

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includingbank leverage, total leverage and fixed charge coverage ratios. At June 30,2009, we were in compliance with all such covenants. Our Amended CreditFacility includes other restrictions that, among other things, limit ourability to incur indebtedness; grant liens; engage in mergers, consolidationsand liquidations; make investments, restricted payment and asset dispositions;enter into transactions with affiliates; and engage in sale/leasebacktransactions.

 

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

 

The bonds are limited, nonrecourseobligations of MCF and secured by the property and equipment, bond reserves,assignment of subleases and substantially all assets related to the facilitiesincluded in the 2001 Sale and Leaseback Transaction (in which we sold elevenfacilities to MCF).  The bonds are notguaranteed by Cornell.

 

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

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

 

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

 

**7.****             ****IncomeTaxes**

 

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

 

Estimated interest andpenalties related to the underpayment of income taxes are classified as acomponent of income tax expense in the accompanying Consolidated Statements ofIncome and Comprehensive Income.  Therewere no material changes to our accrued interest and penalties in the three andsix months end June 30, 2009. Accrued interest and penalties were approximately $0.3 million and $0.2million at June 30, 2009 and December 31, 2008, respectively.

 

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 the

 

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federal return remainssubject to examination by various states for a period up to one year afterformal notification to the state.  We areopen to United States Federal Income Tax examinations for the tax years December 31,2005 through December 2008.  Theaudit of our 2006 federal income tax return by the Internal Revenue Service wasrecently concluded without material findings.

 

Wehave state operating loss carryforwards of approximately $34.4 million on whichwe have provided a valuation allowance of $3.0 million.  These net operating losses expire beginningin 2008 through 2032.

 

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

 

**8.****             ****EarningsPer Share**

 

Basic earnings per share (“EPS”) arecomputed by dividing net income by the weighted average number of shares ofcommon stock outstanding during the period. Diluted EPS is computed by dividing net income by the weighted averagenumber of shares of common stock outstanding after giving effect to allpotentially dilutive common shares outstanding during the period.  Potentially dilutive common shares includethe dilutive effect of outstanding common stock options and restricted commonshares granted under our various option and other incentive plans. Inaccordance with FSP EITF 03-6-1, for our fiscal year beginning January 1,2009, since our restricted common stock grants (including both vested and thoseunvested due to either time or performance requirements) convey nonforfeitablerights to dividends while outstanding, they are included in both basic andfully diluted ESP calculations.  For thethree months ended June 30, 2009 and 2008, there were 141,700 shares($20.98 average price) and 64,200 shares ($23.24 average price), respectively,of stock options that were not included in the computation of diluted EPSbecause to do so would have been anti-dilutive. For the six months ended June 30,2009 and 2008, there were 141,700 shares ($20.98 average price) and 64,200shares ($23.24 average price), respectively, of stock options that were notincluded in the computation of diluted EPS because to do so would have beenanti-dilutive.

 

The following table summarizes thecalculation of net earnings and weighted average common shares and commonequivalent shares outstanding for purposes of the computation of earnings pershare (in thousands, except per share data):

 
| ** **                                                               | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|--------------------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                               | ** ** | **2009**                                        | ** ** | **2008**                                      | ** ** | **2009** | ** ** | **2008** | ** ** |
|                                                                     |       |                                            |       |                                          |       |   |   |   |   |
| Net income  available to stockholders                                    |       | $                                               | 7,230      |                                          | $          | 5,345 |   | $ | 12,487 |   | $ | 9,979 |   |
|                                                                     |       |                                            |       |                                          |       |   |   |   |   |
| Weighted  average common shares outstanding                              |       | 14,881                                          |       | 14,707                                        |       | 14,878 |   | 14,700 |   |
| Weighted  average common share equivalents outstanding                   |       | 89                                              |       | 147                                           |       | 74 |   | 140 |   |
|                                                                     |       |                                            |       |                                          |       |   |   |   |   |
| Weighted  average common shares and common share equivalents outstanding |       | 14,970                                          |       | 14,854                                        |       | 14,952 |   | 14,840 |   |
|                                                                     |       |                                            |       |                                          |       |   |   |   |   |
| Basic income  per share                                                  |       | $                                               | .49        |                                          | $          | .36 |   | $ | .84 |   | $ | .68 |   |
|                                                                     |       |                                            |       |                                          |       |   |   |   |   |
| Diluted  income per share                                                |       | $                                               | .48        |                                          | $          | .36 |   | $ | .84 |   | $ | .67 |   |

 

**9.****             ****Commitmentsand Contingencies**

 

***FinancialGuarantees***

 

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

 

***Legal Proceedings***

 

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

 

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***Valencia County Detention Center***

 

In April 2007, alawsuit 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, theparties 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’s portion of the stipulatedsettlement, based on the number of inmates housed at VCDC during the timeCornell operated the facility in comparison to the number of inmates housed atthe facility during the time Valencia County operated the facility, is $1.2million and was funded principally through our general liability andprofessional liability coverage.  Theclaims administration process is underway and we expect it to be completed inthe fourth quarter of 2009.

 

Inthe year ended December 31, 2007, we previously provided insurancereserves for this matter (as part of our regular review of reported andunreported claims) totaling approximately $0.5 million. During the fourthquarter of 2008, we recorded an additional settlement charge of approximately$0.7 million and the related reimbursement from our general liability andprofessional liability insurance. The charge and reimbursement were recognizedin general and administrative expenses for the year ended December 31,2008. The reimbursement was funded by the insurance carrier in the firstquarter of 2009 into asettlement account, where it will remain until payments are made to thesettlement class members.

 

***Shareholder Lawsuits***

 

OnOctober 19, 2006, a purported class action complaint was filed in theDistrict Court of Harris County, Texas, 269th Judicial District (No. 2006-67413)by Ted Kinbergy, an alleged stockholder of Cornell. The complaint named asdefendants Cornell and each member of the board of directors at the time of thesuit, as well as Veritas Capital Fund III, L.P. (“Veritas”). The complaintalleged, among other things, that (i) the defendants breached fiduciaryduties allegedly owed to our stockholders in connection with our entering intothe Agreement and Plan of Merger, dated as of October 6, 2006, withVeritas, Cornell Holding Corp., and CCI Acquisition Corp., and (ii) themerger consideration was unfair and inadequate. The Plaintiffs sought, among other things, an injunction against theconsummation of the merger.  The proposedmerger was rejected at a special meeting of our stockholders held on January 23,2007.  In April 2009, the Courtgranted an Unopposed Motion for Dismissal with Prejudice of this complaint anddismissed all claims with prejudice.

 

**10.****      ****FINANCIAL INSTRUMENTS**

 

The carrying amounts of ourfinancial 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 June 30,2009, the carrying amount was $318.6 million, and the estimated fair value was$323.5 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.

 

**11.***      ***Derivative Financial Instruments AndGuarantees**

 

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

 

InAugust 2001, MCF, a special purpose entity, completed a bond offering tofinance the 2001 Sale and Leaseback Transaction in which we sold elevenfacilities to MCF.  In connection withthis bond offering, two reserve fund accounts were established by MCF pursuantto the terms of the indenture: (1) MCF’s Debt Service Reserve Fund,aggregating approximately $24.2 million at June 30, 2009, was establishedto: (a) make payments on MCF’s outstanding bonds in the event we (aslessee) should fail to make the scheduled rental payments to MCF or (b) tothe extent payments were not made under (a), then to make final debt servicepayments on the then outstanding bonds and (2) MCF’s Bond Fund PaymentAccount (as reported in Bond Fund Payment Account and other restricted assetsin our Consolidated Balance Sheet) aggregating approximately $15.9 million at June 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 ofLehman in 2008, the derivative instruments no longer qualified as a hedge andwere de-designated.  Amounts included inaccumulated other comprehensive income are reclassified into earnings duringthe same periods in which interest is earned on debt service reservefunds.  Changes in the fair value ofthese derivatives after de-designation were recorded to earnings.  At December 

 

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31,2008, the fair value was determined to be zero. The derivatives were terminated in the first quarter of 2009 with a fairvalue of zero.

 

Inconnection with MCF’s bond offering, Lehman also provided a guarantee of theDebt Service Reserve Fund if a bankruptcy of the Company were to occur and atrustee for the estate of the Company were to include the Debt Service ReserveFund as an asset of the Company’s estate. This guarantee was characterized as an insurance contract and its fairvalue was being amortized to expenses over the life of the debt.  Due to the bankruptcy of Lehman in 2008, thefull carrying value of the insurance guarantee was determined to beunrecoverable.  Accordingly, we recordeda charge of $1.3 million in the year ended December 31, 2008.

 

**12.****      ****Segment Disclosure**

 

Our three operating divisions are our reportablesegments. The Adult Secure Services segment consists of the operations ofsecure adult incarceration facilities. The Abraxas Youth and Family Servicessegment consists of providing residential treatment and educational programsand non-residential community-based programs to juveniles between the ages of10 and 17 who have either been adjudicated or suffer from behavioral problems.The Adult Community-Based Services segment consists of providing pre-releaseand halfway house programs for adult offenders who are either on probation orserving the last three to six-months of their sentences on parole and preparingfor re-entry into society at large as well as community-based treatment andeducation programs as an alternative to incarceration. All of our customers andlong-lived assets are located in the United States of America. The accountingpolicies of our reportable segments are the same as those described in thesummary of significant accounting policies in Note 2 in our 2008 Annual Reporton Form 10-K. Intangible assets are not included in each segment’sreportable assets, and the amortization of intangible assets is not included inthe determination of a reportable segment’s operating income. We evaluateperformance based on income or loss from operations before general andadministrative expenses, amortization of intangibles, interest and incometaxes. Corporate and other assets are comprised primarily of cash, investmentsecurities available for sale, accounts receivable, debt service and debtservice reserve funds, deposits, property and equipment, deferred taxes,deferred costs and other assets. Corporate and other expense from operationsprimarily consists of depreciation and amortization on the corporate officefacilities and equipment and specific general and administrative chargespertaining to corporate personnel. Such expenses are presented separately, asthey cannot be readily identified for allocation to a particular segment.

 

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The only significant non-cash itemreported in the respective segment’s income from operations is depreciation andamortization (excluding intangibles) (in thousands).

 
| ** **                          | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                          | ** ** | **2009**                                        | ** ** | **2008**                                      | ** ** | **2009** | ** ** | **2008** | ** ** |
|                                |       |                                            |       |                                          |       |   |   |   |   |
| Revenues:                           |       |                                            |       |                                          |       |   |   |   |   |
| Adult secure services               |       | $                                               | 59,272     |                                          | $          | 50,305 |   | $ | 116,130 |   | $ | 100,204 |   |
| Abraxas youth  and family services  |       | 27,711                                          |       | 26,886                                        |       | 53,399 |   | 54,659 |   |
| Adult  community-based services     |       | 18,351                                          |       | 17,455                                        |       | 35,515 |   | 35,175 |   |
| Total  revenues                     |       | $                                               | 105,334    |                                          | $          | 94,646 |   | $ | 205,044 |   | $ | 190,038 |   |
|                                |       |                                            |       |                                          |       |   |   |   |   |
| Income from  operations:            |       |                                            |       |                                          |       |   |   |   |   |
| Adult secure services               |       | $                                               | 17,493     |                                          | $          | 15,627 |   | $ | 34,608 |   | $ | 30,884 |   |
| Abraxas youth  and family services  |       | 3,197                                           |       | 2,526                                         |       | 3,931 |   | 4,132 |   |
| Adult  community-based services     |       | 5,864                                           |       | 4,666                                         |       | 10,631 |   | 9,487 |   |
| Subtotal                            |       | 26,554                                          |       | 22,819                                        |       | 49,170 |   | 44,503 |   |
| General and  administrative expense |       | (6,270                                          | )          | (7,232                                        | )          | (12,408 | ) | (13,766 | ) |
| Amortization  of intangibles        |       | (448                                            | )          | (484                                          | )          | (896 | ) | (973 | ) |
| Corporate and  other                |       | (246                                            | )          | (189                                          | )          | (490 | ) | (360 | ) |
| Total income  from operations       |       | $                                               | 19,590     |                                          | $          | 14,914 |   | $ | 35,376 |   | $ | 29,404 |   |

 
| ** **                         | ** ** | ** ** | ** ** | **June 30,** | ** ** | **December 31,** |   |
|------------------------------------|------------|------------|------------|-------------------|------------|-----------------------|--------|
| ** **                         | ** ** | ** ** | ** ** | **2009**          | ** ** | **2008**              |   |
| Assets:                            |       |       |       |              |       |                  |   |
| Adult secure services              |       |       |       | $                 | 359,705    |                  | $      | 358,406 |   |
| Abraxas youth  and family services |       |       |       | 104,327           |       | 105,991               |   |
| Adult  community-based services    |       |       |       | 60,296            |       | 60,170                |   |
| Intangible  assets, net            |       |       |       | 14,731            |       | 15,628                |   |
| Corporate and  other               |       |       |       | 104,887           |       | 96,726                |   |
| Total assets                       |       |       |       | $                 | 643,946    |                  | $      | 636,921 |   |

 

**13.****      ****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).  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 June 30,2009 (in thousands)**

 
| ** **                                                   | ** ** | **Parent** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor****Subsidiary** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|--------------------------------------------------------------|------------|------------|------------|-----------------------------|------------|-----------------------------------|------------|------------------|------------|------------------|------------|
| **Assets**                                                   |       |       |       |                        |       |                              |       |             |       |             |       |
| Current  assets:                                             |       |       |       |                        |       |                              |       |             |       |             |       |
| Cash and cash  equivalents                                   |       | $          | 16,410     |                        | $          | 180                               |       | $                | 30         |             | $          | — |   | $ | 16,620 |   |
| Accounts  receivable                                         |       | 1,644      |       | 64,569                      |       | 33                                |       | —           |       | 66,246           |       |
| Restricted  assets                                           |       | —     |       | 3,581                       |       | 34,718                            |       | —           |       | 38,299           |       |
| Prepaids and  other                                          |       | 14,316     |       | 1,667                       |       | —                            |       | —           |       | 15,983           |       |
| Total current  assets                                        |       | 32,370     |       | 69,997                      |       | 34,781                            |       | —           |       | 137,148          |       |
| Property and  equipment, net                                 |       | —     |       | 314,823                     |       | 140,481                           |       | (4,454           | )          | 450,850          |       |
| Other assets:                                                |       |       |       |                        |       |                              |       |             |       |             |       |
| Debt service  reserve fund                                   |       | —     |       | —                      |       | 24,195                            |       | —           |       | 24,195           |       |
| Deferred  costs and other                                    |       | 63,546     |       | 23,590                      |       | 5,032                             |       | (60,415          | )          | 31,753           |       |
| Investment in  subsidiaries                                  |       | 80,950     |       | 1,856                       |       | —                            |       | (82,806          | )          | —           |       |
| Total assets                                                 |       | $          | 176,866    |                        | $          | 410,266                           |       | $                | 204,489    |             | $          | (147,675 | ) | $ | 643,946 |   |
|                                                         |       |       |       |                        |       |                              |       |             |       |             |       |
| **Liabilities and Stockholders’ Equity**                |       |       |       |                        |       |                              |       |             |       |             |       |
|                                                         |       |       |       |                        |       |                              |       |             |       |             |       |
| Current  liabilities:                                        |       |       |       |                        |       |                              |       |             |       |             |       |
| Accounts  payable and accrued liabilities                    |       | $          | 43,612     |                        | $          | 12,280                            |       | $                | 4,754      |             | $          | 929 |   | $ | 61,575 |   |
| Current  portion of long-term debt                           |       | —     |       | 13                          |       | 12,400                            |       | —           |       | 12,413           |       |
| Total current  liabilities                                   |       | 43,612     |       | 12,293                      |       | 17,154                            |       | 929              |       | 73,988           |       |
| Long-term  debt, net of current portion                      |       | 184,447    |       | 9                           |       | 121,700                           |       | —           |       | 306,156          |       |
| Deferred tax  liabilities                                    |       | 17,492     |       | 94                          |       | —                            |       | 1,063            |       | 18,649           |       |
| Other  long-term liabilities                                 |       | 5,899      |       | 119                         |       | 60,342                            |       | (64,448          | )          | 1,912            |       |
| Intercompany                                                 |       | (316,507   | )          | 316,512                     |       | —                            |       | (5               | )          | —           |       |
| Total  liabilities                                           |       | (65,057    | )          | 329,027                     |       | 199,196                           |       | (62,461          | )          | 400,705          |       |
| Total Cornell Companies, Inc. stockholders’ equity |       | 241,923    |       | 81,239                      |       | 5,293                             |       | (86,532          | )          | 241,923          |       |
| Non-controlling interest                                     |       | —     |       | —                      |       | —                            |       | 1,318            |       | 1,318            |       |
| Total  stockholders’ equity                             |       | 241,923    |       | 81,239                      |       | 5,293                             |       | (85,214          | )          | 243,241          |       |
| Total liabilities and stockholders’ equity              |       | $          | 176,866    |                        | $          | 410,266                           |       | $                | 204,489    |             | $          | (147,675 | ) | $ | 643,946 |   |

 

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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                                   |       | 73,197     |       | 1,856                             |       | —                                      |       | (75,053          | )          | —           |       |
| Total assets                                                  |       | $          | 163,831    |                              | $          | 409,831                                     |       | $                | 199,509    |             | $          | (136,250 | ) | $ | 636,921 |   |
|                                                          |       |       |       |                              |       |                                        |       |             |       |             |       |
| **Liabilities and  stockholders’ equity**                |       |       |       |                              |       |                                        |       |             |       |             |       |
|                                                          |       |       |       |                              |       |                                        |       |             |       |             |       |
| Current liabilities:                                          |       |       |       |                              |       |                                        |       |             |       |             |       |
| Accounts payable and accrued liabilities                      |       | $          | 48,373     |                              | $          | 15,515                                      |       | $                | 4,883      |             | $          | 322 |   | $ | 69,093 |   |
| Current portion of long-term debt                             |       | —     |       | 12                                |       | 12,400                                      |       | —           |       | 12,412           |       |
| Total current liabilities                                     |       | 48,373     |       | 15,527                            |       | 17,283                                      |       | 322              |       | 81,505           |       |
| Long-term debt, net of current portion                        |       | 186,356    |       | 14                                |       | 121,700                                     |       | —           |       | 308,070          |       |
| Deferred tax liabilities                                      |       | 16,246     |       | 94                                |       | —                                      |       | 1,151            |       | 17,491           |       |
| Other long-term liabilities                                   |       | 5,851      |       | 113                               |       | 56,733                                      |       | (61,009          | )          | 1,688            |       |
| Intercompany                                                  |       | (320,717   | )          | 320,722                           |       |                                        |       | (5               | )          | —           |       |
| Total liabilities                                             |       | (63,891    | )          | 336,470                           |       | 195,716                                     |       | (59,541          | )          | 408,754          |       |
| Total Cornell Companies, Inc. stockholders’  equity |       | 227,722    |       | 73,361                            |       | 3,793                                       |       | (77,154          | )          | 227,722          |       |
| Non-controlling interest                                      |       | —     |       | —                            |       | —                                      |       | 445              |       | 445              |       |
| Total stockholders’ equity                               |       | 227,722    |       | 73,361                            |       | 3,793                                       |       | (76,709          | )          | 228,167          |       |
| Total liabilities and stockholders’ equity               |       | $          | 163,831    |                              | $          | 409,831                                     |       | $                | 199,509    |             | $          | (136,250 | ) | $ | 636,921 |   |

 

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**Condensed Consolidating Statement of Operations for the threemonths ended June 30, 2009****(inthousands) (unaudited)**

 
| ** **                                | ** ** | **Parent** | ** ** | **Guarantor********Subsidiaries** | ** ** | **Non-  Guarantor********Subsidiary** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-------------------------------------------|------------|------------|------------|-----------------------------------|------------|---------------------------------------|------------|------------------|------------|------------------|------------|
| ** **                                | ** ** | ** ** | ** ** | ** **                        | ** ** | ** **                            | ** ** | ** **       | ** ** | ** **       | ** ** |
| Revenues                                  |       | $          | 4,502      |                              | $          | 117,983                               |       | $                | 4,502      |             | $          | (21,653 | ) | $ | 105,334 |   |
| Operating  expenses                       |       | 6,211      |       | 89,972                            |       | 111                                   |       | (21,560          | )          | 74,734           |       |
| Depreciation  and amortization            |       | —     |       | 3,856                             |       | 880                                   |       | 4                |       | 4,740            |       |
| General and  administrative expenses      |       | 6,251      |       | —                            |       | 19                                    |       | —           |       | 6,270            |       |
| Income (loss)  from operations            |       | (7,960     | )          | 24,155                            |       | 3,492                                 |       | (97              | )          | 19,590           |       |
| Overhead  allocations                     |       | (11,221    | )          | 11,221                            |       | —                                |       | —           |       | —           |       |
| Interest, net                             |       | (1,818     | )          | 5,674                             |       | 2,938                                 |       | (218             | )          | 6,576            |       |
| Equity  earnings in subsidiaries          |       | 7,260      |       | —                            |       | —                                |       | (7,260           | )          | —           |       |
| Income before  provision for income taxes |       | 12,339     |       | 7,260                             |       | 554                                   |       | (7,139           | )          | 13,014           |       |
| Provision for  income taxes               |       | 5,109      |       | —                            |       | —                                |       | 277              |       | 5,386            |       |
| Net income                                |       | 7,230      |       | 7,260                             |       | 554                                   |       | (7,416           | )          | 7,628            |       |
| Non-controlling  interest                 |       | —     |       | —                            |       | —                                |       | 398              |       | 398              |       |
| Income available  to stockholders         |       | $          | 7,230      |                              | $          | 7,260                                 |       | $                | 554        |             | $          | (7,814 | ) | $ | 7,230 |   |

 

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**Condensed Consolidating Statement of Operations for the threemonths ended June 30, 2008****(inthousands) (unaudited)**

 
| ** **                                  | ** ** | **Parent** | ** ** | **Guarantor********Subsidiaries** | ** ** | **Non-  Guarantor********Subsidiary** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|---------------------------------------------|------------|------------|------------|-----------------------------------|------------|---------------------------------------|------------|------------------|------------|------------------|------------|
| ** **                                  | ** ** | ** ** | ** ** | ** **                        | ** ** | ** **                            | ** ** | ** **       | ** ** | ** **       | ** ** |
| Revenues                                    |       | $          | 4,502      |                              | $          | 107,749                               |       | $                | 4,502      |             | $          | (22,107 | ) | $ | 94,646 |   |
| Operating  expenses, excluding depreciation |       | 4,104      |       | 86,177                            |       | 18                                    |       | (22,019          | )          | 68,280           |       |
| Depreciation  and amortization              |       | —     |       | 3,324                             |       | 1,055                                 |       | (159             | )          | 4,220            |       |
| General and  administrative expenses        |       | 7,216      |       | —                            |       | 16                                    |       | —           |       | 7,232            |       |
| Income (loss)  from operations              |       | (6,818     | )          | 18,248                            |       | 3,413                                 |       | 71               |       | 14,914           |       |
| Overhead  allocations                       |       | (4,317     | )          | 4,317                             |       | —                                |       | —           |       | —           |       |
| Interest, net                               |       | 1,819      |       | 1,274                             |       | 2,536                                 |       | (62              | )          | 5,567            |       |
| Equity  earnings in subsidiaries            |       | 13,253     |       | —                            |       | —                                |       | (13,253          | )          | —           |       |
| Income from  provision for income taxes     |       | 8,933      |       | 12,657                            |       | 877                                   |       | (13,120          | )          | 9,347            |       |
| Provision for  income taxes                 |       | 3,588      |       | —                            |       | —                                |       | 414              |       | 4,002            |       |
| Net income                                  |       | 5,345      |       | 12,657                            |       | 877                                   |       | (13,534          | )          | 5,345            |       |
| Non-controlling  interest                   |       | —     |       | —                            |       | —                                |       | —           |       | —           |       |
| Income  available to stockholders           |       | $          | 5,345      |                              | $          | 12,657                                |       | $                | 877        |             | $          | (13,534 | ) | $ | 5,345 |   |

 

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**Condensed Consolidating Statement of Operations for the sixmonths ended June 30, 2009****(inthousands) (unaudited)**

 
| ** **                                | ** ** | **Parent** | ** ** | **Guarantor********Subsidiaries** | ** ** | **Non-  Guarantor********Subsidiary** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-------------------------------------------|------------|------------|------------|-----------------------------------|------------|---------------------------------------|------------|------------------|------------|------------------|------------|
| ** **                                | ** ** | ** ** | ** ** | ** **                        | ** ** | ** **                            | ** ** | ** **       | ** ** | ** **       | ** ** |
| Revenues                                  |       | $          | 9,004      |                              | $          | 235,803                               |       | $                | 9,004      |             | $          | (48,767 | ) | $ | 205,044 |   |
| Operating  expenses                       |       | 10,350     |       | 185,711                           |       | 153                                   |       | (48,587          | )          | 147,627          |       |
| Depreciation  and amortization            |       | —     |       | 7,862                             |       | 1,761                                 |       | 10               |       | 9,633            |       |
| General and  administrative expenses      |       | 12,370     |       | —                            |       | 38                                    |       | —           |       | 12,408           |       |
| Income (loss)  from operations            |       | (13,716    | )          | 42,230                            |       | 7,052                                 |       | (190             | )          | 35,376           |       |
| Overhead  allocations                     |       | (19,598    | )          | 19,598                            |       | —                                |       | —           |       | —           |       |
| Interest, net                             |       | 136        |       | 7,011                             |       | 5,820                                 |       | (438             | )          | 12,529           |       |
| Equity  earnings in subsidiaries          |       | 15,621     |       | —                            |       | —                                |       | (15,621          | )          | —           |       |
| Income before  provision for income taxes |       | 21,367     |       | 15,621                            |       | 1,232                                 |       | (15,373          | )          | 22,847           |       |
| Provision for  income taxes               |       | 8,880      |       | —                            |       | —                                |       | 607              |       | 9,487            |       |
| Net income                                |       | 12,487     |       | 15,621                            |       | 1,232                                 |       | (15,980          | )          | 13,360           |       |
| Non-controlling  interest                 |       | —     |       | —                            |       | —                                |       | 873              |       | 873              |       |
| Income  available to stockholders         |       | $          | 12,487     |                              | $          | 15,621                                |       | $                | 1,232      |             | $          | (16,853 | ) | $ | 12,487 |   |

 

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**Condensed Consolidating Statement of Operations for the sixmonths ended June 30, 2008****(inthousands) (unaudited)**

 
| ** **                                | ** ** | **Parent** | ** ** | **Guarantor********Subsidiaries** | ** ** | **Non-  Guarantor********Subsidiary** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|-------------------------------------------|------------|------------|------------|-----------------------------------|------------|---------------------------------------|------------|------------------|------------|------------------|------------|
| ** **                                | ** ** | ** ** | ** ** | ** **                        | ** ** | ** **                            | ** ** | ** **       | ** ** | ** **       | ** ** |
| Revenues                                  |       | $          | 9,004      |                              | $          | 216,245                               |       | $                | 9,004      |             | $          | (44,215 | ) | $ | 190,038 |   |
| Operating  expenses                       |       | 7,192      |       | 175,312                           |       | 30                                    |       | (44,043          | )          | 138,491          |       |
| Depreciation  and amortization            |       | —     |       | 6,584                             |       | 2,111                                 |       | (318             | )          | 8,377            |       |
| General and  administrative expenses      |       | 13,731     |       | —                            |       | 35                                    |       | —           |       | 13,766           |       |
| Income (loss)  from operations            |       | (11,919    | )          | 34,349                            |       | 6,828                                 |       | 146              |       | 29,404           |       |
| Overhead  allocations                     |       | (17,659    | )          | 17,659                            |       | —                                |       | —           |       | —           |       |
| Interest, net                             |       | 3,887      |       | 2,547                             |       | 5,552                                 |       | (124             | )          | 11,862           |       |
| Equity  earnings in subsidiaries          |       | 15,055     |       | —                            |       | —                                |       | (15,055          | )          | —           |       |
| Income before  provision for income taxes |       | 16,908     |       | 14,143                            |       | 1,276                                 |       | (14,785          | )          | 17,542           |       |
| Provision for  income taxes               |       | 6,929      |       | —                            |       | —                                |       | 634              |       | 7,563            |       |
| Net income                                |       | 9,979      |       | 14,143                            |       | 1,276                                 |       | (15,419          | )          | 9,979            |       |
| Non-controlling  interest                 |       | —     |       | —                            |       | —                                |       | —           |       | —           |       |
| Income  available to stockholders         |       | $          | 9,979      |                              | $          | 14,143                                |       | $                | 1,276      |             | $          | (15,419 | ) | $ | 9,979 |   |

 

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**Condensed Consolidating Statement of Cash Flows for the sixmonths ended June 30, 2009 (in thousands) (unaudited)**

 
| ** **                                                  | ** ** | **Parent** | ** ** | **Guarantor********Subsidiaries** | ** ** | **Non-  Guarantor********Subsidiary** | ** ** | **Consolidated** | ** ** |
|-------------------------------------------------------------|------------|------------|------------|-----------------------------------|------------|---------------------------------------|------------|------------------|------------|
| **Cash flows from operating activities:**                   |       |       |       |                              |       |                                  |       |             |       |
| Net cash  provided by operating activities                  |       | $          | 3,798      |                              | $          | 7,727                                 |       | $                | 6,753      |   | $ | 18,278 |   |
| ** **                                                  | ** ** | ** ** | ** ** | ** **                        | ** ** | ** **                            | ** ** | ** **       | ** ** |
| **Cash flows from investing activities:**                   |       |       |       |                              |       |                                  |       |             |       |
| Capital  expenditures                                       |       | —     |       | (9,493                            | )          | —                                |       | (9,493           | )          |
| Proceeds from  the sale/disposals of property and equipment |       | —     |       | 1,688                             |       | —                                |       | 1,688            |       |
| Payments to  restricted debt payment account, net           |       | —     |       | —                            |       | (6,780                                | )          | (6,780           | )          |
| Net cash used  in investing activities                      |       | $          | —     |                              | $          | (9,493                                | )          | $                | (6,780     | ) | $ | (14,585 | ) |
| ** **                                                  | ** ** | ** ** | ** ** | ** **                        | ** ** | ** **                            | ** ** | ** **       | ** ** |
| **Cash flows from financing activities:**                   |       |       |       |                              |       |                                  |       |             |       |
| Proceeds from  line of credit                               |       | 2,000      |       | —                            |       | —                                |       | 2,000            |       |
| Payments of  line of credit                                 |       | (4,000     | )          | —                            |       | —                                |       | (4,000           | )          |
| Payments on  capital lease obligations                      |       | —     |       | (7                                | )          | —                                |       | (7               | )          |
| Proceeds from  exercise of stock options                    |       | 321        |       | —                            |       | —                                |       | 321              |       |
| Net cash used  in financing activities                      |       | (1,679     | )          | (7                                | )          | —                                |       | (1,686           | )          |
| ** **                                                  | ** ** | ** ** | ** ** | ** **                        | ** ** | ** **                            | ** ** | ** **       | ** ** |
| **Net increase (decrease) in cash and cash equivalents**    |       | 2,119      |       | (85                               | )          | (27                                   | )          | 2,007            |       |
| ** **                                                  | ** ** | ** ** | ** ** | ** **                        | ** ** | ** **                            | ** ** | ** **       | ** ** |
| **Cash and cash equivalents at beginning of period**        |       | 14,291     |       | 265                               |       | 57                                    |       | 14,613           |       |
| ** **                                                  | ** ** | ** ** | ** ** | ** **                        | ** ** | ** **                            | ** ** | ** **       | ** ** |
| **Cash and cash equivalents at end of period**              |       | $          | 16,410     |                              | $          | 180                                   |       | $                | 30         |   | $ | 16,620 |   |

 

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**Condensed Consolidating Statement of Cash Flows for the sixmonths ended June 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 |       | $          | (19,730    | )                                 | $          | 38,791                                |       | $                | 7,406      |   | $ | 26,467 |   |
| ** **                                           | ** ** | ** ** | ** ** | ** **                        | ** ** | ** **                            | ** ** | ** **       | ** ** |
| **Cash flows from investing activities:**            |       |       |       |                              |       |                                  |       |             |       |
| Capital  expenditures                                |       | —     |       | (38,996                           | )          | —                                |       | (38,996          | )          |
| Sales of  investment securities                      |       | 250        |       | —                            |       | —                                |       | 250              |       |
| Proceeds from  the sale of fixed assets              |       | —     |       | 17                                |       | —                                |       | 17               |       |
| Payments to  restricted debt payment account, net    |       | —     |       | —                            |       | (7,425                                | )          | (7,425           | )          |
| Net cash  provided by (used in) investing activities |       | $          | 250        |                              | $          | (38,979                               | )          | $                | (7,425     | ) | $ | (46,154 | ) |
| ** **                                           | ** ** | ** ** | ** ** | ** **                        | ** ** | ** **                            | ** ** | ** **       | ** ** |
| **Cash flows from financing activities:**            |       |       |       |                              |       |                                  |       |             |       |
| Proceeds from  line of credit                        |       | 17,500     |       | —                            |       | —                                |       | 17,500           |       |
| Tax benefit  of stock option exercises               |       | 3          |       | —                            |       | —                                |       | 3                |       |
| Payments on  capital lease obligations               |       | —     |       | (5                                | )          | —                                |       | (5               | )          |
| Proceeds from  exercise of stock options             |       | 182        |       | —                            |       | —                                |       | 182              |       |
| Net cash  provided by (used in) financing activities |       | 17,685     |       | (5                                | )          | —                                |       | 17,680           |       |
| ** **                                           | ** ** | ** ** | ** ** | ** **                        | ** ** | ** **                            | ** ** | ** **       | ** ** |
| **Net decrease in cash and cash equivalents**        |       | (1,795     | )          | (193                              | )          | (19                                   | )          | (2,007           | )          |
| ** **                                           | ** ** | ** ** | ** ** | ** **                        | ** ** | ** **                            | ** ** | ** **       | ** ** |
| **Cash and cash equivalents at beginning of period** |       | 2,565      |       | 408                               |       | 55                                    |       | 3,028            |       |
| ** **                                           | ** ** | ** ** | ** ** | ** **                        | ** ** | ** **                            | ** ** | ** **       | ** ** |
| **Cash and cash equivalents at end of period**       |       | $          | 770        |                              | $          | 215                                   |       | $                | 36         |   | $ | 1,021 |   |

 

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**ITEM 2.****                            ****Management’s Discussion and Analysis ofFinancial Condition and Results of Operations**

 

**General**

** **

CornellCompanies, Inc. is a leading provider of correctional, detention,educational, rehabilitation and treatment services outsourced by federal,state, county and local government agencies. We provide a diversified portfolioof services for adults and juveniles through our three operating divisions: (1) AdultSecure Services; (2) Abraxas Youth and Family Services and (3) AdultCommunity-Based Services. At June 30, 2009, we operated 69 facilities witha total service capacity of 20,822 and had one vacant facilitywith a service capacity of 70 beds. Our facilities are locatedin 15 states and the District of Columbia.

 

The following table setsforth for the periods indicated total residential service capacity andcontracted beds in operation at the end of the periods shown, average contractoccupancy percentages and total non-residential service capacity.

 
| ** **                                                                | ** ** | **June 30,** | ** ** | **June 30,** | ** ** |
|---------------------------------------------------------------------------|------------|-------------------|------------|-------------------|------------|
| ** **                                                                | ** ** | **2009**          | ** ** | **2008**          | ** ** |
| **Residential**                                                           | ** ** | ** **        | ** ** | ** **        | ** ** |
| Service  capacity (1)                                                     |       | 18,334            |       | 16,147            |       |
| Contracted  beds in operation (end of period) (2)                         |       | 17,480            |       | 15,298            |       |
| Average  contract occupancy based on contracted beds in operation (3) (4) |       | 92.2              | %          | 94.3              | %          |
| **Non-Residential**                                                       | ** ** | ** **        | ** ** | ** **        | ** ** |
| Service  capacity (5)                                                     |       | 2,558             |       | 2,753             |       |

 

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(1)          Residentialservice capacity is comprised of the number of beds currently available forservice in our residential facilities.

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

(3)          Occupancypercentages reflect less than normalized occupancy during the start-up phase ofany applicable facility, resulting in a lower average occupancy in periods whenwe have substantial start-up activities.

(4)          Averagecontract occupancy percentages are calculated based on actual occupancy for theperiod as a percentage of the contracted capacity for residential facilities inoperation.  These percentages do notreflect the operations 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 isbased on 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.

 

Ouroperating results for the six months ended June 30, 2009 were impacted bya few significant events.  We completed the 700 bed expansion at D. RayJames Prison at the beginning of April 2009 and continued construction ona new 1,250 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 six months ended June 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.

 

Althoughwe believe we will continue to see steady, demand across our various businesssegments and customer base (federal, state and local) in 2009, we aremonitoring the declining economic trends and related government budget plansand the effect tightened spending plans could have on our business (withrespect to possible areas including utilization, per diem rates, etc.)  We expect one of the areas of focus for ourperformance in 2009 to be our ability to manage our various facility expansionscurrently in process and bring them on line. We also plan to remain focused on our operating margins, on increasingutilization (particularly in the Abraxas division) and improving customer mixas we believe those initiatives are key elements of our financial performance.

 

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# **Table of Contents**

 

# **ManagementOverview**

# ** **

***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 generally increased at a steady rate over the past tenyears, largely as a result of increasing sentence terms and/or mandatorysentences for criminals and as well a greater range of criminal acts,increasing demand for incarceration of illegal aliens and a public recognitionof the need to provide services to juveniles that will improve the possibilitythat they will lead productive lives. Moreover, demand for our services is alsoaffected by the amount of available capacity in the government systems toenable governments to provide the services themselves, as well as desire andability of these systems to add additional capacity. In addition, the balancebetween community-based corrections treatment of adults as an alternative totraditional incarceration continues to be analyzed by many political andsocietal parties.  Among other things, wemonitor federal, state and industry communications and statistics relative totrends in prison populations, juvenile justice statistics and initiatives, anddevelopments in alternatives to traditional incarceration or detention ofadults for opportunities to expand our scope or delivery of services.

 

The federal governmentcontracts with private providers for the incarceration of adults, whether theyare serving prison sentences, detained as illegal aliens, detained inanticipation of pending judicial administration or transitioning from prison tosociety.  Chief among the federalagencies which use private providers are the Federal Bureau of Prisons (“BOP”),U.S. Immigration and Customs Enforcement (“ICE”) and United States MarshallsService (“USMS”). We provide adult secure and adult community-based services tothe federal government. Most of the federal involvement in juvenileadministration in the federal system is handled via Medicare and Medicaidassistance to state governments. Although there are circumstances in which wemay contract with a federal agency on a sole source basis, the primary means bywhich we secure a contract with a federal agency is via the RFP biddingprocess.  From time to time, we contractto provide management services to a local governmental unit who then bids on afederal contract.

 

States and smallergovernmental units remain divided on the issue of private prisons and privateprovision of juvenile and community-based programs, although a majority ofstates permit private provision for our services.  We anticipate that increasing budget pressureon states and smaller governmental units may cause more states and smallergovernmental units to consider utilizing private providers such as us 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 andcommunity-based programs are utilized by states and local governmental unitsand are organized on a profit and not-for-profit basis.  We monitor opportunities in these segmentsvia our corporate and business division development officers.  Many opportunities are not published in anymanner and, accordingly, we believe that taking the initiative at the state andlocal levels is key in developing sole source opportunities.

 

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

 

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

·      occupancy(utilization),

·      per diemreimbursement rates,

·      revenues,

·      operatingmargins, and

·      operatingexpenses.

 

*Capacity. *Capacity, commonly expressedin terms of number of beds, is primarily impacted by the number and size of thefacilities we own or lease and the facilities we operate on behalf of a thirdparty owner or lessee.  We view capacityas one of the measures of our development efforts, through which we may increasecapacity by adding new projects or by expanding existing projects (as we havedone in 2007 through 2009 at several of our facilities including Great PlainsCorrectional Facility and D. Ray James Prison). As part of the evaluation of our development efforts, we will assess (a) whethera given development project was brought into service in accordance with ourexpectation as to time and expense; and (b) the number of projects indevelopment or under consideration at the relevant point in time.  In addition to the focus on new projects,capacity will reflect our success in renewing and maintaining existingcontracts and facilities.  It will alsoreflect any closure of programs or facilities due to underutilization 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 commitment 

 

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to a given facility to bereduced or even eliminated, which would require us to either secure analternate customer or close the operation.

 

*Occupancy. *Occupancy is typicallyexpressed in terms of percentage of contract capacity utilized.  We look at occupancy to assess the efficacyof both our efforts to market our facilities and our efforts to retain existingcustomers or contracts.  Because revenuevaries directly with occupancy, occupancy is a principal driver of our revenues.Our industry experiences significant economies of scale, whereby as occupancyrises, operating costs per resident decline. Some of our contracts are “take-or-pay,”meaning that the agency making use of the facility is obligated to pay for bedseven though they are not used. Historically, occupancy percentages in many of our facilities have beenhigh and we are mindful of the need to maintain such occupancy levels.  As new development projects are brought intoservice, occupancy percentages may decline until the projects reach fullutilization (as, for example, with the activation of the 1,100 bed expansion atGreat Plains Correctional Facility during the fourth quarter of 2008 and the700 bed expansion at D. Ray James Prison during the second quarter of 2009).Where we have commitments for utilization before the commencement ofoperations, occupancy percentages reflect the speed at which a facilityachieves full service/implementation. However, we may decide to undertakedevelopment projects without written commitments to make full use of afacility. In these instances, we have performed our own assessment of theexisting or anticipated demand, based on discussions with local government orother potential customer representatives and our analysis of other factors, ofthe demand for services at the facility. There is no assurance that we would recover our initial investment inthese projects.  We will monitoroccupancy as a measure of the accuracy of our estimation of the demand for theservices of a development facility and will incorporate this information infuture assessments of potential projects.

 

*Per Diem Reimbursement Rates. *Per diemreimbursement rates are another key element of our gross revenue and operatingmargin since per diem contracts represent a majority of our revenues(approximately 62.0% and 61.8% for the three and six months ended June 30,2009, respectively).  Per diem rates area function of negotiation between management and a governmental unit at theinception of a contract or through the bidding process.  Actual per diem rates vary dramaticallyacross our business segments, as well as within each business segment,depending upon the particular service or program provided. The initial per diemrates often change during the term of a contract in accordance with aschedule.  The amount of the change canbe a fixed amount set forth within the contract, an amount determined byformulas set forth within the contract or an amount determined by negotiationsbetween management and the governmental unit (often these negotiations arealong the same lines as the original per diem negotiation — a review ofexpenses and approval of an amount to recompense for expenses and assure thepotential of an operating profit).  Inrecent years, as budgetary pressures on governmental units have increased, someof our customers have negotiated relief from formulaic increase provisionswithin their agreements or have declined to include in their appropriationlegislation amounts that would increase the per diem rates payable under thecontract. Based on the economic turmoil which began in the second half of 2008,we are expecting such pressures to continue in 2009 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 givenfacility and replacing it with a new customer (as was done with our GreatPlains Correctional Facility in 2007).

 

*Revenues. *We derivesubstantially all of our revenues from providing adult corrections andtreatment and juvenile justice, educational and treatment services outsourcedby federal, state and local government agencies in the United States. Revenuesfor our services are generally recognized on a per diem rate based upon thenumber of occupant days or hours served for the period, on a guaranteedtake-or-pay basis or on a cost-plus reimbursement basis. For the three monthsended June 30, 2009, our revenue base consisted of 62.0% for servicesprovided under per diem contracts, 32.5% for services provided undertake-or-pay and management contracts, 3.6% for services provided undercost-plus reimbursement contracts, 1.8% for services provided underfee-for-service contracts and 0.1% from other miscellaneous sources.  For the three months ended June 30,2008, our revenue base consisted of 53.0% for services provided under per diemcontracts, 40.9% for services provided under take-or-pay and managementcontracts, 3.7% for services provided under cost-plus reimbursement contracts,2.1% for services provided under fee-for-service contracts and 0.3% from othermiscellaneous sources. For the six months ended June 30, 2009 our revenuebase consisted of 61.8% for services provided under per diem contracts, 32.8%for services provided under take-or-pay and management contracts, 3.5% forservices provided under cost-plus reimbursement contracts, 1.8% for servicesprovided under fee-for-service contracts and 0.1% from other miscellaneoussources.  For the six months ended June 30,2008 our revenue base consisted of 52.2% for services provided under per diemcontracts, 41.5% for services provided under take-or-pay and managementcontracts, 3.9% for services provided under cost-plus reimbursement contracts,2.1% for services provided under fee-for-service contracts and 0.3% from othermiscellaneous sources.  The increase inrevenues in the respective 2009 periods provided under per diem contracts (andthe corresponding decrease in revenues provided under take-or-pay andmanagement contracts) primarily reflects the transition of our contract withthe Arizona Department of Corrections from a take-or-pay contract to a per diemcontract upon the activation (and subsequent ramp in the fourth quarter of2008) of its 1,100 bed expansion. In addition, we also terminated severalmanagement contracts in 2008 

 

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(includingSalt Lake Valley Detention Center and Lincoln County Detention Center in September 2008and February 2008, respectively).

 

Revenues can fluctuate from year to year dueto changes in government funding policies, changes in the number or types ofclients referred to our facilities by governmental agencies, changes in thetypes of services delivered to our customers, the opening of new facilities orthe expansion of existing facilities and the termination of contracts for afacility or the closure of a facility.

 

Factors considered in determining billing rates tocharge include: (1) the programs specified by the contract and the relatedstaffing levels; (2) wage levels customary in the respective geographicareas; (3) whether the proposed facility is to be leased or purchased; and(4) the anticipated average occupancy levels that could reasonably beexpected to be maintained and the duration of time required to reach suchoccupancy levels.

 

*Revenues-Adult SecureServices. *Revenues forour Adult Secure Services division are primarily generated from per diem,take-or-pay and management contracts. For the three months ended June 30, 2009 and 2008, we realizedaverage per diem rates on our adult secure facilities of approximately $55.28and $53.41, respectively.  For the six months ended June 30,2009 and 2008, we realized average per diem rates of approximately $54.52 and$54.46, respectively.  The averageper diem rate for the six months ended June 30, 2008 benefited from acontract-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 governmental agencies may periodicallyapproach us in 2009 about per diem rate concessions (or decline to providefunding for contractual rate increases). Decreases in, or the lack of anticipated increases in, per diem ratescould adversely impact our operating margin.

 

*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 June 30, 2009 and 2008, we realized average per diem rates onour residential youth and family services facilities of approximately $194.53and $190.46, respectively.  For the sixmonths ended June 30, 2009 and 2008, we realized average per diem rates ofapproximately $195.96 and $188.66, 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 June 30, 2009and 2008, we realized average fee-for-service rates for our non-residentialcommunity-based Abraxas Youth and Family Services facilities and programs,including rates that are limited by Medicaid and other private insuranceproviders, of approximately $45.17 and $49.33, respectively. For the six monthsended June 30, 2009 and 2008, we realized average fee for service rates ofapproximately $45.12 and $49.80, respectively. The fluctuation in the average fee-for-service rates for 2009 and 2008is due to changes in the mix of services provided at our non-residentialfacilities. The majority of our Abraxas Youth and Family Services contractsrenew 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 June 30, 2009 and 2008, we realized average perdiem rates on our residential adult community-based facilities of approximately$66.85 and $65.80, respectively. For the six months ended June 30, 2009and 2008, we realized average per diem rates on our residential AdultCommunity-Based Services facilities of approximately $67.05 and $65.88,respectively.  For the three months endedJune 30, 2009 and 2008, we realized average fee-for-service rates on ournon-residential Adult Community-Based Services facilities and programs ofapproximately $10.35 and $12.62, respectively. For the six months ended June 30, 2009 and 2008, we realizedaverage fee-for-service rates on our non-residential Adult Community-BasedServices facilities and programs of approximately $9.64 and $12.86,respectively.  Our averagefee-for-service rates fluctuate from year to year principally due to changes inthe mix of services provided by our various Adult Community-Based Servicesprograms and facilities.

 

*Operating Margins. *We havehistorically experienced higher operating margins in our Adult Secure Servicesand Adult Community-Based Services divisions as compared to our Abraxas Youthand Family Services division. Our operating margin, in a given period, will beimpacted by those facilities which may either be underutilized, dormant or havebeen reactivated during the period. As previously discussed, we havereactivated several facilities, including the Abraxas Academy and the HectorGarza Residential Treatment Center in 2006 and 2007, respectively. We have alsoexpanded several of our Adult Secure facilities during 2008 and 2009 (D. RayJames Prison, Great Plains Correctional Facility and Walnut Grove YouthCorrectional Facility, for example), which provides the opportunity to leverageexisting infrastructure. Additionally, our operating margins within a divisioncan vary from facility to facility based on whether a facility is owned orleased, the level of competition for the contract award, the proposed length ofthe contract, the mix of services provided, the occupancy levels for afacility, the level of capital commitment required with respect to a facility,the anticipated changes in operating 

 

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costs over the term of the contract and our ability toincrease a facility’s contract revenue. Under take-or-pay contracts, such asthe contract at the Moshannon Valley Correctional Center, operating margins aretypically higher during the early stages of the contract as the facility’spopulation ramps up (as revenues are received at contract percentagesregardless of actual occupancy). As the variable costs (primarilyresident-related and certain facility costs) increase with the growth inpopulation, operating margins will generally decline to a stabilized level.Following its activation in April 2006, we experienced such operatingmargin impact pertaining to the Moshannon Valley Correctional Center in thethird and fourth quarters of 2006. A decline in occupancy at our Abraxas Youthand Family Services facilities can have a more significant negative impact onoperating margins than a decline in occupancy in our Adult Secure Servicesdivision due to the longer periods typically required to ramp residentpopulation at a youth facility.

 

We have experienced and expect to continue toexperience interim period operating margin fluctuations due to factors such asthe number of calendar days in the period, higher payroll taxes (generally inthe first half of the year) and salary and wage increases and insurance costincreases that are incurred prior to certain contract rate increases.Periodically, many of the governmental agencies with whom we contract mayexperience budgetary pressures and may approach us to limit or reduce per diemrates (including contractual price increases as well). We have seen indicationsof such customer behavior in 2009 and believe it will continue into 2010.Decreases in, or the lack of anticipated increases in, per diem rates couldadversely impact our operating margin. Additionally, a decrease in per diemrates without a corresponding decrease in operating expenses could alsoadversely 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 particularprogram or facility.  Such decisions arebased on our assessments of operating results, operating efficiency andrisk-adjusted returns and are an ongoing part of our portfolio management.  In addition, decisions to restructureemployee positions will typically increase period costs initially (at the time ofsuch 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 14 and 16 facilities under management contracts at June 30,2009 and 2008, respectively. Included in the facilities under managementcontracts at June 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 offixed costs. These fixed costs include lease and rental expense, insurance,utilities and depreciation.  As a result,when we commence operation of new or expanded facilities, fixed operating costsmay increase. The amount of our variable operating costs, including food,medical services, supplies and clothing, depend on occupancy levels at thefacilities. Our largest single operating cost, facility payroll expense andrelated employment taxes and expenses, has both a fixed and a variablecomponent. We can adjust a facility’s staffing levels and the related payrollexpense to a certain extent based on occupancy at a facility; however a minimumfixed number of employees is required to operate and maintain any facilityregardless of occupancy levels. Personnel costs are subject to increases intightening labor markets based on local economic environments and otherconditions.

 

We incur pre-opening and start-up expenses includingpayroll, benefits, training and other operating costs prior to opening a new orexpanded facility and during the period of operation while occupancy is rampingup. These costs vary by contract (and the pace/scale of the activation andrelated population ramp). Since pre-opening and start-up costs are generallyfactored into the revenue per diem rate that is charged to the contractingagency, we typically expect to recover these upfront costs over the life of thecontract. Because occupancy rates during a facility’s start-up phase typicallyresult in capacity under-utilization for at least 90 to 180 days, we may incuradditional post-opening start-up costs. The ramp phase for our youth facilities is typically longer than thatexperienced in adult facilities. We do not anticipate post-opening start-upcosts at any adult secure facilities operated under any future contracts withthe BOP which are take-or-pay contracts, meaning that the BOP will pay at least80.0% of the contractual monthly revenue once the facility opens, regardless ofactual occupancy.

 

Newly opened facilities are staffed according toapplicable regulatory or contractual requirements when we begin receivingoffenders or clients. Offenders or clients are typically assigned to a newlyopened facility on a phased-in basis over a one- to six-month period. Ourstart-up period for new juvenile operations is 12 months from the date we beginrecognizing 

 

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revenue unless break-even occupancy levels areachieved 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.  Although we typically recover these upfrontcosts over the life of the contract, quarterly results can be substantiallyaffected by the timing of the commencement of operations as well as thedevelopment and construction of new facilities.

 

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.

 

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

 

#### **RecentDevelopments**

#### ** **

***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***

 

InAugust 2008, we entered into an agreement pursuant to which we will leasea new 1,250 male bed adult secure facility in Hudson, Colorado. The facility isowned by a third party and is being built on land we sold to the third party.We retained approximately 270 acres out of the original 320 acres we acquiredin 2007. We anticipate the construction, which began in the third quarter of2008, to be completed in late 2009. We have signed an implementation agreementwith the Colorado Department of Corrections (“Colorado DOC”), which governs theconstruction of the facility and contemplates a service agreement which can beentered into upon completion of the implementation agreement.  We wouldexpect to begin receiving inmates upon the activation of the facility, which iscurrently anticipated to be during the first quarter of 2010.  We expectto enter into a service agreement for the facility with the Colorado DOC butcan make no assurances that we will do so (or what the possible timing mightbe).

 

**Liquidity and CapitalResources**

 

***General*****.**Ourprimary capital requirements are for (1) purchases, construction orrenovation of new facilities, (2) expansions of existing facilities, (3) workingcapital, (4) pre-opening and start-up costs related to new operatingcontracts, (5) acquisitions, (6) information systems hardware andsoftware, and (7) furniture, fixtures and equipment.  Working capital requirements generallyincrease immediately prior to commencing management of a new or expanded facilityas we incur start-up costs and purchase necessary equipment and supplies beforefacility management revenue is realized.

 

***CashFlows From Operating Activities.***  Cash provided by operations wasapproximately $18.3 million for the six months ended June 30, 2009compared to $26.5 million for the six months ended June 30, 2008.  The decrease from the prior period wasprincipally due to the timing and amount of vendor payments.

 

***CashFlows From Investing Activities*****. **Cash used in investing activities wasapproximately $14.6 for the six months ended June 30, 2009 due to capitalexpenditures of $9.5 million related to the facility expansion projects at theD. Ray James Prison and Great Plains Correctional Facility, as well as certaininfrastructure work at our Hudson, Colorado facility offset by insuranceproceeds of $1.7 million (related to damages sustained at the Reid CommunityResidential Facility during Hurricane Ike in September 2008) and net paymentsto the restricted debt payment account of $6.8 million. ** **Cash used ininvesting activities was approximately $46.2 million for the six months ended June 30,2008 due to capital expenditures of $39.0 million related primarily to theexpansion projects at the D. Ray James Prison and the Great Plains CorrectionalFacility and net payments to the restricted debt payment account of $7.4million.  Additionally, we had sales ofinvestment securities of $0.3 million.

 

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***CashFlows From Financing Activities*****. **Cash used in financing activities wasapproximately $1.7 million for the six months ended June 30, 2009 dueprimarily to borrowings of $2.0 million on our Amended Credit Facility offsetby payments on the Amended Credit Facility of $4.0 million and proceeds fromthe exercise of stock options of $0.3 million.** **Cash provided by financingactivities was approximately $17.7 million for the six months ended June 30,2008 due primarily to borrowings on our Amended Credit Facility of $17.5million and proceeds from the exercise of stock options of $0.2 million.

 

***TreasuryStock Repurchases.***  We did not purchase any of our common stock inthe six months ended June 30, 2009 and 2008.

 

***Long-Term Credit Facilities.***  Our Amended CreditFacility provides for borrowings up to $100.0 million (including letters ofcredit) and matures in December 2011. At our election, outstandingborrowings bear interest, at either the LIBOR rate plus a margin ranging from1.50% to 2.25% or a rate which ranges from 0.00% to 0.75% above the applicableprime rate.  The applicable margins aresubject to adjustments based on our total leverage ratio. The availablecommitment under our Amended Credit Facility was approximately $11.6 million atJune 30, 2009.  We had outstandingborrowings under our Amended Credit Facility of $73.0 million and we hadoutstanding letters of credit of approximately $15.4 million at June 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 limitsour ability, subject to certain conditions, to expand the Amended CreditFacility beyond $100.0 million.  We canprovide no assurance that all of the banks that have made commitments to usunder our Amended Credit Facility would be willing to participate in anexpansion to the Amended Credit Facility should we desire to do so. The AmendedCredit 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.

 

OurAmended Credit Facility contains financial and other restrictive covenants thatlimit our ability to engage in certain activities.  Our ability to borrow under the AmendedCredit Facility is subject to compliance with certain financial covenants,including bank leverage, total leverage and fixed charge coverage ratios. At June 30,2009, we were in compliance with all such covenants. Our Amended CreditFacility includes other restrictions that, among other things, limit ourability to incur indebtedness; grant liens; engage in mergers, consolidationsand liquidations; make investments, restricted payment and asset dispositions;enter into transactions with affiliates; and engage in sale/leasebacktransactions.

 

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

 

The bonds are limited, nonrecourseobligations of MCF and secured by the property and equipment, bond reserves,assignment of subleases and substantially all assets related to the facilitiesincluded in the 2001 Sale and Leaseback Transaction (in which we sold elevenfacilities to MCF).  The bonds are notguaranteed by Cornell.

 

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

 

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

 

Uponthe occurrence of specified change of control events, unless we have exercisedour option to redeem all the Senior Notes as described above, each holder willhave the right to require us to repurchase all or a portion of such holder’sSenior Notes at a purchase price in cash equal to 101% of the aggregateprincipal amount of the notes repurchased plus accrued and unpaid interest, ifany, on the Senior Notes repurchased, to the applicable date of purchase.  The Senior Notes were issued under anindenture which limits our ability and the ability of our Guarantors to, amongother things, incur additional indebtedness, pay dividends or make otherdistributions, make other restricted payments and investments, create liens,incur 

 

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restrictionson the ability of the Guarantors to pay dividends or other payments to us,enter into transactions with affiliates, and engage in mergers, consolidationsand certain sales of assets.

 

In conjunction with theissuance of the Senior Notes, we entered into an interest rate swap transactionwith a financial institution to hedge our exposure to changes in the fair valueon $84.0 million of our Senior Notes. The purpose of this transaction was to convert future interest due on$84.0 million of the Senior Notes to a variable rate.  The terms of the interest rate swap contractand the underlying debt instrument were identical.  The swap agreement was designated as a fairvalue hedge.  The swap had a notionalamount of $84.0 million and matured in July 2012 to mirror the maturity ofthe Senior Notes.  Under the agreement,we paid, on a semi-annual basis (each January 1 and July 1), afloating rate based on a six-month U.S. dollar LIBOR rate, plus a spread, andreceived a fixed-rate interest of 10.75%. The swap agreement wasmarked to market each quarter with a corresponding mark-to-market adjustmentreflected as either a discount or premium on the Senior Notes.  The carrying value of the Senior Notes as ofthis date was adjusted accordingly by the same amount. Because the swapagreement was an effective fair-value hedge, there was no effect on our resultsof operations from the mark-to-market adjustment as long as the swap was ineffect. In October 2007, we terminated the swap agreement. We receivedapproximately $0.2 million in conjunction with the termination, which is beingamortized over the remaining term of the Senior Notes.

 

***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 June 30, 2009, we had approximately$11.6 million of available capacity under our Amended Credit Facility.  Wewill continue to analyze our capital structure, including a potentialrefinancing of our Senior Notes and financing for our expected future capitalexpenditures, including any potential acquisitions.  We will considerpotential acquisitions from time to time.  Our principal focus foracquisitions is anticipated to be in our Adult Secure and Adult Community-Baseddivisions, although we would also pursue attractively priced acquisitions inour Abraxas Youth and Family Services division.  We may decide to use internallygenerated funds, bank financing, equity issuances, debt issuances or acombination of any of the foregoing to finance our future capital needs. We mayalso seek, from time to time,   to retireor purchase some of our common stock and/or outstanding debt through cashpurchases in open market purchases, privately negotiated transactions orotherwise. Such repurchases, if any, will depend on prevailing marketconditions, our liquidity requirements, contractual restrictions and otherfactors. At June 30, 2009, we believe we have sufficient liquiditynecessary to complete those projects 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 for thenear term.  Such volatility could result in decreased availability ofcapital at economical terms and could also put additional financial andbudgetary pressure on our customers.  Such conditions could potentiallyresult in our inability to pursue additional future growth opportunities (suchas facility expansions or new facility construction) and, if coupled withunexpected client, operational or other issues affecting our cash flow, in aneed to seek additional financing at terms we 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. Recently, the State of California has notified vendorsproviding services to the state that it will temporarily issue IOU’s, whichwill be repaid October 2, 2009. While we will closely monitor thissituation, we do not currently expect this to have a permanent impact on the repaymentof our receivables related to our facilities in California.

 

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**Results ofOperations**

 

The following table sets forth for theperiods indicated the percentages of revenue represented by certain items in ourhistorical consolidated statements of operations.

 
| ** **                                                | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|-----------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                                                | ** ** | **2009**                         | ** ** | **2008**                       | ** ** | **2009** | ** ** | **2008** | ** ** |
|                                                      |       |                             |       |                           |       |   |   |   |   |
| Revenues                                                  |       | 100.0                            | %          | 100.0                          | %          | 100.0 | % | 100.0 | % |
| Operating  expenses                                       |       | 70.9                             |       | 72.1                           |       | 72.0 |   | 72.9 |   |
| Depreciation  and amortization                            |       | 4.5                              |       | 4.5                            |       | 4.7 |   | 4.4 |   |
| General and  administrative expenses                      |       | 6.0                              |       | 7.6                            |       | 6.1 |   | 7.2 |   |
| Income from  operations                                   |       | 18.6                             |       | 15.8                           |       | 17.2 |   | 15.5 |   |
| Interest  expense, net                                    |       | 6.2                              |       | 5.9                            |       | 6.1 |   | 6.3 |   |
| Income from  operations before provision for income taxes |       | 12.4                             |       | 9.9                            |       | 11.1 |   | 9.2 |   |
| Provision for  income taxes                               |       | 5.1                              |       | 4.3                            |       | 4.6 |   | 3.9 |   |
| Net income                                                |       | 7.3                              |       | 5.6                            |       | 6.5 |   | 5.3 |   |
| Non-controlling  interest                                 |       | 0.4                              |       | —                         |       | 0.4 |   | — |   |
| Income  available to stockholders                         |       | 6.9                              | %          | 5.6                            | %          | 6.1 | % | 5.3 | % |

 

***ThreeMonths Ended June 30, 2009 Compared to Three Months Ended June 30,2008***

 

***Revenues*****.**  Revenues increased approximately $10.7million, or 11.3%, to $105.3 million for the three months ended June 30,2009 from $94.6 million for the three months ended June 30, 2008.

 

*Adult Secure Services.*****Adult Secure Services revenues increased approximately $9.0million, or 17.9%, to $59.3 million for the three months ended June 30,2008 from $50.3 million for the three months ended June 30, 2007 due primarilyto (1) revenues of $5.1 million at the Great Plains CorrectionalFacility due to increased occupancy as a result of a facility expansioncompleted in September 2008, (2) an increase in revenues of $2.0million at the RCC due to improved occupancy, (3) an increase in revenuesof $0.8 million at the Walnut Grove Youth Correctional Facility (“Walnut Grove”)due to a facility expansion completed in the third quarter of 2008 and (4) anincrease in revenues of $0.7 million at the Big Spring Correctional Center dueto increased occupancy.  The remainingnet increase in revenues of $0.4 million was due to various immaterial fluctuationsin revenues at our other Adult Secure Services facilities.

 

AtJune 30, 2009, we operated ten Adult Secure Services facilities with anaggregate service capacity of 13,541. Average contract occupancy was 87.3% for the three months ended June 30,2009 compared to 92.4% for the three months ended June 30, 2008. Thedecrease in the average contract occupancy is primarily due to (1) theadditional capacity brought into operations in September 2008 at WalnutGrove, which we began ramping during the fourth quarter of 2008, (2) under-utilizationat certain California facilities and (3) the activation of the secondexpansion at the D. Ray James Prison in April 2009. The average per diemrate for our Adult Secure Services facilities was approximately $55.28 and$53.41 for the three months ended June 30, 2009 and 2008, respectively.

 

*Abraxas Youth and Family Services.** ***Abraxas Youth and Family Services revenues increasedapproximately $0.8 million, or 3.0%, to $27.7 million for the three monthsended June 30, 2009 from $26.9 million for the three months ended June 30,2008 due primarily to (1) an increase in revenues of$0.9 million at the Cornell Abraxas 1 facility (“A-1”) due to improvedoccupancy, (2) an increase in revenues of $0.7 million at the TexasAdolescent Treatment Center (“TATC”) due to improved occupancy, (3) anincrease in revenues of $0.5 million at the Abraxas Academy due to increasedoccupancy and (4) an increase in revenues of $0.4 million at the HectorGarza Residential Treatment Center due to improved occupancy.  The increase in revenues due to the above wasoffset by (1) a decrease in revenues of $1.0 million due to thetermination of our management contract for the Salt Lake Valley DetentionCenter as of September 2008 and (2) a decrease in revenues of $0.6million due to the termination of our management contract for the ReadingAlternative Education School Program in June 2008.  The remaining net decrease in revenues of$0.1 million was due to various immaterial fluctuations in revenues at ourother Abraxas Youth and Family Services facilities and programs.

 

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AtJune 30, 2009, we operated 17 residential AbraxasYouth and Family Services facilities and 11 non-residential Abraxas Youth and Family Services community-based programswith an aggregate service capacity of 3,321. Additionally, we had one facilitythat was vacant at June 30, 2009 with a service capacity of 70 beds.  Average contract occupancy for the threemonths ended June 30, 2009 was 89.4% compared to 81.9% for the threemonths ended June 30, 2008.  Theincrease in the average contract occupancy in 2009 was due to increasedoccupancy/higher utilization at such facilities as the Abraxas Academy, A-1 andthe Hector Garza Residential Treatment Center.

 

Theaverage per diem rate for our residential AbraxasYouth and Family Services facilities was approximately $194.53 for thethree months ended June 30, 2009 compared to $190.46 for the three monthsended June 30, 2008.  Our averagefee-for-service rate for our non-residential AbraxasYouth and Family Services community-based facilities and programs wasapproximately $45.17 for the three months ended June 30, 2009 compared to$49.33 for the three months ended June 30, 2008. Our averagefee-for-service rate can fluctuate from period-to-period depending on the mixof services provided at our various AbraxasYouth and Family Services facilities and programs.

 

*Adult Community-Based Services.***AdultCommunity-Based Services revenues increased approximately $0.9 million, or5.1%, to $18.4 million for the three months ended June 30, 2009 from $17.5million for the three months ended June 30, 2008 due to various immaterialfluctuations in revenues spread across our Adult Community-Based Servicesfacilities and programs.

 

At June 30, 2009, we operated 28residential Adult Community-Based Services facilities and three non-residentialAdult Community-Based Services programs with an aggregate service capacity of3,960.  Average contract occupancy was 111.3%for the three months ended June 30, 2009 compared to 101.0% for the threemonths ended June 30, 2008.  Theaverage per diem rate for our residential Adult Community-BasedServices facilities was approximately $66.85 for the three months ended June 30,2009 compared to $65.80 for the three months ended June 30, 2008.  The average fee-for-service rate for ournon-residential Adult Community-Based Services programs was approximately$10.35 for the three months ended June 30, 2009 compared to $12.62 for thethree months ended June 30, 2008. Our average fee-for-service ratesfluctuate as a result of changes in the mix of services provided by our variousAdult Community-Based Services programs and facilities.

 

*Operating Expenses**.*Operatingexpenses increased approximately $6.4 million, or 9.4%, to $74.7 million forthe three months ended June 30, 2009 from $68.3 million for the threemonths ended June 30, 2008.

 

*Adult Secure Services.*****Adult Secure Services operating expenses increased approximately$6.7 million, or 20.8%, to $38.9 million for the three months ended June 30,2009 from $32.2 million for the three months ended June 30, 2008 due primarilyto (1) an increase in operating expenses of $2.3 million atthe Great Plains Correctional Facility due to increased occupancy as a resultof a facility expansion completed in September 2008, (2) an increasein operating expenses of $1.1 million at the D. Ray James Prison due to increasedoccupancy, (3) an increase in operating expenses of $0.9 million at RCCdue to increased occupancy, (4) an increase in operating expenses of $0.9million at the Big Spring Correctional Center due to improved occupancy and (5) anincrease in operating expenses of $0.5 million at Walnut Grove due to increasedoccupancy following the completion of a facility expansion in the third quarterof 2008. The remaining net increase in operating expenses of approximately $1.0million was due to various immaterial fluctuations in operating expenses at ourother Adult Secure Services facilities as well as an increase in divisionaloperating expenses in the 2009 period.

 

Asa percentage of segment revenues, Adult Secure Services operating expenses were65.6% for the three months ended June 30, 2009 compared to 64.1% for thethree months ended June 30, 2008.

 

*Abraxas Youth and Family Services.** ***Abraxas Youth and Family Services division operating expenses increasedapproximately $0.3 million, or 1.3%, to $23.9 million for the three monthsended June 30, 2009 from $23.6 million for the three months ended June 30,2008 due primarily to (1) an increase in operating expenses of $0.5million at the Abraxas Academy due to increased occupancy, (2) an increasein operating expenses of $0.6 million at the Hector Garza Residential TreatmentCenter due to improved occupancy and (3) an increase in operating expensesof $0.6 million at TATC due to increased occupancy,   The increase in operating expenses due tothe above was offset, in part, by (1) a decrease in operating expenses of$0.9 million due to the termination of our management contract for the SaltLake Valley Detention Center as of September 2008 and (2) a decreasein operating expenses of $0.4 million due to the termination of our managementcontract for the Reading Alternative Education School Program in June 2008.The remaining net decrease in operating expenses of approximately $0.1million was due to various immaterial fluctuations in operating expenses at ourother Abraxas Youth and Family Services facilities and programs.

 

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As a percentage of segment revenues, AbraxasYouth and Family Services operating expenses were 85.8% for the three monthsended June 30, 2009 compared to 87.9% for the three months ended June 30,2008.  The reduction in the operatingexpense ratio in 2009 was principally due to the increased utilization at thosefacilities noted.

 

*Adult Community-Based Services.* Adult Community-Based Services operating expenses wereapproximately $12.1 million and $12.4 for the three months ended June 30,2009 and 2008, respectively.  The decreasewas primarily due to an estimated gain of $0.4 million in June 2009related to the insurance recoveries in excess of property carrying values atthe Reid Community Residential Facility damaged in Hurricane Ike in September 2008.  This gain is reflected in operating expensesfor the three months ended June 30, 2009. There were no significantfluctuations in operating expenses at our various Adult Community-BasedServices facilities and programs between the two periods.

 

As a percentage of segment revenues,Adult Community-Based Services operating expenses were 65.7% for the threemonths ended June 30, 2009 compared to 71.0% for the three months ended June 30,2008. The improvement in the operating margin was primarily due to theincreased utilization across the various facilities and programs during theperiod.

 

***Depreciationand Amortization*****. **Depreciation and amortization expense was approximately $4.7million and $4.2 million for the three months ended June 30, 2009 and2008, respectively.  Depreciation expenseincreased primarily due to the facility expansions at the Great PlainsCorrectional Facility and the D. Ray James Prison.  Amortization of intangibles was approximately$0.4 million and $0.5 million for the three months ended June 30, 2009 and2008, respectively.

 

***Generaland Administrative Expenses.***General and administrative expenses decreased approximately $0.9 million, or12.5%, to $6.3 million for the three months ended June 30, 2009 comparedto $7.2 million for the three months ended June 30, 2008.  The decrease was due primarily to higherlegal and other professional expenses incurred in the 2008 period.

 

***Interest.*** Interest expense, net of interest income, increased to approximately$6.6 million for the three months ended June 30, 2009 from $5.6 millionfor the three months ended June 30, 2008. The increase in net interestexpense was partially due to higher average outstanding borrowings during 2009.Capitalized interest for the three months ended June 30, 2008 wasapproximately $0.8 million and related to the facility expansion projects atthe Great Plains Correctional Facility and the D. Ray James Prison. There wasno interest capitalized during the three months ended June 30, 2009.

 

***IncomeTaxes.*** For the threemonths ended June 30, 2009, we recognized a provision for income taxes atan estimated effective rate of 41.4%.  Forthe three months ended June 30, 2008, we recognized a provision for incometaxes at an estimated effective rate of 42.8%. The change in our estimated effective tax rate in 2009 was related to anincrease in operating income across certain of our business segments and thedecreased impact of certain non-deductible expenses.

 

***SixMonths Ended June 30, 2009 Compared to Six Months Ended June 30, 2008***

 

***Revenues*****.**Revenues increased approximately $15.0 million, or 7.9%, to $205.0 million forthe six months ended June 30, 2009 from $190.0 million for the six monthsended June 30, 2008.

 

*Adult Secure Services.*****Adult Secure Services revenues increased approximately $15.9million, or 15.9%, to $116.1 million for the six months ended June 30, 2009from $100.2 million for the six months ended June 30, 2008 due primarilyto (1) an increase in revenues of approximately $10.2million at the Great Plains Correctional Facility due to increased occupancy asa result of a facility expansion completed in September 2008, (2) anincrease in revenues of $2.4 million at RCC due to improved occupancy, (3) anincrease in revenues of $1.5 million at Walnut Grove due to a facilityexpansion completed in the third quarter of 2008, (4) an increase inrevenues of $1.0 million at the Big Spring Correctional Center due to increasedoccupancy and (5) an increase in revenues of $0.7 million at the D. RayJames Prison due to increased occupancy resulting from the facility expansioncompleted in February 2008.  Theremaining net increase in revenues of $0.1 million was due to variousimmaterial fluctuations in revenues at our other Adult Secure Servicesfacilities.

 

Averagecontract occupancy for the six months ended June 30, 2009 was 89.6%compared to 94.0% for the six months ended June 30, 2008.  The average per diem rate for our AdultSecure Services facilities was approximately $54.52 and $54.46 for the sixmonths ended June 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 and Family Services.** ***Abraxas Youth and Family Services revenues decreasedapproximately $1.3 million, or 2.4%, to $53.4 million for the six months ended June 30,2009 from $54.7 million for the six months ended June 30, 2008 due to (1) adecrease in revenues of $1.9 million due to the termination of our managementcontract for the Salt Lake Valley Detention Center as of September 2008and (2) a decrease in revenues of $1.2 million due to the termination ofour management contract for the Reading Alternative Education School Program asof June 2008.  The decrease in 

 

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revenuesdue to the above was offset, in part, by (1) an increase in revenues of$1.2 million at the Abraxas Academy due to increased occupancy, (2) anincrease in revenues of $1.0 million at TATC due to improved occupancy and (3) anincrease in revenues of $0.4 million at the Hector Garza Residential TreatmentCenter due to increased occupancy.  Theremaining net decrease in revenues of $0.8 million was due to variousimmaterial fluctuations in revenues at our other Abraxas Youth and FamilyServices facilities and programs.

 

Averagecontract occupancy was 86.8% and 83.8% for the six months ended June 30,2009 and 2008, respectively. The increase in the 2009 average contractoccupancy was primarily a result of higher utilization of the Hector GarzaResidential Treatment Center, the Abraxas Academy and TATC facilities.  The average per diem rate for our residentialAbraxas Youth and Family Services facilities was approximately $195.96 and$188.66 for the six months ended June 30, 2009 and 2008, respectively. Theincrease in the 2009 average per diem rate reflects the continued ramp-up ofthe Abraxas Academy, increased utilization at A-1 and our San Antoniofacilities, as well as changes in the mix of services provided at other facilities.The average fee-for-service rate for our non-residential Abraxas Youth andFamily Services community-based facilities and programs was approximately$45.12 and $49.80 for the six months ended June 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-residentialAbraxas Youth and Family Services facilities and programs.

 

*Adult Community-Based Services.* Adult Community-Based Services revenues increased approximately$0.3 million, or 0.9%, to $35.5 million for the six months ended June 30,2009 from $35.2 million for the six months ended June 30, 2008.  Revenues decreased approximately $0.6 milliondue to the termination of our management contract for the Lincoln CountyDetention Center in May 2008.  Thisdecrease was offset by a net increase in revenues of $0.9 million due toimmaterial fluctuations in revenues among our various Adult Community-BasedServices facilities and programs.

 

Averagecontract occupancy was 107.4% and 100.9% for the six months ended June 30,2009 and 2008.  The average per diem ratefor our residential Adult Community-Based Services facilities was $67.05 and$65.88 for the six months ended June 30, 2009 and 2008, respectively.  The average fee-for-service rate for ournon-residential Adult Community-Based Services programs was $9.64 and $12.86for the six months ended June 30, 2009 and 2008, respectively. Thedecrease in the average fee-for-service rate for 2009 was due to changes in themix of services provided by our various non-residential Adult Community-BasedServices facilities and programs.

 

***OperatingExpenses.*** Operatingexpenses increased approximately $9.1 million, or 6.6%, to $147.6 million forthe six months ended June 30, 2009 from $138.5 million for the six monthsended June 30, 2008.

 

*Adult Secure Services.*****Adult Secure Services operating expenses increased approximately$11.1 million, or 17.2%, to $75.6 million for the six months ended June 30,2009 from $64.5 million for the six months ended June 30, 2008 due to (1) anincrease in operating expenses of $4.5 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$1.6 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 $1.4 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 $0.8 million at RCC due to improved occupancy. The remainingnet increase in operating expenses of $1.7 million was due to variousimmaterial fluctuations in operating expenses at our other Adult SecureServices facilities as well as an increase in divisional operating expenses of$1.5 million in the 2009 period.

 

As a percentage of segment revenues, AdultSecure Services operating expenses were 65.1% for the six months ended June 30,2009 compared to 64.3% for the six months ended June 30, 2008. The 2008operating margin was favorably impacted by a $1.5 million contract-basedrevenue adjustment at the RCC for the contract year ended March 2008(which we recognized in March 2008).

 

*Abraxas Youth and Family Services.** ***Abraxas Youth and Family Services operating expenses decreasedapproximately $1.1 million, or 2.2%, to $48.0 million for the six months ended June 30,2009 from $49.1 million for the six months ended June 30, 2008 dueprimarily to (1) a decrease in operating expenses of $1.9 million due tothe termination of our management contract for the Salt Lake Valley DetentionCenter as of September 2008 and (2) a decrease in operating expensesof $0.9 million due to the termination of our management contract for theReading Alternative Education School Program as of June 2008. The decreasein operating expenses due to the above was offset, in part, by (1) anincrease in operating expenses of $1.2 million at the Abraxas Academy due toimproved occupancy, (2) an increase in operating expenses of $1.1 millionat the Hector Garza Residential Treatment Center due to improved occupancy and (3) anincrease in operating expenses of $0.8 million at TATC due to improvedoccupancy.  The remaining net decrease inoperating expenses of approximately $1.4 

 

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millionwas due to various immaterial fluctuations in operating expenses at our otherAbraxas Youth and Family Services facilities and programs.

 

As a percentage of segment revenues, AbraxasYouth and Family Services operating expenses were 89.9% and 89.8% for the sixmonths ended June 30, 2009 and 2008, respectively.

 

*Adult Community-Based Services.* Adult Community-Based Services operating expenses decreasedapproximately $0.9 million, or 3.6%, to $24.0 million for the six months ended June 30,2009 from $24.9 million for the six months ended June 30, 2008 due primarily to adecrease in operating expenses of $0.6 million due to the termination of ourmanagement contract for the Lincoln County Detention Center in May 2008.  Additionally, in June 2009, we recordedan estimated gain of $0.4 million related to the insurance recoveries in excessof property carrying values at the Reid Community Residential Facility damagedin Hurricane Ike in September 2008. This gain is reflected in operating expenses for the six months ended June 30,2009.  The remaining net increase inoperating expenses of $0.1 million was due to immaterial fluctuations in operatingexpenses at our other Adult Community-Based Services facilities and programs. As a percentageof segment revenues, Adult Community-Based Services operating expenses were67.7% for the six months ended June 30, 2009 compared to 70.8% for the sixmonths ended June 30, 2008.

 

***Depreciationand Amortization*****.** Depreciation and amortization expense wasapproximately $9.6 million and $8.4 million for the six months ended June 30,2009 and 2008, respectively. Depreciation of property and equipment increased approximately $1.3million 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 $1.0 million for the six months ended June 30,2009 and 2008, respectively.

 

***Generaland Administrative Expenses.***General and administrative expenses decreased approximately $1.4 million, or10.1%, to approximately $12.4 million for the six months ended June 30,2009 from $13.8 million for the six months ended June 30, 2008 due primarilyto lower legal and other professional expenses in the 2009 period.

 

***Interest.*** Interest expense, net of interest income, increased toapproximately $12.5 million for the six months ended June 30, 2009 from $11.9million for the six months ended June 30, 2008. The increase in netinterest expense was partially due to higher levels of borrowings outstandingduring 2009. For the six months ended June 30, 2009, we capitalizedinterest of $0.7 million related to the 700 bed facility expansion project atthe D. Ray James Prison.  For the sixmonths ended June 30, 2008, we capitalized interest of approximately $1.3million related to the expansion projects at the D. Ray James Prison and theGreat Plains Correctional Facility.

 

***IncomeTaxes.*** For the sixmonths ended June 30, 2009, we recognized a provision for income taxes atan estimated effective rate of 41.5%.  Forthe six months ended June 30, 2008, we recognized a provision for incometaxes at an estimated effective rate of 43.1%. The change in our estimated effective tax rate in 2009 was related to anincrease in operating income across certain of our business segments and thedecreased impact of certain non-deductible expenses.

 

***Contractual Uncertainties Related toCertain Facilities***

 

***Regional Correctional Center.***  The Office of Federal Detention Trustee (“OFDT”)holds the contract for the use of the RCC on behalf of ICE, USMS and the BOPwith Bernalillo County (the “County”) through an intergovernmental servicesagreement, and we have an operating and management agreement with theCounty.  In July 2007, we werenotified by ICE that it was removing all ICE detainees from the RCC and theremoval was completed in early August 2007.  The facility is still beingutilized by 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 right tounilaterally amend the contract in this manner, and OFDT has been informed ofour position. Although either party to the intergovernmental services agreementhas the right to terminate upon 180 days notice, neither party has exercisedsuch right as of June 30, 2009.

 

Thereis a pending lawsuit against the County concerning the County jail system,known as the “McClendon” case. In 1994, plaintiffs sued the County in federal district court in the District ofNew Mexico over conditions at the county jail, which was then located at whatis now the Regional Correctional Center and run by the County.  The Countysubsequently built their new Metropolitan Detention Center to house the Countyinmates and also negotiated two stipulated agreements in 2004 designed to endthe McClendon lawsuit.   Thesestipulated settlements covered the Metropolitan Detention Facility and wereapproved by the Court in 2005 (the “2005 settlement agreements”).

 

InMarch 2009, the Federal Judge presiding over the case issued an Orderbased on motions filed by Plaintiffs class counsel asking the Judge to reformthe 2005 settlement agreements to allow for access to the RCC.  In those motions, the Plaintiffs alsorequested alternative relief in the form of withdrawal of the Court’s approvalof the 2005 settlement agreements.  Basedon our interpretation of the Order, the Judge denied Plaintiffs’ request foraccess to the RCC, granted the alternative relief requested, withdrew herapproval of the 2005 settlement agreements and granted the option to Plaintiffsto

 

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rescindtheir 2005 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.

 

The2005 settlement agreements imposed various conditions on the MetropolitanDetention Center that resulted in material increases to its operatingcosts.  The effect of the rescission ofthe 2005 settlement agreements is unclear since those settlement agreementsreplaced prior settlement agreements approved in 1996.  We do not believe we are contractuallyobligated to bear any incremental costs of complying with any settlementagreements in the McClendon case although the County has expressed to usthat it may want us to absorb a portion of any costs that would be incurred.   We currently plan to continue to operate thefacility and also continue with our marketing plans for the RCC.

 

Revenuesfor this facility were approximately $6.4 million and $4.0 million (including a$1.5 million contract-based revenue adjustment for the contract year ended March 31,2008, for which the related receivable is carried in accounts receivable-tradeat June 30, 2009) for the six months ended June 30, 2009 and 2008,respectively. The net carrying value of the leasehold improvements for thisfacility was approximately $1.1 million at June 30, 2009 and December 31,2008. Our lease for this facility requires monthly rent payments ofapproximately $0.13 million for the remaining term of the lease (which wasextended through June 2010). To date, although we have several federalagencies using the RCC, the facility still has available capacity. Ourinability to expand the existing population with current or new customers orany disruption of our operations due to activity in the McClendon case couldhave an adverse effect on our financial condition, results of operations andcash flows.  We believe that pursuant to the provisions of SFAS No. 144,no impairment to the carrying value of the leasehold improvements for thisfacility has occurred.

 

***Hector Garza ResidentialTreatment 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 $4.0 million at June 30, 2009and December 31, 2008.  We believethat, pursuant to the provisions of SFAS No. 144, no impairment to thecarrying value of this facility has occurred due to existing (and increasing)demand from current customers (including the Texas Youth Commission) andanticipated incremental demand from additional multiple customers to whom thefacility is being marketed (including several current and anticipated requestsfor proposal).

 

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

 

We review our long-lived assets (including ourfacilities at a facility-by-facility level) for impairment at least annually orwhen changes in circumstances or a triggering event indicates that the carryingamount of the asset may not be recoverable in accordance with the provisions ofSFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.”SFAS No. 144 requires that long-lived assets to be held and used recognize animpairment loss only if the carrying amount of the long-lived asset is notrecoverable from its estimated future undiscounted cash flows and to measure animpairment loss as the difference between the carrying value and the fair valueof the asset. Assets to be disposed of by sale are recorded at the lower oftheir carrying amount or fair value less estimated selling costs. We estimateprojections of undiscounted cash flows, and also fair value, based upon thebest information available, which may include expected future discounted cashflows to be produced by the asset and/or available market prices. Factors thatsignificantly influence estimated future cash flows include the periods andlevels of occupancy for the facility, expected per diem or reimbursement rates,assumptions regarding the levels of staffing, services and future operating andcapital expenditures necessary to generate forecasted revenues, related costsfor these activities and future rate of increases or decreases associated withthese factors. Information typically utilized will also include relevant termsof existing contracts (for similar services and customers), market knowledge ofcustomer demand (both present and anticipated) and related pricing, marketcompetitors, and our historical experience (as to areas including customerrequirements, contract terms, operating requirements/costs, occupancy trends,etc.). We may also consider the results of any appraisals if a fair value isnecessary. Estimates for factors such as per diem or reimbursement rates may behighly subjective, particularly in circumstances where there is no currentoperating contract in place and changes in the assumptions and estimates couldresult in the recognition of impairment charges. 

 

The most subjective estimates made in our impairmentanalysis for 2008 related to Cornell Abraxas 1 and the Hector Garza ResidentialTreatment Center, particularly with respect to estimated occupancy. Theapproximate carrying values at December 31, 2008 for Cornell Abraxas 1 and theHector Garza Residential Treatment Center were $10.4 million and $4.0 million,respectively. The estimated undiscounted future cash flow values exceeded thecarrying values noted for the facilities, and all facilities had operatingcontracts in place. During 2009, there were no significant events that causedus to believe that an impairment of these facilities during the current periodhad occurred.

 

We may be required to record an impairment charge inthe future if we are unable to successfully negotiate a replacement contract onany of our facilities for which we currently have an operating contract.

 

***ContractualObligations and Commercial Commitments*****.** We haveassumed various financial obligations and commitments in the ordinary course ofconducting our business. We have contractual obligations requiring future cashpayments under our existing contractual arrangements, such as management,consultative and non-competition agreements.

 

We maintain operating leases in theordinary course of our business activities. These leases include those for operating facilities, office space andoffice and operating equipment, and the terms of these agreements range from2008 until 2075.  As of June 30,2009, our total commitment under these operating leases was approximately$118.5 million.

 

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The following table details our knownfuture cash payments (on an undiscounted basis) related to various contractualobligations as of June 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          |       | 134,100                                   |       | 12,400 |   | 28,000 |   | 33,000 |   | 60,700 |   |
| Long-term debt — interest         |       |                                      |       |   |   |   |   |   |   |   |   |
| · Cornell Companies, Inc.    |       | 36,120                                    |       | 6,020 |   | 24,080 |   | 6,020 |   | — |   |
| · Special Purpose Entity          |       | 50,257                                    |       | 5,679 |   | 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.    |       | 696                                       |       | 486 |   | 210 |   | — |   | — |   |
| Capital lease obligations              |       |                                      |       |   |   |   |   |   |   |   |   |
| · Cornell Companies, Inc.    |       | 21                                        |       | 7 |   | 14 |   | — |   | — |   |
| Construction commitments               |       | 4,619                                     |       | 4,619 |   | — |   | — |   | — |   |
| Operating leases                       |       | 118,462                                   |       | 3,851 |   | 25,580 |   | 21,876 |   | 67,155 |   |
| Consultative and non-competeagreements |       | 110                                       |       | 110 |   | — |   | — |   | — |   |
| Total contractual cash obligations     |       | $                                         | 529,385    |   | $ | 33,172 |   | $ | 170,366 |   | $ | 187,430 |   | $ | 138,417 |   |

 

Approximately$2.7 million of unrecognized tax benefits have been recorded as liabilities inaccordance with FIN 48 as of June 30, 2009 but are not included in thecontractual obligations table above because we are uncertain as to if or whensuch amounts may be settled.  Related tothe unrecognized tax benefits not included in the table above, we have alsorecorded a liability for potential penalties of approximately $0.1 million andfor interest of approximately $0.1 million as of June 30, 2009.

 

Weenter into letters of credit in the ordinary course of operating and financingactivities.  As of June 30, 2009, wehad outstanding letters of credit of approximately $15.4 million primarily forcertain workers’ compensation insurance and other operating obligations.  The following table details our letters ofcredit commitments as of June 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 |       | $             | 15,449     |                                                                    | $          | 14,699 |   | $ | 750 |   | $ | — |   | $ | — |   |
|                           |            |               |            |                                                                         |            |  |  |  |  |  |  |  |  |  |  |  |

 

**ITEM 3.          Quantitative andQualitative Disclosures about Market Risk**

 

Inthe normal course of business, we are exposed to market risk, primarily fromchanges in interest rates.  Wecontinually monitor exposure to market risk and develop appropriate strategiesto manage this risk.  We are not exposedto any other significant market risks, including commodity price risk or,foreign currency exchange risk or interest rate risks from the use ofderivative financial instruments.  Inconjunction with the issuance of the Senior Notes, we entered into an interestrate swap of $84.0 million related to the interest obligations under the SeniorNotes in effect converting them to a floating rate based on six-month LIBOR. Weterminated the interest rate swap in October 2007.

 

**Credit Risk**

 

Dueto the short duration of our investments, changes in market interest rateswould not have a significant impact on their fair value.  In addition, our accounts receivables arewith federal, state, county and local government agencies, which we believereduces our credit risk. However, it is possible that such situations as continuingbudget resolutions, delayed passage of budgets or budget pressures may increasethe length of repayment of certain receivables. Recently, the State ofCalifornia has notified vendors providing services to the state that it willtemporarily issue IOU’s, which will be repaid October 2, 2009. While wewill closely monitor this situation, we do not currently expect this to have apermanent impact on the repayment of our receivables related to our facilitiesin California.

 

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**Interest Rate Exposure**

 

Our exposure to changes in interest ratesprimarily results from our Amended Credit Facility, as these borrowings havefloating interest rates.  The debt on ourconsolidated financial statements at June 30, 2009 with fixed interestrates consist of the 8.47% Bonds issued by MCF, a special purpose entity, in August 2001in connection with the 2001 Sale and Leaseback Transaction and $112.0 millionof Senior Notes.  The detrimental effectof a hypothetical 100 basis point increase in interest rates on our currentborrowings under our Amended Credit Facility would be to reduce income beforeprovision for income taxes by approximately $0.4 million for the six months endedJune 30, 2009.  At June 30, 2009,the fair value of our consolidated fixed rate debt was approximately $323.5million 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, and employee medical and worker’scompensation insurance costs, we believe that inflation has not had a materialeffect on our results of operations during the past two years.  We have experienced significant increases inoffender medical costs and employee medical and worker’s compensation insurancecosts, and we have also experienced higher personnel costs during the past twoyears. Most of our facility management contracts provide for payments of eitherfixed per diem fees or per diem fees that increase by only small amounts duringthe term of the contracts. Inflation could substantially increase our personnelcosts (the largest component of our operating expenses), medical and insurancecosts or other operating expenses at rates faster than any increases incontract revenues.  Food costs (part ofour resident/inmate care costs) have also been subject to rising prices in 2008and 2009. We believe we have limited our exposure through long-term contractswith fixed term pricing.

 

**ITEM 4.      Controls and Procedures**

 

**Evaluation ofDisclosure Controls and Procedures**

 

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

 

We do not expect that ourdisclosure controls and procedures will prevent all errors or fraud. A controlsystem, no matter how well conceived and operated, can provide only reasonable,not absolute, assurance that the objectives of the control system are met. Inaddition, the design of disclosure controls and procedures must reflect thefact that there are resource constraints, and the benefits of controls must beconsidered relative to their costs. Because of the inherent limitation in acost-effective control system, misstatements due to error or fraud could occurand not be detected.

 

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

 

**Changes in Internal Control over Financial Reporting**

 

In connection with the evaluation as requiredby paragraph (d) of Rules 13a-15 and 15d-15 of the Exchange Act, wehave not identified any change in our internal control over financial reporting(as such term is defined in Rules 13a-15(f) and 15d-15(f) underExchange Act) during our fiscal quarter ended June 30, 2009 that hasmaterially affected, or is reasonably likely to materially affect, our internalcontrol over financial reporting.

 

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

 

**ITEM 1.****                ****LegalProceedings.**

 

See Part I, Item 1.Note 9 to the Consolidated Financial Statements, which is incorporated hereinby reference.

 

**ITEM 1A.****             ****RiskFactors.**

 

The risk factors aspreviously disclosed in our Form 10-K for the fiscal year ended December 31,2008 are incorporated herein by this reference. There are no material changesto such risk factors.

 

**ITEM 2.****                ****UnregisteredSales of Equity Securities and Use of Proceeds.**

 

None.

 

**ITEM 3.****                ****DefaultsUpon Senior Securities.**

 

None.

 

## **ITEM 4.**                 Submission of Matters to aVote of Security Holders.

## ** **

On June 18, 2009, the Company heldits 2009 Annual Meeting of Shareholders. The matters voted on at the meeting and the results thereof are asfollows:

 

1.        Shareholders elected the persons listed below as directors whoseterms expire at the 2010 Annual Meeting of Shareholders or until theirsuccessors are elected and qualified. Results by nominee were:

 
| ** **                  | ** ** | ** **         | ** ** | **Authority** | ** ** |
|-----------------------------|------------|--------------------|------------|---------------|------------|
| ** **                  | ** ** | **Voted For** | ** ** | **Withheld**  | ** ** |
|                        |       |               |       |          |       |
| Max Batzer                  |       | 14,095,978         |       | 361,321       |       |
| Anthony R.  Chase           |       | 14,098,081         |       | 359,218       |       |
| Richard Crane               |       | 13,804,844         |       | 652,455       |       |
| Zachary R.  George          |       | 14,359,370         |       | 97,929        |       |
| Todd Goodwin                |       | 14,007,311         |       | 449,988       |       |
| James E.  Hyman             |       | 14,022,681         |       | 434,618       |       |
| Andrew R.  Jones            |       | 14,068,623         |       | 388,676       |       |
| Alfred Jay  Moran, Jr. |       | 14,006,898         |       | 450,401       |       |
| D. Stephen  Slack           |       | 14,015,661         |       | 441,638       |       |

 

2.        Shareholders ratified the selection of PricewaterhouseCoopers LLPas the Company’s independent registered public accounting firm for the fiscalyear ending December 31, 2009. Results were as follows:

 
| **For**    | ** ** | **Against** | ** ** | **Abstain** | ** ** | **Broker Non-Vote** | ** ** |
|------------|------------|-------------|------------|-------------|------------|---------------------|------------|
| 14,404,262 |       | 50,611      |       | 2,426       |       | 0                   |       |

 

3.        Shareholders approved amendments to the Company’s 2006 EquityIncentive Plan and reapproval of performance goals that may apply to awardsunder the plan.  Results were as follows:

 
| **For**    | ** ** | **Against** | ** ** | **Abstain** | ** ** | **Broker Non-Vote** | ** ** |
|------------|------------|-------------|------------|-------------|------------|---------------------|------------|
| 12,627,017 |       | 1,371,848   |       | 5,720       |       | 452,714             |       |

 

4.        Shareholders approved amendments to the Company’s 2000 DirectorStock Plan.  Results were as follows:

 
| **For**    | ** ** | **Against** | ** ** | **Abstain** | ** ** | **Broker Non-Vote** | ** ** |
|------------|------------|-------------|------------|-------------|------------|---------------------|------------|
| 13,366,765 |       | 627,930     |       | 9,890       |       | 452,714             |       |

 

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5.        Shareholders rejected ashareholders proposal that the Company provide semi-annual reports toshareholders regarding the Company’s political contributions and tradeassociation dues.  Results were asfollows:

 
| **For**   | ** ** | **Against** | ** ** | **Abstain** | ** ** | **Broker Non-Vote** | ** ** |
|-----------|------------|-------------|------------|-------------|------------|---------------------|------------|
| 3,958,000 |       | 9,338,683   |       | 707,902     |       | 452,714             |       |

 

## **ITEM 5.**                 Other Information.

## ** **

None.

 

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

 
| 10.1   |   | Form of  Cornell Companies, Inc. Restricted Stock Award Agreement  (Profitability & Time-Based) (incorporated by reference to  Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on  April 7, 2009) |
|--------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.2   |   | Form of  Cornell Companies, Inc. Restricted Stock Award Agreement (Performance  Based) (incorporated by reference to Exhibit 10.2 to the Company’s  Current Report on Form 8-K filed on April 7, 2009)                    |
| 10.3   |   | Cornell  Companies, Inc. 2006 Incentive Plan, as amended and restated  (incorporated by reference to the Company’s Proxy Statement on Schedule 14A  filed April 28, 2009)                                                                |
| 10.4   |   | Cornell  Companies, Inc. Amended and Restated 2000 Director Stock Plan (incorporated  by reference to the Company’s Proxy Statement on Schedule 14A filed  April 28, 2009)                                                               |
| 10.5*  |   | Cornell  Companies, Inc. First Amendment to the Amended and Restated 1996 Stock  Option Plan                                                                                                                                                       |
| 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**

 

Pursuant to the requirements of Section 13 or 15(d) of the SecuritiesExchange Act of 1934, the Registrant has duly caused this report to be signedon its behalf by the undersigned, thereunto duly authorized.

 
| ** **                            | ** ** | **CORNELL COMPANIES, INC.**                                                                                                |
|---------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------|
|                                  |       |                                                                                                                            |
|                                  |       |                                                                                                                            |
| Date:  August 7,  2009 | By:        | /s/  James E. Hyman                                                                                                             |
|                                  |       | JAMES  E. HYMAN                                                                                                                 |
|                                  |       | Chief  Executive Officer, President and Chairman  of the Board (Principal Executive Officer)                                    |
|                                  |       |                                                                                                                            |
|                                  |       |                                                                                                                            |
| Date:  August 7,  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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