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**UNITEDSTATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, DC 20549**

 

**FORM 10-Q**

 

| **x**                                                  | ** ** | **QUARTERLY  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE  ACT OF 1934**  |
|--------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------|
| ** **                                             | ** ** | ** **                                                                                               |
| **For the Quarterly Period Ended March 31, 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’sTelephone Number, Including Area Code:  **(713) 623-0790**

 

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

 

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

 

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

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

 

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

 

At May 6, 2009, the registrant had 14,915,751 shares of common stockoutstanding.

 

 

 

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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 | 26         |
| Item 3.          | Quantitative  and Qualitative Disclosures About Market Risk                                 | 38         |
| Item 4.          | Controls and  Procedures                                                                    | 38         |
|             |                                                                                        |       |
| **Part II** | ** **                                                                                  | ** ** |
| Item 1.          | Legal Proceedings                                                                           | 40         |
| Item 1A.         | Risk Factors                                                                                | 40         |
| Item 2.          | Unregistered  Sales of Equity Securities and Use of Proceeds                                | 40         |
| Item 3.          | Defaults Upon  Senior Securities                                                            | 40         |
| Item 4.          | Submission  of Matters to a Vote of Security Holders                                        | 40         |
| Item 5.          | Other Information                                                                           | 40         |
| Item 6.          | Exhibits                                                                                    | 40         |

 

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**Forward-Looking Information**

 

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

 

·                  revenues,

·                  revenue mix,

·                  expenses, including personnel and medicalcosts,

·                  results of operations,

·                  operating margins,

·                  supply and demand,

·                  market outlook in our various markets,

·                  our other expectations with regard tomarket outlook,

·                  utilization,

·                  parolee, detainee, inmate and youthoffender trends,

·                  pricing and per diem rates,

·                  contract commencements,

·                  new contract opportunities,

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

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

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

·                  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”

 

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·               “forecasts”

·               “intends”

·               “may”

·               “might”

·               “plans”

·               “predicts”

·               “projects”

·               “scheduled”

·               “should”

 

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

 

·                  those described (in the Company’s 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)**

 
| ** **                                                                                                                                                            | ** ** | **March 31,  2009** | ** ** | **December 31,  2008** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| **ASSETS**                                                                                                                                                            | ** ** | ** **               | ** ** | ** **                  | ** ** |
| **CURRENT ASSETS:**                                                                                                                                                   | ** ** | ** **               | ** ** | ** **                  | ** ** |
| Cash and cash equivalents                                                                                                                                             |       | $                        | 10,271     |                        | $          | 14,613 |   |
| Accounts receivable — trade (net of allowance for doubtful accounts  of $4,825 and $4,272, respectively)                                                         |       | 67,892                   |       | 64,622                      |       |
| Other receivables (net of allowance for doubtful accounts of $4,926)                                                                                                  |       | 4,074                    |       | 4,766                       |       |
| Debt service fund and other restricted assets                                                                                                                         |       | 31,691                   |       | 31,370                      |       |
| Deferred tax assets                                                                                                                                                   |       | 9,458                    |       | 9,151                       |       |
| Prepaid expenses and other                                                                                                                                            |       | 6,002                    |       | 6,368                       |       |
| **Total current assets**                                                                                                                                              |       | 129,388                  |       | 130,890                     |       |
| **PROPERTY AND EQUIPMENT, net**                                                                                                                                       |       | 450,620                  |       | 450,354                     |       |
| **OTHER ASSETS:**                                                                                                                                                     |       |                     |       |                        |       |
| Debt service reserve fund                                                                                                                                             |       | 24,185                   |       | 23,750                      |       |
| Goodwill, net                                                                                                                                                         |       | 13,308                   |       | 13,308                      |       |
| Intangible assets, net                                                                                                                                                |       | 1,872                    |       | 2,320                       |       |
| Deferred costs and other                                                                                                                                              |       | 16,228                   |       | 16,299                      |       |
| **Total assets**                                                                                                                                                      |       | $                        | 635,601    |                        | $          | 636,921 |   |
|                                                                                                                                                                  |       |                     |       |                        |       |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**                                                                                                                        | ** ** | ** **               | ** ** | ** **                  | ** ** |
|                                                                                                                                                                  |       |                     |       |                        |       |
| **CURRENT LIABILITIES:**                                                                                                                                              | ** ** | ** **               | ** ** | ** **                  | ** ** |
| Accounts payable and accrued liabilities                                                                                                                              |       | $                        | 59,532     |                        | $          | 69,093 |   |
| Current portion of long-term debt                                                                                                                                     |       | 12,412                   |       | 12,412                      |       |
| **Total current liabilities**                                                                                                                                         |       | 71,944                   |       | 81,505                      |       |
| **LONG-TERM DEBT, net of current portion**                                                                                                                            |       | 309,113                  |       | 308,070                     |       |
| **DEFERRED TAX LIABILITIES**                                                                                                                                          |       | 18,118                   |       | 17,491                      |       |
| **OTHER LONG-TERM LIABILITIES**                                                                                                                                       |       | 1,833                    |       | 1,688                       |       |
| **Total liabilities**                                                                                                                                                 |       | 401,008                  |       | 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,  16,242,601 and 16,238,685 shares issued and 14,754,715 and 14,732,522 shares  outstanding, respectively |       | 16                       |       | 16                          |       |
| Additional paid-in capital                                                                                                                                            |       | 165,356                  |       | 164,746                     |       |
| Retained earnings                                                                                                                                                     |       | 78,575                   |       | 73,318                      |       |
| Accumulated other comprehensive income                                                                                                                                |       | 1,613                    |       | 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.**                                                                                                                                     |       | 233,672                  |       | 227,722                     |       |
| Non-controlling interest                                                                                                                                              |       | 921                      |       | 445                         |       |
| **Total stockholders’ equity**                                                                                                                                   |       | 234,593                  |       | 228,167                     |       |
| **Total liabilities and stockholders’ equity**                                                                                                                   |       | $                        | 635,601    |                        | $          | 636,921 |   |

 

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

 

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

 
| ** **                                                                             | ** ** | **Three Months Ended  March 31,** | ** ** |
|----------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                             | ** ** | **2009**                                         | ** ** | **2008** | ** ** |
|                                                                                   |       |                                             |       |   |   |
| REVENUES                                                                               |       | $                                                | 99,710     |   | $ | 95,392 |   |
| OPERATING EXPENSES, EXCLUDING DEPRECIATION                                             |       | 72,891                                           |       | 70,209 |   |
| DEPRECIATION AND AMORTIZATION                                                          |       | 4,893                                            |       | 4,157 |   |
| GENERAL AND ADMINISTRATIVE EXPENSES                                                    |       | 6,138                                            |       | 6,536 |   |
|                                                                                   |       |                                             |       |   |   |
| INCOME FROM OPERATIONS                                                                 |       | 15,788                                           |       | 14,490 |   |
|                                                                                   |       |                                             |       |   |   |
| INTEREST EXPENSE                                                                       |       | 6,199                                            |       | 6,605 |   |
| INTEREST INCOME                                                                        |       | (246                                             | )          | (310 | ) |
|                                                                                   |       |                                             |       |   |   |
| INCOME FROM OPERATIONS BEFORE PROVISION FOR INCOME TAXES AND  NON-CONTROLLING INTEREST |       | 9,835                                            |       | 8,195 |   |
|                                                                                   |       |                                             |       |   |   |
| PROVISION FOR INCOME TAXES                                                             |       | 4,101                                            |       | 3,561 |   |
|                                                                                   |       |                                             |       |   |   |
| NET INCOME                                                                             |       | 5,734                                            |       | 4,634 |   |
|                                                                                   |       |                                             |       |   |   |
| NON-CONTROLLING INTEREST                                                               |       | 477                                              |       | — |   |
|                                                                                   |       |                                             |       |   |   |
| INCOME AVAILABLE TO SHAREHOLDERS                                                       |       | $                                                | 5,257      |   | $ | 4,634 |   |
|                                                                                   |       |                                             |       |   |   |
| EARNINGS PER SHARE:                                                                    |       |                                             |       |   |   |
| BASIC                                                                                  |       | $                                                | .36        |   | $ | .32 |   |
| DILUTED                                                                                |       | $                                                | .36        |   | $ | .32 |   |
|                                                                                   |       |                                             |       |   |   |
| NUMBER OF SHARES USED IN PER SHARE COMPUTATION:                                        |       |                                             |       |   |   |
| BASIC                                                                                  |       | 14,572                                           |       | 14,435 |   |
| DILUTED                                                                                |       | 14,629                                           |       | 14,558 |   |
|                                                                                   |       |                                             |       |   |   |
| COMPREHENSIVE INCOME:                                                                  |       |                                             |       |   |   |
| Net Income                                                                             |       | $                                                | 5,734      |   | $ | 4,634 |   |
| Other comprehensive income, net of tax:                                                |       |                                             |       |   |   |
| Unrealized gain on derivative instruments, net of tax provision of  $511 in 2008       |       | —                                           |       | 735 |   |
| Total other comprehensive income, net of tax                                           |       | 5,734                                            |       | 5,369 |   |
| Comprehensive income attributable to non-controlling interest                          |       | (477                                             | )          | — |   |
| Comprehensive income attributable to Cornell Companies, Inc.                           |       | $                                                | 5,257      |   | $ | 5,369 |   |
|                                                                                        |            |                                                  |            |  |  |  |  |  |  |

 

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

 

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

 
| ** **                                                                                              | ** ** | **Three Months Ended  March 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                                                              | ** ** | **2009**                                         | ** ** | **2008** | ** ** |
| CASH FLOWS FROM OPERATING ACTIVITIES:                                                                   |       |                                             |       |   |   |
| Net income                                                                                              |       | $                                                | 5,734      |   | $ | 4,634 |   |
| Adjustments to reconcile net income to net cash provided by (used) in  operating activities —      |       |                                             |       |   |   |
| Depreciation                                                                                            |       | 4,445                                            |       | 3,669 |   |
| Amortization of intangibles and other assets                                                            |       | 448                                              |       | 488 |   |
| Amortization of deferred financing costs                                                                |       | 319                                              |       | 407 |   |
| Amortization of Senior Notes discount                                                                   |       | 46                                               |       | 46 |   |
| Amortization of other comprehensive income                                                              |       | (64                                              | )          | — |   |
| Stock-based compensation                                                                                |       | 594                                              |       | 999 |   |
| Provision for bad debts                                                                                 |       | 668                                              |       | 1,248 |   |
| (Gains) losses on sale of property and equipment, net                                                   |       | 14                                               |       | (3 | ) |
| Deferred income taxes                                                                                   |       | 249                                              |       | 283 |   |
| Change in assets and liabilities:                                                                       |       |                                             |       |   |   |
| Accounts receivable                                                                                     |       | (4,611                                           | )          | (1,500 | ) |
| Other restricted assets                                                                                 |       | (375                                             | )          | (167 | ) |
| Other assets                                                                                            |       | 854                                              |       | (259 | ) |
| Accounts payable and accrued liabilities                                                                |       | (10,555                                          | )          | (1,350 | ) |
| Other liabilities                                                                                       |       | 145                                              |       | (1,273 | ) |
| Net cash provided by (used in) operating activities                                                     |       | (2,089                                           | )          | 7,222 |   |
|                                                                                                    |       |                                             |       |   |   |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                                                   |       |                                             |       |   |   |
| Capital expenditures                                                                                    |       | (3,168                                           | )          | (11,924 | ) |
| Payments to restricted debt payment account, net                                                        |       | (381                                             | )          | (650 | ) |
| Net cash used in investing activities                                                                   |       | (3,549                                           | )          | (12,574 | ) |
|                                                                                                    |       |                                             |       |   |   |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                                                   |       |                                             |       |   |   |
| Proceeds from line of credit                                                                            |       | 2,000                                            |       | 5,000 |   |
| Payments of line of credit                                                                              |       | (1,000                                           | )          | — |   |
| Payments of capital lease obligations                                                                   |       | (3                                               | )          | (3 | ) |
| Proceeds from exercise of stock options                                                                 |       | 299                                              |       | 156 |   |
| Net cash provided by financing activities                                                               |       | 1,296                                            |       | 5,153 |   |
|                                                                                                    |       |                                             |       |   |   |
| NET DECREASE IN CASH AND CASH EQUIVALENTS                                                               |       | (4,342                                           | )          | (199 | ) |
| CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD                                                        |       | 14,613                                           |       | 3,028 |   |
| CASH AND CASH EQUIVALENTS AT END OF PERIOD                                                              |       | $                                                | 10,271     |   | $ | 2,829 |   |
|                                                                                                    |       |                                             |       |   |   |
| OTHER NON-CASH INVESTING AND FINANCING ACTIVITIES:                                                      |       |                                             |       |   |   |
| Other comprehensive income                                                                              |       | $                                                | —     |   | $ | 735 |   |
| Common stock issued for board of directors fees                                                         |       | 115                                              |       | 148 |   |
| Purchases and additions to property and equipment included in  accounts payable and accrued liabilities |       | 1,557                                            |       | 8,012 |   |

 

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

 

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**CORNELL COMPANIES, INC.**

**NOTESTO CONSOLIDATED FINANCIAL STATEMENTS**

** **

**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 our 2008 Annual Report on Form 10-K.

 

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

 

We have an employee stock purchase plan (“ESPP”) under whichemployees can make contributions to purchase our common stock. Participation inthe plan is elected annually by employees. The plan year typically begins each January 1st(the “Beginning Date”) and ends on December 31st (the “Ending Date”).Purchases of common stock are made at the end of the year using the lower ofthe fair market value on either the Beginning Date or Ending Date, less a 15%discount. 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 over periodsup to seven years after the date of grant and expire no more than 10 yearsafter grant.

 

At March 31, 2008,127,500 shares of restricted stock were outstanding subject toperformance-based vesting criteria (32,500 of these restricted shares were consideredmarket-based restricted stock under SFAS No. 123R). There were also 52,700stock options outstanding subject to performance-based vesting criteria. Werecognized $0.5 million of expense associated with these shares of restrictedstock and stock options during the three months ended March 31, 2008.

 

At March 31, 2009,153,300 shares of restricted stock were outstanding subject toperformance-based vesting criteria (32,500 of these restricted shares wereconsidered market-based restricted stock under SFAS No. 123R). There werealso 6,260 stock options outstanding subject to performance-based vestingcriteria. We recognized $0.04 million of expense associated with these sharesof restricted stock and stock options during the three months ended March 31,2009.

 

The amounts above relate to the impact of recognizingcompensation expense related to stock options and restricted stock.Compensation expense related to stock options (6,260 shares) and restrictedstock (120,800 shares) that vest based upon performance conditions is notrecorded for such performance-based awards until it has been deemed probablethat the related performance targets allowing the vesting of these options andrestricted stock will be met. We are required to periodically re-assess the probabilitythat these options will vest and record expense at that point in time. Duringthe three months ended March 31, 2009 it was not deemed probable thatcertain performance targets pertaining to certain restricted stock and stockoptions would be achieved by their vesting date. Accordingly, no compensationexpense was recognized in the three months ended March 31, 2009 related tothese stock-based awards.

 

We recognize expense for our stock-based compensationover the vesting period, which represents the period in which an employee isrequired to provide service in exchange for the award. We recognizecompensation expense for stock-based awards immediately if the award hasimmediate vesting.

 

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*** ***

***Assumptions***

 

Thefair values for the significant stock-based awards granted during the threemonths ended March 31, 2009 and 2008 were estimated at the date of grantusing a Black-Scholes option pricing model with the following weighted-averageassumptions:

 
| ** **                       | ** ** | **Three Months Ended   March 31,** | ** ** |
|----------------------------------|------------|--------------------------------------------------------|------------|
| ** **                       | ** ** | **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 currently have no reason to believe thatfuture stock volatility will significantly differ from historical stockvolatility. Estimated forfeiture rates are derived from historical forfeiturepatterns. We believe the historical experience method is the best estimate offorfeitures currently available.

 

Inaccordance with SAB 107, we generally considered the “simplified” method for “plainvanilla” options to estimate the expected term of options granted during 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 on stock options during the three months ended March 31,2009 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                                          |       | (750                   | )          | 12.93                                  |        |                                                |       |                            |       |
| Canceled                                           |       | (7,642                 | )          | 14.73                                  |        |                                                |       |                            |       |
|                                               |       |                   |       |                                   |        |                                                |       |                            |       |
| Outstanding at March 31, 2009                 |       | 517,307                |       | $                                      |  15.27 |                                                | 6.6        |                            | $          |  7.9 |   |
|                                               |       |                   |       |                                   |        |                                                |       |                            |       |
| Vested and expected to vest at March 31, 2009 |       | 509,373                |       | $                                      |  15.16 |                                                | 6.6        |                            | $          |  7.6 |   |
|                                               |       |                   |       |                                   |        |                                                |       |                            |       |
| Exercisable at March 31, 2009                 |       | 444,092                |       | $                                      |  14.77 |                                                | 6.4        |                            | $          |  6.6 |   |

 

Thetotal intrinsic value of stock options exercised during the three months ended March 31,2009 and 2008 was approximately $0.01 million in each period. Net cash proceedsfrom the exercise of stock options were approximately $0.3 and $0.2 million foreach of the three months ended March 31, 2009 and 2008, respectively.

 

Asof March 31, 2009, approximately $0.2 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 5.8 months.

 

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Thefollowing table summarizes information with respect to stock optionsoutstanding and exercisable at March 31, 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       |       | 19,690                  |       | 2.5                                                 |       | $                                      |  5.83  |                    | 19,690     |                                   | $          |  5.83 |   |
| $10.01  to  $13.50      |       | 152,717                 |       | 5.5                                                 |       | 12.83                                  |        | 145,497                 |       | 12.82                                  |       |
| $13.51  to $14.50            |       | 193,200                 |       | 6.4                                                 |       | 13.95                                  |        | 180,040                 |       | 13.94                                  |       |
| $14.51  to $25.00            |       | 151,700                 |       | 8.6                                                 |       | 20.62                                  |        | 98,865                  |       | 20.93                                  |       |
|                                        |       | 517,307                 |       | 6.6                                                 |       | $                                      |  15.27 |                    | 444,092    |                                   | $          |  14.77 |   |

 

Stock-basedaward activity for nonvested awards during the three months ended March 31,2009 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                              |       | (61,903                | )          | 14.74                                                       |        |
| Canceled                            |       | —                 |       | —                                                      |        |
|                                |       |                   |       |                                                        |        |
| Nonvested at March 31, 2009    |       | 73,215                 |       | $                                                           |  18.26 |   |

 

***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 three monthsended March 31, 2009, we issued restricted stock as part of our normalequity awards under our 2006 Equity Incentive Plan.  These shares of restricted common stock aresubject to restrictions on transfer and certain conditions to vesting.

 

Restricted stock activityfor the three months ended March 31, 2009 was as follows:

 
| ** **                          | ** ** | **Number  of  Shares** | ** ** | **Weighted Average  Grant Date  Fair Value** | ** ** |
|-------------------------------------|------------|------------------------|------------|-------------------------------------------------------------|------------|
| Nonvested at December 31, 2008 |       | 403,124                |       | $                                                           | 22.44      |   |
| Granted                             |       | 12,500                 |       | 17.50                                                       |       |
| Vested                              |       | (39,575                | )          | 21.82                                                       |       |
| Canceled                            |       | —                 |       | —                                                      |       |
|                                |       |                   |       |                                                        |       |
| Nonvested at March 31, 2009    |       | 376,049                |       | $                                                           | 22.34      |   |

 

We recognized $0.4million of expense associated with nonvested time-based restricted stock awardsduring the three months ended March 31, 2009.  As of March 31, 2009, approximately $2.8million of estimated expense with respect to nonvested time-based restrictedstock awards had yet to be recognized and will be amortized over a weightedaverage period of 2.2 years. Approximately $3.1 million of estimatedexpense with respect to nonvested performance-based restricted stock optionawards had yet to be recognized as of March 31, 2009.

 

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** **

**4.****    ****Intangible Assets**

 

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

 
| ** **                                              | ** ** | **March 31,  2009** | ** **   | **December 31,  2008** | ** ** |
|---------------------------------------------------------|------------|--------------------------|--------------|-----------------------------|------------|
|                                                    |       |                     |         |                        |       |
| Non-compete agreements                                  |       | $                        |  8,200  |                        | $          |  8,200 |   |
| Accumulated amortization — non-compete agreements  |       | (7,782                   | )            | (7,595                      | )          |
| Acquired contract value                                 |       | 6,240                    |         | 6,240                       |       |
| Accumulated amortization — acquired contract value |       | (4,786                   | )            | (4,525                      | )          |
| Identified intangibles, net                             |       | 1,872                    |         | 2,320                       |       |
| Goodwill, net                                           |       | 13,308                   |         | 13,308                      |       |
| Total intangibles, net                                  |       | $                        |  15,180 |                        | $          |  15,628 |   |

 

There were no changes in the carryingamount of our goodwill in the three months ended March 31, 2009.

 

Amortizationexpense for our non-compete agreements was approximately $0.2 million for eachof the three months ended March 31, 2009 and 2008.

 

Amortizationexpense for our acquired contract value was approximately $0.3 million for eachof the three months ended March 31, 2009 and 2008.

 

**5.****    ****NEW ACCOUNTING PRONOUNCEMENTS**

 

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

 

InSeptember 2006, the FASB issued SFAS No. 157, “Fair ValueMeasurements” (“SFAS No. 157”). SFAS No. 157 defines fair value, establishes a framework formeasuring fair value within generally accepted accounting principles andexpands disclosures about fair value measurements for financial assets andliabilities, as well as for any other assets and liabilities that are carriedat fair value on a recurring basis in the financial statements. SFAS No. 157became effective for financial statements issued for fiscal years beginningafter November 15, 2007, and interim periods within those fiscalyears.  This statement appliesprospectively to financial assets and liabilities. In February 2008, theFASB issued FASB Staff Position (“FSP”) 157-2, which delayed the effective dateof SFAS No. 157 by 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.  On January 1, 2009, weadopted the provisions of SFAS No. 157 for applying fair value to assets,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 that establishes a framework formeasuring fair value and expands disclosures about fair valuemeasurements.  SFAS No. 157 requiresthat fair value measurements be classified and disclosed in one of thefollowing categories:

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

 

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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 March 31,2009:

 
| ** **         | ** ** | **Fair Value as of  March 31, 2009 (in thousands)** | ** ** |
|--------------------|------------|-----------------------------------------------------------------------------------|------------|
| ** **         | ** ** | **Level 1**                                                                  | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Total** | ** ** |
| Assets:            |       |                                                                              |       |   |   |   |   |   |   |
| Cash Equivalents   |       | $                                                                                 | —     |   | $ | — |   | $ | — |   | $ | — |   |
| Corporate Bonds    |       | —                                                                            |       | 10,059 |   | — |   | 10,059 |   |
| Money Market Funds |       | —                                                                            |       | 42,445 |   | — |   | 42,445 |   |
|                    |            |                                                                                   |            |  |  |  |  |  |  |  |  |  |  |

 

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.

 

SFAS No. 157 requires areconciliation of the beginning and ending balances for fair value measurementsusing Level 3 inputs. We had no such assets or liabilities which were measuredat fair value on a recurring basis using significant unobservable inputs (Level3) during the three months ended March 31, 2009.

 

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

 

InOctober 2008, the FASB issued FSP SFAS No. 157-3, “Determining theFair Value of a Financial Asset When the Market for That Asset Is Not Active” (“FSPSFAS 157-3”).  This FSP clarifies theapplication of SFAS No. 157 in a market that is not active and provides anexample to illustrate key considerations in determining the fair value of afinancial asset when the market for that financial asset is not active.  This FSP was effective upon issuance,including prior periods for which financial statements have not beenissued.  We applied this FSP to financialassets measured at fair value on a recurring basis at March 31, 2009 and December 31,2008. The adoption of FSP SFAS 157-3 did not have a significant impact on ourconsolidated financial position, results of operations or cash flows.

 

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

 

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

 

***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 limited exceptions.SFAS No. 141R changes the accounting treatment for certain specific items,including acquisition costs, noncontrolling interests, acquired contingentliabilities, in-process research and development costs, restructuring costs andchanges in deferred tax asset valuation allowances and income tax uncertaintiessubsequent to the acquisition date.  SFASNo. 141R applies prospectively to business combinations for which theacquisition date is on or after the beginning of the first annual reportingperiod beginning on or after December 15, 2008.  Our adoption of SFAS No. 141 on January 1,2009 did not have any impact on our consolidated results of operations orfinancial condition as we did not have any business combination activity in thethree months ended March 31, 2009.

 

***FASB Staff Position No. FAS142-3***

** **

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 

 

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isto improve the consistency between the useful life of a recognized intangibleasset under SFAS No. 142 and the period of expected cash flows used tomeasure the fair value of the asset under SFAS No. 141R, “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 significant impact on our consolidated financial position,results of operations or cash flows.

 

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

 

In December 2007,the FASB issued SFAS No. 160, “Noncontrolling Interests in ConsolidatedFinancial Statements — An Amendment of ARB No. 51” (“SFAS No. 160”).  SFAS No. 160 establishes new accountingand reporting standards for the noncontrolling interest in a subsidiary and forthe deconsolidation of a subsidiary. SFAS No. 160 requires the recognition of a noncontrolling interest(minority interest) as equity in the consolidated financial statements andseparate from the parent’s equity.  Theamount of net income attributable to the noncontrolling interest will beincluded in consolidated net income on the face of the income statement.  This statement clarifies that changes in aparent’s ownership interest in a subsidiary that do not result in deconsolidationare equity transactions if the parent retains its controlling financialinterest.  In addition, this statementrequires that a parent recognize a gain or loss in net income when a subsidiaryis deconsolidated.  Such gain or losswill be measured using the fair value of the noncontrolling equity investmenton the deconsolidation date.  SFAS No. 160also includes expanded disclosure requirements regarding the interests of theparent and its noncontrolling interest. SFAS No. 160 is effective for fiscal years, and interim periodswithin those fiscal years, beginning on or after December 15, 2008.  We adopted SFAS No. 160 on January 1,2009 and applied the provisions retroactively to all 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. 161on January 1, 2009 did not have a significant impact on our consolidated financial position,results of operations 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 will have to beadjusted retrospectively (including interim financial statements, summaries ofearnings, and selected financial data) to conform to the provisions of thisFSP.  Our adoption of this FSP in January 2009did not have a significant effect on our earnings per share.

 

**New Accounting Pronouncement Not Yet Adopted**

 

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

 

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

 

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** **

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

 

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

 
| ** **                                                                                                                                                                  | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                  | ** ** | **2009**           | ** ** | **2008**              | ** ** |
| **Debt of Cornell Companies, Inc.:**                                                                                                                                   |       |               |       |                  |       |
| Senior Notes, unsecured, due July 2012 with an interest rate of  10.75%, net of discount                                                                               |       | $                  | 111,401    |                  | $          | 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”) |       | 76,000             |       | 75,000                |       |
| Capital lease obligations                                                                                                                                                   |       | 24                 |       | 26                    |       |
| Subtotal                                                                                                                                                                    |       | 187,425            |       | 186,382               |       |
|                                                                                                                                                                        |       |               |       |                  |       |
| **Debt of Special Purpose Entity (MCF):**                                                                                                                                   |       |               |       |                  |       |
| 8.47% Bonds due 2016                                                                                                                                                        |       | 134,100            |       | 134,100               |       |
|                                                                                                                                                                        |       |               |       |                  |       |
| Total consolidated debt                                                                                                                                                     |       | 321,525            |       | 320,482               |       |
|                                                                                                                                                                        |       |               |       |                  |       |
| Less: current maturities                                                                                                                                                    |       | (12,412            | )          | (12,412               | )          |
|                                                                                                                                                                        |       |               |       |                  |       |
| Consolidated long-term debt                                                                                                                                                 |       | $                  | 309,113    |                  | $          | 308,070 |   |

 

***Long-Term Credit Facilities.***  Our Amended CreditFacility provides for borrowings up to $100.0 million (including letters ofcredit), matures in December 2011 and bears interest, at our electiondepending on our total leverage ratio, at either the LIBOR rate plus a marginranging from 1.50% to 2.25%, or a rate which ranges from 0.00% to 0.75% abovethe applicable prime rate. The available commitment under our AmendedCredit Facility was approximately $8.6 million at March 31, 2009.  We had outstanding borrowings under ourAmended Credit Facility of $76.0 million and we had outstanding letters ofcredit of approximately $15.4 million at March 31, 2009.  Subject to certain requirements, we have theright to increase the commitments under our Amended Credit Facility up to$150.0 million, although the indenture for our Senior Notes limits our ability,subject to certain conditions, to expand the Amended Credit Facility beyond$100.0 million. We can provide no assurance that all of the banks that havemade commitments to us under our Amended Credit Facility would be willing toparticipate in an expansion to the Amended Credit Facility should we desire todo so.  The Amended Credit Facility is collateralized by substantially all of our assets, includingthe assets and stock of all of our subsidiaries. The Amended Credit Facility isnot secured by the assets of MCF, a special purpose entity. Our Amended CreditFacility contains commonly used covenants including compliance with laws andlimitations on certain financing transactions and mergers and also includesvarious financial covenants.  We believethe most restrictive covenant under our Amended Credit Facility is the fixedcharge coverage ratio.  At March 31,2009, we were in compliance with all of our debt financial covenants.

 

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

 

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

 

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

 

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

 

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

 

In conjunction with the issuance of the Senior Notes,we entered into an interest rate swap transaction with a financial institutionto hedge our exposure to changes in the fair value on $84.0 million of ourSenior Notes.  The purpose of thistransaction was to convert future interest due on $84.0 million of the Senior Notesto a variable rate.  The terms of theinterest rate swap contract and the underlying debt instrument wereidentical.  The swap agreement wasdesignated as a fair value hedge.  Theswap had a notional amount of $84.0 million and was scheduled to mature in July 2012to mirror the maturity of the Senior Notes. Under the agreement, we paid, on a semi-annual basis (each January 1and July 1), a floating rate based on a six-month U.S. dollar LIBOR rate,plus a spread, and received a fixed-rate interest of 10.75%. The swapagreement was marked to market each quarter with a corresponding mark-to-marketadjustment reflected as either a discount or premium on the Senior Notes.  The carrying value of the Senior Notes as ofthis date was adjusted accordingly by the same amount. Because the swapagreement was an effective fair-value hedge, there was no effect on our resultsof operations from the mark-to-market adjustment as long as the swap was ineffect.In October 2007,we terminated the swap agreement. We received approximately $0.2 million inconjunction with the termination, which is being amortized over the remainingterm of the Senior Notes.

 

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

 

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

 

We adopted the provisionsof FIN 48 effective January 1, 2007. As a result of our adoption of FIN 48, we recorded an adjustment ofapproximately $0.3 million which increased retained earnings at January 1,2007. At December 31, 2008, the total amount of our unrecognized taxbenefits was approximately $2.5 million.  There were nomaterial changes to the total amount of our unrecognized tax benefits in thethree months ended March 31, 2009.

 

Estimatedinterest and penalties related to the underpayment of income taxes areclassified as a component of income tax expense in the accompanyingConsolidated Statements of Income and Comprehensive Income. There were nomaterial changes to interest and penalties in the three months ended March 31,2009.  Accrued interest and penaltieswere approximately $0.2 million at both March 31, 2009 and December 31,2008.

 

We aresubject to income tax in the United States and many of the individual states weoperate in.  We currently havesignificant operations in Texas, California, Oklahoma, Georgia, Illinois andPennsylvania.  State income tax returnsare generally subject to examination for a period of three to five years afterfiling.  The state impact of any changesmade to the federal return remains subject to examination by various states fora period up to one year after formal notification to the state.  We are open to United States Federal IncomeTax examinations for the tax years ended December 31, 2005 through December 31, 2007.The 2006 federal income tax return is currently under audit by theInternal Revenue Service.  We expect theaudit to close within the next 12 months.

 

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

 

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** **

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

 

Basic earningsper share (EPS) are computed by dividing net income by the weighted averagenumber of shares of common stock outstanding during the period.  Diluted EPS reflects the potential dilutionfrom common stock equivalents such as stock options and warrants.  For the three months ended March 31,2009 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 followingtable summarizes the calculation of net earnings and weighted average commonshares and common equivalent shares outstanding for purposes of the computationof earnings per share (in thousands, except per share data):

 
| ** **                                                               | ** ** | **Three Months Ended  March 31,** | ** ** |
|--------------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                               | ** ** | **2009**                                         | ** ** | **2008** | ** ** |
|                                                                     |       |                                             |       |   |   |
| Net income                                                               |       | $                                                | 5,257      |   | $ | 4,634 |   |
|                                                                     |       |                                             |       |   |   |
| Weighted average common share  outstanding                               |       | 14,572                                           |       | 14,435 |   |
| Weighted average common share  equivalents outstanding                   |       | 57                                               |       | 123 |   |
| Weighted average common shares  and common share equivalents outstanding |       | 14,629                                           |       | 14,558 |   |
|                                                                     |       |                                             |       |   |   |
| Basic income per share                                                   |       | $                                                | .36        |   | $ | .32 |   |
|                                                                     |       |                                             |       |   |   |
| Diluted income per share                                                 |       | $                                                | .36        |   | $ | .32 |   |

 

**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 equitablerelief, and could have a material adverse impact on the net income of theperiod in which the ruling occurs or in future periods.

 

***Valencia County Detention Center***

 

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

 

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

 

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** **

Inthe year ended December 31, 2007, we previously provided insurance reserves forthis matter (as part of our regular review of reported and unreported claims) totalingapproximately $0.5 million. During the fourth quarter of 2008, we recorded anadditional settlement charge of approximately $0.7 million and the relatedreimbursement from our general liability and professional liability insurance. Thecharge and reimbursement were recognized in general and administrative expensesfor the year ended December 31, 2008. The reimbursement was funded by theinsurance carrier in the first quarter of 2009 into a settlement account, where it will remain untilpayments are made to the settlement class members.  The Court granted preliminary approval of thesettlement in the first quarter of 2009, and the claims administration processis underway. A hearing for final approval by the Court has been scheduled forJuly, 2009. We expect the claims administration process to be completed in thefourth quarter of 2009.

 

***Shareholder Lawsuits***

 

OnOctober 19, 2006, a purported class action complaint was filed in the DistrictCourt of Harris County, Texas, 269th Judicial District (No. 2006-67413) by TedKinbergy, an alleged stockholder of Cornell. The complaint names as defendantsCornell and each member of the board of directors at the time of the suit, aswell as Veritas Capital Fund III, L.P. (“Veritas”). The complaint alleges,among other things, that (i) the defendants have breached fiduciary duties theyassertedly owed to our stockholders in connection with our entering into theAgreement and Plan of Merger, dated as of October 6, 2006, with Veritas,Cornell Holding Corp., and CCI Acquisition Corp., and (ii) the mergerconsideration is unfair and inadequate. The plaintiffs sought, among otherthings, an injunction against the consummation of the merger. The proposedmerger was rejected at a special meeting of our stockholders held on January 23,2007. Consequently, we believe the case is moot. Based upon our agreement topay Plaintiffs’ legal fees, the Plaintiffs filed an Unopposed Motion forDismissal with Prejudice with the Court in April, 2009.  On April 28, 2009, the Court granted theMotion and dismissed all claims with prejudice.

 

***Other***

 

We hold insurance policiesto cover potential director and officer liability, some of which may limit ourcash outflows in the event of a decision adverse to us in the matters discussedabove. However, if an adverse decision in these matters exceeds the insurancecoverage or if the insurance coverage is deemed not to apply to these matters,it could have a material adverse effect on us, our financial condition, resultsof operations and future cash flows.

 

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

 

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

 

**10.***      ***Derivative Financial Instruments AndGuarantees**

 

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

 

In August 2001, MCFcompleted a bond offering to finance the 2001 Sale and Leaseback Transaction inwhich we sold eleven facilities to MCF. In connection with this bond offering,two reserve fund accounts were established by MCF pursuant to the terms of theindenture: (1) MCF’s Debt Service Reserve Fund, aggregating $28.3 million at March31, 2009, was established to make payments on MCF’s outstanding bonds in theevent we (as lessee) should fail to make the scheduled rental payments to MCFand (2) MCF’s Debt Service Fund, aggregating $24.2 million at March 31, 2009,was established to accumulate the monthly lease payments that MCF receives fromus until such funds are used to pay MCF’s semi-annual bond interest and annualbond principal payments. These reserve funds are typically invested inshort-term money markets and commercial paper. Both reserve fund accounts weresubject to agreements with the MCF Equity Investors (Lehman Brothers, Inc. (“Lehman”))whereby guaranteed rates of return of 3.0% and 5.08%, respectively, wereprovided for in the balance of the Debt Service Reserve Fund and the DebtService Fund. The guaranteed rates of return were characterized as cash flowhedge derivative instruments. At inception, the derivative instruments had anaggregate fair value of $4.0 million, which was recorded as a decrease to theequity 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

 

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our ConsolidatedStatements of Income and Comprehensive Income. Due to the bankruptcy ofLehman in 2008, the derivative instruments no longer qualified as a hedge andwere de-designated. Amounts included in accumulated other comprehensive incomeare reclassified into earnings during the same periods in which interest isearned on debt service funds. Changes in the fair value of these derivativesafter de-designation were recorded to earnings. At December 31, 2008, the fairvalue was determined to be zero. The derivatives were terminated in the firstquarter of 2009 with a fair value 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 asan insurance contract and its fair value was being amortized to expense overthe life of the debt. Due to the bankruptcy of Lehman in 2008, the fullcarrying value of the insurance guarantee was determined to be unrecoverable. Accordingly,we recorded a charge of $1.3 million in the year ended December 31, 2008.

 

**11.****      ****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’s reportableassets, and the amortization of intangible assets is not included in thedetermination 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, investment securitiesavailable for sale, accounts receivable, debt service and debt service reservefunds, deposits, property and equipment, deferred taxes, deferred costs andother assets. Corporate and other expense from operations primarily consists ofdepreciation and amortization on the corporate office facilities and equipmentand specific general and administrative charges pertaining to corporatepersonnel. Such expenses are presented separately, as they cannot be readilyidentified for allocation to a particular segment.

 

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

 
| ** **                          | ** ** | **Three Months Ended  March 31,** | ** ** |
|-------------------------------------|------------|---------------------------------------------|------------|
| ** **                          | ** ** | **2009**                                    | ** ** | **2008** | ** ** |
|                                |       |                                        |       |   |   |
| Revenues:                           |       |                                        |       |   |   |
| Adult Secure Services               |       | $                                           | 56,858     |   | $ | 49,899 |   |
| Abraxas Youth and Family Services   |       | 25,689                                      |       | 27,773 |   |
| Adult Community-Based Services      |       | 17,163                                      |       | 17,720 |   |
| Total revenues                      |       | $                                           | 99,710     |   | $ | 95,392 |   |
|                                |       |                                        |       |   |   |
| Income from operations:             |       |                                        |       |   |   |
| Adult Secure Services               |       | $                                           | 17,118     |   | $ | 15,113 |   |
| Abraxas Youth and Family Services   |       | 734                                         |       | 1,768 |   |
| Adult Community-Based Services      |       | 4,767                                       |       | 4,809 |   |
| Sub-total                           |       | 22,619                                      |       | 21,690 |   |
| General and administrative expenses |       | (6,138                                      | )          | (6,536 | ) |
| Amortization of intangibles         |       | (448                                        | )          | (488 | ) |
| Corporate and other expenses        |       | (245                                        | )          | (176 | ) |
| Total income from operations        |       | $                                           | 15,788     |   | $ | 14,490 |   |

 
| ** **                        | ** ** | **March 31,  2009** | ** ** | **December 31,  2008** | ** ** |
|-----------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| Assets:                           |       |                     |       |                        |       |
| Adult Secure Services             |       | $                        | 358,773    |                        | $          | 358,406 |   |
| Abraxas Youth and Family Services |       | 107,958                  |       | 105,991                     |       |
| Adult Community-Based Services    |       | 62,410                   |       | 60,170                      |       |
| Intangible assets, net            |       | 15,180                   |       | 15,628                      |       |
| Corporate and other               |       | 91,280                   |       | 96,726                      |       |
| Total assets                      |       | $                        | 635,601    |                        | $          | 636,921 |   |

 

**12.****      ****Guarantor Disclosures**

 

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

 

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**Condensed Consolidating BalanceSheet as of March 31, 2009 (in thousands) (unaudited)**

 
| ** **                                              | ** ** | ** ** | ** ** | ** **       | ** ** | **Non-**       | ** ** | ** **       | ** ** | ** **       | ** ** |
|---------------------------------------------------------|------------|------------|------------|------------------|------------|----------------|------------|------------------|------------|------------------|------------|
| ** **                                              | ** ** | ** ** | ** ** | **Guarantor**    | ** ** | **Guarantor**  | ** ** | ** **       | ** ** | ** **       | ** ** |
| ** **                                              | ** ** | **Parent** | ** ** | **Subsidiaries** | ** ** | **Subsidiary** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
| **Assets**                                              |       |       |       |             |       |           |       |             |       |             |       |
|                                                    |       |       |       |             |       |           |       |             |       |             |       |
| Current assets:                                         |       |       |       |             |       |           |       |             |       |             |       |
| Cash and cash equivalents                               |       | $          | 9,863      |             | $          | 370            |       | $                | 38         |             | $          | — |   | $ | 10,271 |   |
| Accounts receivable                                     |       | 1,165      |       | 70,778           |       | 23             |       | —           |       | 71,966           |       |
| Restricted assets                                       |       | —     |       | 3,372            |       | 28,319         |       | —           |       | 31,691           |       |
| Prepaids and other                                      |       | 13,823     |       | 1,637            |       | —         |       | —           |       | 15,460           |       |
| Total current assets                                    |       | 24,851     |       | 76,157           |       | 28,380         |       | —           |       | 129,388          |       |
|                                                    |       |       |       |             |       |           |       |             |       |             |       |
| Property and equipment, net                             |       | 101        |       | 313,601          |       | 141,360        |       | (4,442           | )          | 450,620          |       |
| Other Assets:                                           |       |       |       |             |       |           |       |             |       |             |       |
| Debt service reserve fund                               |       | —     |       | —           |       | 24,185         |       | —           |       | 24,185           |       |
| Deferred costs and other                                |       | 61,722     |       | 23,000           |       | 5,200          |       | (58,514          | )          | 31,408           |       |
| Investments in subsidiaries                             |       | 82,426     |       | 1,856            |       | —         |       | (84,282          | )          | —           |       |
| Total assets                                            |       | $          | 169,100    |             | $          | 414,614        |       | $                | 199,125    |             | $          | (147,238 | ) | $ | 635,601 |   |
|                                                    |       |       |       |             |       |           |       |             |       |             |       |
| **Liabilities and Stockholders’  Equity**          |       |       |       |             |       |           |       |             |       |             |       |
|                                                    |       |       |       |             |       |           |       |             |       |             |       |
| Current liabilities:                                    |       |       |       |             |       |           |       |             |       |             |       |
| Accounts payable and accrued liabilities                |       | $          | 43,896     |             | $          | 13,024         |       | $                | 1,957      |             | $          | 655 |   | $ | 59,532 |   |
| Current portion of long-term debt                       |       | —     |       | 12               |       | 12,400         |       | —           |       | 12,412           |       |
| Total current liabilities                               |       | 43,896     |       | 13,036           |       | 14,357         |       | 655              |       | 71,944           |       |
| Long-term debt, net of current portion                  |       | 187,402    |       | 11               |       | 121,700        |       | —           |       | 309,113          |       |
| Deferred tax liabilities                                |       | 16,917     |       | 94               |       | —         |       | 1,107            |       | 18,118           |       |
| Other long-term liabilities                             |       | 5,861      |       | 164              |       | 58,329         |       | (62,521          | )          | 1,833            |       |
| Intercompany                                            |       | (318,648   | )          | 318,653          |       |           |       | (5               | )          | —           |       |
| Total liabilities                                       |       | (64,572    | )          | 331,958          |       | 194,386        |       | (60,764          | )          | 401,008          |       |
| Total Cornell Companies, Inc. stockholders’ equity |       | 233,672    |       | 82,656           |       |           |       | (82,656          | )          | 233,672          |       |
| Non-controlling interest                                |       | —     |       | —           |       | 4,739          |       | (3,818           | )          | 921              |       |
| Total stockholders’ equity                         |       | 233,672    |       | 82,656           |       | 4,739          |       | (86,474          | )          | 234,593          |       |
|                                                    |       |       |       |             |       |           |       |             |       |             |       |
| Total liabilities and stockholders’ equity         |       | $          | 169,100    |             | $          | 414,614        |       | $                | 199,125    |             | $          | (147,238 | ) | $ | 635,601 |   |

 

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**Condensed Consolidating BalanceSheet as of December 31, 2008 (in thousands)**

 
| ** **                                              | ** ** | ** ** | ** ** | ** **       | ** ** | **Non-**       | ** ** | ** **       | ** ** | ** **       | ** ** |
|---------------------------------------------------------|------------|------------|------------|------------------|------------|----------------|------------|------------------|------------|------------------|------------|
| ** **                                              | ** ** | ** ** | ** ** | **Guarantor**    | ** ** | **Guarantor**  | ** ** | ** **       | ** ** | ** **       | ** ** |
| ** **                                              | ** ** | **Parent** | ** ** | **Subsidiaries** | ** ** | **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 Income for the three months ended March31, 2009**(in thousands) (unaudited)

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

 

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# **Condensed Consolidating Statement of Income for the three months ended March31, 2008**(in thousands) (unaudited)

 
| ** **                                  | ** ** | **Parent** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor****Subsidiary** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|---------------------------------------------|------------|------------|------------|-----------------------------|------------|-----------------------------------|------------|------------------|------------|------------------|------------|
|                                        |       |       |       |                        |       |                              |       |             |       |             |       |
| Revenues                                    |       | $          | 4,502      |                        | $          | 108,496                           |       | $                | 4,502      |             | $          | (22,108 | ) | $ | 95,392 |   |
| Operating expenses, excluding  depreciation |       | 3,086      |       | 89,135                      |       | 12                                |       | (22,024          | )          | 70,209           |       |
| Depreciation and amortization               |       | 3⁄4     |       | 3,260                       |       | 1,056                             |       | (159             | )          | 4,157            |       |
| General and administrative  expenses        |       | 6,517      |       | 3⁄4                      |       | 19                                |       | 3⁄4           |       | 6,536            |       |
| Income (loss) from operations               |       | (5,101     | )          | 16,101                      |       | 3,415                             |       | 75               |       | 14,490           |       |
| Overhead allocations                        |       | (13,342    | )          | 13,342                      |       | 3⁄4                            |       | 3⁄4           |       | 3⁄4           |       |
| Interest, net                               |       | 2,068      |       | 1,273                       |       | 3,016                             |       | (62              | )          | 6,295            |       |
| Equity earnings in subsidiaries             |       | 1,802      |       | 3⁄4                      |       | 3⁄4                            |       | (1,802           | )          | 3⁄4           |       |
| Income before provision for  income taxes   |       | 7,975      |       | 1,486                       |       | 399                               |       | (1,665           | )          | 8,195            |       |
| Provision for income taxes                  |       | 3,341      |       | 3⁄4                      |       | 3⁄4                            |       | 220              |       | 3,561            |       |
| Net income                                  |       | $          | 4,634      |                        | $          | 1,486                             |       | $                | 399        |             | $          | (1,885 | ) | $ | 4,634 |   |

 

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# **Condensed Consolidating Statement of Cash Flows for the three monthsended March 31, 2009 (in thousands) (unaudited)**

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

 

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**Condensed Consolidating Statement of Cash Flows for the three monthsended March 31, 2008 (in thousands) (unaudited)**

 
| ** **                                           | ** ** | **Parent** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor****Subsidiary** | ** ** | **Consolidated** | ** ** |
|------------------------------------------------------|------------|------------|------------|-----------------------------|------------|-----------------------------------|------------|------------------|------------|
| **Cash flows from  operating activities:**           | ** ** | ** ** | ** ** | ** **                  | ** ** | ** **                        | ** ** | ** **       | ** ** |
| Net cash provided by (used in)  operating activities |       | $          | (5,136     | )                           | $          | 11,736                            |       | $                | 622        |   | $ | 7,222 |   |
| ** **                                           | ** ** | ** ** | ** ** | ** **                  | ** ** | ** **                        | ** ** | ** **       | ** ** |
| **Cash flows from  investing activities:**           | ** ** | ** ** | ** ** | ** **                  | ** ** | ** **                        | ** ** | ** **       | ** ** |
| Capital expenditures                                 |       | 3⁄4     |       | (11,924                     | )          | 3⁄4                            |       | (11,924          | )          |
| Payments to restricted debt  payment account, net    |       | 3⁄4     |       | 3⁄4                      |       | (650                              | )          | (650             | )          |
| Net cash used in investing activities                |       | 3⁄4     |       | (11,924                     | )          | (650                              | )          | (12,574          | )          |
|                                                 |       |       |       |                        |       |                              |       |             |       |
| **Cash flows from  financing activities:**           | ** ** | ** ** | ** ** | ** **                  | ** ** | ** **                        | ** ** | ** **       | ** ** |
| Proceeds from line of credit                         |       | 5,000      |       | 3⁄4                      |       | 3⁄4                            |       | 5,000            |       |
| Payments on capital lease  obligations               |       | 3⁄4     |       | (3                          | )          | 3⁄4                            |       | (3               | )          |
| Proceeds from exercise of stock  options             |       | 156        |       | 3⁄4                      |       | 3⁄4                            |       | 156              |       |
| Net cash provided by (used in)  financing activities |       | 5,156      |       | (3                          | )          | 3⁄4                            |       | 5,153            |       |
|                                                 |       |       |       |                        |       |                              |       |             |       |
| Net increase (decrease) in cash and cash equivalents |       | 20         |       | (191                        | )          | (28                               | )          | (199             | )          |
|                                                 |       |       |       |                        |       |                              |       |             |       |
| Cash and cash equivalents at beginning of period     |       | 2,565      |       | 408                         |       | 55                                |       | 3,028            |       |
|                                                 |       |       |       |                        |       |                              |       |             |       |
| Cash and cash equivalents at end of period           |       | $          | 2,585      |                        | $          | 217                               |       | $                | 27         |   | $ | 2,829 |   |

 

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

 

**General**

** **

Cornell is a leading provider of correctional,detention, educational, rehabilitation and treatment services outsourced byfederal, state and local government agencies. We provide a diversifiedportfolio of services for adults and juveniles through our three operatingdivisions: (1) Adult Secure Services; (2) Abraxas Youth and Family Services and(3) Adult Community-Based Services. At March 31, 2009, we operated 69 facilitieswith a total service capacity of 20,122 beds and had one facility with aservice capacity of 70 beds that was vacant. Our facilities are locatedin 15 states and the District of Columbia.

 

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

 
| ** **                                                                | ** ** | **Three Months Ended  March 31,** | ** ** |
|---------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                | ** ** | **2009**                                    | ** ** | **2008** | ** ** |
|                                                                      |       |                                        |       |   |   |
| **Residential**                                                           |       |                                        |       |   |   |
| Service capacity (1)                                                      |       | 17,634                                      |       | 16,056 |   |
| Contracted beds in operation  (end of period) (2)                         |       | 16,780                                      |       | 14,618 |   |
| Average contract occupancy based  on contracted beds in operation (3) (4) |       | 93.2                                        | %          | 95.5 | % |
| **Non-Residential**                                                       |       |                                        |       |   |   |
| Service capacity (5)                                                      |       | 2,558                                       |       | 2,953 |   |

 

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

 

Our operating results forthe three months ended March 31, 2009 were impacted by a few significantevents. We completed the 700 bed expansion at D. Ray James Prison at thebeginning of April 2009, and continued construction on a new 1,250 bed facilityin Hudson, Colorado. Our 2008 results of operation were positively affected bya 300 bed expansion at the D. Ray James Prison which we activated in February 2008.In addition, in the three months ended March 31, 2008 we recorded acontract-based revenue adjustment of approximately $1.5 million at the RegionalCorrectional Center (“RCC”) for the contract year ended March 2008.

 

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

 

# **Management Overview**

# ** **

***Demand*****.** Our business is driven generally by demand for incarceration ortreatment services, and specifically by demand for private incarceration ortreatment services, within our three primary business segments: Adult SecureServices; Abraxas Youth and Family Services; and Adult Community-BasedServices. The demand for adult and juvenile corrections and treatment

 

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services has generallyincreased at a steady rate over the past ten years, largely as a result ofincreasing sentence terms and/or mandatory sentences for criminals and as wella greater range of criminal acts, increasing demand for incarceration ofillegal aliens and a public recognition of the need to provide services tojuveniles that will improve the possibility that they will lead productivelives. Moreover, demand for our services is also affected by the amount ofavailable capacity in the government systems to enable governments to providethe services themselves, as well as desire and ability of these systems to addadditional capacity. In addition, the balance between community-basedcorrections treatment of adults as an alternative to traditional incarcerationcontinues to be analyzed by many political and societal parties.  Among other things, we monitor federal, stateand industry communications and statistics relative to trends in prisonpopulations, juvenile justice statistics and initiatives, and developments inalternatives to traditional incarceration or detention of adults foropportunities to expand our scope or delivery of services.

 

The federal governmentcontracts with private providers for the incarceration of adults, whether theyare serving prison sentences, detained as illegal aliens, detained inanticipation of pending judicial administration or transitioning from prison tosociety.  Chief among the federalagencies which use private providers are the 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 monitorfinancial performance.  Chief among themare:

 

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

·      occupancy(utilization),

·      per diemreimbursement rates,

·      revenues,

·      operatingmargins, and

·      operatingexpenses.

 

*Capacity. *Capacity, commonly expressedin terms of number of beds, is primarily impacted by the number and size of thefacilities we own or lease and the facilities we operate on behalf of a thirdparty owner or lessee.  We view capacityas one of the measures of our development efforts, through which we mayincrease capacity by adding new projects or by expanding existing projects (aswe have done in 2007 through 2009 at several of our facilities including GreatPlains Correctional Facility and D. Ray James Prison).  As part of the evaluation of our developmentefforts, we will assess (a) whether a given development project wasbrought into service in accordance with our expectation as to time and expense;and (b) the number of projects in development or under consideration atthe relevant point in time.  In additionto the focus on new projects, capacity will reflect our success in renewing andmaintaining existing contracts and facilities. It will also reflect any closure of programs or facilities due tounderutilization or failure to earn an adequate risk-adjusted rate ofreturn.  We must also be cognizant of thepossibility that state or local budgetary limitations may cause the contractualcommitment to a given facility to be reduced or even eliminated, which wouldrequire us to either secure an alternate 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 driver of our revenues. Ourindustry experiences significant economies of 

 

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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). Where wehave commitments for utilization before the commencement of operations,occupancy percentages reflect the speed at which a facility achieves fullservice/implementation. However, we may decide to undertake developmentprojects without written commitments to make full use of a facility. In theseinstances, we have performed our own assessment, based on discussions withlocal government or other potential customer representatives and analysis ofother factors, of the demand for services at the facility.  There is no assurance that we would recoverour initial investment in these projects. We will monitor occupancy as a measure of the accuracy of our estimationof the demand for the services of a development facility, and will incorporatethis information in future assessments of potential projects.

 

*Per Diem ReimbursementRates. *Per diem reimbursement ratesare another key element of our gross revenue and operating margin since perdiem contracts represent a majority of our revenues (61.1% for the three monthsended March 31, 2009).  Per diemrates are a function of negotiation between management and a governmental unitat the inception of a contract or through the bidding process.  Actual per diem rates vary dramaticallyacross our business segments, and as well as within each business segmentdepending 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 months endedMarch 31, 2009, our revenue base consisted of 61.1% for services providedunder per diem contracts, 33.5% for services provided under take-or-pay andmanagement contracts, 3.4% for services provided under cost-plus reimbursementcontracts, 1.8% for services provided under fee-for-service contracts and 0.2%from other miscellaneous sources.  Forthe three months ended March 31, 2008, our revenue base consisted of 51.9%for services provided under per diem contracts, 41.7% for services providedunder take-or-pay and management contracts, 4.1% for services provided undercost-plus reimbursement contracts, 2.0% for services provided underfee-for-service contracts and 0.3% from other miscellaneous sources.  The increase in revenues provided under perdiem contracts (and the 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 (including Salt Lake Valley Detention Center andLincoln County Detention Center in September 2008 and February 2008,respectively).

 

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

 

Factors considered indetermining billing rates to charge include: (1) the programs specified bythe contract and the related staffing levels; (2) wage levels customary inthe respective geographic areas; (3) whether the proposed facility is tobe leased or purchased; and (4) the anticipated average occupancy levelsthat could reasonably be expected to be maintained and the duration of timerequired to reach such occupancy levels.

 

*Revenues-Adult SecureServices. *Revenues forour Adult Secure Services division are primarily generated from per diem,take-or-pay and management contracts. For the three months ended March 31, 2009, and 2008, we realizedaverage per diem rates on our adult secure facilities of approximately $53.75and $55.56, respectively. The 2008 average per diem rate benefited 

 

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from a contract-basedrevenue adjustment for the contract year ended March 2008 in the amount ofapproximately $1.5 million at the RCC. We periodically have experiencedpressure from contracting governmental agencies to limit or even reduce perdiem rates. Many of these governmental entities are under severe budgetpressures 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 FamilyServices. *Revenues forour Abraxas Youth and Family Services division are primarily generated from perdiem, fee-for-service and cost-plus reimbursement contracts.  For the three months ended March 31,2009 and 2008, we realized average per diem rates on our residential youth andfamily services facilities of approximately $197.51 and $186.94, respectively.The increase in the average per diem rate for 2009 reflects the continuedramp-up of the Cornell Abraxas Academy (reactivated in the fourth quarter of2006), the reactivation of the Hector Garza Residential Treatment Center in August 2007as well as changes in the mix of services provided and customers served atother facilities.  For the three monthsended March 31, 2009 and 2008, we realized average fee-for-service ratesfor our non-residential community-based Abraxas Youth and Family Servicesfacilities and programs, including rates that are limited by Medicaid and otherprivate insurance providers, of approximately $45.04 and $50.24, respectively.The fluctuation in the average fee-for-service rates for 2009 and 2008 is dueto changes in the mix of services provided at our non-residential facilities.The majority of our Abraxas Youth and Family Services contracts renew annually.

 

*Revenues-Adult Community-BasedServices. *Revenues forour Adult Community-Based Services division are primarily generated from perdiem and fee-for-service contracts. For the three months ended March 31,2009 and 2008, we realized average per diem rates on our residential adultcommunity-based facilities of approximately $67.25 and $65.96, respectively.For the three months ended March 31, 2009 and 2008, we realized averagefee-for-service rates on our non-residential Adult Community-Based Servicesfacilities and programs of approximately $9.07 and $13.11, respectively.  Our average fee-for-service rates fluctuatefrom year to year principally due to changes in the mix of services provided byour various Adult Community-Based Services programs and facilities.

 

*Operating Margins. *We have historicallyexperienced higher operating margins in our Adult Secure Services and AdultCommunity-Based Services divisions as compared to our Abraxas Youth and FamilyServices division. Our operating margin, in a given period, will be impacted bythose facilities which may either be underutilized, dormant or have beenreactivated during the period. As previously discussed, we have reactivatedseveral facilities, including the Cornell Abraxas Academy and the Hector GarzaResidential Treatment Center in 2006 and 2007, respectively. We have alsoexpanded several of our Adult Secure facilities in 2008 (D. Ray James Prison,Great Plains Correctional Facility and Walnut Grove Youth CorrectionalFacility, for example), which provides the opportunity to leverage existing infrastructure.Additionally, our operating margins within a division can vary from facility tofacility based on whether a facility is owned or leased, the level ofcompetition for the contract award, the proposed length of the contract, themix of services provided, the occupancy levels for a facility, the level ofcapital commitment required with respect to a facility, the anticipated changesin operating costs over the term of the contract and our ability to increase afacility’s contract revenue. Under take-or-pay contracts, such as the contractat the Moshannon Valley Correctional Center, operating margins are typicallyhigher during the early stages of the contract as the facility’s populationramps up (as revenues are received at contract percentages regardless of actualoccupancy). As the variable costs (primarily resident-related and certainfacility costs) increase with the growth in population, operating margins willgenerally decline to a stabilized level. Following its activation in April 2006,we experienced such operating margin impact pertaining to the Moshannon ValleyCorrectional Center in the third and fourth quarters of 2006. A decline inoccupancy at our Abraxas Youth and Family Services facilities can have a moresignificant impact on operating margins than our Adult Secure Services divisiondue to the longer periods typically required to ramp resident population at ayouth facility.  In addition, decreasedutilization, particularly at our Abraxas Youth and Family Services facilities,will also generally negatively impact our operating margins.

 

We have experienced andexpect to continue to experience interim period operating margin fluctuationsdue to factors such as the number of calendar days in the period, higherpayroll taxes (generally in the first half of the year) and salary and wageincreases and insurance cost increases that are incurred prior to certaincontract rate increases. Periodically, many of the governmental agencies withwhom we contract may experience budgetary pressures and may approach us tolimit or reduce per diem rates (including contractual price increases as well).We anticipate such customer behavior in 2009. Decreases in, or the lack ofanticipated increases in, per diem rates could adversely impact our operating margin.Additionally, a decrease in per diem rates without a corresponding decrease inoperating expenses could also adversely impact our operating margin.

 

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*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 timeof such actions), but generally reduce post-restructuring expense levels.

 

We are responsible for allfacility operating costs, except for certain debt service and interest or leasepayments for facilities where we have a management contract only. At thesefacilities, the facility owner is responsible for all debt service and interestor lease payments related to the facility. We are responsible for all otheroperating expenses at these facilities. We operated 14 and 16 facilities undermanagement contracts at March 31, 2009 and 2008, respectively. Included inthe facilities under management contracts at March 31, 2009 were theWalnut Grove Youth Correctional Facility and the eight Los Angeles CountyJails, which represented 1,714 beds of service capacity, or approximately82.5%, of the residential service capacity represented by management contracts.

 

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

 

We incur pre-opening andstart-up expenses including payroll, benefits, training and other operatingcosts prior to opening a new or expanded facility and during the period ofoperation while occupancy is ramping up. These costs vary by contract (and thepace/scale of the activation and related population ramp). Since pre-openingand start-up costs are generally factored into the revenue per diem rate thatis charged to the contracting agency, we typically expect to recover theseupfront costs over the life of the contract. Because occupancy rates during afacility’s start-up phase typically result in capacity under-utilization for atleast 90 to 180 days, we may incur additional post-opening start-up costs. Wedo not anticipate post-opening start-up costs at any adult secure facilities operatedunder any future contracts with the BOP which are take-or-pay contracts,meaning that the BOP will pay at least 80.0% of the contractual monthly revenueonce the facility opens, regardless of actual occupancy.

 

Newly opened facilities arestaffed according to applicable regulatory or contractual requirements when webegin receiving offenders or clients. Offenders or clients are typicallyassigned to a newly opened facility on a phased-in basis over a one- tosix-month period. Our start-up period for new juvenile operations is 12 monthsfrom the date we begin recognizing revenue unless break-even occupancy levelsare achieved before then. The actual time required to ramp a juvenile facility(with an approximate capacity, for example, of 100 to 200 beds) may be a periodof one to three years. Our start-up period for new adult operations is ninemonths from the date we begin recognizing revenue unless break-even occupancylevels are achieved before then.  Theapproximate time to ramp an adult facility of approximately 1,000 beds may be aperiod of three to six months, depending upon the customer requirements.  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.

 

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

 

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#### **Recent Developments**

#### ** **

***D. Ray James Prison***

 

InAugust 2007, we announced that we were initiating a second expansion ofthe D. Ray James Prison. This expansion project increased the facility’sservice capacity by an additional 700 beds for a total service capacity ofapproximately 2,800 beds. This expansion project began in the first quarter of2008 and was completed at the beginning of April 2009. We are marketing thisadditional expansion to multiple customers but believe those beds are wellsuited for a Georgia Department of Corrections (“Georgia DOC”) bid thatrequires expansion of an existing Georgia DOC-contracted facility. We can makeno assurance that we will be awarded this contract.

 

***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 Capital Resources**

## ** **

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

 

***Cash Flows FromOperating Activities.*** Cash flows used in operating activities wereapproximately $2.1 million for the three months ended March 31, 2009compared to cash provided by operating activities of approximately $7.2 millionfor the three months ended March 31, 2008. The decrease from the priorperiod was principally due to changes in certain working capital accounts(including accounts receivable, accounts payable and accrued liabilities) dueto timing of receipts and payments.

 

***Cash Flows From Investing Activities*****.** Cash used ininvesting activities was approximately $3.5 million for the three months ended March 31,2009 due primarily to capital expenditures of approximately $3.2 million,primarily related to the facility expansion projects at the D. Ray James Prisonand the Great Plains Correctional Facility. There were also net payments to therestricted debt payment account of approximately $0.4 million. Cash used ininvesting activities was approximately $12.6 million for the three months endedMarch 31, 2008 due primarily to capital expenditures of approximately$11.9 million, primarily related to the facility expansion projects at the D.Ray James Prison and the Great Plains Correctional Facility. There were alsonet payments to the restricted debt payment account of approximately $0.7million.

 

***Cash Flows FromFinancing Activities*****. **Cash provided by financingactivities was approximately $1.3 million for the three months ended March 31,2009 due primarily to net borrowings on our Amended Credit Facility of $1.0million and proceeds from the exercise of stock options of $0.3 million.****Cash provided by financing activities wasapproximately $5.2 million for the three months ended March 31, 2008 dueprimarily to net borrowings on our Amended Credit Facility of $5.0 million.

 

***Treasury StockRepurchases.*** We did notpurchase any of our common stock in the three months ended March 31, 2009and 2008.  Under the terms of our SeniorNotes and our Amended Credit Facility, we can purchase shares of our stocksubject to certain cumulative restrictions.

 

***Long-Term Credit Facilities.***  Our Amended CreditFacility provides for borrowings up to $100.0 million (including letters ofcredit), matures in December 2011 and bears interest, at our electiondepending on our total leverage ratio, at either the LIBOR rate plus a marginranging from 1.50% to 2.25%, or a rate which ranges from 0.00% to 0.75% abovethe applicable prime rate. The available commitment under our AmendedCredit Facility was approximately $8.6 million at March 31, 2009.  We had outstanding borrowings under ourAmended Credit Facility of $76.0 million and we had outstanding letters ofcredit of 

 

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approximately $15.4 millionat March 31, 2009.  Subject tocertain requirements, we have the right to increase the commitments under ourAmended Credit Facility up to $150.0 million, although the indenture for ourSenior Notes limits our ability, subject to certain conditions, to expand theAmended Credit Facility beyond $100.0 million. We can provide no assurance thatall of the banks that have made commitments to us under our Amended CreditFacility would be willing to participate in an expansion to the Amended CreditFacility should we desire to do so.  TheAmended Credit Facility iscollateralized by substantially all of our assets, including the assets andstock of all of our subsidiaries. The Amended Credit Facility is not secured bythe assets of MCF, a special purpose entity. Our Amended Credit Facilitycontains commonly used covenants including compliance with laws and limitationson certain financing transactions and mergers and also includes variousfinancial covenants.  We believe the mostrestrictive covenant under our Amended Credit Facility is the fixed chargecoverage ratio.  At March 31, 2009,we were in compliance with all of our debt financial covenants.

 

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

 

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

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

 

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

 

Inconjunction with the issuance of the Senior Notes, we entered into an interestrate swap transaction with a financial institution to hedge our exposure tochanges in the fair value on $84.0 million of our Senior Notes.  The purpose of this transaction was toconvert future interest due on $84.0 million of the Senior Notes to a variablerate.  The terms of the interest rateswap contract and the underlying debt instrument were identical.  The swap agreement was designated as a fairvalue hedge.  The swap had a notionalamount of $84.0 million and was scheduled to mature in July 2012 to mirrorthe maturity of the Senior Notes.  Underthe agreement, we paid, on a semi-annual basis (each January 1 and July 1),a floating 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 registration statement under Form S-3for potential offerings from time to time of up to $75.0 million in grossproceeds of debt securities, common stock, preferred stock, warrants or certainother securities was declared effective by the Securities and Exchange Commissionin September 2008.

 

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We expect to use existing cash balances, internallygenerated cash flows and borrowings from our Amended Credit Facility to fulfillanticipated obligations such as capital expenditures, working-capital needs andscheduled debt maturities over at least the next twelve months.  As of March 31, 2009, we hadapproximately $8.6 million of available capacity under our Amended CreditFacility.  We will continue to analyzeour capital structure, including a potential refinancing of our Senior Notesand financing for our expected future capital expenditures, including anypotential acquisitions.  We will considerpotential acquisitions from time to time. Our principal focus for acquisitions is anticipated to be in our AdultSecure and Adult Community-Based divisions, although we would also pursueattractively priced acquisitions in our Abraxas Youth and Family Servicesdivision.  We may decide to useinternally generated funds, bank financing, equity issuances, debt issuances ora combination of any of the foregoing to finance our future capital needs. We mayalso seek to repurchase some of our common stock and/or retire debt bypurchasing some of our Senior Notes from time to time, depending on prevailingmarket conditions. The repurchase of stock and/or purchase of Senior Noteswould be accomplished through open market purchases, private purchases, or acombination of both. At March 31, 2009, we believe we have sufficientliquidity necessary to complete those projects for which we have outstandingcommitments.

 

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

 

In addition, our accountsreceivable are with federal, state, county and local government agencies, whichwe believe generally reduces our credit risk. However, it is possible that situations such as continuing budget resolutions,delayed passage of budgets or budget pressures may increase the length ofrepayment of certain of these receivables.

 

**Results ofOperations**

 

The following table setsforth for the periods indicated the percentages of revenues represented bycertain items in our consolidated statements of operations.

 
| ** **                                               | ** ** | **Three Months  Ended March 31,** | ** ** |
|----------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                               | ** ** | **2009**                                    | ** ** | **2008** | ** ** |
|                                                     |       |                                        |       |   |   |
| Revenues                                                 |       | 100.0                                       | %          | 100.0 | % |
| Operating expenses, excluding depreciation               |       | 73.1                                        |       | 73.5 |   |
| Depreciation and amortization                            |       | 4.9                                         |       | 4.4 |   |
| General and administrative expenses                      |       | 6.2                                         |       | 6.9 |   |
| Income from operations                                   |       | 15.8                                        |       | 15.2 |   |
| Interest expense, net                                    |       | 5.9                                         |       | 6.6 |   |
| Income from operations before provision for income taxes |       | 9.9                                         |       | 8.6 |   |
| Provision for income taxes                               |       | 4.1                                         |       | 3.7 |   |
| Net income                                               |       | 5.8                                         |       | 4.9 |   |
| Non-controlling interest                                 |       | 0.5                                         |       | 3⁄4 |   |
| Income available to shareholders                         |       | 5.3                                         | %          | 4.9 | % |

 

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##### ***Three Months Ended March 31,2009 Compared to Three Months Ended March 31, 2008***

##### *** ***

***Revenues***.  Revenues increased approximately $4.3million, or 4.5%, to $99.7 million for the three months ended March 31,2009 from approximately $95.4 million for the three months ended March 31,2008.

 

*AdultSecure Services*. Adult Secure Services revenues increasedapproximately $7.0 million, or 14.0%, to $56.9 million for the three monthsended March 31, 2009 from approximately $49.9 million for the three monthsended March 31, 2008 due primarily to (1) an increase in revenues of $5.0million 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 $0.7 million at the Walnut Grove Youth CorrectionalFacility (“Walnut Grove”) due to a facility expansion completed in the thirdquarter of 2008, (3) an increase in revenues of $0.5 million at theRegional Correctional Center (“RCC”) due to improved occupancy and (4) anincrease in revenues of $0.4 million at the D. Ray James Prison due to increasedoccupancy related to a facility expansion completed in February 2008. Theremaining net increase in revenues of $0.4 million was due to variousfluctuations in revenues at our other adult secure facilities.

 

At March 31, 2009, weoperated ten adult secure facilities with an aggregate service capacity of12,841.  Average contract occupancy was91.9% for the three months ended March 31, 2009 compared to 95.5% for thethree months ended March 31, 2008. The decrease in the average contractoccupancy is primarily due to the additional capacity brought into operationsin September 2008 at Walnut Grove, which we began ramping during thefourth quarter of 2008, as well as under-utilization at certain Californiafacilities. The average per diem rate was $53.75 and $55.56 for the threemonths ended March 31, 2009 and 2008, respectively.

 

*AbraxasYouth and Family Services*. Abraxas Youth and Family Services revenuesdecreased approximately $2.1 million, or 7.6%, to $25.7 million for the threemonths ended March 31, 2009 from $27.8 million for the three months ended March 31,2008 due primarily to (1) a decrease in revenues of $0.9 million at theCornell Abraxas 1 facility (“A-1”) due to decreased occupancy, and (2) adecrease in revenues of $0.9 million due to the termination of our managementcontract for the Salt Lake Valley Detention Center as of September 2008.  The remaining net decrease in revenues of$0.3 million was due to various insignificant fluctuations in revenues at ourother Abraxas Youth and Family Services facilities and programs.

 

***At March 31, 2009, we operated 17 residential AbraxasYouth and Family Services facilities and 11 non-residential community-basedprograms and facilities with an aggregate service capacity of 3,321.Additionally, we had one vacant facility with a service capacity of 70 beds.Average contract occupancy for the three months ended March 31, 2009 was83.9% compared to 85.5% for the three months ended March 31, 2008.  The decrease in 2009 average contractoccupancy reflects the under-utilization at certain facilities, including A-1.***

*** ***

***The average per diem rate for our residential Abraxas Youthand Family Services facilities was $197.51 for the three months ended March 31,2009 compared to $186.94 for the three months ended March 31, 2008.  The increase in the 2009 average per diemrate reflects the continued ramp-up of the Abraxas Academy as well as changesin the mix of services provided at other facilities.  Our average fee-for-service rate for ournon-residential Abraxas Youth and Family Services community-based facilitiesand programs was $45.04 for the three months ended March 31, 2009 comparedto $50.24 for the three months ended March 31, 2008.  Our average fee-for-service rate canfluctuate from period-to-period depending on the mix of services provided atour various non-residential Abraxas Youth and Family Services facilities andprograms.***

*** ***

*AdultCommunity-Based*. Adult Community-Based Services revenues decreasedapproximately $0.5 million, or 2.8%, to $17.2 million for the three monthsended March 31, 2009 from $17.7 million for the three months ended March 31,2008 due primarily to the termination of our management contract for theLincoln County Detention Center in May 2008 (we gave notice of earlytermination of our management contract for the facility in February 2008due to continual staffing and other issues in the rural area). This contractgenerated revenues of $0.5 million in the three months ended March 31,2008.

 

At March 31, 2009, we operated 28 residentialAdult Community-Based Services facilities and three non-residentialcommunity-based programs with an aggregate service capacity of 3,960. Averagecontract occupancy for the three months ended March 31, 2009 was 104.3%compared to 100.6% for the three months ended March 31, 2008.

 

The average per diem rate for our residential AdultCommunity-Based Services facilities was $67.25 for the three months ended March 31,2009 compared to $65.96 for the three months ended March 31, 2008. Theaverage fee-for-service rate for our non-residential Adult Community-BasedServices programs was $9.07 for the three months ended March 31, 2009compared to $13.11 for the three months ended March 31, 2008.  Our average fee-for-service rates fluctuateas a result of changes in the mix of services provided by our various AdultCommunity-Based Services programs and facilities.

 

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***OperatingExpenses****.*Operating expenses increasedapproximately $2.7 million, or 3.8%, to $72.9 million for the three monthsended March 31, 2009 from $70.2 million for the three months ended March 31,2008.

 

*AdultSecure Services*. Adult Secure Services operating expenses increasedapproximately $4.3 million, or 13.3%, to $36.7 million for the three monthsended March 31, 2009 from $32.4 million for the three months ended March 31,2008. The increase was primarily due to (1) an increase in operatingexpenses of $2.2 million at the Great Plains Correctional Facility due toincreased occupancy following a facility expansion completed in September 2008,(2) an increase in operating expenses of $0.5 million at the Walnut GroveYouth Correctional Facility due to increased occupancy following the completionof a facility expansion in the third quarter of 2008, (3) an increase inoperating expenses of $0.5 million at the Big Spring Correctional Center due toincreased occupancy and (4) an increase in operating expenses of $0.6million at the D. Ray James Prison due to increased occupancy following afacility expansion completed in February 2008. The remaining net increasein operating expenses of $0.5 million was due to various insignificantfluctuations in operating expenses at our other Adult Secure Servicesfacilities.

 

As a percentage of segment revenues, Adult SecureServices operating expenses were 64.5% for the three months ended March 31,2009 compared to 64.9% for the three months ended March 31, 2008.

 

*AbraxasYouth and Family Services*.** **Abraxas Youth and Family Services operating expenses decreasedapproximately $1.1 million, or 4.3%, to $24.2 million for the three monthsended March 31, 2009 from $25.3 million for the three months ended March 31,2008 due primarily to (1) a decrease in operating expenses of $1.0 milliondue to the termination of our management contract for the Salt Lake ValleyDetention Center in September 2008, (2) a decrease in operatingexpenses of $0.5 million due to the termination of our management contract forthe Reading Alternative Education School Program in June 2008 and (3) adecrease in operating expenses of $0.4 million at A-1 due to reducedoccupancy.  The decrease in operatingexpenses due to the above was offset, in part; by an increase in operatingexpenses of $0.6 million at the Cornell Abraxas Academy and $0.3 million at theTexas Adolescent Treatment Center, both due to improved occupancy.  The remaining net decrease in operatingexpenses of $0.1 million was due to various insignificant fluctuations inoperating expenses at our other Abraxas Youth and Family Services facilitiesand programs.

 

As a percentage of segment revenues, Abraxas Youthand Family Services division operating expenses were 94.4% for the three monthsended March 31, 2009 compared to 91.1% for the three months ended March 31,2008.  The decrease in the 2009 operatingmargin was due to the lower utilization at those facilities previously noted.

 

*AdultCommunity-Based Services*. Adult Community-Based Services operatingexpenses decreased approximately $0.5 million, or 4.0%, to $12.0 million forthe three months ended March 31, 2009 from $12.5 million for the three months ended March 31,2008 due primarily to a decrease in operating expenses of $0.4 million due tothe termination of our management contract for the Lincoln County DetentionCenter in May 2008 (we gave notice of early termination of our managementcontract for the facility in February 2008 due to continual staffing andother issues in the rural area).  Theremaining net decrease in operating expenses of $0.1 million was due to variousinsignificant fluctuations in operating expenses at our other AdultCommunity-Based facilities and programs.

 

As apercentage of segment revenues, Adult Community-Based Services operatingexpenses were 69.8% for the three months ended March 31, 2009 compared to70.7% for the three months ended March 31, 2008.

 

***Pre-opening andstart-up expenses.***** **There were no pre-openingand start-up expenses for the three months ended March 31, 2009 and 2008.

 

***Depreciation andAmortization*****. **Depreciation and amortization was approximately $4.9 million and $4.2million for the three months ended March 31, 2009 and 2008,respectively.  The increase indepreciation expense in the three months ended March 31, 2009 was dueprimarily to additional depreciation expense resulting from the facilityexpansions at the Big Spring Correctional Center, the Great Plains CorrectionalCenter and the D. Ray James Prison. Amortization of intangibles was approximately $0.4 million and $0.5million for the three months ended March 31, 2009 and 2008, respectively.

 

***General andAdministrative Expenses. ***General andadministrative expenses decreased approximately $0.4 million, or 6.2%, toapproximately $6.1 million for the three months ended March 31, 2009 from$6.5 million for the three months ended March 31, 2008 due primarily to adecrease in 2009 of approximately $0.4 million in stock-based compensationexpense over the same period of the prior year.

 

***Interest. ***Interest expense, net ofinterest income, decreased approximately $0.3 million, or 4.8%, to $6.0 millionfor the three months ended March 31, 2009 from $6.3 million for the threemonths ended March 31, 2008 due primarily to (1) a decrease ininterest expense of $0.2 million due to a lower outstanding principal balanceon MCF’s bonds and (2) an increase in capitalized 

 

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interestof $0.2 million in the 2009 period.  Forthe three months ended March 31, 2009, we capitalized interest ofapproximately $0.7 million related to the 700 bed facility expansion project atthe D. Ray James Prison.  For the threemonths ended March 31, 2008, we capitalized interest of $0.5 millionrelated to the facility expansion projects at the Great Plains CorrectionalFacility and the D. Ray James Prison.

 

***Income Taxes.***For the threemonths ended March 31, 2009, we recognized a provision for income taxes atan estimated effective rate of 41.7%. For the three months ended March 31, 2008, we recognized aprovision for income taxes at an estimated effective rate of 43.5%. Thereduction in the estimated income tax rate in 2009 is principally due to anincrease in operating income across certain of our business segments and thedecreased impact of certain nondeductible expenses.

 

***Contractual Uncertainties Related to Certain 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 through an intergovernmental services agreement, and wehave an operating and management agreement with Bernalillo County.  In July 2007, we were notified by ICEthat it was removing all ICE detainees from the RCC and the removal wascompleted in early August 2007.  The facility is still being utilizedby the USMS, and since May 2008 by the BOP, but not at its fullcapacity.  In February 2008, ICEinformed us that it would not resume use of the facility.  In February 2008, OFDT attempted tounilaterally amend its agreement with the County to reduce the number ofminimum annual guaranteed mandays under the agreement from 182,500 to66,300.  Neither we nor the County believe OFDT has the right tounilaterally amend the contract in this manner, and OFDT has been informed ofour position. Although either party to the intergovernmental services agreementhas the right to terminate upon 180 days notice, neither party has exercisedsuch right as of March 31, 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”).

 

 In March 2009, the Federal Judgepresiding over the case issued an Order based on motions filed by Plaintiffsclass counsel asking the Judge to reform the 2005 settlement agreements toallow for access to the RCC.  In thosemotions, the Plaintiffs also requested alternative relief in the form ofwithdrawal of the Court’s approval of the 2005 settlement agreements.  Based on our interpretation of the Order, theJudge denied Plaintiffs’ request for access to the RCC, granted the alternativerelief requested, withdrew her approval of the 2005 settlement agreements andgranted the option to Plaintiffs to rescind their 2005 settlementagreements.   The Plaintiffs chose torescind the 2005 settlement agreements. In the Order, the Judge concluded that the RCC at least to the extent itis used to house detainees by Bernalillo County pursuant to theintergovernmental services agreement, is part of the county jail system.  The County has informed us that it does notbelieve McClendon should apply to the RCC and the County has filed a notice ofappeal with the Court.  We are not a party to this lawsuit and theramifications of the Court’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 beincurred.   We currently plan to continueto operate the facility and also continue with our marketing plans for theRegional Correctional Center.

 

Revenuesfor this facility were approximately $3.0 million and $2.6 million for thethree months ended March 31, 2009 and 2008, respectively. The net carryingvalue of the leasehold improvements for this facility was approximately $0.6million and $1.1 million at March 31, 2009 and December 31, 2008,respectively. Our lease for this facility requires monthly rent payments ofapproximately $0.13 million for the remaining term of the lease (which has beenextended 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.

 

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***Hector Garza Residential TreatmentCenter.***  In October 2005,we initiated the temporary closure of this MCF leased facility in San Antonio,Texas. We reactivated the facility during the third quarter of 2007. The netcarrying value for this facility was approximately $4.0 million at March 31,2009 and December 31, 2008.  We believe that, pursuant to theprovisions of SFAS No. 144, no impairment to the carrying value of thisfacility has occurred due to existing (and increasing) demand from currentcustomers (including the Texas Youth Commission) and anticipated incrementaldemand from additional multiple customers to whom the facility is beingmarketed (including several current requests for proposal).

 

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

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

We have assumed variousfinancial obligations and commitments in the ordinary course of conducting ourbusiness.  We have contractualobligations requiring future cash payments, such as management, consulting andnon-competition agreements.

 

We maintain operating leasesin the ordinary course of our business activities.  These leases include those for operatingfacilities, office space and office and operating equipment, and the agreementsexpire between 2009 and 2075. As of March 31, 2009, our total commitmentunder these operating leases was approximately $118.8 million.

 

The following table detailsthe known future cash payments (on an undiscounted basis) related to ourvarious contractual obligations as of March 31, 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.     |       | 39,130                                    |       | 9,030 |   | 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.     |       | 76,000                                    |       | — |   | 76,000 |   | — |   | — |   |
| Revolving line of credit-interest       |       |                                      |       |   |   |   |   |   |   |   |   |
| · Cornell Companies, Inc.     |       | 2,150                                     |       | 1,030 |   | 1,120 |   | — |   | — |   |
| Capital lease obligations               |       |                                      |       |   |   |   |   |   |   |   |   |
| · Cornell Companies, Inc.     |       | 24                                        |       | 10 |   | 14 |   | — |   | — |   |
| Construction commitments                |       | 7,182                                     |       | 7,182 |   | — |   | — |   | — |   |
| Operating leases                        |       | 118,847                                   |       | 5,506 |   | 24,309 |   | 21,876 |   | 67,156 |   |
| Consultative and non-compete agreements |       | 243                                       |       | 243 |   | — |   | — |   | — |   |
| Total contractual cash obligations      |       | $                                         | 539,933    |   | $ | 41,080 |   | $ | 173,005 |   | $ | 187,430 |   | $ | 138,418 |   |

 

Approximately $2.6 million of unrecognized taxbenefits have been recorded as liabilities in accordance with FIN 48 as of March 31,2009 but are not included in the contractual obligations table above because weare uncertain as to if or when such amounts may be settled.  Related to the unrecognized tax benefits notincluded in the table above, we have also recorded a liability for potential penaltiesof approximately $0.1 million and for interest of approximately $0.1 million asof March 31, 2009.

 

We enter into letters of credit in the ordinarycourse of operating and financing activities. As of March 31, 2009, we had outstanding letters of credit ofapproximately $15.4 million primarily for certain workers’ compensationinsurance and other operating obligations. The following table details our letters of credit commitments as of March 31,2009 (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     |                                                                    | $          | 14,199 |   | $ | 1,250 |   | $ | — |   | $ | — |   |
|                           |            |               |            |                                                                         |            |  |  |  |  |  |  |  |  |  |  |  |

 

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

** **

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

 

**Credit Risk**

 

Due to the short duration of our investments,changes in market interest rates would not have a significant impact on theirfair value.  In addition, our accountsreceivables are with federal, state, county and local government agencies,which we believe generally reduces our credit risk. However, it is possiblethat such situations as continuing budget resolutions, delayed passage ofbudgets or budget pressures may increase the length of repayment of certainreceivables.

 

**Interest Rate Exposure**

 

Ourexposure to changes in interest rates primarily results from our Amended CreditFacility, as these borrowings have floating interest rates.  The debt on our consolidated financialstatements at March 31, 2009 with fixed interest rates consist of the8.47% Bonds issued by MCF, a special purpose entity, in August 2001 inconnection with the 2001 Sale and Leaseback Transaction and $112.0 million ofSenior Notes.  The detrimental effect ofa hypothetical 100 basis point increase in interest rates on our currentborrowings under our Amended Credit Facility would be to reduce income beforeprovision for income taxes by approximately $0.2 million for the three months endedMarch 31, 2009.  At March 31,2009, the fair value of our consolidated debt was approximately $315.0 millionbased upon quoted market prices or discounted future cash flows using the sameor similar securities.

 

**Inflation**

 

Other than personnel, resident/inmatemedical 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 inresident/inmate medical costs and employee medical and worker’s compensationinsurance costs, and we have also experienced higher personnel costs during thepast two years. Most of our facility management contracts provide for paymentsof either fixed per diem fees or per diem fees that increase by only smallamounts during the term of the contracts. Inflation could substantiallyincrease our personnel costs (the largest component of our operating expenses),medical and insurance costs or other operating expenses at rates faster thanany increases in contract revenues.  Foodcosts (part of our resident/inmate care costs) have also been subject to risingprices in 2009.  We believe we havelimited our exposure through long-term contracts with fixed term pricing.

 

**ITEM 4.**                       Controls and Procedures.

** **

**Evaluationof Disclosure Controls and Procedures**

 

We maintain disclosure controls and proceduresdesigned to provide reasonable assurance that information disclosed in ourannual and periodic reports is recorded, processed, summarized and reported,within the time periods specified in the Securities and Exchange Commission’s rules andforms. In addition, we designed these disclosure controls and procedures toensure that this information is accumulated and communicated to management,including the chief executive officer (“CEO”) and chief financial officer (“CFO”),to allow timely decisions regarding required disclosures. SEC rules requirethat we disclose the conclusions of our CEO and CFO about the effectiveness ofour disclosure 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.  In addition, the design of disclosurecontrols and procedures must reflect the fact that there are resourceconstraints, and the benefits of controls must be considered relative to theircosts. Because of the inherent limitation in a cost-effective control system,misstatements due to error or fraud could occur and not be detected.

 

Under the supervision and with the participation ofour management, including our principal executive officer and principalfinancial officer, and as required by paragraph (b) of Rules 13a-15and 15d-15 of the Exchange Act, we have evaluated the effectiveness of thedesign and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and15d-15(e)

 

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ofthe Exchange Act) as of the end of the period required by this report. Based onthat evaluation, our principal executive officer and principal financialofficer have concluded that these controls and procedures are effective at areasonable assurance level as of that date.

 

**Changesin Internal Control over Financial Reporting**

 

In connection with theevaluation as required by paragraph (d) of Rules 13a-15 and 15d-15 ofthe Exchange Act, we have not identified any change in our internal controlover financial reporting (as such term is defined in Rules 13a-15(f) and15d-15(f) under Exchange Act) that occurred during our fiscal quarterended March 31, 2009 that has materially affected, or is reasonably likelyto materially affect, our internal control over financial reporting.

 

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**PART II**     OTHER INFORMATION

 
| **ITEM 1.**  | ** ** | **Legal Proceedings.**                                                                                                                                                                                            |
|--------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| ** **   | ** ** | ** **                                                                                                                                                                                                        |
|         |       | See Part I, Item 1. Note 9 to the Consolidated Financial  Statements, which is incorporated herein by reference.                                                                                             |
| ** **   | ** ** | ** **                                                                                                                                                                                                        |
| **ITEM 1A.** | ** ** | **Risk Factors.**                                                                                                                                                                                                 |
| ** **   | ** ** | ** **                                                                                                                                                                                                        |
|         |       | The risk factors as previously discussed in our Form 10-K for  the fiscal year ended December 31, 2008 are incorporated herein by this  reference. There were no material changes to such risk factors. |
|         |       |                                                                                                                                                                                                              |
| **ITEM 2.**  | ** ** | **Unregistered Sales of Equity Securities  and Use of Proceeds.**                                                                                                                                                 |
|         |       |                                                                                                                                                                                                              |
|         |       | None.                                                                                                                                                                                                             |
|         |       |                                                                                                                                                                                                              |
| **ITEM 3.**  | ** ** | **Defaults Upon Senior Securities.**                                                                                                                                                                              |
|         |       |                                                                                                                                                                                                              |
|         |       | None.                                                                                                                                                                                                             |
|         |       |                                                                                                                                                                                                              |
| **ITEM 4.**  | ** ** | **Submission of Matters to a  Vote of Security Holders.**                                                                                                                                                         |
| ** **   | ** ** | ** **                                                                                                                                                                                                        |
|         |       | None                                                                                                                                                                                                              |
|         |       |                                                                                                                                                                                                              |
| **ITEM 5.**  | ** ** | **Other Information.**                                                                                                                                                                                            |
| ** **   | ** ** | ** **                                                                                                                                                                                                        |
|         |       | None.                                                                                                                                                                                                             |
|         |       |                                                                                                                                                                                                              |
| **ITEM 6.**  | ** ** | **Exhibits.**                                                                                                                                                                                                     |
| ** **   | ** ** | ** **                                                                                                                                                                                                        |
|         |       | 31.1*                                                                                                                                                                                                             | Section 302 Certification of Chief Executive Officer |
|         |       | 31.2*                                                                                                                                                                                                             | Section 302 Certification of Chief Financial Officer |
|         |       | 32.1**                                                                                                                                                                                                            | Section 906 Certification of Chief Executive Officer |
|         |       | 32.2**                                                                                                                                                                                                            | Section 906 Certification of Chief Financial Officer |

 

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

 

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**SIGNATURES**

 

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

 
|                              |      | **CORNELL COMPANIES, INC.**                                                                                              |
|-----------------------------------|-----------|-------------------------------------------------------------------------------------------------------------------------------|
|                              |      |                                                                                                                          |
|                              |      |                                                                                                                          |
| Date:  May 8, 2009 | By:       | /s/ James E. Hyman                                                                                                            |
|                              |      | JAMES E. HYMAN                                                                                                                |
|                              |      | Chief Executive Officer, President and Chairman  of the Board (Principal Executive Officer)                                   |
|                              |      |                                                                                                                          |
|                              |      |                                                                                                                          |
| Date:  May 8, 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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