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** **

 

** **

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington, DC 20549**

 

**FORM 10-Q**

 

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

 

**For the Quarterly Period Ended June 30, 2010**

 

**OR**

 

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

 

**For the transition period from           to           **

 

**Commission File Number 1-14472**

 

**CORNELL COMPANIES, INC.**

(Exact Name of Registrant as Specified in ItsCharter)

 

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

 

Registrant’s Telephone Number, IncludingArea Code: **(713) 623-0790**

 

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

 

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

 

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

 

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

 

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

 

AtAugust 5, 2010, the registrant had 15,108,415 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 |       | 29         |
| Item 3.          |       | Quantitative and Qualitative  Disclosures About Market Risk                                 |       | 45         |
| Item 4.          |       | Controls and  Procedures                                                                    |       | 46         |
|             |       |                                                                                        |       |       |
| **Part II** |       |                                                                                        | ** ** | ** ** |
| Item 1.          |       | Legal Proceedings                                                                           |       | 47         |
| Item 1A.         |       | Risk Factors                                                                                |       | 47         |
| Item 2.          |       | Unregistered Sales of Equity  Securities and Use of Proceeds                                |       | 48         |
| Item 3.          |       | Defaults Upon  Senior Securities                                                            |       | 48         |
| Item 4.          |       | Removed and Reserved                                                                        |       | 48         |
| Item 5.          |       | Other Information                                                                           |       | 48         |
| Item 6.          |       | Exhibits                                                                                    |       | 49         |

 

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**Forward-LookingInformation**

 

The statements included inthis quarterly report regarding future financial performance and results ofoperations and other statements that are not historical facts areforward-looking statements within the meaning of Section 27A of theSecurities Act of 1933 and Section 21E of the Securities Exchange Act of1934.  Forward-looking statements in thisquarterly report include, but are not limited to, statements about thefollowing subjects:

 

·                  revenues,

·                  revenue mix,

·                  expenses, including personnel and medicalcosts,

·                  results of operations,

·                  operating margins,

·                  supply and demand,

·                  market outlook in our various markets,

·                  our other expectations with regard to marketoutlook,

·                  utilization,

·                  parolee, detainee, inmate and youth offendertrends,

·                  pricing and per diem rates,

·                  contract commencements,

·                  new contract opportunities,

·                  our proposed merger transaction with The GEOGroup, Inc. (including, but not limited to, expected timing of completionof the transaction and satisfaction of required closing conditions),

·                  operations at, future contracts for, andresults from our Baker Community Correctional Facility, High PlainsCorrectional Facility and Mesa Verde Community Correctional Facility,

·                  operations at, future contracts for, andresults from our Regional Correctional Center and Great Plains CorrectionalFacility,

·                  the timing (including ramp of facilitypopulation) and other aspects of our planned customer transition at our D. RayJames Prison,

·                  adequacy of insurance,

·                  debt levels,

·                  debt reduction,

·                  the effect of income tax positions andrelated assets and liabilities,

·                  our effective tax rate,

·                  tax assessments,

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

·                  liquidity, including future liquidity and ourability to obtain financing,

·                  financial markets,

·                  cash flow from operations,

·                  adequacy of cash flow for our obligations,

·                  capital requirements,

·                  capital expenditures,

·                  effects of accounting changes and adoption ofaccounting policies,

·                  changes in laws and regulations,

·                  adoption of accounting policies,

·                  benefit payments, and

·                  changes in laws and regulations.

 

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

 

·               “anticipates”

·               “believes”

·               “budgets”

·               “could”

·               “estimates”

·               “expects”

 

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·               “forecasts”

·               “intends”

·               “may”

·               “might”

·               “plans”

·               “predicts”

·               “projects”

·               “scheduled”

·               “should”

 

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

 

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

·                  the adequacy of sources of liquidity,

·                  the effect and results of litigation, auditsand 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*.

 

Shouldone or more of these risks or uncertainties materialize, or should underlyingassumptions prove incorrect, actual results may vary materially from thoseindicated.

 

Allsubsequent written and oral forward-looking statements attributable to theCompany or to persons acting on our behalf are expressly qualified in theirentirety by reference to these risks and uncertainties. You should not placeundue reliance on forward-looking statements. Each forward-looking statementspeaks only as of the date of the particular statement, and we undertake noobligation to publicly update or revise any forward-looking statements.

 

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**PART I FINANCIAL INFORMATION**

**ITEM 1.      Financial Statements.**

 

**CORNELL COMPANIES, INC.**

**CONSOLIDATED BALANCE SHEETS**

**(Unaudited)**

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

 
| ** **                                                                                                                                                            | ** ** | **June 30,  2010** | ** ** | **December 31,  2009** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
| **ASSETS**                                                                                                                                                            | ** ** | ** **              | ** ** | ** **                  | ** ** |
| **CURRENT ASSETS:**                                                                                                                                                   | ** ** | ** **              | ** ** | ** **                  | ** ** |
| Cash and cash equivalents                                                                                                                                             |       | $                       | 16,164     |                        | $          | 27,724 |   |
| Accounts receivable — trade (net of allowance for  doubtful accounts of $4,650 and $4,345, respectively)                                                    |       | 63,739                  |       | 59,496                      |       |
| Other receivables                                                                                                                                                     |       | 2,814                   |       | 1,587                       |       |
| Bond fund payment account and other restricted  assets                                                                                                                |       | 29,041                  |       | 29,978                      |       |
| Deferred tax assets                                                                                                                                                   |       | 10,081                  |       | 9,843                       |       |
| Prepaid expenses and other                                                                                                                                            |       | 7,678                   |       | 11,647                      |       |
| **Total current assets**                                                                                                                                              |       | 129,517                 |       | 140,275                     |       |
| **PROPERTY AND EQUIPMENT, net**                                                                                                                                       |       | 460,421                 |       | 455,523                     |       |
| **OTHER ASSETS:**                                                                                                                                                     |       |                    |       |                        |       |
| Debt service reserve fund and other restricted  assets                                                                                                                |       | 33,270                  |       | 27,017                      |       |
| Goodwill                                                                                                                                                              |       | 13,308                  |       | 13,308                      |       |
| Intangible assets, net                                                                                                                                                |       | 922                     |       | 1,185                       |       |
| Deferred costs and other                                                                                                                                              |       | 16,117                  |       | 13,257                      |       |
| **Total assets**                                                                                                                                                      |       | $                       | 653,555    |                        | $          | 650,565 |   |
|                                                                                                                                                                  |       |                    |       |                        |       |
| **LIABILITIES AND EQUITY**                                                                                                                                            | ** ** | ** **              | ** ** | ** **                  | ** ** |
|                                                                                                                                                                  |       |                    |       |                        |       |
| **CURRENT LIABILITIES:**                                                                                                                                              | ** ** | ** **              | ** ** | ** **                  | ** ** |
| Accounts payable and accrued liabilities                                                                                                                              |       | $                       | 60,850     |                        | $          | 62,287 |   |
| Current portion of long-term debt                                                                                                                                     |       | 13,408                  |       | 13,413                      |       |
| **Total current liabilities**                                                                                                                                         |       | 74,258                  |       | 75,700                      |       |
| **LONG-TERM DEBT, net of current  portion**                                                                                                                           |       | 287,332                 |       | 289,841                     |       |
| **DEFERRED TAX LIABILITIES**                                                                                                                                          |       | 26,242                  |       | 24,455                      |       |
| **OTHER LONG-TERM LIABILITIES**                                                                                                                                       |       | 2,125                   |       | 1,831                       |       |
| **Total liabilities**                                                                                                                                                 |       | 389,957                 |       | 391,827                     |       |
|                                                                                                                                                                  |       |                    |       |                        |       |
| **COMMITMENTS AND CONTINGENCIES**                                                                                                                                     | ** ** | ** **              | ** ** | ** **                  | ** ** |
|                                                                                                                                                                  |       |                    |       |                        |       |
| **EQUITY:**                                                                                                                                                           | ** ** | ** **              | ** ** | ** **                  | ** ** |
| Preferred stock, $.001 par value, 10,000,000  shares authorized, none issued                                                                                          |       | —                  |       | —                      |       |
| Common stock, $.001 par value, 30,000,000 shares  authorized, 16,069,290 and 16,434,940 shares issued and 14,933,148 and  14,947,054 shares outstanding, respectively |       | 16                      |       | 16                          |       |
| Additional paid-in capital                                                                                                                                            |       | 163,904                 |       | 168,852                     |       |
| Retained earnings                                                                                                                                                     |       | 106,353                 |       | 97,944                      |       |
| Accumulated other comprehensive income                                                                                                                                |       | 1,295                   |       | 1,422                       |       |
| Treasury stock (1,136,142 and 1,487,886 shares of  common stock, at cost, respectively)                                                                               |       | (9,078                  | )          | (11,888                     | )          |
| **Total Cornell  Companies, Inc. stockholders’ equity**                                                                                                     |       | 262,490                 |       | 256,346                     |       |
| Non-controlling interest                                                                                                                                              |       | 1,108                   |       | 2,392                       |       |
| **Total equity**                                                                                                                                                      |       | 263,598                 |       | 258,738                     |       |
| **Total liabilities and equity**                                                                                                                                      |       | $                       | 653,555    |                        | $          | 650,565 |   |

 

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

 

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**CORNELL COMPANIES, INC.**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME**

**(Unaudited)**

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

 
| ** **                                                                     | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|--------------------------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                                     | ** ** | **2010**                                        | ** ** | **2009**                                      | ** ** | **2010** | ** ** | **2009** | ** ** |
|                                                                           |       |                                            |       |                                          |       |   |   |   |   |
| REVENUES                                                                       |       | $                                               | 103,871    |                                          | $          | 105,334 |   | $ | 203,877 |   | $ | 205,044 |   |
| OPERATING  EXPENSES, EXCLUDING DEPRECIATION AND AMORTIZATION                   |       | 74,793                                          |       | 74,734                                        |       | 151,476 |   | 147,627 |   |
| DEPRECIATION  AND AMORTIZATION                                                 |       | 4,555                                           |       | 4,740                                         |       | 9,254 |   | 9,633 |   |
| GENERAL AND  ADMINISTRATIVE EXPENSES                                           |       | 8,001                                           |       | 6,270                                         |       | 13,760 |   | 12,408 |   |
|                                                                           |       |                                            |       |                                          |       |   |   |   |   |
| INCOME FROM  OPERATIONS                                                        |       | 16,522                                          |       | 19,590                                        |       | 29,387 |   | 35,376 |   |
|                                                                           |       |                                            |       |                                          |       |   |   |   |   |
| INTEREST  EXPENSE                                                              |       | 6,287                                           |       | 6,736                                         |       | 12,601 |   | 12,935 |   |
| INTEREST  INCOME                                                               |       | (127                                            | )          | (160                                          | )          | (255 | ) | (406 | ) |
|                                                                           |       |                                            |       |                                          |       |   |   |   |   |
| INCOME FROM  OPERATIONS BEFORE PROVISION FOR INCOME TAXES                      |       | 10,362                                          |       | 13,014                                        |       | 17,041 |   | 22,847 |   |
|                                                                           |       |                                            |       |                                          |       |   |   |   |   |
| PROVISION FOR  INCOME TAXES                                                    |       | 4,646                                           |       | 5,386                                         |       | 7,477 |   | 9,487 |   |
|                                                                           |       |                                            |       |                                          |       |   |   |   |   |
| NET INCOME                                                                     |       | 5,716                                           |       | 7,628                                         |       | 9,564 |   | 13,360 |   |
|                                                                           |       |                                            |       |                                          |       |   |   |   |   |
| NON-CONTROLLING  INTEREST                                                      |       | 586                                             |       | 398                                           |       | 1,155 |   | 873 |   |
|                                                                           |       |                                            |       |                                          |       |   |   |   |   |
| INCOME  AVAILABLE TO CORNELL COMPANIES, INC.                              |       | $                                               | 5,130      |                                          | $          | 7,230 |   | $ | 8,409 |   | $ | 12,487 |   |
|                                                                           |       |                                            |       |                                          |       |   |   |   |   |
| EARNINGS PER  SHARE ATTRIBUTABLE TO CORNELL COMPANIES, INC. STOCKHOLDERS: |       |                                            |       |                                          |       |   |   |   |   |
| BASIC                                                                          |       | $                                               | .34        |                                          | $          | .49 |   | $ | .56 |   | $ | .84 |   |
| DILUTED                                                                        |       | $                                               | .34        |                                          | $          | .48 |   | $ | .56 |   | $ | .84 |   |
|                                                                           |       |                                            |       |                                          |       |   |   |   |   |
| NUMBER OF  SHARES USED IN PER SHARE COMPUTATION:                               |       |                                            |       |                                          |       |   |   |   |   |
| BASIC                                                                          |       | 14,944                                          |       | 14,881                                        |       | 14,903 |   | 14,878 |   |
| DILUTED                                                                        |       | 15,111                                          |       | 14,970                                        |       | 15,050 |   | 14,952 |   |
|                                                                           |       |                                            |       |                                          |       |   |   |   |   |
| COMPREHENSIVE  INCOME:                                                         |       |                                            |       |                                          |       |   |   |   |   |
| Net income                                                                     |       | $                                               | 5,716      |                                          | $          | 7,628 |   | $ | 9,564 |   | $ | 13,360 |   |
| Comprehensive  income attributable to non-controlling interest                 |       | (586                                            | )          | (398                                          | )          | (1,155 | ) | (873 | ) |
| Comprehensive  income attributable to Cornell Companies, Inc.                  |       | $                                               | 5,130      |                                          | $          | 7,230 |   | $ | 8,409 |   | $ | 12,487 |   |

 

The accompanying notes are anintegral part of these consolidated financial statements.

 

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**CORNELL COMPANIES, INC.**

**CONSOLIDATEDSTATEMENT OF CHANGES IN EQUITY**

**ANDCOMPREHENSIVE INCOME**

**FOR THE SIX MONTHS ENDED JUNE 30, 2010**

**(Unaudited)**

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

 
| ** **                                                                | ** ** | ** **            | ** ** | ** **     | ** ** | ** **  | ** ** | ** **   | ** ** | ** **              | ** ** | ** **        | ** ** | **Accumulated** | ** ** | ** **             | ** ** | ** **        | ** ** | ** ** | ** ** |
|---------------------------------------------------------------------------|------------|-----------------------|------------|----------------|------------|-------------|------------|--------------|------------|-------------------------|------------|-------------------|------------|-----------------|------------|------------------------|------------|-------------------|------------|------------|------------|
| ** **                                                                | ** ** | **Common Stock** | ** ** | **Additional** | ** ** | ** **  | ** ** | ** **   | ** ** | ** **              | ** ** | **Other**         | ** ** | **Non-**        | ** ** | **Total**              | ** ** | ** **        | ** ** |
| ** **                                                                | ** ** | ** **            | ** ** | **Par**        | ** ** | **Paid-In** | ** ** | **Retained** | ** ** | **Treasury Stock** | ** ** | **Comprehensive** | ** ** | **Controlling** | ** ** | **Stockholders’** | ** ** | **Comprehensive** | ** ** |
| ** **                                                                | ** ** | **Shares**            | ** ** | **Value**      | ** ** | **Capital** | ** ** | **Earnings** | ** ** | **Shares**              | ** ** | **Cost**          | ** ** | **Income**      | ** ** | **Interest**           | ** ** | **Equity**        | ** ** | **Income** | ** ** |
| ** **                                                                | ** ** | ** **            | ** ** | ** **     | ** ** | ** **  | ** ** | ** **   | ** ** | ** **              | ** ** | ** **        | ** ** | ** **      | ** ** | ** **             | ** ** | ** **        | ** ** | ** ** | ** ** |
| BALANCES  AT DECEMBER 31, 2009                                            |       | 16,434,940            |       | $              | 16         |        | $          | 168,852      |       | $                       | 97,944     |              | 1,487,886  |            | $          | (11,888                | )          | $                 | 1,422      |       | $          | 2,392 |   | $ | 258,738 |   | $ | — |   |
|                                                                      |       |                  |       |           |       |        |       |         |       |                    |       |              |       |            |       |                   |       |              |       |       |       |
| NET  INCOME                                                               |       | —                |       | —         |       | —      |       | 8,409        |       | —                  |       | —            |       | —          |       | 1,155                  |       | 9,564             |       | 8,409      |       |
| COMPREHENSIVE  INCOME                                                     |       |                  |       |           |       |        |       |         |       |                    |       |              |       |            |       |                   |       |              |       | $          | 8,409      |   |
| DISTRIBUTION  TO MCF PARTNERS                                             |       | —                |       | —         |       | —      |       | —       |       | —                  |       | —            |       | —          |       | (2,439                 | )          | (2,439            | )          |       |       |
| REPURCHASE  AND RETIREMENT OF COMMON STOCK                                |       | (145,473              | )          | —         |       | (3,000      | )          | —       |       | —                  |       | —            |       | —          |       | —                 |       | (3,000            | )          |       |       |
| EXERCISE  OF STOCK OPTIONS                                                |       | 625                   |       | —         |       | 251         |       | —       |       | (38,212                 | )          | 305               |       | —          |       | —                 |       | 556               |       |       |       |
| TAX  BENEFIT OF STOCK OPTION EXERCISES                                    |       | —                |       | —         |       | 89          |       | —       |       | —                  |       | —            |       | —          |       | —                 |       | 89                |       |       |       |
| AMORTIZATION  OF GAIN ON TERMINATION OF DERIVATIVE                        |       | —                |       | —         |       | —      |       | —       |       | —                  |       | —            |       | (127            | )          | —                 |       | (127              | )          |       |       |
| STOCK  BASED COMPENSATION                                                 |       | —                |       | —         |       | 1,342       |       | —       |       | —                  |       | —            |       | —          |       | —                 |       | 1,342             |       |       |       |
| RESTRICTED  STOCK ACTIVITY                                                |       | (221,384              | )          | —         |       | (3,994      | )          | —       |       | (282,655                | )          | 2,258             |       | —          |       | —                 |       | (1,736            | )          |       |       |
| ISSUANCE  OF COMMON STOCK TO EMPLOYEE STOCK PURCHASE PLAN       |       | —                |       | —         |       | 169         |       | —       |       | (23,237                 | )          | 186               |       | —          |       | —                 |       | 355               |       |       |       |
| ISSUANCE  OF COMMON STOCK UNDER 2000 DIRECTOR’S STOCK PLAN |       | 582                   |       | —         |       | 195         |       | —       |       | (7,640                  | )          | 61                |       | —          |       | —                 |       | 256               |       |       |       |
|                                                                      |       |                  |       |           |       |        |       |         |       |                    |       |              |       |            |       |                   |       |              |       |       |       |
| BALANCES  AT JUNE 30, 2010                                                |       | 16,069,290            |       | $              | 16         |        | $          | 163,904      |       | $                       | 106,353    |              | 1,136,142  |            | $          | (9,078                 | )          | $                 | 1,295      |       | $          | 1,108 |   | $ | 263,598 |   |   |   |

 

The accompanying notes are an integral part of these consolidated financialstatements.

 

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**CORNELL COMPANIES, INC.**

**CONSOLIDATEDSTATEMENT OF CHANGES IN EQUITY**

**ANDCOMPREHENSIVE INCOME**

**FOR THE SIX MONTHS ENDED JUNE 30, 2009**

**(Unaudited)**

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

 
| ** **                                                      | ** ** | ** **            | ** ** | ** **     | ** ** | ** **  | ** ** | ** **   | ** ** | ** **              | ** ** | ** **        | ** ** | **Accumulated** | ** ** | ** **             | ** ** | ** **        | ** ** | ** ** | ** ** |
|-----------------------------------------------------------------|------------|-----------------------|------------|----------------|------------|-------------|------------|--------------|------------|-------------------------|------------|-------------------|------------|-----------------|------------|------------------------|------------|-------------------|------------|------------|------------|
| ** **                                                      | ** ** | **Common Stock** | ** ** | **Additional** | ** ** | ** **  | ** ** | ** **   | ** ** | ** **              | ** ** | **Other**         | ** ** | **Non-**        | ** ** | **Total**              | ** ** | ** **        | ** ** |
| ** **                                                      | ** ** | ** **            | ** ** | **Par**        | ** ** | **Paid-In** | ** ** | **Retained** | ** ** | **Treasury Stock** | ** ** | **Comprehensive** | ** ** | **Controlling** | ** ** | **Stockholders’** | ** ** | **Comprehensive** | ** ** |
| ** **                                                      | ** ** | **Shares**            | ** ** | **Value**      | ** ** | **Capital** | ** ** | **Earnings** | ** ** | **Shares**              | ** ** | **Cost**          | ** ** | **Income**      | ** ** | **Interest**           | ** ** | **Equity**        | ** ** | **Income** | ** ** |
| ** **                                                      | ** ** | ** **            | ** ** | ** **     | ** ** | ** **  | ** ** | ** **   | ** ** | ** **              | ** ** | ** **        | ** ** | ** **      | ** ** | ** **             | ** ** | ** **        | ** ** | ** ** | ** ** |
| BALANCES  AT DECEMBER 31, 2008                                  |       | 16,238,685            |       | $              | 16         |        | $          | 164,746      |       | $                       | 73,318     |              | 1,506,163  |            | $          | (12,034                | )          | $                 | 1,676      |       | $          | 445 |   | $ | 228,167 |   | $ | — |   |
|                                                            |       |                  |       |           |       |        |       |         |       |                    |       |              |       |            |       |                   |       |              |       |       |       |
| NET  INCOME                                                     |       | —                |       | —         |       | —      |       | 12,487       |       | —                  |       | —            |       | —          |       | 873                    |       | 13,360            |       | 12,487     |       |
| COMPREHENSIVE  INCOME                                           |       |                  |       |           |       |        |       |         |       |                    |       |              |       |            |       |                   |       |              |       | $          | 12,487     |   |
| EXERCISE  OF STOCK OPTIONS                                      |       | 2,550                 |       | —         |       | 32          |       | —       |       | —                  |       | —            |       | —          |       | —                 |       | 32                |       |       |       |
| INCOME  TAX BENEFIT FROM STOCK OPTION EXERCISES                 |       | —                |       |           |       | (71         | )          |         |       |                    |       |              |       |            |       |                   |       | (71               | )          |       |       |
| STOCK  BASED COMPENSATION                                       |       | —                |       | —         |       | 1,634       |       | —       |       | —                  |       | —            |       | —          |       | —                 |       | 1,634             |       |       |       |
| RESTRICTED  STOCK ACTIVITY                                      |       | 153,983               |       | —         |       | (271        | )          | —       |       | —                  |       | —            |       | —          |       | —                 |       | (271              | )          |       |       |
| AMORTIZATION  OF GAIN ON TERMINATION OF DERIVATIVE              |       | —                |       | —         |       | —      |       | —       |       | —                  |       | —            |       | (127            | )          | —                 |       | (127              | )          |       |       |
| ISSUANCE  OF COMMON STOCK TO EMPLOYEE STOCK PURCHASE PLAN  |       | —                |       | —         |       | 143         |       | —       |       | (18,277                 | )          | 146               |       | —          |       | —                 |       | 289               |       |       |       |
| ISSUANCE  OF COMMON STOCK UNDER 2000 DIRECTOR’S STOCK PLAN |       | 8,419                 |       | —         |       | 228         |       | —       |       | —                  |       | —            |       | —          |       | —                 |       | 228               |       |       |       |
|                                                            |       |                  |       |           |       |        |       |         |       |                    |       |              |       |            |       |                   |       |              |       |       |       |
| BALANCES  AT JUNE 30, 2009                                      |       | 16,403,637            |       | $              | 16         |        | $          | 166,441      |       | $                       | 85,805     |              | 1,487,886  |            | $          | (11,888                | )          | $                 | 1,549      |       | $          | 1,318 |   | $ | 243,241 |   |   |   |

 

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

 

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**CORNELL COMPANIES, INC.**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(Unaudited)**

**(in thousands)**

 
| ** **                                                                                               | ** ** | **Six Months Ended** | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                                               | ** ** | **June 30,**              | ** ** |
| ** **                                                                                               | ** ** | **2010**                       | ** ** | **2009** | ** ** |
| CASH FLOWS  FROM OPERATING ACTIVITIES:                                                                   |       |                           |       |   |   |
| Net income                                                                                               |       | $                              | 9,564      |   | $ | 13,360 |   |
| Adjustments  to reconcile net income to net cash provided by operating activities                        |       |                           |       |   |   |
| Depreciation                                                                                             |       | 8,990                          |       | 8,737 |   |
| Amortization  of intangibles                                                                             |       | 264                            |       | 896 |   |
| Amortization  of deferred financing costs                                                                |       | 620                            |       | 635 |   |
| Amortization  of Senior Notes discount                                                                   |       | 92                             |       | 92 |   |
| Amortization  of gain on termination of derivative                                                       |       | (127                           | )          | (127 | ) |
| Stock-based  compensation                                                                                |       | 1,342                          |       | 1,634 |   |
| Provision for  bad debts                                                                                 |       | 685                            |       | 1,265 |   |
| (Gain)loss on  disposal of property and equipment                                                        |       | 35                             |       | (349 | ) |
| Change in  assets and liabilities:                                                                       |       |                           |       |   |   |
| Accounts  receivable                                                                                     |       | (5,671                         | )          | (354 | ) |
| Other restricted  assets                                                                                 |       | (6,723                         | )          | (594 | ) |
| Deferred  income taxes                                                                                   |       | 1,545                          |       | 141 |   |
| Other assets                                                                                             |       | 896                            |       | 1,759 |   |
| Accounts  payable and accrued liabilities                                                                |       | (5,068                         | )          | (9,041 | ) |
| Other liabilities                                                                                        |       | 293                            |       | 224 |   |
| Net cash  provided by operating activities                                                               |       | 6,737                          |       | 18,278 |   |
|                                                                                                     |       |                           |       |   |   |
| CASH FLOWS  FROM INVESTING ACTIVITIES:                                                                   |       |                           |       |   |   |
| Capital  expenditures                                                                                    |       | (13,200                        | )          | (9,493 | ) |
| Proceeds from  the sale/disposals of fixed assets                                                        |       | 541                            |       | 1,688 |   |
| Proceeds from  (payments to) restricted debt payment account, net                                        |       | 1,407                          |       | (6,780 | ) |
| Net cash used  in investing activities                                                                   |       | (11,252                        | )          | (14,585 | ) |
|                                                                                                     |       |                           |       |   |   |
| CASH FLOWS  FROM FINANCING ACTIVITIES:                                                                   |       |                           |       |   |   |
| Proceeds from  line of credit                                                                            |       | —                         |       | 2,000 |   |
| Payments of  line of credit                                                                              |       | (2,600                         | )          | (4,000 | ) |
| Distribution  to MCF partners                                                                            |       | (2,439                         | )          | — |   |
| Tax benefit  of stock option exercises                                                                   |       | 89                             |       | — |   |
| Payments of  capital lease obligations                                                                   |       | (6                             | )          | (7 | ) |
| Purchase and  retirement of common stock                                                                 |       | (3,000                         | )          | — |   |
| Proceeds from  exercise of stock options and employee stock purchase plan                                |       | 911                            |       | 321 |   |
| Net cash used  in financing activities                                                                   |       | (7,045                         | )          | (1,686 | ) |
|                                                                                                     |       |                           |       |   |   |
| NET INCREASE  (DECREASE) IN CASH AND CASH EQUIVALENTS                                                    |       | (11,560                        | )          | 2,007 |   |
| CASH AND CASH  EQUIVALENTS AT BEGINNING OF PERIOD                                                        |       | 27,724                         |       | 14,613 |   |
| CASH AND CASH  EQUIVALENTS AT END OF PERIOD                                                              |       | $                              | 16,164     |   | $ | 16,620 |   |
|                                                                                                     |       |                           |       |   |   |
| OTHER  NON-CASH INVESTING AND FINANCING ACTIVITIES:                                                      |       |                           |       |   |   |
| Common stock  issued for board of directors fees                                                         |       | $                              | 256        |   | $ | 228 |   |
| Tax expense  of stock option exercises                                                                   |       | —                         |       | (71 | ) |
| Purchases and  additions to property and equipment included in accounts payable and accrued  liabilities |       | 1,264                          |       | 1,253 |   |

 

The accompanying notes are anintegral part of these consolidated financial statements.

 

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**CORNELL COMPANIES, INC.****NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

 

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

 

Theaccompanying unaudited consolidated financial statements have been prepared byCornell Companies, Inc. (collectively with its subsidiaries andconsolidated special purpose entities, unless the context requires otherwise,the “Company,” “we,” “us” or “our”) pursuant to the rules and regulationsof the Securities and Exchange Commission. Certain information and footnote disclosures normally included infinancial statements prepared in accordance with generally accepted accountingprinciples in the United States (“GAAP”) have been condensed or omittedpursuant to such rules and regulations. The year-end consolidated balance sheet was derived from auditedfinancial statements but does not include all disclosures required by GAAP. Inthe opinion of management, adjustments and disclosures necessary for a fair presentationof these financial statements have been included.  Estimates were used in the preparation ofthese financial statements.  Actualresults could differ from those estimates. These financial statements should be read in conjunction with thefinancial statements and notes thereto included in the Company’s 2009 AnnualReport on Form 10-K as filed with the Securities and Exchange Commission.

 

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

 

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

 

**3.****             ****MergerAgreement**

 

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

 

Underthe terms of the definitive agreement, stockholders of Cornell will have theoption to elect to receive either (x) 1.3 shares of GEO common stock foreach share of Cornell common stock or (y) an amount of cash considerationequal to the greater of (i) the fair market value of one share of GEOcommon stock plus $6.00 or (ii) the fair market value of 1.3 shares of GEOcommon stock. In order to preserve the tax-deferred treatment of thetransaction, no more than 20% of the outstanding shares of Cornell Common Stockmay be exchanged for the cash consideration. If elections are made such thatthe aggregate cash consideration to be received by Cornell stockholders wouldexceed $100 million in the aggregate, such excess amount may be paid at theelection of GEO in shares of GEO common stock or in cash. GEO has expressed theintent to pay such excess amount in cash, as indicated in the definitive jointproxy statement (“Joint Proxy Statement”) filed by GEO and Cornell with the SECon July 15, 2010.

 

Themerger is expected to close in the third quarter of 2010, subject to theapproval of the issuance of GEO common stock by GEO’s shareholders, approval ofthe transaction by Cornell’s stockholders and, as well as the fulfillment ofother customary conditions. The special meeting of Cornell stockholders toconsider and adopt the agreement and plan of merger will take place onThursday, August 12, 2010. The special meeting of GEO stockholders toconsider and vote upon the issuance of GEO common stock in connection with theproposed merger is scheduled for the same day.

 

Uponthe consummation of the merger, GEO would honor the existing employmentagreements between Cornell and various members of Cornell’s executivemanagement.  The merger would constitute a change of control for purposesof these agreements and, would entitle said members to receive the severanceand other benefits in accordance with the terms of these agreements if theiremployment is terminated.  Please refer to the definitive Joint ProxyStatement/Prospectus filed with the SEC on July 15, 2010, as supplementedon July 22, 2010 for a more detailed discussion of employment and changein control agreements.

 

***Litigation Relating to the Merger***

 

OnApril 27, 2010, a putative stockholder class action was filed in theDistrict Court for Harris County, Texas by Todd Shelby against Cornell, membersof the Cornell board of directors, individually, and GEO. The complaintalleged, among other things, that the Cornell directors breached their dutiesby entering into the Agreement without first taking steps to obtain adequate,fair and maximum consideration for Cornell’s stockholders by shopping thecompany or initiating an auction process, by structuring the transaction totake advantage of Cornell’s low current stock valuation, and by structuring thetransaction to benefit GEO while making an alternative transaction eitherprohibitively expensive or otherwise impossible, and that Cornell and GEO haveaided and abetted such breaches by Cornell’s directors.  The plaintiff filed an amended complaint onMay 28, 2010. The amended complaint added additional allegationscontending that the disclosures about the merger in the Joint Proxy Statementwere misleading and/or inadequate.  Amongother things, the original complaint and the amended complaint seek to enjoinCornell, its directors and GEO from completing the merger and seek aconstructive trust over any benefits improperly received by the defendants as aresult of their alleged wrongful conduct. The parties have reached a settlement of the litigation in principle (atan amount immaterial to the consolidated financial position of the Company),pursuant to which certain additional disclosures were included in the finalform of the Joint Proxy Statement.  Thesettlement did not alter the terms of the transaction or 

 

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theconsideration to be received by shareholders. The settlement remains subject to confirmatory discovery, preparationand execution of a formal stipulation of settlement, final court approval ofthe settlement and dismissal of the action with prejudice.

 

**4.****             ****Stock-BasedCompensation**

 

We have an employee stock purchaseplan (“ESPP”) underwhich employees can make contributions to purchase our common stock.Participation in the plan is elected annually by employees. The plan yeartypically begins each January 1st (the “Beginning Date”) and ends onDecember 31st (the “Ending Date”). Purchases of common stock are made atthe end of the year using the lower of the fair market value on either theBeginning Date or Ending Date, less a 15% discount. Under current authoritativeguidance our employee-stock purchase plan is considered to be a compensatoryESPP, and therefore, we recognize compensation expense over the requisiteservice period for grants made under the ESPP. Compensation expense ofapproximately $0.03 million was recognized in the three months ended June 30,2010 and 2009, respectively. Compensation expense of approximately $0.07million and $0.05 million was recognized in the six months ended June 30,2010 and 2009, respectively.

 

Ourstock incentive plans provide for the granting of stock options (both incentivestock options and nonqualified stock options), stock appreciation rights,restricted stock shares and other stock-based awards to officers, directors andemployees of the Company. Grants of stock options made to date under theseplans vest over periods up to seven years after the date of grant and expire nomore than 10 years after grant. Upon the occurrence of specified change ofcontrol events (which would include consummation of the pending merger of theCompany with The GEO Group as discussed in Note 3), those awards outstandingwhich have not previously vested will automatically vest.

 

AtJune 30, 2009, 317,602 shares of restricted stock were outstanding subjectto performance-based vesting criteria (32,500 of these restricted shares wereconsidered market-based restricted stock under authoritative guidance). Therewere also 6,260 stock options outstanding subject to performance-based vestingcriteria. We recognized $0.4 million and $0.5 million of expense associatedwith these shares of restricted stock and stock options during the three andsix months ended June 30, 2009, respectively.

 

AtJune 30, 2010, 414,488 shares of restricted stock were outstanding subjectto performance-based vesting criteria (22,500 of these restricted shares wereconsidered market-based restricted stock under authoritative guidance). Therewere also stock options for 840 shares outstanding subject to performance-basedvesting criteria. We recognized $0.3 million and $0.4 million of expenseassociated with these shares of restricted stock and stock options during thethree and six months ended June 30, 2010, respectively.

 

The amounts above relate to theimpact of recognizing compensation expense related to stock options andrestricted stock. Compensation expense related to stock options (840 shares)and restricted stock (391,988 shares) that vest based upon performanceconditions is not recorded for such performance-based awards until it has beendeemed probable that the related performance targets allowing the vesting ofthese options and restricted stock will be met. We are required to periodicallyre-assess the probability that these options will vest and begin to recordexpense at that point in time. During the six months ended June 30, 2010and 2009, it was deemed probable that certain performance targets pertaining tocertain restricted stock and stock options would be achieved by their vestingdate. Accordingly, compensation expense of approximately $0.2 million and $0.4million was recognized in the six months ended June 30, 2010 and 2009,respectively, related to these performance-based awards.

 

We recognize expense for ourstock-based compensation over the vesting period, or in the case ofperformance-based awards, during the service period for which the performancetarget becomes probable of being met, which represents the period in which anemployee is required to provide service in exchange for the award. We recognizecompensation expense for stock-based awards immediately if the award hasimmediate vesting.

 

***Assumptions***

 

Thefair values for the significant stock option awards grantedduring the six months ended June 30, 2010 and 2009 were estimated at thedate of grant using a Black-Scholes option pricing model with the followingweighted-average assumptions:

 
| ** **                       | ** ** | **Six Months Ended  June 30,** | ** ** |
|----------------------------------|------------|-----------------------------------------------|------------|
| ** **                       | ** ** | **2010**                                      | ** ** | **2009** | ** ** |
|                             |       |                                          |       |   |   |
| Risk-free rate of return         |       | 3.04                                          | %          | 1.90 | % |
| Expected life of award           |       | 6.0 years                                     |       | 6.0 years |   |
| Expected dividend yield of stock |       | 0                                             | %          | 0 | % |
| Expected volatility of stock     |       | 41.89                                         | %          | 50.49 | % |
| Weighted-average fair value      |       | $                                             | 10.34      |   | $ | 8.89 |   |
|                                  |            |                                               |            |  |  |  |  |

 

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

 

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

 

Stockoption award activityduring the six months ended June 30, 2010 was as follows (aggregateintrinsic value in millions):

 
| ** **                                        | ** ** | **Number  of  Shares** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Remaining  Contractual  Term** | ** ** | **Aggregate  Intrinsic  Value** | ** ** |
|---------------------------------------------------|------------|------------------------|------------|----------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------|------------|
|                                              |       |                   |       |                                   |       |                                                |       |                            |       |
| Outstanding at December 31, 2009             |       | 496,247                |       | $                                      | 15.36      |                                                | 5.9        |                            | $          | 7.6 |   |
| Granted                                           |       | 40,000                 |       | 23.08                                  |       |                                                |       |                            |       |
| Exercised                                         |       | (38,837                | )          | 14.32                                  |       |                                                |       |                            |       |
| Canceled                                          |       | (2,962                 | )          | 11.00                                  |       |                                                |       |                            |       |
|                                              |       |                   |       |                                   |       |                                                |       |                            |       |
| Outstanding at June 30, 2010                 |       | 494,448                |       | $                                      | 16.09      |                                                | 5.8        |                            | $          | 8.0 |   |
|                                              |       |                   |       |                                   |       |                                                |       |                            |       |
| Vested and expected to vest at June 30, 2010 |       | 493,484                |       | $                                      | 16.08      |                                                | 5.8        |                            | $          | 7.9 |   |
|                                              |       |                   |       |                                   |       |                                                |       |                            |       |
| Exercisable at June 30, 2010                 |       | 468,858                |       | $                                      | 15.78      |                                                | 5.6        |                            | $          | 7.4 |   |

 

Thetotal intrinsic value of stock options exercised during the six months endedJune 30, 2010 and 2009 was $0.5 million and $0.01 million, respectively.Net cash proceeds from the exercise of stock options were approximately $0.6million and $0.03 million for the six months ended June 30, 2010 and 2009,respectively.

 

Werecognized $0.2 million of expense associated with time-based stock optionsduring the six months ended June 30, 2010. As of June 30, 2010, approximately $0.2 million of estimatedexpense with respect to time-based nonvested stock-based awards has yet to berecognized and will be amortized into expense over the employee’s remainingrequisite service period of approximately 2.5 months.

 

Thefollowing table summarizes information with respect to stock optionsoutstanding and exercisable at June 30, 2010.

 
| **Range of Exercise Prices** | ** ** | **Number  Outstanding** | ** ** | **Weighted  Average  Remaining  Life (Years)** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Number  Exercisable** | ** ** | **Weighted  Average  Exercise  Price** | ** ** |
|---------------------------------------------|------------|-------------------------|------------|-----------------------------------------------------|------------|----------------------------------------|------------|-------------------------|------------|----------------------------------------|------------|
|                                        |       |                    |       |                                                |       |                                   |       |                    |       |                                   |       |
| $3.75  to  $10.00       |       | 16,355                  |       | 1.3                                                 |       | $                                      | 5.68       |                    | 16,355     |                                   | $          | 5.68 |   |
| $10.01  to  $13.50      |       | 129,225                 |       | 4.1                                                 |       | 12.84                                  |       | 129,225                 |       | 12.84                                  |       |
| $13.51  to  $14.50           |       | 162,168                 |       | 5.2                                                 |       | 13.97                                  |       | 158,468                 |       | 13.96                                  |       |
| $14.51  to  $25.00           |       | 186,700                 |       | 7.8                                                 |       | 21.09                                  |       | 164,810                 |       | 20.83                                  |       |
|                                        |       | 494,448                 |       | 5.8                                                 |       | $                                      | 16.09      |                    | 468,858    |                                   | $          | 15.78 |   |

 

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Stock-basedaward activity for nonvested awards during the six months ended June 30,2010 is as follows:

 
| ** **                          | ** ** | **Number  of  Shares** | ** ** | **Weighted Average  Grant Date  Fair Value** | ** ** |
|-------------------------------------|------------|------------------------|------------|-------------------------------------------------------------|------------|
| Nonvested at December 31, 2009 |       | 20,510                 |       | $                                                           | 20.32      |   |
| Granted                             |       | 40,000                 |       | 23.08                                                       |       |
| Vested                              |       | (34,920                | )          | 22.38                                                       |       |
| Canceled                            |       | —                 |       | —                                                      |       |
|                                |       |                   |       |                                                        |       |
| Nonvested at June 30, 2010     |       | 25,590                 |       | $                                                           | 21.82      |   |

 

***Restricted Stock***

 

We have previously issuedrestricted stock under certain employment agreements and stock incentive planswhich vests either over a specific period of time, generally three to fiveyears, or which will vest subject to certain market or performanceconditions.  Those shares of restrictedcommon stock issued are subject to restrictions on transfer and certainconditions to vesting.  During the sixmonths ended June 30, 2010, we issued restricted stock as part of ournormal equity awards under our 2006 Incentive Plan.

 

Restricted stock activityfor the six months ended June 30, 2010 was as follows:

 
| ** **                          | ** ** | **Number  of  Shares** | ** ** | **Weighted Average  Grant Date  Fair Value** | ** ** |
|-------------------------------------|------------|------------------------|------------|-------------------------------------------------------------|------------|
| Nonvested at December 31, 2009 |       | 520,574                |       | $                                                           | 20.61      |   |
| Granted                             |       | 158,000                |       | 18.48                                                       |       |
| Vested                              |       | (193,024               | )          | 22.80                                                       |       |
| Canceled                            |       | (16,875                | )          | 22.07                                                       |       |
|                                |       |                   |       |                                                        |       |
| Nonvested at June 30, 2010     |       | 468,675                |       | $                                                           | 18.94      |   |

 

We recognized $0.2million and $0.6 million of expense associated with nonvested time-basedrestricted stock awards during the three and six months ended June 30,2010, respectively.  As of June 30,2010, approximately $1.0 million of estimated expense with respect to nonvestedtime-based restricted stock awards had yet to be recognized and will beamortized over a weighted average period of 1.86 years. Approximately$6.9 million of estimated expense with respect to nonvested performance-basedrestricted stock option awards had yet to be recognized as of June 30,2010.

 

**5.     Fair ValueMeasurements**

 

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

 

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

 

Level 1                                Unadjusted quoted prices in active markets that areaccessible at the measurement date for identical, unrestricted assets orliabilities;

 

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

 

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

 

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Asrequired, financial assets and liabilities are classified based on the lowestlevel of input that is significant for the fair value measurement.  The following table summarizes the valuationof our financial assets and liabilities by pricing levels as of June 30,2010 and December 31, 2009:

 
| ** **         | ** ** | **Fair Value as of  June 30, 2010 (in thousands)** | ** ** |
|--------------------|------------|---------------------------------------------------------------------------------------|------------|
| ** **         | ** ** | **Level 1**                                                                      | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Total** | ** ** |
| Assets:            |       |                                                                                  |       |   |   |   |   |   |   |
| Corporate Bonds    |       | $                                                                                     | —     |   | $ | 15,957 |   | $ | — |   | $ | 15,957 |   |
| Money Market Funds |       | —                                                                                |       | 42,054 |   | — |   | 42,054 |   |
|                    |            |                                                                                       |            |  |  |  |  |  |  |  |  |  |  |

 
| ** **         | ** ** | **Fair Value as of  December 31, 2009 (in thousands)** | ** ** |
|--------------------|------------|-------------------------------------------------------------------------------------------|------------|
| ** **         | ** ** | **Level 1**                                                                          | ** ** | **Level 2** | ** ** | **Level 3** | ** ** | **Total** | ** ** |
| Assets:            |       |                                                                                      |       |   |   |   |   |   |   |
| Corporate Bonds    |       | $                                                                                         | —     |   | $ | 9,813 |   | $ | — |   | $ | 9,813 |   |
| Money Market Funds |       | —                                                                                    |       | 43,351 |   | — |   | 43,351 |   |
|                    |            |                                                                                           |            |  |  |  |  |  |  |  |  |  |  |

 

Thecorporate bonds and money market funds are carried in the bond fund paymentaccount and other restricted assets and also in the debt service reserve fundand other restricted assets in the accompanying balance sheet. The fair valuemeasurements for corporate bonds and money-market funds are based upon thequoted price for similar assets in markets that are not active, multiplied bythe number of shares owned, exclusive of any transaction costs and without anyadjustments to reflect discounts that may be applied to selling a large blockof securities at one time.  We do notbelieve that the changes in fair value of these assets will materially differfrom the amounts that could be realized upon settlement or that the changes infair value will have a material effect on our results of operations, liquidityand capital resources.

 

Thisaccounting standard requires a reconciliation of the beginning and endingbalances for fair value measurements using Level 3 inputs. We had no suchassets or liabilities which were measured at fair value on a recurring basisusing significant unobservable inputs (level 3) during the six months endedJune 30, 2010.  We evaluate our long-livedassets for impairment using internally developed, unobservable inputs (Level 3inputs in the fair value hierarchy of fair value accounting) based on theprojected cash flows of our idle facilities. Such inputs that may significantlyinfluence estimated future cash flows include the periods and levels ofoccupancy for the facility, expected per diem or reimbursement rates,assumptions regarding the levels of staffing, services and future operating andcapital expenditures necessary to generate forecasted revenues, related costsfor these activities and future rate of increases or decreases associated withthese factors. Information typically utilized will also include relevant termsof existing contracts (for similar services and customers), market knowledge ofcustomer demand (both present and anticipated) and related pricing, marketcompetitors, and our historical experience (as to areas including customerrequirements, contract terms, operating requirements/costs, occupancy trends, etc.).

 

**6.     Recent AccountingStandards**

 

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

 

InJune 2009, the FASB issued an amendment to the accounting and disclosurerequirements for transfers of financial assets. This amendment applies to the financial reporting of a transfer offinancial assets; the effects of a transfer on an entity’s financial position,financial performance and cash flows; and a transferor’s continuing involvement,if any, in transferred financial assets. It eliminates (1) the exceptions for qualifying special-purposeentities from the consolidation guidance and (2) the exception thatpermitted sale accounting for certain mortgage securitizations when a transferorhas not surrendered control over the transferred financial assets.  The provisions of this amendment must beapplied as of the beginning of each reporting entity’s first annual reportingperiod that begins after November 15, 2009, for interim periods withinthat first annual reporting period and for interim and annual reporting periodsthereafter.  Earlier application wasprohibited.  The requirements in theamendment must be applied to transfers occurring on or after 

 

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theeffective date. Our adoption of this amendment as of January 1, 2010 didnot have a material affect on our consolidated financial position, results ofoperations or cash flows.

 

In June 2009, the FASBalso issued an amendment to the accounting and disclosure requirements for theconsolidation of variable interest entities (“VIEs”). This amendment requiresan enterprise to perform a qualitative analysis when determining whether or notit must consolidate a VIE.  The amendmentalso requires an enterprise to continuously reassess whether it mustconsolidate a VIE.  Additionally, theamendment requires enhanced disclosures about an enterprise’s involvement withVIEs and any significant change in risk exposure due to that involvement, aswell as how its involvement with VIEs impacts the enterprise’s financialstatements.  Finally, an enterprise willbe required to disclose significant judgments and assumptions used to determinewhether or not to consolidate a VIE. This amendment is effective for financialstatements issued for fiscal years beginning after November 15, 2009.  Earlier application was prohibited. Ouradoption of this amendment as of January 1, 2010 did not have a materialaffect on our consolidated financial position, results of operations or cashflows; however, we have included the applicable disclosure requirements at Note14 to the consolidated financial statements.

 

**7.     Intangible Assets**

 

Intangibleassets at June 30, 2010 and December 31, 2009 consisted of thefollowing (in thousands):

 
| ** **                                              | ** ** | **June 30,  2010** | ** ** | **December 31,  2009** | ** ** |
|---------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
|                                                    |       |                    |       |                        |       |
| Acquired contract value                                 |       | $                       | 6,240      |                        | $          | 6,240 |   |
| Accumulated amortization — acquired contract value |       | (5,318                  | )          | (5,055                      | )          |
| Identified intangibles, net                             |       | 922                     |       | 1,185                       |       |
| Goodwill                                                |       | 13,308                  |       | 13,308                      |       |
| Total intangibles, net                                  |       | $                       | 14,230     |                        | $          | 14,493 |   |

 

There were no changes in the carryingamount of our goodwill in the six months ended June 30, 2010.

 

Amortization expense for our acquired contract value was approximately$0.1 million and $0.3 million for the three and six months ended June 30,2010, respectively, and approximately $0.3 million and $0.5 million for thethree and six months ended June 30, 2009, respectively.

 

Our non-compete agreements were fully amortized as of December 31,2009. Amortization expense for our non-compete agreements was approximately$0.2 million and $0.4 million for the three and six months ended June 30,2009, respectively.

 

**8.****             ****CreditFacilities**

 

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

 
| ** **                                                                                                                                                                            | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                            | ** ** | **2010**          | ** ** | **2009**              | ** ** |
| **Debt of Cornell  Companies, Inc.:**                                                                                                                                            |       |              |       |                  |       |
| Senior Notes, unsecured, due July 2012 with  an interest rate of 10.75%, net of discount                                                                               |       | $                 | 111,632    |                  | $          | 111,540 |   |
| Revolving Line of Credit due December 2011  with an interest rate of LIBOR plus 1.50% to 2.25% or prime plus 0.00%  to 0.75% (the “Amended Credit Facility”) |       | 67,400            |       | 70,000                |       |
| Capital lease obligations                                                                                                                                                             |       | 8                 |       | 14                    |       |
| Subtotal                                                                                                                                                                              |       | 179,040           |       | 181,554               |       |
|                                                                                                                                                                                  |       |              |       |                  |       |
| **Debt of Special Purpose Entity:**                                                                                                                                                   |       |              |       |                  |       |
| 8.47% Bonds due 2016                                                                                                                                                                  |       | 121,700           |       | 121,700               |       |
|                                                                                                                                                                                  |       |              |       |                  |       |
| Total consolidated debt                                                                                                                                                               |       | 300,740           |       | 303,254               |       |
|                                                                                                                                                                                  |       |              |       |                  |       |
| Less: current maturities                                                                                                                                                              |       | (13,408           | )          | (13,413               | )          |
|                                                                                                                                                                                  |       |              |       |                  |       |
| Consolidated long-term debt                                                                                                                                                           |       | $                 | 287,332    |                  | $          | 289,841 |   |

 

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***Long-Term Credit Facilities.***  Our Amended CreditFacility provides for borrowings up to $100.0 million (including letters ofcredit) and matures in December 2011. At our election, outstandingborrowings bear interest at either the LIBOR rate plus a margin ranging from1.50% to 2.25% or a rate which ranges from 0.00% to 0.75% above the applicableprime rate. The applicable margins are subject to adjustments based on ourtotal leverage ratio. The available commitment under our Amended CreditFacility was approximately $20.5 million at June 30, 2010.  We had outstanding borrowings under ourAmended Credit Facility of $67.4 million and we had outstanding letters ofcredit of approximately $12.1 million at June 30, 2010.  Subject to certain requirements, we have theright to increase the commitments under our Amended Credit Facility up to$150.0 million, although the indenture for our Senior Notes limits our ability,subject to certain conditions, to expand the Amended Credit Facility beyond$100.0 million. We can provide no assurance that all of the banks that havemade commitments to us under our Amended Credit Facility would be willing toparticipate in an expansion to the Amended Credit Facility should we desire todo so. The Amended Credit Facility iscollateralized by substantially all of our assets, including the assets andstock of all of our subsidiaries. The Amended Credit Facility is not collateralizedby the assets of Municipal Corrections Finance, L.P. (“MCF”).

 

Our Amended Credit Facility containscertain financial and other restrictive covenants that limit our ability toengage in certain activities. Our ability to borrow under the Amended CreditFacility is subject to compliance with certain financial covenants, includingbank leverage, total leverage and fixed charge coverage rates. At June 30,2010, we were in compliance with all such covenants. Our AmendedCredit Facility includes other restrictions that, among other things, limit ourability to: incur indebtedness; grant liens; engage in mergers, consolidationsand liquidations; make investments, restricted payments and asset dispositions;enter into transactions with affiliates; and engage in sale/leasebacktransactions.

 

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

 

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

 

In June 2004, we issued $112.0million in principal of 10.75% Senior Notes the (“Senior Notes”) dueJuly 1, 2012.  The Senior Notes areunsecured senior indebtedness and are guaranteed by all of our existing andfuture subsidiaries (collectively, the “Guarantors”).  The Senior Notes are not guaranteed by MCF(the “Non-Guarantor”).  Interest on theSenior Notes is payable semi-annually on January 1 and July 1 of eachyear, commencing January 1, 2005. On or after July 1, 2008, we have the right to redeem all or a portionof the Senior 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 remainingyears indicated below:

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

 

Asthe Senior Notes are redeemable at our option (subject to the requirementsnoted) we anticipate we will monitor the capital markets and continue to assess(pending the merger) our capital needs and our capital structure, including apotential refinancing of the Senior Notes.

 

Uponthe occurrence of specified change of control events (which would includeconsummation of the pending merger with GEO), unless we have exercised ouroption to redeem all the Senior Notes as described above, each holder will havethe right to require us to repurchase all or a portion of such holder’s SeniorNotes at a purchase price in cash equal to 101% of the aggregate principalamount of the notes repurchased plus accrued and unpaid interest, if any, onthe Senior Notes repurchased, to the applicable date of purchase.  The Senior Notes were issued under anindenture which limits our ability and the ability of our Guarantors to, amongother things, incur additional indebtedness, pay dividends or make otherdistributions, make other restricted payments and investments, create liens,incur restrictions on the ability of the Guarantors to pay dividends or otherpayments to us, enter into transactions with affiliates, and engage in mergers,consolidations and certain sales of assets.

 

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**9.****             ****IncomeTaxes**

 

AtJune 30, 2010, the total amount of our unrecognized tax benefits wasapproximately $2.9 million.

 

Weare subject to income tax in the United States and many of the individualstates we operate in.  We currently havesignificant operations in Texas, California, Colorado, Oklahoma, Georgia, Illinoisand Pennsylvania.  State income taxreturns are generally subject to examination for a period of three to fiveyears after filing.  The state impact ofany changes made to the federal return remains subject to examination byvarious states for a period up to one year after formal notification to thestate.  We are open to United StatesFederal Income Tax examinations for the tax years ended December 31, 2005through December 31, 2009.

 

Wedo not anticipate a significant change in the balance of our unrecognized taxbenefits within the next 12 months.

 

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

 

Basic earnings per share (“EPS”) arecomputed by dividing net income by the weighted average number of shares ofcommon stock outstanding during the period. Diluted EPS is computed by dividing net income by the weightedaverage number of shares of common stock outstanding giving effect to allpotentially dilutive common shares outstanding during the period. Potentiallydilutive common shares include the dilutive effect of outstanding common stockoptions and restricted common stock granted under our various option and otherincentive plans. For the six monthsended June 30, 2010, there were 55,000 shares ($23.60 average price) ofstock options that were not included in the computation of diluted EPS becauseto do so would have been anti-dilutive. There were no anti-dilutive shares forthe three months ended June 30, 2010. For the three and six months ended June 30, 2009, there were141,700 shares ($20.98 average price) of stock options that were not includedin the computation of diluted EPS because to do so would have beenanti-dilutive.  As ofJanuary 1, 2009, instruments with nonforfeitabledividend rights granted in share-based payment transactions areparticipating securities prior to vesting and, therefore, need to be includedin the earnings allocation in computing EPS under the two-class method. For our fiscal year beginning January 1, 2009, since ourrestricted common stock grants (including both vested and those unvested due toeither time or performance requirements) convey nonforfeitable rights todividends while outstanding, they are included in both basic and fully dilutedESP calculations. All prior-period EPS data has been adjustedretrospectively to conform to the calculation of EPS.

 

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

 
| ** **                                                               | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|--------------------------------------------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                               | ** ** | **2010**                                        | ** ** | **2009**                                      | ** ** | **2010** | ** ** | **2009** | ** ** |
|                                                                     |       |                                            |       |                                          |       |   |   |   |   |
| Income  available to stockholders                                        |       | $                                               | 5,130      |                                          | $          | 7,230 |   | $ | 8,409 |   | $ | 12,487 |   |
|                                                                     |       |                                            |       |                                          |       |   |   |   |   |
| Weighted  average common shares outstanding                              |       | 14,944                                          |       | 14,881                                        |       | 14,903 |   | 14,878 |   |
| Weighted  average common share equivalents outstanding                   |       | 167                                             |       | 89                                            |       | 147 |   | 74 |   |
|                                                                     |       |                                            |       |                                          |       |   |   |   |   |
| Weighted  average common shares and common share equivalents outstanding |       | 15,111                                          |       | 14,970                                        |       | 15,050 |   | 14,952 |   |
|                                                                     |       |                                            |       |                                          |       |   |   |   |   |
| Basic income  per share                                                  |       | $                                               | .34        |                                          | $          | .49 |   | $ | .56 |   | $ | .84 |   |
|                                                                     |       |                                            |       |                                          |       |   |   |   |   |
| Diluted  income per share                                                |       | $                                               | .34        |                                          | $          | .48 |   | $ | .56 |   | $ | .84 |   |

 

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

 

***Financial Guarantees***

 

Duringthe normal course of business, we enter into contracts that contain a varietyof representations and warranties and provide general indemnifications. Ourmaximum exposure under these arrangements is unknown as this would involvefuture claims that may be made against us that have not yet occurred. However,based on experience, we believe the risk of loss to be remote.

 

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***Legal Proceedings***

 

Weare party to various legal proceedings, including those noted below. Whilemanagement presently believes that the ultimate outcome of these proceedingswill not have a material adverse effect on our financial position, overalltrends in results of operations or cash flows, litigation is subject toinherent uncertainties, and unfavorable rulings could occur. An unfavorableruling could include monetary damages or equitable relief, and could have amaterial adverse impact on the net income of the period in which the rulingoccurs 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, in July 2009, the Court granted final approval of thesettlement.  The settlement amount underthe terms of the agreement is $3.3 million. Cornell’s portion of the stipulated settlement, based on the number ofinmates housed at VCDC during the time Cornell operated the facility incomparison to the number of inmates housed at the facility during the timeValencia County operated the facility, is $1.2 million and was fundedprincipally through our general liability and professional liability coverage.The claims administration process is under way and we expect it to be completedin the second half of 2010.

 

Inthe year ended December 31, 2007, we previously provided insurancereserves for this matter (as part of our regular review of reported andunreported claims) totaling approximately $0.5 million.  During the fourth quarter of 2008, werecorded an additional settlement charge of approximately $0.7 million and therelated reimbursement from our general liability and professional liabilityinsurance.  The charge and reimbursementwere recognized in general and administrative expenses for the year endedDecember 31, 2008.  Thereimbursement was funded by the insurance carrier in the first quarter of 2009into a settlement account, where it will remain until payments are made to thesettlement class members.

*** ***

***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 theBOP with Bernalillo County, New Mexico (the “County”) through anintergovernmental services agreement, and we have an operating and managementagreement with the County.  InJuly 2007, we were notified by ICE that it was removing all ICE detaineesfrom the RCC and the removal was completed in early August 2007.  Thefacility is still being utilized by the USMS and since May 2008 by theBOP, but not at its full capacity.  InFebruary 2008, ICE informed us that it would not resume use of thefacility.  In February 2008, OFDTattempted to unilaterally amend its agreement with the County to reduce thenumber of minimum annual guaranteed mandays under the agreement from 182,500 to66,300.  Neither we nor the County believe OFDT has the right to unilaterallyamend the contract in this manner, and OFDT has been informed of our position.Although either party to the intergovernmental services agreement has the rightto terminate upon 180 days notice, neither party has exercised such right as ofJune 30, 2010.

 

Duringthe third quarter of 2009, we filed a claim against the United States, actingthrough the United States Department of Justice, OFDT and ICE (collectively,“Defendants”) for breach of contract and breach of the duty of good faith andfair dealing, arising out of the Defendants’ improper modification of theintergovernmental services agreement (the “Contract”) and subsequent failure topay for the shortfalls in the 2007-2008 and 2008-2009 minimum annual guaranteedmandays specified in the Contract. The United States Court of Federal Claimsissued an opinion on July 14, 2010 in Board of County Commissioners of theCounty of Bernalillo, New Mexico, v. United States, Case No. 09-549 C,overturning the government’s decision to unilaterally reduce the number ofmandays it used at the RCC. Cornell and the County successfully argued that theContract with the OFDT obligated the government to utilize the RCC for anagreed upon number of mandays, and the government’s failure to meet that numberrequired the government to pay for unused beds.  The OFDT argued that ithad properly partially terminated the Contract to reduce the number of mandays.The Court will now decide damages for the government’s breach of theagreement.  Cornell and the County believe that the government owesapproximately $4.2 million previously billed to the government for contractyears March 26, 2007 through March 25, 2008 and March 26, 2008 through March25, 2009, plus appropriate Contract Disputes Act interest. The government hasthe right to appeal the decision to the United States Court of Appeals for theFederal Circuit.

 

 

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TheCompany is currently in settlement negotiations on this matter. Based on therecent legal ruling that affirmed that the agreement was not partiallyterminated and therefore billings under the contract terms were appropriate aswell as our ongoing settlement discussions, Cornell recognized an additional$2.7 million contract-based revenue adjustment in the quarter endedJune 30, 2010 related to the contract years March 26, 2007 through March25, 2008 and March 26, 2008 through March 25, 2009.

 

***Litigation Relating to the Merger***

 

OnApril 27, 2010, a putative stockholder class action was filed in theDistrict Court for Harris County, Texas by Todd Shelby against Cornell, membersof the Cornell board of directors, individually, and GEO. The complaintalleged, among other things, that the Cornell directors breached their dutiesby entering into the Agreement without first taking steps to obtain adequate,fair and maximum consideration for Cornell’s stockholders by shopping thecompany or initiating an auction process, by structuring the transaction totake advantage of Cornell’s low current stock valuation, and by structuring thetransaction to benefit GEO while making an alternative transaction eitherprohibitively expensive or otherwise impossible, and that Cornell and GEO have aidedand abetted such breaches by Cornell’s directors.  The plaintiff filed an amended complaint onMay 28, 2010. The amended complaint added additional allegationscontending that the disclosures about the merger in the Joint Proxy Statementwere misleading and/or inadequate.  Amongother things, the original complaint and the amended complaint seek to enjoinCornell, its directors and GEO from completing the merger and seek aconstructive trust over any benefits improperly received by the defendants as aresult of their alleged wrongful conduct. The parties have reached a settlement of the litigation in principle (atan amount immaterial to the consolidated financial position of the Company),pursuant to which certain additional disclosures were included in the finalform of the Joint Proxy Statement.  Thesettlement did not alter the terms of the transaction or the consideration tobe received by shareholders.  Thesettlement remains subject to confirmatory discovery, preparation and executionof a formal stipulation of settlement, final court approval of the settlementand dismissal of the action with prejudice.

 

***Other***

 

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

 

Wecurrently and from time to time are subject to claims and suits arising in theordinary course of business, including claims for damages for personal injuriesor for wrongful restriction of or interference with offender privileges andemployment matters. If an adverse decision in these matters exceeds ourinsurance coverage, or if our coverage is deemed not to apply to these matters,or if the

underlyinginsurance carrier was unable to fulfill its obligation under the insurancecoverage provided, it could have a material adverse effect on our financialcondition, results of operations or cash flows.

 

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

 

**12.  Financial Instruments**

 

Thecarrying amounts of our financial instruments, including cash and cashequivalents, investment securities, accounts receivable and accounts payableand accrued expenses, approximate fair value due to the short term maturitiesof these financial instruments.  AtDecember 31, 2009, the carrying amount of consolidated debt was $303.3million, and the estimated fair value was $309.1 million.  At June 30, 2010, the carrying amountwas $300.7 million and the estimated fair value was $305.6 million.  The estimated fair value of long-term debt isbased primarily on quoted market prices or discounted cash flow analysis forthe same or similar assets.

 

**13.***      ***DerivativeFinancial Instruments And Guarantees**

 

***Debt Service Reserve Fund and DebtService Fund***

 

InAugust 2001, Municipal Corrections Finance, L.P. (“MCF”) completed a bondoffering to finance the 2001 Sale and Leaseback Transaction in which we soldeleven facilities to MCF. In connection with this bond offering, two reservefund accounts were established by MCF pursuant to the terms of the indenture:(1) MCF’s Debt Service Reserve Fund, (as reported in Debt service reservefund and other restricted assets in our Consolidated Balance sheet) aggregating$23.4 million at June 30, 2010, was established to: (a) make paymentson MCF’s outstanding bonds in the event we (as lessee) should fail to make thescheduled rental payments to MCF or (b) to the extent payments were notmade under (a), then to make final debt service payments on the thenoutstanding bonds and (2) MCF’s Bond Fund Payment Account, (as reported inBond fund payment account and other restricted assets in our ConsolidatedBalance Sheet) aggregating $16.0 million at June 30, 2010, was establishedto accumulate the monthly lease payments that MCF receives from us until suchfunds are used to pay MCF’s semi-annual bond interest and annual bond principalpayments, with any excess to pay certain other expenses and to make certaintransfers. These reserve funds are invested in money markets and short-termcommercial paper. Both reserve fund accounts were subject to agreements withthe MCF Equity Investors (Lehman Brothers, Inc. (“Lehman”)) wherebyguaranteed rates of return of 3.0% and 5.08%, respectively, were provided forin the balance of the Debt Service Reserve Fund and the Bond Fund PaymentAccount. The guaranteed rates of return were characterized as cash flow hedgederivative 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 non-controllinginterest) and is included in other long-term liabilities in our ConsolidatedBalance Sheets. Changes in the fair value of the derivative instruments were recordedas an adjustment to other long-term liabilities and reported as othercomprehensive income in our Consolidated Statements of Income and ComprehensiveIncome. Due to the bankruptcy of Lehman in 2008, the derivative instruments nolonger qualified as a hedge and were de-designated. Amounts included inaccumulated other comprehensive income are reclassified into earnings duringthe same periods in which interest is earned on debt service funds(approximately $0.1 million was amortized and recognized in earnings in the sixmonths ended June 30, 2010). Changes in the fair value of thesederivatives after de-designation were recorded to earnings. The derivativeswere terminated in the first quarter of 2009 with a fair value of zero.

 

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Inaccordance with the terms of its partnership agreement, MCF made a distributionof $2.4 million to its partners in April 2010.

 

**14.****      ****VariableInterest Entity**

 

Inconnection with the 2001 Sale and Leaseback Transaction with MCF, the Companydetermined that MCF was a variable interest entity.  The Company concluded that it is the primarybeneficiary of MCF’s activities because substantially all of the operatingassets of MCF are utilized by the Company and the lease payments made by theCompany are the main source of cash available to fund the debt obligations ofMCF.  As a result, our consolidated balancesheet includes the assets and liabilities of MCF. The results of operations ofMCF are reflected in non-controlling interest in our Consolidated Statements ofIncome and Comprehensive Income.

 

**15.****      ****SegmentDisclosure**

 

Ourthree operating divisions are our reportable segments. The Adult SecureServices segment consists of the operations of secure adult incarcerationfacilities. The Abraxas Youth and Family Services segment consists of providingresidential treatment and educational programs and non-residentialcommunity-based programs to juveniles between the ages of 10 and 18 who haveeither been adjudicated or suffer from behavioral problems. The AdultCommunity-Based Services segment consists of providing pre-release

andhalfway house programs for adult offenders who are either on probation orserving the last three to six-months of their sentences on parole and preparingfor re-entry into society at large as well as community-based treatment andeducation programs as an alternative to incarceration. All of our customers andlong-lived assets are located in the United States of America. The accountingpolicies of our reportable segments are the same as those described in thesummary of significant accounting policies in Note 2 in our 2009 Annual Reporton Form 10-K. Intangible assets are not included in each segment’sreportable assets, and the amortization of intangible assets is not included inthe determination of a reportable segment’s operating income. We evaluateperformance based on income or loss from operations before general and administrativeexpenses, incentive bonuses, amortization of intangibles, interest and incometaxes. Corporate and other assets are comprised primarily of cash, accountsreceivable, debt service fund, deposits, property and equipment, deferredtaxes, deferred costs and other assets. Corporate and other expense fromoperations primarily consists of depreciation and amortization on the corporateoffice facilities and equipment and specific general and administrative chargespertaining to corporate personnel and is presented separately as such chargescannot be readily identified for allocation to a particular segment.

 
| ** **                          | ** ** | **Three Months Ended  June 30,** | ** ** | **Six Months Ended  June 30,** | ** ** |
|-------------------------------------|------------|-------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                          | ** ** | **2010**                                        | ** ** | **2009**                                      | ** ** | **2010** | ** ** | **2009** | ** ** |
|                                |       |                                            |       |                                          |       |   |   |   |   |
| Revenues:                           |       |                                            |       |                                          |       |   |   |   |   |
| Adult secure services               |       | $                                               | 61,149     |                                          | $          | 59,272 |   | $ | 119,969 |   | $ | 116,130 |   |
| Abraxas youth  and family services  |       | 24,682                                          |       | 27,711                                        |       | 48,156 |   | 53,399 |   |
| Adult  community-based services     |       | 18,040                                          |       | 18,351                                        |       | 35,752 |   | 35,515 |   |
| Total  revenues                     |       | $                                               | 103,871    |                                          | $          | 105,334 |   | $ | 203,877 |   | $ | 205,044 |   |
|                                |       |                                            |       |                                          |       |   |   |   |   |
| Income from  operations:            |       |                                            |       |                                          |       |   |   |   |   |
| Adult secure services               |       | $                                               | 17,528     |                                          | $          | 17,493 |   | $ | 31,030 |   | $ | 34,608 |   |
| Abraxas youth  and family services  |       | 1,125                                           |       | 3,197                                         |       | 949 |   | 3,931 |   |
| Adult  community-based services     |       | 6,194                                           |       | 5,864                                         |       | 11,830 |   | 10,631 |   |
| Subtotal                            |       | 24,847                                          |       | 26,554                                        |       | 43,809 |   | 49,170 |   |
| General and  administrative expense |       | (8,001                                          | )          | (6,270                                        | )          | (13,760 | ) | (12,408 | ) |
| Amortization  of intangibles        |       | (132                                            | )          | (448                                          | )          | (263 | ) | (896 | ) |
| Corporate and  other                |       | (192                                            | )          | (246                                          | )          | (399 | ) | (490 | ) |
| Total income  from operations       |       | $                                               | 16,522     |                                          | $          | 19,590 |   | $ | 29,387 |   | $ | 35,376 |   |

 
| ** **                         | ** ** | **June 30,** | ** ** | **December 31,** | ** ** |
|------------------------------------|------------|-------------------|------------|-----------------------|------------|
| ** **                         | ** ** | **2010**          | ** ** | **2009**              | ** ** |
| Assets:                            |       |              |       |                  |       |
| Adult secure services              |       | $                 | 373,157    |                  | $          | 356,247 |   |
| Abraxas youth  and family services |       | 100,160           |       | 103,276               |       |
| Adult  community-based services    |       | 61,722            |       | 62,251                |       |
| Intangible  assets, net            |       | 14,230            |       | 14,498                |       |
| Corporate and  other               |       | 104,286           |       | 114,298               |       |
| Total assets                       |       | $                 | 653,555    |                  | $          | 650.565 |   |

 

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

 

We completed an offering of $112.0million of Senior Notes in June 2004. The Senior Notes are guaranteed byeach of our 100% owned subsidiaries (Guarantor Subsidiaries). MCF does notguarantee the Senior Notes (“Non-Guarantor Subsidiary”). These guarantees arefull and unconditional and are joint and several obligations of the GuarantorSubsidiaries. The following condensed consolidating financial informationpresents the financial condition, results of operations and cash flows for theParent, the Guarantor Subsidiaries and the Non-Guarantor Subsidiary, togetherwith the consolidating adjustments necessary to present our results on aconsolidated basis.

 

**Condensed Consolidating Balance Sheet as ofJune 30, 2010 (in thousands) (unaudited)**

 
| ** **                                                   | ** ** | **Parent** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor****Subsidiary** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|--------------------------------------------------------------|------------|------------|------------|-----------------------------|------------|-----------------------------------|------------|------------------|------------|------------------|------------|
| **Assets**                                                   |       |       |       |                        |       |                              |       |             |       |             |       |
| Current  assets:                                             |       |       |       |                        |       |                              |       |             |       |             |       |
| Cash and cash  equivalents                                   |       | $          | 15,991     |                        | $          | 170                               |       | $                | 3          |             | $          | — |   | $ | 16,164 |   |
| Accounts  receivable                                         |       | 1,954      |       | 64,529                      |       | 70                                |       | —           |       | 66,553           |       |
| Restricted  assets                                           |       | —     |       | 4,300                       |       | 24,741                            |       | —           |       | 29,041           |       |
| Prepaids and  other                                          |       | 16,149     |       | 1,565                       |       | 45                                |       | —           |       | 17,759           |       |
| Total current  assets                                        |       | 34,094     |       | 70,564                      |       | 24,859                            |       | —           |       | 129,517          |       |
| Property and  equipment, net                                 |       | 178        |       | 328,861                     |       | 136,959                           |       | (5,577           | )          | 460,421          |       |
| Other assets:                                                |       |       |       |                        |       |                              |       |             |       |             |       |
| Restricted  assets                                           |       | —     |       | —                      |       | 33,270                            |       | —           |       | 33,270           |       |
| Deferred  costs and other                                    |       | 69,849     |       | 23,091                      |       | 4,470                             |       | (67,063          | )          | 30,347           |       |
| Investment in  subsidiaries                                  |       | 105,024    |       | 1,856                       |       | —                            |       | (106,880         | )          | —           |       |
| Total assets                                                 |       | $          | 209,145    |                        | $          | 424,372                           |       | $                | 199,558    |             | $          | (179,520 | ) | $ | 653,555 |   |
|                                                         |       |       |       |                        |       |                              |       |             |       |             |       |
| **Liabilities and Equity**                                   |       |       |       |                        |       |                              |       |             |       |             |       |
|                                                         |       |       |       |                        |       |                              |       |             |       |             |       |
| Current  liabilities:                                        |       |       |       |                        |       |                              |       |             |       |             |       |
| Accounts  payable and accrued liabilities                    |       | $          | 41,197     |                        | $          | 14,489                            |       | $                | 4,361      |             | $          | 803 |   | $ | 60,850 |   |
| Current  portion of long-term debt                           |       | —     |       | 8                           |       | 13,400                            |       | —           |       | 13,408           |       |
| Total current  liabilities                                   |       | 41,197     |       | 14,497                      |       | 17,761                            |       | 803              |       | 74,258           |       |
| Long-term  debt, net of current portion                      |       | 179,032    |       | —                      |       | 108,300                           |       | —           |       | 287,332          |       |
| Deferred tax  liabilities                                    |       | 23,585     |       | 94                          |       | —                            |       | 2,563            |       | 26,242           |       |
| Other  long-term liabilities                                 |       | 5,881      |       | 9                           |       | 67,339                            |       | (71,104          | )          | 2,125            |       |
| Intercompany                                                 |       | (304,148   | )          | 305,310                     |       | —                            |       | (1,162           | )          | —           |       |
| Total liabilities                                            |       | (54,453    | )          | 319,910                     |       | 193,400                           |       | (68,900          | )          | 389,957          |       |
| Total Cornell Companies, Inc. stockholders’ equity |       | 262,490    |       | 104,462                     |       | 6,158                             |       | (110,620         | )          | 262,490          |       |
| Non-controlling interest                                     |       | 1,108      |       | —                      |       | —                            |       | —           |       | 1,108            |       |
| Total equity                                                 |       | 263,598    |       | 104,462                     |       | 6,158                             |       | (110,620         | )          | 263,598          |       |
| Total liabilities and equity                                 |       | $          | 209,145    |                        | $          | 424,372                           |       | $                | 199,558    |             | $          | (179,520 | ) | $ | 653,555 |   |

 

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**Condensed Consolidating Balance Sheet as of December 31, 2009 (inthousands)**

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

 

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**Condensed Consolidating Statement of Operations for the threemonths ended June 30, 2010 (in thousands) (unaudited)**

 
| ** **                                                   | ** ** | **Parent** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiary** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|--------------------------------------------------------------|------------|------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
| ** **                                                   | ** ** | ** ** | ** ** | ** **                  | ** ** | ** **                      | ** ** | ** **       | ** ** | ** **       | ** ** |
| Revenues                                                     |       | $          | 4,502      |                        | $          | 118,937                         |       | $                | 4,502      |             | $          | (24,070 | ) | $ | 103,871 |   |
| Operating  expenses, excluding depreciation and amortization |       | 4,662      |       | 94,068                      |       | 47                              |       | (23,984          | )          | 74,793           |       |
| Depreciation  and amortization                               |       | —     |       | 3,686                       |       | 881                             |       | (12              | )          | 4,555            |       |
| General and  administrative expenses                         |       | 7,982      |       | —                      |       | 19                              |       | —           |       | 8,001            |       |
| Income (loss)  from operations                               |       | (8,142     | )          | 21,183                      |       | 3,555                           |       | (74              | )          | 16,522           |       |
| Overhead  allocations                                        |       | (12,577    | )          | 12,577                      |       | —                          |       | —           |       | —           |       |
| Interest, net                                                |       | 167        |       | 3,505                       |       | 2,690                           |       | (202             | )          | 6,160            |       |
| Equity  earnings in subsidiaries                             |       | 5,102      |       | —                      |       | —                          |       | (5,102           | )          | —           |       |
| Income before  provision for income taxes                    |       | 9,370      |       | 5,101                       |       | 865                             |       | (4,974           | )          | 10,362           |       |
| Provision for  income taxes                                  |       | 4,240      |       | —                      |       | —                          |       | 406              |       | 4,646            |       |
| Net income                                                   |       | 5,130      |       | 5,101                       |       | 865                             |       | (5,380           | )          | 5,716            |       |
| Non-controlling  interest                                    |       | —     |       | —                      |       | —                          |       | 586              |       | 586              |       |
| Income  available to Cornell Companies, Inc.            |       | $          | 5,130      |                        | $          | 5,101                           |       | $                | 865        |             | $          | (5,966 | ) | $ | 5,130 |   |

 

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

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

 

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**Condensed Consolidating Statement of Operations for the sixmonths ended June 30, 2010 (in thousands) (unaudited)**

 
| ** **                                                   | ** ** | **Parent** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiary** | ** ** | **Eliminations** | ** ** | **Consolidated** | ** ** |
|--------------------------------------------------------------|------------|------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|------------------|------------|
| ** **                                                   | ** ** | ** ** | ** ** | ** **                  | ** ** | ** **                      | ** ** | ** **       | ** ** | ** **       | ** ** |
| Revenues                                                     |       | $          | 9,004      |                        | $          | 234,086                         |       | $                | 9,004      |             | $          | (48,217 | ) | $ | 203,877 |   |
| Operating  expenses, excluding depreciation and amortization |       | 8,703      |       | 190,727                     |       | 92                              |       | (48,046          | )          | 151,476          |       |
| Depreciation  and amortization                               |       | —     |       | 7,516                       |       | 1,761                           |       | (23              | )          | 9,254            |       |
| General and  administrative expenses                         |       | 13,722     |       | —                      |       | 38                              |       | —           |       | 13,760           |       |
| Income (loss)  from operations                               |       | (13,421    | )          | 35,843                      |       | 7,113                           |       | (148             | )          | 29,387           |       |
| Overhead  allocations                                        |       | (20,405    | )          | 20,405                      |       | —                          |       | —           |       | —           |       |
| Interest, net                                                |       | 333        |       | 7,005                       |       | 5,410                           |       | (402             | )          | 12,346           |       |
| Equity  earnings in subsidiaries                             |       | 8,433      |       | —                      |       | —                          |       | (8,433           | )          | —           |       |
| Income before  provision for income taxes                    |       | 15,084     |       | 8,433                       |       | 1,703                           |       | (8,179           | )          | 17,041           |       |
| Provision for  income taxes                                  |       | 6,675      |       | —                      |       | —                          |       | 802              |       | 7,477            |       |
| Net income                                                   |       | 8,409      |       | 8,433                       |       | 1,703                           |       | (8,981           | )          | 9,564            |       |
| Non-controlling  interest                                    |       | —     |       | —                      |       | —                          |       | 1,155            |       | 1,155            |       |
| Income  available to Cornell Companies, Inc.            |       | $          | 8,409      |                        | $          | 8,433                           |       | $                | 1,703      |             | $          | (10,136 | ) | $ | 8,409 |   |

 

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

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

 

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**Condensed Consolidating Statement of Cash Flows for the sixmonths ended June 30, 2010 (in thousands) (unaudited)**

 
| ** **                                           | ** ** | **Parent** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiary** | ** ** | **Consolidated** | ** ** |
|------------------------------------------------------|------------|------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|
| **Cash flows from operating activities:**            |       |       |       |                        |       |                            |       |             |       |
| Net cash  provided by (used in) operating activities |       | $          | (6,795     | )                           | $          | 12,518                          |       | $                | 1,014      |   | $ | 6,737 |   |
| ** **                                           | ** ** | ** ** | ** ** | ** **                  | ** ** | ** **                      | ** ** | ** **       | ** ** |
| **Cash flows from investing activities:**            |       |       |       |                        |       |                            |       |             |       |
| Capital  expenditures                                |       | —     |       | (13,200                     | )          | —                          |       | (13,200          | )          |
| Proceeds from  the sale of fixed assets              |       | —     |       | 541                         |       | —                          |       | 541              |       |
| Proceeds from  restricted debt payment account, net  |       | —     |       | —                      |       | 1,407                           |       | 1,407            |       |
| Net cash used  in investing activities               |       | $          | —     |                        | $          | (12,659                         | )          | $                | 1,407      |   | $ | (11,252 | ) |
| ** **                                           | ** ** | ** ** | ** ** | ** **                  | ** ** | ** **                      | ** ** | ** **       | ** ** |
| **Cash flows from financing activities:**            |       |       |       |                        |       |                            |       |             |       |
| Payments of  line of credit                          |       | (2,600     | )          | —                      |       | —                          |       | (2,600           | )          |
| Purchase and  retirement of common stock             |       | (3,000     | )          | —                      |       | —                          |       | (3,000           | )          |
| Distribution  to MCF partners                        |       | —     |       | —                      |       | (2,439                          | )          | (2,439           | )          |
| Tax benefit  of stock option exercises               |       | 89         |       | —                      |       | —                          |       | 89               |       |
| Payments on  capital lease obligations               |       | —     |       | (6                          | )          | —                          |       | (6               | )          |
| Proceeds from  exercise of stock options             |       | 911        |       | —                      |       | —                          |       | 911              |       |
| Net cash used  in financing activities               |       | (4,600     | )          | (6                          | )          | (2,439                          | )          | (7,045           | )          |
| ** **                                           | ** ** | ** ** | ** ** | ** **                  | ** ** | ** **                      | ** ** | ** **       | ** ** |
| **Net decrease in cash and cash equivalents**        |       | (11,395    | )          | (147                        | )          | (18                             | )          | (11,560          | )          |
| ** **                                           | ** ** | ** ** | ** ** | ** **                  | ** ** | ** **                      | ** ** | ** **       | ** ** |
| **Cash and cash equivalents at beginning of period** |       | 27,386     |       | 317                         |       | 21                              |       | 27,724           |       |
| ** **                                           | ** ** | ** ** | ** ** | ** **                  | ** ** | ** **                      | ** ** | ** **       | ** ** |
| **Cash and cash equivalents at end of period**       |       | $          | 15,991     |                        | $          | 170                             |       | $                | 3          |   | $ | 16,164 |   |

 

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

 
| ** **                                                  | ** ** | **Parent** | ** ** | **Guarantor  Subsidiaries** | ** ** | **Non-  Guarantor  Subsidiary** | ** ** | **Consolidated** | ** ** |
|-------------------------------------------------------------|------------|------------|------------|-----------------------------|------------|---------------------------------|------------|------------------|------------|
| **Cash flows from operating activities:**                   |       |       |       |                        |       |                            |       |             |       |
| Net cash  provided by operating activities                  |       | $          | 3,798      |                        | $          | 7,727                           |       | $                | 6,753      |   | $ | 18,278 |   |
| ** **                                                  | ** ** | ** ** | ** ** | ** **                  | ** ** | ** **                      | ** ** | ** **       | ** ** |
| **Cash flows from investing activities:**                   |       |       |       |                        |       |                            |       |             |       |
| Capital  expenditures                                       |       | —     |       | (9,493                      | )          | —                          |       | (9,493           | )          |
| Proceeds from  the sale/disposals of property and equipment |       | —     |       | 1,688                       |       | —                          |       | 1,688            |       |
| Payments to  restricted debt payment account, net           |       | —     |       | —                      |       | (6,780                          | )          | (6,780           | )          |
| Net cash used  in investing activities                      |       | $          | —     |                        | $          | (7,805                          | )          | $                | (6,780     | ) | $ | (14,585 | ) |
| ** **                                                  | ** ** | ** ** | ** ** | ** **                  | ** ** | ** **                      | ** ** | ** **       | ** ** |
| **Cash flows from financing activities:**                   |       |       |       |                        |       |                            |       |             |       |
| Proceeds from  line of credit                               |       | 2,000      |       | —                      |       | —                          |       | 2,000            |       |
| Payments of  line of credit                                 |       | (4,000     | )          | —                      |       | —                          |       | (4,000           | )          |
| Payments on  capital lease obligations                      |       | —     |       | (7                          | )          | —                          |       | (7               | )          |
| Proceeds from  exercise of stock options                    |       | 321        |       | —                      |       | —                          |       | 321              |       |
| Net cash used  in financing activities                      |       | (1,679     | )          | (7                          | )          | —                          |       | (1,686           | )          |
| ** **                                                  | ** ** | ** ** | ** ** | ** **                  | ** ** | ** **                      | ** ** | ** **       | ** ** |
| **Net increase (decrease) in cash and cash equivalents**    |       | 2,119      |       | (85                         | )          | (27                             | )          | 2,007            |       |
| ** **                                                  | ** ** | ** ** | ** ** | ** **                  | ** ** | ** **                      | ** ** | ** **       | ** ** |
| **Cash and cash equivalents at beginning of period**        |       | 14,291     |       | 265                         |       | 57                              |       | 14,613           |       |
| ** **                                                  | ** ** | ** ** | ** ** | ** **                  | ** ** | ** **                      | ** ** | ** **       | ** ** |
| **Cash and cash equivalents at end of period**              |       | $          | 16,410     |                        | $          | 180                             |       | $                | 30         |   | $ | 16,620 |   |

 

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

 

**General**

 

CornellCompanies, Inc. is a leading provider of correctional, detention,educational, rehabilitation and treatment services outsourced by federal,state, county and local government agencies. We provide a diversified portfolioof services for adults and juveniles through our three operating divisions:(1) Adult Secure Services; (2) Abraxas Youth and Family Services and(3) Adult Community-Based Services. At June 30, 2010, we operated 62facilities with a total service capacity of 20,259 and had six facilities witha combined service capacity of 1,133 beds that were vacant. Our facilities arelocated in 15 states and the District of Columbia.

 

Thefollowing table sets forth for the periods indicated total residential servicecapacity and contracted beds in operation at the end of the periods shown,average contract occupancy percentages and total non-residential servicecapacity.

 
| ** **                                                                | ** ** | **June 30,** | ** ** | **June 30,** | ** ** |
|---------------------------------------------------------------------------|------------|-------------------|------------|-------------------|------------|
| ** **                                                                | ** ** | **2010**          | ** ** | **2009**          | ** ** |
| **Residential**                                                           | ** ** | ** **        | ** ** | ** **        | ** ** |
| Service  capacity (1)                                                     |       | 19,284            |       | 18,334            |       |
| Contracted  beds in operation (end of period) (2)                         |       | 17,639            |       | 17,480            |       |
| Average  contract occupancy based on contracted beds in operation (3) (4) |       | 86.9              | %          | 92.2              | %          |
| **Non-Residential**                                                       | ** ** | ** **        | ** ** | ** **        | ** ** |
| Service  capacity (5)                                                     |       | 2,108             |       | 2,558             |       |

 

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

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

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

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

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

 

Duringthe six months ended June 30, 2010, we initiated the transition plan at our D.Ray James Prison from our current customer, the Georgia Department ofCorrections (“GADOC”), to the Federal Bureau of Prisons (“BOP”) (anticipated totake through the fourth quarter of 2010). This will include the ramp-down ofthe current GADOC population, preparation of the facility for the BOP and subsequentramp-up of the BOP population. In the six months ended June 30, 2010, revenuesincluded approximately $2.7 million due to a contract-based revenue adjustmentresulting from the guaranteed population contract at the Regional CorrectionalCenter for the contract years March 26, 2007 through March 25, 2008 and March26, 2008 through March 25, 2009.

 

Althoughwe believe we will continue to see steady, long-term demand across our variousbusiness segments and customer base (federal, state and local), we aremonitoring the continuation of the negative/stagnant economic trends (whichbegan in 2008) and the related impact on government budget plans and the effecttightened spending plans could have on our business (with respect to possibleareas including current utilization and per diem rates, among others) in thenear and short-term.  We expect a keyarea of focus for our performance in 2010 to include the transition of thecustomer at our D. Ray James Prison from GADOC to the BOP (by the fourthquarter of 2010).  As noted, this willinclude the ramp-down of the current GADOC population, preparation of thefacility for the BOP and subsequent ramp-up of the BOP population.

 

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Wealso plan to remain focused on our operating margins, on increasing utilization(particularly in the Abraxas Youth and Family Services division and in ourAdult Secure division) and improving customer mix as we believe thoseinitiatives are the key elements of our financial performance.

 

**Management Overview**

 

***Demand*****.** Our business is driven generally by demand for incarceration ortreatment services, and specifically by demand for private incarceration ortreatment services, within our three primary business segments: Adult SecureServices; Abraxas Youth and Family Services; and Adult Community-BasedServices. The demand for adult and juvenile corrections and treatment serviceshas generally increased at a steady rate over the past ten years, largely as aresult of increasing sentence terms and/or mandatory sentences for criminalsand as well a greater range of criminal acts, increasing demand forincarceration of illegal aliens and a public recognition of the need to provideservices to juveniles that will improve the possibility that they will leadproductive lives. Moreover, demand for our services is also affected by theamount of available capacity in the government systems to enable governments toprovide the services themselves, as well as desire and ability of these systemsto add additional capacity. Furthermore,as a result of, among other things, recent economic developments, federal,state and local governments have encountered, and may continue to encounter,unusual budgetary constraints. As a result, a number of state and localgovernments are under pressure to control additional spending or reduce currentlevels of spending which could limit or eliminate appropriations for thefacilities that we operate, and thus reduce the near term demand for ourservices.**** In addition, the balance betweencommunity-based corrections treatment of adults as an alternative totraditional incarceration continues to be analyzed by many political and societalparties.  Among other things, we monitorfederal, state and industry communications and statistics relative to trends inprison populations, juvenile justice statistics and initiatives, anddevelopments in alternatives to traditional incarceration or detention ofadults for opportunities to expand our scope or delivery of services.

 

The federal government contracts withprivate providers for the incarceration of adults, whether they are servingprison sentences, detained as illegal aliens, detained in anticipation ofpending judicial administration or transitioning from prison to society.  Chief among the federal agencies which useprivate providers are the Federal Bureau of Prisons (“BOP”), U.S. Immigrationand Customs Enforcement (“ICE”) and United States Marshalls Service (“USMS”).We provide adult secure and adult community-based services to the federalgovernment. Most of the federal involvement in juvenile administration in thefederal system is handled via Medicare and Medicaid assistance to state governments.Although there are circumstances in which we may contract with a federal agencyon a sole source basis, the primary means by which we secure a contract with afederal agency is via the RFP bidding process. From time to time, we contract to provide management services to a localgovernmental unit who then bids on a federal contract.

 

States and smaller governmental unitsremain divided on the issue of private prisons and private provision ofjuvenile and community-based programs, although a majority of states permitprivate provision for our services.  Weanticipate that increasing budget pressure on states and smaller governmentalunits may cause more states and smaller governmental units to consider futureutilization of private providers such as us to provide these services on a moreeconomical basis. We believe capital budget constraints among prison agenciesmay encourage them to explore outsourcing to private operators as a futurealternative to deploying their own capital for prison construction or majorrefurbishment. Although it varies from governmental unit to governmental unit,the primary political forces who typically oppose privatization of prisons areorganized labor and religious groups.

 

Private juvenile and community-basedprograms are utilized by states and local governmental units and are organizedon a profit and not-for-profit basis.  Wemonitor opportunities in these segments via our corporate and business divisiondevelopment officers.  Many opportunitiesare not published in any manner and, accordingly, we believe that taking theinitiative at the state and local levels is key in developing sole sourceopportunities.

 

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

 

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

·      occupancy (utilization),

·      per diem reimbursementrates,

·      revenues,

·      operating margins, and

·      operating expenses.

 

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*Capacity. *Capacity,commonly expressed in terms of number of beds, is primarily impacted by thenumber and size of the facilities we own or lease and the facilities we operateon behalf of a third party owner or lessee. We view capacity as one of the measures of our development efforts,through which we may increase capacity by adding new projects or by expandingexisting projects (as we have done in 2007 through 2009 at several of ourfacilities including Great Plains Correctional Facility, D. Ray James Prisonand the Hudson Correctional Facility). As part of the evaluation of our development efforts, we will assess(a) whether a given development project was brought into service inaccordance with our expectation as to time and expense; and (b) the numberof projects in development or under consideration at the relevant point intime.  In addition to the focus on newprojects, capacity will reflect our success in renewing and maintainingexisting contracts and facilities.  Itwill also reflect any closure of programs or facilities due to underutilizationor failure to earn an adequate risk-adjusted rate of return.  We must also be cognizant of the possibilitythat state or local budgetary limitations may cause the contractual commitmentto a given facility to be reduced or even eliminated, which would require us toeither secure an alternate customer or close the operation.

 

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

 

*Per Diem Reimbursement Rates. *Perdiem reimbursement rates are another key element of our gross revenue andoperating margin since per diem contracts represent a majority of our revenues(approximately 57.7% and 58.5% for the three and six months ended June 30,2010, respectively).  Per diem rates area function of negotiation between management and a governmental unit at theinception of a contract or through the bidding process.  Actual per diem rates vary dramaticallyacross our business segments, and within each business segment, depending uponthe particular service or program provided. The initial per diem rates often changeduring the term of a contract in accordance with a schedule.  The amount of the change can be a fixedamount set forth within the contract, an amount determined by formulas setforth within the contract or an amount determined by negotiations betweenmanagement and the governmental unit (often these negotiations are along thesame lines as the original per diem negotiation — a review of expenses andapproval of an amount to recompense for expenses and assure the potential of anoperating profit).  In recent years, asbudgetary pressures on governmental units have increased, some of our customershave negotiated relief from formulaic increase provisions within theiragreements or have declined to include in their appropriation legislationamounts that would increase the per diem rates payable under the contract.Based on the economic turmoil which began in the second half of 2008, we areexpecting such pressures to continue in 2010 for many of our customers. Insimilar prior situations we have attempted to mitigate the impact of thesedevelopments by negotiating services provided, obtaining commitments forincreased volume and other measures. Customers may choose to reduce per diem rates through the reduction ofservices we may provide. We may also choose to consider terminating an existingrelationship at a given facility and replacing it with a new customer (as wasdone with our Great Plains Correctional Facility in 2007 and as we are in theprocess of doing with our D. Ray James Prison in 2010).

 

*Revenues. *We derivesubstantially all of our revenues from providing adult corrections andtreatment and juvenile justice, educational and treatment services outsourcedby federal, state and local government agencies in the United States. Revenuesfor our services are generally recognized on a per diem rate based upon thenumber of occupant days or hours served for the period, on a guaranteedtake-or-pay basis or on a cost-plus reimbursement basis. For the three monthsended June 30, 2010, our revenue base consisted of 57.7% for services providedunder per diem contracts, 37.6% for services provided under take-or-pay andmanagement contracts, 3.1% for services provided under cost-plus reimbursementcontracts and 1.6% for services provided under fee-for-service contracts. Forthe three months ended June 30, 2009, our revenue base consisted of 62.0%for services provided under per diem contracts, 32.5% for services providedunder take-or-pay and management contracts, 3.6% for services provided undercost-plus reimbursement contracts, 1.8% for services provided underfee-for-service contracts and 0.1% from other miscellaneous sources.  For the six months ended June 30, 2010,our revenue base consisted of 58.5% for services provided under per diemcontracts, 36.6% for 

 

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servicesprovided under take-or-pay and management contracts, 3.3% for services providedunder cost-plus reimbursement contracts and 1.6% for services provided underfee-for-service contracts. For the six months ended June 30, 2009 ourrevenue base consisted of 61.8% for services provided under per diem contracts,32.8% for services provided under take-or-pay and management contracts, 3.5%for services provided under cost-plus reimbursement contracts, 1.8% forservices provided under fee-for-service contracts and 0.1% from othermiscellaneous sources. The increase in the services provided under take or payand management contracts for the three and six months ending June 30, 2010 wasprincipally due to the inclusion of approximately $2.7 million from a contract-basedrevenue adjustment resulting from the guaranteed population contract at theRegional Correctional Center for the contract years March 26, 2007 throughMarch 25, 2008 and March 26, 2008 through March 25, 2009.

 

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

 

Factors considered in determining billingrates to charge include: (1) the programs specified by the contract andthe related staffing levels; (2) wage levels customary in the respectivegeographic areas; (3) whether the proposed facility is to be leased orpurchased; and (4) the anticipated average occupancy levels that couldreasonably be expected to be maintained and the duration of time required toreach such occupancy levels.

 

*Revenues-Adult Secure Services. *Revenuesfor our Adult Secure Services division are primarily generated from per diem,take-or-pay and management contracts. For the three months ended June 30, 2010 and 2009, we realizedaverage per diem rates on our adult secure facilities of approximately $56.61and $55.28, respectively. The average per diem rates for the three and sixmonths ended June 30, 2010 exclude the contract-based revenue adjustmentrecognized of approximately $2.7 million pertaining to the RCC.  For the six months ended June 30, 2010and 2009, we realized average per diem rates of approximately $56.12 and$54.52, respectively.  The 2010 averageper diem rate benefited from the activation of our Hudson Correctional Facilityduring the fourth quarter of 2009.  Weperiodically have experienced pressure from contracting governmental agenciesto limit or even reduce per diem rates. Many of these governmental entities areunder severe budget pressures and we anticipate that governmental agencies mayperiodically approach us in 2010 about per diem rate concessions (or decline toprovide funding for contractual rate increases).  Decreases in, or the lack of anticipatedincreases in, per diem rates could adversely impact our operating margin.

 

*Revenues-Abraxas Youth and Family Services. *Revenuesfor our Abraxas Youth and Family Services division are primarily generated fromper diem, fee-for-service and cost-plus reimbursement contracts.  For the three months ended June 30, 2010and 2009, we realized average per diem rates on our residential youth andfamily services facilities of approximately $194.97 and $194.53,respectively.  For the six months endedJune 30, 2010 and 2009, we realized average per diem rates ofapproximately $194.82 and $195.96, respectively.  For the three months ended June 30, 2010and 2009, we realized average fee-for-service rates for our non-residentialcommunity-based Abraxas Youth and Family Services facilities and programs,including rates that are limited by Medicaid and other private insuranceproviders, of approximately $46.15 and $45.17, respectively. For the six monthsended June 30, 2010 and 2009, we realized average fee for service rates ofapproximately $47.28 and $45.12, respectively. The changes in the average fee-for-service rates for are due to changesin the mix of services provided at our non-residential facilities. The majorityof our Abraxas Youth and Family Services contracts renew annually.

 

*Revenues-Adult Community-Based Services. *Revenuesfor our Adult Community-Based Services division are primarily generated fromper diem and fee-for-service contracts. For the three months endedJune 30, 2010 and 2009, we realized average per diem rates on ourresidential adult community-based facilities of approximately $71.35 and$66.85, respectively. For the six months ended June 30, 2010 and 2009, werealized average per diem rates on our residential Adult Community-BasedServices facilities of approximately $70.82 and $67.05, respectively.  For the three months ended June 30, 2010and 2009, we realized average fee-for-service rates on our non-residentialAdult Community-Based Services facilities and programs of approximately $10.05and $10.35, respectively.  For the sixmonths ended June 30, 2010 and 2009, we realized average fee-for-servicerates on our non-residential Adult Community-Based Services facilities andprograms of approximately $9.72 and $9.64, respectively.  Our average fee-for-service rates fluctuatefrom period to period principally due to changes in the mix of servicesprovided by our various Adult Community-Based Services programs and facilities.

 

*Operating Margins. *We havehistorically experienced higher operating margins in our Adult Secure Servicesand Adult Community-Based Services divisions as compared to our Abraxas Youthand Family Services division. Our operating margin, in a given period, will beimpacted by both utilization at active facilities as well as by thosefacilities which may either be dormant or have been reactivated (ordeactivated) during the period. As previously discussed, we have expandedseveral of our Adult Secure facilities (D. Ray James Prison, Great PlainsCorrectional Facility and Walnut Grove Youth Correctional Facility, forexample), which provides the opportunity to leverage existing infrastructure.  Operating margins will generally declineduring a customer transition phase as the original inmate population rampsdown, the facility is prepared, and the new customer population is received. Wewould expect to 

 

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experiencesuch an impact on our Adult Secure Services margins from our D. Ray JamesPrison in 2010 due to its ongoing customer transition.  Additionally, our operating margins within adivision can vary from facility to facility based on whether a facility isowned or leased, the level of competition for the contract award, the proposedlength of the contract, the mix of services provided, the occupancy levels fora facility, the level of capital commitment required with respect to afacility, the anticipated changes in operating costs over the term of thecontract and our ability to increase a facility’s contract revenue.

 

Undertake-or-pay contracts, such as the contract at the Moshannon ValleyCorrectional Center, operating margins are typically higher during the earlystages of the contract as the facility’s population ramps up (as revenues arereceived at contract percentages regardless of actual occupancy). As the variablecosts (primarily resident-related and certain facility costs) increase with thegrowth in population, operating margins will generally decline to a stabilizedlevel. Such an impact is anticipated at our D. Ray James Prison upon theactivation of its transition to the BOP (under its take-or-pay contract) in thefourth quarter of 2010.  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.

 

We have experienced and expect tocontinue to experience interim period operating margin fluctuations due tofactors such as the number of calendar days in the period, higher payroll taxes(generally in the first half of the year) and salary and wage increases andinsurance cost increases that are incurred prior to certain contract rateincreases. Periodically, many of the governmental agencies with whom we contractmay experience budgetary pressures and may approach us to limit or reduce perdiem rates (including contractual price increases as well). We experienced suchbehavior in 2009 and we anticipate such customer behavior will continue in2010. Decreases in, or the lack of anticipated increases in, per diem ratescould adversely impact our operating margin. Additionally, a decrease in perdiem rates without a corresponding decrease in operating expenses could alsoadversely impact our operating margin. Furthermore, our margins may be negatively impacted during a customertransition at a facility due to required population ramp patterns and timing aswe change customers.

 

*Operating Expenses. *We track several different areasof our operating expenses.  Foremostamong these expenses are employee compensation and benefits and expenses, riskrelated areas such as general liability, medical and worker’s compensation,client/inmate costs such as food, clothing, medical and programming costs,financing costs and administrative overhead expenses. Increases or decreases inone or more of these expenses, such as our experience with rising insurancecosts, can have a material effect on our financial performance.  Operating expenses are also impacted bydecisions to close or terminate a particular program or facility.  Such decisions are based on our assessmentsof operating results, operating efficiency and risk-adjusted returns and are anongoing part of our portfolio management. In addition, decisions to restructure employee positions will typicallyincrease period costs initially (at the time of such actions), but generallyreduce post-restructuring expense levels.

 

We are responsible for all facilityoperating costs, except for certain debt service and interest or lease paymentsfor facilities where we have a management contract only. At these facilities,the facility owner is responsible for all debt service and interest or leasepayments related to the facility. We are responsible for all other operatingexpenses at these facilities. We operated 11 and 14 facilities under managementcontracts at June 30, 2010 and 2009, respectively. Included in the 11facilities under management contracts at June 30, 2010 were the WalnutGrove Youth Correctional Facility and the eight Los Angeles County Jails, whichrepresented 1,714 beds of service capacity, or approximately 96.5%, of theresidential service capacity represented by management contracts.

 

A majority of our facility operatingcosts consists of fixed costs. These fixed costs include lease and rentalexpense, insurance, utilities and depreciation. As a result, when we commence operation of new or expanded facilities,fixed operating costs may increase. The amount of our variable operating costs,including food, medical services, supplies and clothing, depend on occupancylevels at the facilities. Our largest single operating cost, facility payrollexpense and related employment taxes and expenses, has both a fixed and avariable component. We can adjust a facility’s staffing levels and the relatedpayroll expense to a certain extent based on occupancy at a facility; however aminimum fixed number of employees are required to operate and maintain anyfacility regardless of occupancy levels. Personnel costs are subject to increasesin tightening labor markets based on local economic environments and otherconditions.

 

We incur pre-opening and start-upexpenses including payroll, benefits, training and other operating costs priorto opening a new or expanded facility (including customer transitions) andduring the period of operation while occupancy is ramping up. These costs varyby contract (and the pace/scale of the activation and related population ramp).We incurred such costs at our Hudson Correctional Facility in conjunction withits activation during the fourth quarter of 2009 and would also expect to incursimilar costs in conjunction with the planned customer transition at our D. RayJames Prison in the second half of 2010. Since pre-opening and start-up costs are generally factored into therevenue per diem rate that is charged to the contracting agency, we typicallyexpect to recover these upfront costs over the life of the contract. Becauseoccupancy rates during a facility’s start-up phase typically result in capacityunder-utilization for at least 90 to 180 days, we may incur additionalpost-opening start-up costs.  We do notanticipate post-opening start-up costs at any adult secure facilities operatedunder any future contracts with the BOP which are take-or-pay contracts,meaning that the 

 

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BOP will pay a certain percentage of thecontractual monthly revenue once the facility opens, regardless of actualoccupancy (with an adjusted percentage level (up to 90%) as the populationachieves certain thresholds). This should be the case when the transitionramp-up of BOP inmates at D. Ray James Prison begins in the fourth quarter of2010.

 

Newlyopened (or reactivated) facilities are staffed according to applicableregulatory or contractual requirements when we begin receiving offenders orclients. Offenders or clients are typically assigned to a newly opened facilityon a phased-in basis over a one- to six-month period. Our start-up period fornew juvenile operations is 12 months from the date we begin recognizing revenueunless break-even occupancy levels are achieved before then. The actual timerequired to ramp a juvenile facility (with an approximate capacity, forexample, of 100 to 200 beds) may be a period of one to three years. Ourstart-up period for new adult operations is nine months from the date we beginrecognizing revenue unless break-even occupancy levels are achieved beforethen.  The approximate time to ramp anadult facility of approximately 1,000 beds may be a period of three to sixmonths, 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 requirements generallyincrease immediately prior to commencing management of a new or expandedfacility as we incur start-up costs and purchase necessary equipment andsupplies before facility management revenue is realized.

 

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

 

**RecentDevelopments**

 

***Merger Agreement***

 

OnApril 18, 2010, the Company entered into an Agreement and Plan of Merger (“Agreement”)with The GEO Group (NYSE:GEO) (“GEO”), a private provider of correctional,detention, and residential treatment services to federal, state and localgovernment agencies around the globe. Pursuant to the Agreement, GEO willacquire Cornell for stock and/or cash at an estimated enterprise value of$685.0 million based on the closing prices of both companies’ stock onApril 16, 2010, including the assumption of approximately $300.0 millionin Cornell debt, excluding cash.

 

Underthe terms of the definitive agreement, stockholders of Cornell will have theoption to elect to receive either (x) 1.3 shares of GEO common stock foreach share of Cornell common stock or (y) an amount of cash considerationequal to the greater of (i) the fair market value of one share of GEOcommon stock plus $6.00 or (ii) the fair market value of 1.3 shares of GEOcommon stock. In order to preserve the tax-deferred treatment of thetransaction, no more than 20% of the outstanding shares of Cornell Common Stockmay be exchanged for the cash consideration. If elections are made such thatthe aggregate cash consideration to be received by Cornell stockholders wouldexceed $100 million in the aggregate, such excess amount may be paid at theelection of GEO in shares of GEO common stock or in cash. GEO has expressed theintent to pay such excess amount in cash, as indicated in the definitive jointproxy statement (“Joint Proxy Statement”) filed by GEO and Cornell with the SECon July 15, 2010.

 

Themerger is expected to close in the third quarter of 2010, subject to theapproval of the issuance of GEO common stock by GEO’s shareholders, approval ofthe transaction by Cornell’s stockholders and, as well as the fulfillment ofother customary conditions. The special meeting of Cornell stockholders toconsider and adopt the agreement and plan of merger will take place onThursday, August 12, 2010. The special meeting of GEO stockholders to considerand vote upon the issuance of GEO common stock in connection with the proposedmerger is scheduled for the same day.

 

Uponthe consummation of the merger, GEO would honor the existing employmentagreements between Cornell and various members of Cornell’s executivemanagement.  The merger would constitute a change of control for purposesof these agreements and, would entitle said members to receive the severanceand other benefits in accordance with the terms of these agreements if theiremployment is terminated.  Please refer to the definitive Joint ProxyStatement/Prospectus filed with the SEC on July 15, 2010, as supplementedon July 22, 2010 for a more detailed discussion of employment and changein control agreements.

 

***Litigation Relating to the Merger***

 

OnApril 27, 2010, a putative stockholder class action was filed in theDistrict Court for Harris County, Texas by Todd Shelby against Cornell, membersof the Cornell board of directors, individually, and GEO. The complaintalleged, among other things, that the Cornell directors breached their dutiesby entering into the Agreement without first taking steps to obtain adequate,fair and maximum consideration for Cornell’s stockholders by shopping thecompany or initiating an auction process, by structuring the transaction totake advantage of Cornell’s low current stock valuation, and by structuring thetransaction to benefit GEO while making an alternative transaction eitherprohibitively expensive or otherwise impossible, and that Cornell and GEO haveaided and abetted such breaches by Cornell’s directors.  The plaintiff filed an amended complaint onMay 28, 2010. The amended complaint added additional allegationscontending that the disclosures about the merger in the Joint Proxy Statementwere misleading and/or inadequate.  Amongother things, the original complaint and the amended complaint seek to enjoinCornell, its directors and GEO from completing the merger and seek aconstructive trust over any benefits improperly received by the defendants as aresult of their alleged wrongful conduct. The parties have reached a settlement of the litigation in principle (atan amount immaterial to the consolidated financial position of the Company),pursuant to which certain additional 

 

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disclosureswere included in the final form of the Joint Proxy Statement.  The settlement did not alter the terms of thetransaction or the consideration to be received by shareholders.  The settlement remains subject toconfirmatory discovery, preparation and execution of a formal stipulation ofsettlement, final court approval of the settlement and dismissal of the actionwith prejudice.

 

***D. Ray James Prison***

 

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

 

**Liquidity and CapitalResources**

 

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

 

***CashFlows From Operating Activities.***  Cash provided by operations wasapproximately $6.7 million for the six months ended June 30, 2010 compared to$18.3 million for the six months ended June 30, 2009, principally due to:(1) a reduction of approximately $3.8 million in net income during the sixmonths ended June 30, 2010 as compared to the same period of the prior year and(2) an increase in restricted assets of approximately $6.7 million.

 

***CashFlows From Investing Activities*****. **Cash used in investing activities wasapproximately $11.3 million for the six months ended June 30, 2010 dueprimarily to capital expenditures of $13.2 million related to our HudsonCorrectional Facility as well as the renovations at the D. Ray James Prison aswe prepare for the transition of the facility to the BOP from the GeorgiaDepartment of Corrections.  These werepartially offset by proceeds from the sale of fixed assets of $0.5 million andproceeds from the restricted debt payment account of $1.4 million.  Cash used in investing activities wasapproximately $14.6 million for the six months ended June 30, 2009 due tocapital expenditures of $9.5 million related to the facility expansion projectsat the D. Ray James Prison and Great Plains Correctional Facility, as well ascertain infrastructure work at our Hudson, Colorado facility offset byinsurance proceeds of $1.7 million (related to damages sustained at the ReidCommunity Residential Facility during Hurricane Ike in September 2008) and netpayments to the restricted debt payment account of $6.8 million.

 

***CashFlows From Financing Activities*****. **Cash used in financing activities wasapproximately $7.0 million for the six months ended June 30, 2010 due topayments on our Amended Credit Facility of $2.6 million and the purchase andretirement of $3.0 million of our common stock. Additionally, MCF made adistribution to its partners of approximately $2.4 million. These werepartially offset by proceeds from the exercise of stock options and theemployee stock purchase plan of $0.9 million. Cash used in financing activitieswas approximately $1.7 million for the six months ended June 30, 2009 dueprimarily to borrowings of $2.0 million on our Amended Credit Facility offsetby payments on the Amended Credit Facility of $4.0 million and proceeds fromthe exercise of stock options of $0.3 million.

 

***TreasuryStock Repurchases.***  We repurchased 145,473 shares of common stockin the six months ended June 30, 2010. All of these shares were retired.  We did not purchase any of our common stockin the six months ended June 30, 2009. Under the terms of our Senior Notes and our Amended Credit Facility, wecan repurchase shares of our stock subject to certain cumulative restrictions.

 

***Long-Term Credit Facilities.***  Our Amended CreditFacility provides for borrowings up to $100.0 million (including letters ofcredit) and matures in December 2011. At our election, outstandingborrowings bear interest, at either the LIBOR rate plus a margin ranging from1.50% to 2.25% or a rate which ranges from 0.00% to 0.75% above the applicableprime rate.  The applicable margins aresubject to adjustments based on our total leverage ratio. The availablecommitment under our Amended Credit Facility was approximately $20.5 million atJune 30, 2010.  We had outstandingborrowings under our Amended Credit Facility of $67.4 million and we hadoutstanding letters of credit of approximately $12.1 million at June 30,2010.  Subject to certain requirements,we have the right to increase the commitments under our Amended Credit Facilityup to $150.0 million, although the indenture for our Senior Notes limits ourability, subject to certain conditions, to expand the Amended Credit Facilitybeyond $100.0 million.  We can provide noassurance that all of the banks that have made commitments to us under ourAmended Credit Facility would be willing to participate in an expansion to theAmended Credit Facility should we desire to do so. The Amended Credit Facility 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.

 

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OurAmended Credit Facility contains financial and other restrictive covenants thatlimit our ability to engage in certain activities.  Our ability to borrow under the AmendedCredit Facility is subject to compliance with certain financial covenants, includingbank leverage, total leverage and fixed charge coverage ratios. AtJune 30, 2010, we were in compliance with all such covenants. Our AmendedCredit Facility includes other restrictions that, among other things, limit ourability to incur indebtedness; grant liens; engage in mergers, consolidationsand liquidations; make investments, restricted payments and asset dispositions;enter into transactions with affiliates; and engage in sale/leasebacktransactions.

 

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

 

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

 

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

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

 

Asthe Senior Notes are redeemable at our option (subject to the requirementsnoted) we anticipate we will monitor the capital markets and continue to assess(pending the Merger) our capital needs and our capital structure, includingpotential refinancing of the Senior Notes.

 

Uponthe occurrence of specified change of control events, (which would includeconsummation of the pending merger with GEO) unless we have exercised ouroption to redeem all the Senior Notes as described above, each holder will havethe right to require us to repurchase all or a portion of such holder’s SeniorNotes at a purchase price in cash equal to 101% of the aggregate principalamount of the notes repurchased plus accrued and unpaid interest, if any, onthe Senior Notes repurchased, to the applicable date of purchase.  The Senior Notes were issued under anindenture which limits our ability and the ability of our Guarantors to, amongother things, incur additional indebtedness, pay dividends or make otherdistributions, make other restricted payments and investments, create liens,incur restrictions on the ability of the Guarantors to pay dividends or otherpayments to us, enter into transactions with affiliates, and engage in mergers,consolidations and certain sales of assets.

 

***Future Liquidity***

 

Ourshelf registration statement under Form S-3 for potential offerings fromtime to time of up to $75.0 million in gross proceeds of debt securities,common stock, preferred stock, warrants or certain other securities wasdeclared effective by the Securities and Exchange Commission inSeptember 2008.

 

Weexpect to use existing cash balances, internally generated cash flows andborrowings from our Amended Credit Facility to fulfill anticipated obligationssuch as capital expenditures, working-capital needs and scheduled debtmaturities over at least the next twelve months.  As of June 30,2010, we had approximately $20.5 million of available capacity under ourAmended Credit Facility.  We will continue to analyze our capitalstructure, including a potential refinancing of our Senior Notes and financingfor our expected future capital expenditures, including any potentialacquisitions.  We will consider potential acquisitions from time totime.  Our principal focus for acquisitions is anticipated to be in ourAdult Secure and Adult Community-Based divisions, although we would also pursueattractively priced acquisitions in our Abraxas Youth and Family Servicesdivision.  We may decide to use internally generated funds, bank financing,equity issuances, debt issuances or a combination of any of the foregoing tofinance our future capital needs. We may also seek, from time to time, toretire or purchase some of our common stock and/or outstanding debt throughcash purchases in open market purchases, privately negotiated transactions orotherwise. Such repurchases, if any, will depend on prevailing marketconditions, our liquidity requirements, contractual restrictions and otherfactors.  In July 2009, our Board ofDirectors authorized a stock repurchase program which provides for up to $10.0million in purchases through December 2010. In 

 

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September2009, we adopted a 10b5-1 Plan to facilitate purchases of our common stockpursuant to such stock repurchase plan. As noted, we purchased approximately $3.0 million of our common stockduring the six months ended June 30, 2010. The Company may also repurchase our common stock in open marketpurchases.  As a result of the proposedMerger with GEO, we terminated the 10b5-1 Plan and we do not intend torepurchase further shares of our common stock pending the Merger.  At June 30, 2010, we believe we have sufficientliquidity necessary to complete those projects (including the facilitymaintenance improvements to be performed in association with the contracttransition preparation at D. Ray James Prison) for which we have outstandingcommitments (as contained in Item 2. “Management’s Discussion and Analysis ofFinancial Conditions and Results of Operations-Contractual Obligations andCommercial Commitments”).

 

Ourinternally generated cash flow is directly related to our business. Should theprivate corrections and juvenile businesses deteriorate, or should weexperience poor results in our operations, cash flow from operations may bereduced. We have, however, continued to generate positive cash flow fromoperating activities over recent years and expect that cash flow will continueto be positive over the next year. Our access to debt and equity markets may bereduced or closed to us due to a variety of events, including, among others,industry conditions, general economic conditions, market conditions, credit ratingagency downgrades of our debt and/or market perceptions of us and ourindustry.  The volatility seen in the financial markets which began in thethird quarter of 2008 and has continued into 2010 (to varying degrees) isexpected to be present (at some level) for the near term.  Such volatilitycould result in decreased availability of capital at economical terms (or atvarious times) and could also put additional financial and budgetary pressureon our customers.  Such conditions could potentially result in ourinability to pursue additional future growth opportunities (such as facilityexpansions or new facility construction) and, if coupled with unexpectedclient, operational or other issues affecting our cash flow, in a need to seekadditional financing at terms we would otherwise not accept.

 

Inaddition, our accounts receivable are with federal, state, county and localgovernment agencies, which we believe generally reduces our credit risk. However, it is possible that situations such as continuing budget resolutions,delayed passage of budgets or budget pressures may increase the length ofrepayment of certain of these receivables. For example, during 2009 the Stateof California notified vendors providing services to the state that it willtemporarily issue IOU’s.  We received IOU’sfrom the State of California which were subsequently paid in full during thethird quarter of 2009.  We do notcurrently hold any IOU’s from the State of California.  In addition, delays in the passage of budgets(such as experienced in the State of Pennsylvania in 2009) may lead totemporary delays in the repayment of our receivables from operations in suchstates.  This would lead to a temporaryincrease in our receivables, as evidenced by the increase in our accountsreceivable — trade in the third quarter of 2009.  As the State of Pennsylvania did not pass afiscal 2010 budget until mid-October 2009, the majority of the cities andcounties in Pennsylvania chose to defer their payments (during the state budgetimpasse present through the third quarter of 2009) until the state budget hadbeen adopted.  Subsequent to the passageof the state’s fiscal 2010 budget, our various Pennsylvania customers returnedto their historic payment patterns. Budgetary pressures, such as those beingexperienced in states including Illinois, may also lead to a temporary increasein our accounts receivable, due to a lengthening of the payment of outstandingbillings.  While we will closely monitorsuch situations, we do not currently expect this to have a significant negativeimpact on the repayment of our receivables related to our facilities in suchlocations.

 

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**Results ofOperations**

 

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

 
| ** **                                                   | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|--------------------------------------------------------------|------------|----------------------------------|------------|--------------------------------|------------|
| ** **                                                   | ** ** | **June 30,**                | ** ** | **June 30,**              | ** ** |
| ** **                                                   | ** ** | **2010**                         | ** ** | **2009**                       | ** ** | **2010** | ** ** | **2009** | ** ** |
|                                                         |       |                             |       |                           |       |   |   |   |   |
| Revenues                                                     |       | 100.0                            | %          | 100.0                          | %          | 100.0 | % | 100.0 | % |
| Operating  expenses, excluding depreciation and amortization |       | 72.0                             |       | 70.9                           |       | 74.3 |   | 72.0 |   |
| Depreciation  and amortization                               |       | 4.4                              |       | 4.5                            |       | 4.5 |   | 4.7 |   |
| General and  administrative expenses                         |       | 7.7                              |       | 6.0                            |       | 6.8 |   | 6.1 |   |
| Income from  operations                                      |       | 15.9                             |       | 18.6                           |       | 14.4 |   | 17.2 |   |
| Interest  expense, net                                       |       | 5.9                              |       | 6.2                            |       | 6.1 |   | 6.1 |   |
| Income from  operations before provision for income taxes    |       | 10.0                             |       | 12.4                           |       | 8.3 |   | 11.1 |   |
| Provision for  income taxes                                  |       | 4.5                              |       | 5.1                            |       | 3.6 |   | 4.6 |   |
| Net income                                                   |       | 5.5                              |       | 7.3                            |       | 4.7 |   | 6.5 |   |
| Non-controlling  interest                                    |       | 0.6                              |       | 0.4                            |       | 0.6 |   | 0.4 |   |
| Income  available to Cornell Companies, Inc.                 |       | 4.9                              | %          | 6.9                            | %          | 4.1 | % | 6.1 | % |

 

***ThreeMonths Ended June 30, 2010 Compared to Three Months Ended June 30,2009***

 

***Revenues*****.**  Revenues decreased approximately $1.4million, or 1.3%, to $103.9 million for the three months ended June 30, 2010from $105.3 million for the three months ended June 30, 2009.

 

*Adult Secure Services.*****Adult Secure Services revenues increased approximately $1.9million, or 3.2%, to $61.2 million for the three months ended June 30, 2010from $59.3 million for the three months ended June 30, 2009 due primarilyto (1) revenues of $4.8 million at the Hudson Correctional Facility whichbegan operations in November 2009 and (2) an increase in revenues of $3.7million at the Regional Correctional Center (“RCC”) due primarily to a $2.7million contract-based revenue adjustment for the contract years March 26, 2007through March 25, 2008 and March 26, 2008 through March 25, 2009. The increasein revenues due to the above, was offset by (1) a decrease in revenues of $3.5million at the D. Ray James Prison due to reduced occupancy as we ramp down thepopulation to transition the facility to the Federal Bureau of Prisons (“BOP”)from the Georgia Department of Corrections (“ GADOC”) and (2) a decrease inrevenues of $0.9 million and $1.4 million, respectively, due to the terminationof our contracts for the Baker Community Correctional Facility (“Baker”) andthe Mesa Verde Community Correctional Facility (“Mesa Verde”) in December2009.  The remaining net change inrevenues of approximately $0.8 million was due to various fluctuations inrevenues at our other Adult Secure Facilities.

 

AtJune 30, 2010, we operated eight Adult Secure Services facilities with anaggregate service capacity of 13,897. Additionally, we had three vacant facilities with a combined servicecapacity of 894 beds at June 30, 2010.  Averagecontract occupancy was 80.4% for the three months ended June 30, 2010compared to 87.3% for the three months ended June 30, 2009. The decreasein the average contract occupancy is primarily due to the under-utilization atour two facilities in California as a result of the termination of ourcontracts for these facilities in December 2009, and as well as reducedoccupancy at the D. Ray James Prison due to its ongoing transition from GADOCto the BOP.  The average per diem ratefor our Adult Secure Services facilities was approximately $56.61 and $55.28for the three months ended June 30, 2010 and 2009, respectively. Theaverage per diem rate for the three months ended June 30, 2010 excludes thecontract-based revenue adjustment noted above pertaining to the RCC.

 

*Abraxas Youth and Family Services.** ***Abraxas Youth and Family Services revenues decreasedapproximately $3.0 million, or 10.8%, to $24.7 million for the three monthsended June 30, 2010 from $27.7 million for the three months ended June 30,2009 due primarily to (1) a net decrease in revenues of $0.5 million dueto the consolidation of the Texas Adolescent Treatment Center (“TATC”)operations with our Hector Garza Residential Treatment Center (“Hector Garza”)in late November 2009, (2) a decrease in revenues of $0.6 million at theCornell Abraxas Center for Adolescent Females (“ACAF”) due to a reduction inoccupancy, (3) a decrease in revenues of $0.5 million at the Cornell Abraxas ofOhio facility due to reduced occupancy and (4) a decrease in revenues of $0.5million due to the termination of our management contracts for the LebanonAlternative Education Program in August 2009 and the State ReintegrationProgram as of June 2009.  The remainingnet decrease in revenues of $0.9 million was due to various fluctuations inrevenues at our other Abraxas Youth and Family Services facilities andprograms.

 

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AtJune 30, 2010, we operated 15 residential AbraxasYouth and Family Services facilities and nine non-residentialcommunity-based programs with an aggregate service capacity of 2,804.Additionally, we had three vacant facilities with a combined service capacityof 239 beds.  Average contract occupancyfor the three months ended June 30, 2010 was 92.8% compared to 89.4% forthe three months ended June 30, 2009. The increase in occupancy for the three months ended June 30, 2010 alsoreflects the decreased service capacity at June 30, 2010 of 3,043 as comparedto 3,391 at June 30, 2009.

 

Theaverage per diem rate for our residential AbraxasYouth and Family Services facilities was approximately $194.97 for thethree months ended June 30, 2010 compared to $194.53 for the three monthsended June 30, 2009.  Our averagefee-for-service rate for our non-residential AbraxasYouth and Family Services community-based facilities and programs wasapproximately $46.15 for the three months ended June 30, 2010 compared to$45.17 for the three months ended June 30, 2009. Our averagefee-for-service rate can fluctuate from period-to-period depending on the mixof services provided at our various AbraxasYouth and Family Services facilities and programs.

 

*Adult Community-Based Services.***AdultCommunity-Based Services revenues decreased approximately $0.4 million, or2.2%, to $18.0 million for the three months ended June 30, 2010 from $18.4million for the three months ended June 30, 2009 due primarily to thetermination of our management contract for the Dallas County Judicial TreatmentCenter (“Dallas”) in late November 2009 which decreased revenues by $1.1million.  The remaining net increase inrevenues of approximately $0.7 million was due to various fluctuations inrevenues at our other Adult Community-Based Services facilities and programs.

 

At June 30, 2010, we operated 27residential Adult Community-Based Services facilities and three non-residentialAdult Community-Based Services programs with an aggregate service capacity of3,558.  Average contract occupancy was 115.5%for the three months ended June 30, 2010 compared to 111.3% for the threemonths ended June 30, 2009.  Theaverage per diem rate for our residential Adult Community-BasedServices facilities was approximately $71.35 for the three months endedJune 30, 2010 compared to $66.85 for the three months ended June 30,2009.  The average fee-for-service ratefor our non-residential Adult Community-Based Services programs wasapproximately $10.05 for the three months ended June 30, 2010 compared to$10.35 for the three months ended June 30, 2009. Our averagefee-for-service rates fluctuate as a result of changes in the mix of servicesprovided by our various Adult Community-Based Services programs and facilities.

 

***OperatingExpenses******.*****Operatingexpenses increased approximately $0.1 million, or 0.1%, to $74.8 million forthe three months ended June 30, 2010 from $74.7 million for the threemonths ended June 30, 2009.

 

*Adult Secure Services.*****Adult Secure Services operating expenses increased approximately$1.6 million, or 4.1%, to $40.5 million for the three months ended June 30,2010 from $38.9 million for the three months ended June 30, 2009 due primarilyto operating expenses of $5.9 million at the Hudson Correctional Facility whichbegan operations in November 2009.  Thisincrease in operating expenses was offset, in part, by (1) a combined decreasein operating expenses of $1.6 million due to the termination of our managementcontracts for Baker and Mesa Verde in December 2009 and (2) a decrease inoperating expenses of $1.2 million at the D. Ray James Prison due to thereduced population in conjunction with the facility transition in process fromGADOC to the BOP.  The remaining netdecrease in operating expenses of $1.5 million was due to various fluctuationsin operating expense at our other Adult Secure Services facilities.

 

Asa percentage of segment revenues, Adult Secure Services operating expenses were66.2% for the three months ended June 30, 2010 compared to 65.6% for thethree months ended June 30, 2009. The decrease in our operating margin for the three months ended June 30,2010 was primarily to (1) the activation of our Hudson Correctional Facility inNovember 2009 (which is currently operating with available capacity), (2) thoseexpenses related to our closed Baker and Mesa Verde facilities and (3) thecustomer transition in process at our D. Ray James Prison.

 

*Abraxas Youth and Family Services.** ***Abraxas Youth and Family Services division operating expenses decreasedapproximately $1.0 million, or 4.2%, to $22.9 million for the three monthsended June 30, 2010 from $23.9 million for the three months ended June 30,2009 due primarily to the consolidation of TATC operations with our HectorGarza facility in late November 2009 which decreased operating expenses byapproximately $0.7 million.  Theremaining net decrease in operating expenses of $0.3 million was due to variousfluctuations in operating expenses at our other Abraxas Youth and FamilyServices facilities and programs.

 

As a percentage of segment revenues, AbraxasYouth and Family Services operating expenses were 92.6% for the three monthsended June 30, 2010 compared to 85.8% for the three months ended June 30,2009.  The decrease in our operating marginin the three months ended June 30, 2010 was due primarily to the decrease inrevenues as noted above (reflective of occupancy and customer mix at certainfacilities).

 

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*Adult Community-Based Services.* Adult Community-Based Services operating expenses decreasedapproximately $0.6 million, or 5.0% to $11.5 million for the three months endedJune 30, 2010 from $12.1 million for the three months ended June 30, 2009due primarily to the termination of our management contract for Dallas in lateNovember 2009 which decreased operating expenses by approximately $0.9million.  The remaining net increase inoperating expenses of approximately $0.3 million was due to variousfluctuations in operating expenses at our other Adult Community-Basedfacilities and programs.

 

As a percentage of segment revenues,Adult Community-Based Services operating expenses were 63.6% for the threemonths ended June 30, 2010 compared to 65.7% for the three months endedJune 30, 2009.

 

***Depreciationand Amortization*****. **Depreciation and amortization expense was approximately $4.5million and $4.7 million for the three months ended June 30, 2010 and 2009,respectively.  Amortization ofintangibles was approximately $0.1 million and $0.5 million for the threemonths ended June 30, 2010 and 2009, respectively.  The decrease in amortization expense in thethree months ended June 30, 2010 was due to the full amortization of ournon-compete agreements as of December 2009.

 

***Generaland Administrative Expenses.***General and administrative expenses increased approximately $1.7 million, or26.9%, to $8.0 million for the three months ended June 30, 2009 compared to$6.3 million for the three months ended June 30, 2009 due primarily tolegal and other professional advisory expenses incurred related to the MergerAgreement in the three months ended June 30, 2010 of approximately $2.3million.

 

***Interest.*** Interest expense, net of interest income, decreased to approximately$6.2 million for the three months ended June 30, 2010 from $6.6 millionfor the three months ended June 30, 2009. The decrease was primarily dueto both lower average borrowings outstanding as well as lower average interestrates during the 2010 period.

 

***IncomeTaxes.***For the threemonths ended June 30, 2010, we recognized a provision for income taxes atan estimated effective rate of 44.8%.  For the three months endedJune 30, 2009, we recognized a provision for income taxes at an estimatedeffective rate of 41.4%.  The change in our estimated effective tax ratein 2010 was related to a decrease in operating income across certain of ourbusiness segments and the increased impact of certain non-deductible expenses(including those attributable to certain stock-based awards).

 

***SixMonths Ended June 30, 2010 Compared to Six Months Ended June 30, 2009***

 

***Revenues*****.**Revenues decreased approximately $1.1 million, or 0.5%, to $203.9 million forthe six months ended June 30, 2010 from $205.0 million for the six monthsended June 30, 2009.

 

*Adult Secure Services.*****Adult Secure Services revenues increased approximately $3.9million, or 3.4%, to $120.0 million for the six months ended June 30, 2010from $116.1 million for the six months ended June 30, 2009 due primarilyto (1) revenues of $9.4 million at the Hudson Correctional Facility which beganoperations in November 2009 and (2) an increase in revenues of $4.3million at RCC due primarily to a contract-based revenue adjustment of $2.7million related to the contract years March 26, 2007 through March 25, 2008 andMarch 26, 2008 through March 25, 2009.This increase in revenues was offset by (1) a decrease in revenues of$2.1 million and $2.9 million, respectively, due to the termination of ourcontracts at Baker and Mesa Verde in December 2009 and (2) a decrease inrevenues of $4.3 million due to the reduced population at the D. Ray James Prisondue reduced occupancy as we transition the facility over to the BOP from the GADOC.  The remaining net decrease in revenues of$0.5 million was due to increases in our other Adult Secure Facilities,primarily the Big Spring Correctional Center.

 

Averagecontract occupancy for the six months ended June 30, 2010 was 81.9% comparedto 89.6% for the six months ended June 30, 2009. The decrease in theaverage contract occupancy is primarily due to the under-utilization at our twofacilities in California as a result of the termination of our contracts forthese facilities in December 2009 as well as reduced occupancy at the D. RayJames Prison in conjunction with its transition from GADOC to the BOP. Theaverage per diem rate for our Adult Secure Services facilities wasapproximately $56.12 and $54.52 for the six months ended June 30, 2010 and2009, respectively. The average per diem rate for the six months ended June 30,2010 excludes the contract-based revenue adjustment noted above pertaining tothe RCC.

 

*Abraxas Youth and Family Services.** ***Abraxas Youth and Family Services revenues decreasedapproximately $5.2 million, or 9.7%, to $48.2 million for the six months endedJune 30, 2010 from $53.4 million for the six months ended June 30,2009 due to (1) a decrease in revenues of $0.8 million due to the consolidationof TATC operations with our Hector Garza facility in late November 2009, (2) adecrease in revenues of $1.0 million at the Cornell Abraxas Academy due toreduced occupancy, (3) a decrease in 

 

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revenues of $0.9 million at ACAF due toreduced occupancy, (4) a decrease in revenues of $0.7 million due to thetermination of management contract for the Lebanon Alternative Education Programin August 2009 and (5) a decrease in revenues of $0.6 million due to thetermination of our management contract for the State Reintegration Program asof June 30, 2009.  The remaining netdecrease in revenues of $1.2 million was due to various fluctuations inrevenues at our other Abraxas Youth and Family Services facilities andprograms.

 

Averagecontract occupancy was 89.9% and 86.8% for the six months ended June 30,2010 and 2009, respectively. The increase in occupancy for the six months endedJune 30, 2010 is also reflective of the decreased service capacity at June 30,2010 of 3,043 as compared to 3,391 at June 30, 2009. The average per diem ratefor our residential Abraxas Youth and Family Services facilities wasapproximately $194.82 and $195.96 for the six months ended June 30, 2010and 2009, respectively.  The averagefee-for-service rate for our non-residential Abraxas Youth and Family Servicescommunity-based facilities and programs was approximately $47.28 and $45.12 forthe six months ended June 30, 2010 and 2009, respectively.

 

*Adult Community-Based Services.* Adult Community-Based Services revenues increased approximately$0.3 million, or 0.8 %, to $35.8 million for the six months ended June 30,2010 from $35.5 million for the six months ended June 30, 2009.  Revenues decreased approximately $2.1 milliondue to the termination of our management contract for the Dallas CountyJudicial Treatment Center in late November 2009.  This decrease in revenues was offset byvarious increases in revenues at our other Adult Community-Based Servicesfacilities and programs, including among other facilities, an increase inrevenues of $0.7 million at the Reid Community Residential Center and anincrease in revenues of $0.4 million at the Grossman Center due to improvedoccupancy.

 

Averagecontract occupancy was 115.4% and 107.4% for the six months ended June 30,2010 and 2009.  The average per diem ratefor our residential Adult Community-Based Services facilities was $70.82 and$67.05 for the six months ended June 30, 2010 and 2009, respectively.  The average fee-for-service rate for ournon-residential Adult Community-Based Services programs was $9.72 and $9.64 forthe six months ended June 30, 2010 and 2009, respectively.

 

***OperatingExpenses.*** Operatingexpenses increased approximately $3.9 million, or 2.6%, to $151.5 million forthe six months ended June 30, 2010 from $147.6 million for the six monthsended June 30, 2009.

 

*Adult Secure Services.*****Adult Secure Services operating expenses increased approximately$6.9 million, or 9.1%, to $82.5 million for the six months ended June 30,2010 from $75.6 million for the six months ended June 30, 2009 dueprimarily to operating expenses of $11.7 million at the Hudson CorrectionalFacility which began operations in November 2009.  This increase in operating expenses wasoffset by (1) a combined decrease in operating expenses of $3.2 million due tothe termination of our contracts at Baker and Mesa Verde in December 2009 and(2) a decrease in operating expenses of $1.4 million at the D. Ray James Prisondue to reduced occupancy. The remaining net decrease in operatingexpenses of $0.2 million was due to various fluctuations in operating expensesat our other Adult Secure Services facilities.

 

As a percentage of segment revenues, AdultSecure Services operating expenses were 68.8% for the six months ended June 30,2010 compared to 65.1% for the six months ended June 30, 2009. The decrease inour operating margin for the six months ended June 30, 2010 was primarily to(1) the activation of our Hudson Correctional Facility in November 2009 (whichis currently operating with available capacity), (2) those expenses related toour closed Baker and Mesa Verde facilities and (3) the customer transition inprocess at our D. Ray James Prison.

 

*Abraxas Youth and Family Services.** ***Abraxas Youth and Family Services operating expenses decreasedapproximately $2.2 million, or 4.6%, to $45.8 million for the six months endedJune 30, 2010 from $48.0 million for the six months ended June 30, 2009due primarily to (1) a decrease in operating expenses of $1.2 million due tothe consolidation of TATC operations with our Hector Garza facility in lateNovember 2009, (2) a decrease in operating expenses of $0.5 million due to thetermination of our management contract for the Lebanon Alternative EducationProgram in August 2009 and (3) a decrease in operating expenses of $0.5 milliondue to the termination of the State Reintegration Program as of June 30, 2009.

 

As a percentage of segment revenues, AbraxasYouth and Family Services operating expenses were 95.2% and 89.9% for the sixmonths ended June 30, 2010 and 2009, respectively.  The decrease in our operating margin for thesix months ended June 30, 2010 was due primarily to the decrease in revenues asnoted above (reflective of occupancy and customer mix at certain facilities).

 

*Adult Community-Based Services.* Adult Community-Based Services operating expenses decreasedapproximately $0.8 million, or 3.3%, to $23.2 million for the six months ended June 30,2010 from $24.0 million for the six months ended June 30, 2009 due primarily to adecrease in operating expenses of $1.5 million due to the termination of ourmanagement contract for the Dallas County Judicial Treatment Center in lateNovember 2009.  The remaining netincrease in operating expenses of $0.7 million was due to various fluctuationsin operating expenses at our other Adult Community-Based Services facilitiesand programs.

 

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Asa percentage of segment revenues, Adult Community-Based Services operatingexpenses were 64.8% for the six months ended June 30, 2010 compared to67.7% for the six months ended June 30, 2009.

 

***Depreciationand Amortization*****.** Depreciation and amortization expense wasapproximately $9.3 million and $9.6 million for the six months ended June 30,2010 and 2009, respectively. Amortization of intangibles was approximately $0.3 million and $0.9million for the six months ended June 30, 2010 and 2009,respectively.  The decrease inamortization expense in the six months ended June 30, 2010 was due to the fullamortization of our non-compete agreements as of December 2009.

 

***Generaland Administrative Expenses.***General and administrative expenses increased approximately $1.4 million, or11.3%, to approximately $13.8 million for the six months ended June 30, 2010from $12.4 million for the six months ended June 30, 2009 due primarily toan increase in legal and other professional advisory expenses related theMerger Agreement (of approximately $2.3 million) in the 2010 period.

 

***Interest.*** Interest expense, net of interest income, decreased toapproximately $12.3 million for the six months ended June 30, 2010 from $12.5million for the six months ended June 30, 2009 due primarily to lowerinterest income in the six months ended June 30, 2010. The decrease in interestexpense was due to both lower average interest rates as well as decreasedborrowings outstanding in the 2010 period. We did not capitalize any interestin the six months ended June 30, 2010. For the six months ended June 30, 2009, we capitalized interest of$0.7 million related to the 700 bed facility expansion project at the D. RayJames Prison.

 

***IncomeTaxes.*** For the six months endedJune 30, 2010, we recognized a provision for income taxes at an estimatedeffective rate of 43.9%.  For the six months ended June 30, 2009, werecognized a provision for income taxes at an estimated effective rate of41.5%.  The change in our estimated effective tax rate in 2010 was relatedto a decrease in operating income across certain of our business segments andthe increased impact of certain non-deductible expenses (including those attributableto certain stock-based awards).

 

***ContractualUncertainties 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, New Mexico (the “County”) through an intergovernmentalservices agreement, and we have an operating and management agreement with theCounty.  In July 2007, we werenotified by ICE that it was removing all ICE detainees from the RCC and theremoval was completed in early August 2007.  The facility is stillbeing utilized by the USMS and since May 2008 by the BOP, but not at itsfull capacity.  In February 2008,ICE informed us that it would not resume use of the facility.  In February 2008, OFDT attempted tounilaterally amend its agreement with the County to reduce the number ofminimum annual guaranteed mandays under the agreement from 182,500 to66,300.  Neither we nor the County believe OFDT has the right tounilaterally amend the contract in this manner, and OFDT has been informed ofour position. Although either party to the intergovernmental services agreementhas the right to terminate upon 180 days notice, neither party has exercisedsuch right as of June 30, 2010.

 

Duringthe third quarter of 2009, we filed a claim against the United States, actingthrough the United States Department of Justice, OFDT and ICE (collectively, “Defendants”)for breach of contract and breach of the duty of good faith and fair dealing,arising out of the Defendants’ improper modification of the intergovernmentalservices agreement (the “Contract”) and subsequent failure to pay for theshortfalls in the 2007-2008 and 2008-2009 minimum annual guaranteed mandaysspecified in the Contract. The United States Court of Federal Claims issued anopinion on July 14, 2010 in Board of County Commissioners of the County ofBernalillo, New Mexico, v. United States, Case No. 09-549 C, overturning thegovernment’s decision to unilaterally reduce the number of mandays it used atthe RCC. Cornell and the County successfully argued that the Contract with theOFDT obligated the government to utilize the RCC for an agreed upon number ofmandays, and the government’s failure to meet that number required thegovernment to pay for unused beds.  The OFDT argued that it had properlypartially terminated the Contract to reduce the number of mandays. The Courtwill now decide damages for the government’s breach of the agreement. Cornell and the County believe that the government owes approximately $4.2million previously billed to the government for contract years March 26, 2007through March 25, 2008 and March 26, 2008 through March 25, 2009, plusappropriate Contract Disputes Act interest. The government has the right toappeal the decision to the United States Court of Appeals for the FederalCircuit.

 

TheCompany is currently in settlement negotiations on this matter. Based on therecent legal ruling that affirmed that the agreement was not partiallyterminated and therefore billings under the contract terms were appropriate aswell as our ongoing settlement discussions, Cornell recognized an additional$2.7 million contract-based revenue adjustment in the quarter endedJune 30, 2010 related to the contract years March 26, 2007 through March25, 2008 and March 26, 2008 through March 25, 2009.

 

 

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

 

InMarch 2009, the Federal Judge presiding over the case issued an Orderbased on motions filed by Plaintiffs class counsel asking the Judge to reformthe 2005 settlement agreements to allow for access to the RCC. In 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 extentit is 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 an appeal ofthe Order to the U.S. Court of Appeals for the Tenth Circuit.  We are not 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 us thatit may want us to absorb a portion of any costs that would be incurred.  We currently plan to continue to operate thefacility and also continue with our marketing plans for the RCC.

 

Revenuesfor this facility were approximately $10.7 million (including the previouslynoted $2.7 million contract-based revenue adjustment) and $6.4 million for thesix months ended June 30, 2010 and 2009, respectively.  The net carrying value of the leaseholdimprovements for this facility was approximately $0.2 million and $0.6 millionat June 30, 2010 and December 31, 2009, respectively. Our lease for thisfacility requires monthly rent payments of approximately $0.13 million for theremaining term of the lease (which was extended through June 2011). Todate, although we have several federal agencies using the RCC, the facilitystill has available capacity.  Ourinability to expand the existing population with current or new customers orany disruption of our operations due to activity in the McClendon case couldhave an adverse effect on our financial condition, results of operations andcash flows.  We believe there has been noimpairment to the carrying value of the leasehold improvements at thisfacility.

 

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

 

Revenuesfor Baker were approximately $0.9 million and $2.1 million for the three andsix months ended June 30, 2009.  Therewere no revenues in the three and six months ended June 30, 2010. The netcarrying value of this owned facility was approximately $2.8 million at June30, 2010 and December 31, 2009.  Weare considering potential alternate customers for this facility (including theprocurement in process for female low-security beds by the CDCR (for which thisfacility would qualify)), but we can make no assurances as to who the customerwill be or what the possible timing might be. We believe that there has been noimpairment to the carrying value of this facility.

 

Revenuesfor Mesa Verde were $1.4 million and $2.9 million for the three and six monthsended June 30, 2009.  There were norevenues for the three and six months ended June 30, 2010. The net carryingvalue of the leasehold improvements for this facility was approximately $0.5million and $0.6 million at June 30, 2010 and December 31, 2009, respectively.Our lease for this facility requires monthly rent payments ranging fromapproximately $0.14 million to $0.16 million over the remaining term of thelease through June 2015. We are considering potential alternate customersfor this facility (including the procurement in process for female low-securitybeds by the CDCR (for which this facility would qualify)), which we believewill ultimately result in the recovery of our investment in this facility.However, we can make no assurances as to who the customer will be (or what thepossible timing might be). We believe that there has been no impairment to thecarrying value of the leasehold improvements at this facility.

 

***Great Plains Correctional Facility.*** On August 6,2010, we announced that we had received notification from the ArizonaDepartment of Corrections (“AZDOC”) of its election not to renew its contractat our 2,048 bed Great Plains Correctional Facility (“Great Plains”) in Hinton,Oklahoma, which is scheduled to expire on September 12, 2010.  The Company will be working with Arizona todetermine the schedule for the transfer of inmates, which the Company expectsto complete in 2010.

 

Revenuesfor Great Plains were approximately $8.6 million and $9.8 million for the threemonths ended June 30, 2010 and 2009, respectively. Revenues wereapproximately $17.3 million and $19.7 million for the six months ended June 30,2010 and 2009, respectively. The net carrying value of this owned facility wasapproximately $80.5 million at June 30, 2010 and $81.5 million at December 31,2009. We are considering potential alternate customers for this facility(including several procurements in-process or pending for which this facilitywould qualify), but we can make no assurances as to who the customer will be orwhat the possible timing might be. We believe that there has been no impairmentto the carrying value of this facility.

 

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

 

Wereview our long-lived assets (including our facilities at afacility-by-facility level) for impairment at least annually or when changes incircumstances or a triggering event indicates that the carrying amount of theasset may not be recoverable in accordance with GAAP.  GAAP requires that long-lived assets to beheld and used recognize an impairment loss only if the carrying amount of thelong-lived asset is not recoverable from its estimated future undiscounted cashflows and to measure an impairment loss as the difference between the carryingvalue and the fair value of the asset. Assets to be disposed of by sale arerecorded at the lower of their carrying amount or fair value less estimatedselling costs. We estimate projections of undiscounted cash flows, and alsofair value, based upon the best information available, which may includeexpected future discounted cash flows to be produced by the asset and/oravailable market prices. Factors that significantly influence estimated futurecash flows include the periods and levels of occupancy for the facility,expected per diem or reimbursement rates, assumptions regarding the levels of staffing,services and future operating and capital expenditures necessary to generateforecasted revenues, related costs for these activities and future rate ofincreases or decreases associated with these factors. Information typicallyutilized will also include relevant terms of existing contracts (for similarservices and customers), market knowledge of customer demand (both present andanticipated) and related pricing, market competitors, and our historicalexperience (as to areas including customer requirements, contract terms,operating requirements/costs, occupancy trends, etc.). We may also consider theresults of any appraisals if a fair value is necessary. Estimates for factorssuch as per diem or reimbursement rates may be highly subjective, particularlyin circumstances where there is no current operating contract in place andchanges in the assumptions and estimates could result in the recognition ofimpairment charges.

 

Wemay be required to record an impairment charge in the future if we are unableto successfully negotiate a replacement contract on any of our facilities forwhich we currently have an operating contract.

 

***Contractual Obligations and CommercialCommitments***

 

We have assumed various financialobligations and commitments in the ordinary course of conducting ourbusiness.  We have contractualobligations requiring future cash payments, such as management and consultingagreements.

 

We maintain operating leases in theordinary course of our business activities. These leases include those for operating facilities, office space andoffice and operating equipment, and the agreements expire between 2010 and2075. As of June 30, 2010, our total commitment under these operating leaseswas approximately $125.8 million.

 

Thefollowing table details the known future cash payments (on an undiscountedbasis) related to our various contractual obligations as of June 30, 2010 (inthousands):

 
| ** **                           | ** ** | **Payments Due by Period** | ** ** |
|--------------------------------------|------------|-------------------------------------------|------------|
| ** **                           | ** ** | ** **                                | ** ** | ** ** | ** ** | **2011 -** | ** ** | **2013 -** | ** ** | ** ** | ** ** |
| ** **                           | ** ** | **Total**                                 | ** ** | **2010** | ** ** | **2012** | ** ** | **2014** | ** ** | **Thereafter** | ** ** |
|                                 |       |                                      |       |   |   |   |   |   |   |   |   |
| **Contractual Obligations:**         |       |                                      |       |   |   |   |   |   |   |   |   |
| Long-term debt — principal      |       |                                      |       |   |   |   |   |   |   |   |   |
| · Cornell  Companies, Inc. |       | $                                         | 112,000    |   | $ | — |   | $ | 112,000 |   | $ | — |   | $ | — |   |
| · Special Purpose Entity        |       | 121,700                                   |       | 13,400 |   | 30,400 |   | 35,800 |   | 42,100 |   |
| Long-term debt — interest       |       |                                      |       |   |   |   |   |   |   |   |   |
| · Cornell Companies, Inc.  |       | 24,080                                    |       | 6,020 |   | 18,060 |   | — |   | — |   |
| · Special Purpose Entity        |       | 39,424                                    |       | 5,154 |   | 17,110 |   | 11,740 |   | 5,420 |   |
| Revolving line of credit-principal   |       |                                      |       |   |   |   |   |   |   |   |   |
| · Cornell  Companies, Inc. |       | 67,400                                    |       | — |   | 67,400 |   | — |   | — |   |
| Revolving line of credit-interest    |       |                                      |       |   |   |   |   |   |   |   |   |
| · Cornell  Companies, Inc. |       | 2,157                                     |       | 724 |   | 1,433 |   | — |   | — |   |
| Capital lease obligations            |       |                                      |       |   |   |   |   |   |   |   |   |
| · Cornell  Companies, Inc. |       | 8                                         |       | 8 |   | — |   | — |   | — |   |
| Construction commitments             |       | 2,758                                     |       | 2,758 |   | — |   | — |   | — |   |
| Operating leases                     |       | 125,757                                   |       | 8,761 |   | 29,648 |   | 27,585 |   | 59,763 |   |
| Total contractual cash obligations   |       | $                                         | 495,284    |   | $ | 36,825 |   | $ | 276,051 |   | $ | 75,125 |   | $ | 107,283 |   |

 

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Approximately$2.9 million of unrecognized tax benefits have been recorded as liabilities asof June 30, 2010 but are not included in the contractual obligations tableabove because we are uncertain as to if or when such amounts may besettled.  Related to the unrecognized taxbenefits not included in the table above, we have also recorded a liability forpotential penalties of approximately $0.1 million and for interest ofapproximately $0.2 million as of June 30, 2010.

 

Weenter into letters of credit in the ordinary course of operating and financingactivities.  As of June 30, 2010, wehad outstanding letters of credit of approximately $12.1 million primarily forcertain workers’ compensation insurance and other operating obligations.  The following table details our letters ofcredit commitments as of June 30, 2010 (in thousands):

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

 

**ITEM 3.****     ****QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK**

 

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

 

**Credit Risk**

 

Dueto the short duration of our investments, changes in market interest rateswould not have a significant impact on their fair value.  In addition, ouraccounts receivables are with federal, state, county and local governmentagencies, which we believe reduces our credit risk. However, it is possiblethat such situations as continuing budget resolutions, delayed passage ofbudgets or budget pressures may increase the length of repayment of certainreceivables.  During the third quarter of2009 the State of California notified vendors providing services to the statethat it would temporarily issue IOU’s. We received IOU’s from the State of California which were subsequentlyrepaid prior to September 30, 2009, and we do not presently hold any IOU’sfrom the State of California as of December 31, 2009.  In addition, delays in the passage of budgets(such as experienced in the State of Pennsylvania in 2009) may lead totemporary delays in the repayment of our receivables from operations in such states.As the State of Pennsylvania did not pass a fiscal 2010 budget untilmid-October 2009, the majority of the cities and counties in Pennsylvaniachose to defer their payments (during the state budget impasse through thethird quarter 2009) until the state budget had been adopted. Subsequent to thepassage of the state’s fiscal 2010 budget, our various Pennsylvania customersreturned to their historic payment patterns. Budgetary pressures, such as thosebeing experienced in states including Illinois, may also lead to a temporaryincrease in our accounts receivable, due to a lengthening of the payment ofoutstanding billings. While we closely monitor such situations, we do notcurrently expect this to have a permanent impact on the repayment of our receivablesrelated to our facilities.

 

**Interest Rate Exposure**

 

Our exposure to changes in interest ratesprimarily results from our Amended Credit Facility, as these borrowings havefloating interest rates.  The debt on ourconsolidated financial statements at June 30, 2010 with fixed interest ratesconsist of the 8.47% Bonds issued by MCF, in August 2001 in connectionwith the 2001 Sale and Leaseback Transaction and $112.0 million of SeniorNotes.  The detrimental effect of ahypothetical 100 basis point increase in interest rates on our currentborrowings under our Amended Credit Facility would be to reduce income beforeprovision for income taxes by approximately $0.3 million for the six months endedJune 30, 2010.  At June 30, 2010, thefair value of our consolidated debt was approximately $305.6 million based uponquoted market prices or discounted future cash flows using the same or similarsecurities.

 

**Inflation**

 

Other than personnel,offender medical costs at certain facilities, and employee medical and worker’scompensation insurance costs, we believe that inflation has not had a materialeffect on our results of operations during the past two years.  We have experienced significant increases 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 contracts provide for payments of eitherfixed per diem fees or per diem fees that increase by only small amounts duringthe term of the contracts. Inflation could substantially increase our personnelcosts (the largest component of our operating expenses), medical and insurancecosts or other operating expenses at rates faster than any increases incontract revenues.  Food costs (part ofour resident/inmate care costs) were also 

 

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subject to rising prices in 2009 and 2010.  We believe we have limited our exposurethrough long-term contracts with fixed term pricing.

 

**ITEM 4.****     ****CONTROLS AND PROCEDURES**

 

**Evaluation of Disclosure Controls and Procedures**

 

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

 

We do not expect that our disclosurecontrols and procedures will prevent all errors or fraud. A control system, nomatter how well conceived and operated, can provide only reasonable, notabsolute, 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.

 

Underthe supervision and with the participation of our management, including ourprincipal executive officer and principal financial officer, and as required byparagraph (b) of Rules 13a-15 and 15d-15 of the Exchange Act, we haveevaluated the effectiveness of the design and operation of our disclosurecontrols and procedures (as defined in Rules 13a-15(e) and15d-15(e) of the Exchange Act) as of the end of the period required bythis report. Based on that evaluation, our principal executive officer andprincipal financial officer have concluded that these controls and proceduresare effective at a reasonable assurance level as of that date.

 

**Changes in 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 inRules 13a-15(f) and 15d-15(f) under Exchange Act) that occurredduring our fiscal quarter ended June 30, 2010 that has materially affected, oris reasonably likely to materially affect, our internal control over financialreporting.

 

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

 

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

 

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

 

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

 

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

 

**Risks Related to the Merger**

 

***There can be no assurance that theproposed merger of The GEO Group and Cornell will be consummated.  Theannouncement and pendency of the Merger, or the failure of the Merger to beconsummated, could have an adverse effect on Cornell’s stock price, business,financial condition, results of operations or prospects.***

 

Wehave entered into an Agreement and Plan of Merger with The GEO Group, Inc.(“GEO”) and GEO Acquisition III, Inc. (“Merger Sub”), dated April 18,2010, as amended on July 22, 2010 (the “Merger Agreement”), pursuant to whichGEO will acquire the Company (the “Merger”). The Merger is subject to a numberof conditions to closing, including (i) the approval of the issuance ofshares of GEO common stock in accordance with the terms of the MergerAgreement, (ii) the adoption of the Merger Agreement by the Cornellstockholders, (iii) the expiration or termination of the waiting period(and any extension thereof) or the resolution of any litigation institutedapplicable to the Merger under the Hart-Scott-Rodino Antitrust Improvements Actof 1976, as amended (the “HSR Act”) or any other applicable federal or statestatute or regulation, (iv) no temporary restraining order, preliminary orpermanent injunction or other order shall have been issued (and remain ineffect) by a court or other governmental entity having the effect of making themerger illegal or otherwise prohibiting the consummation of the Merger,(v) the approval for listing on the New York Stock Exchange of the sharesof GEO common stock issuable in connection with the Merger, and (vi) thereceipt of certain third party contractual approvals that are required as aresult of the Merger.

 

Ifthe stockholders of GEO fail to approve the GEO share issuance or if Cornellstockholders fail to adopt the Merger Agreement, we will not be able tocomplete the Merger.  Additionally, if the other closing conditions arenot met or waived, we will not be able to complete the Merger.  As aresult, there can be no assurance that the Merger will be completed in a timelymanner or at all.

 

Further,the announcement and pendency of the Merger could disrupt our businesses, inany of the following ways, among others:

 

·      Our employees mayexperience uncertainty about their future roles with the combined company,which might adversely affect our ability to retain and hire key managers andother employees;

 

·      the attentionof our management may be directed toward the completion of the merger andtransaction-related considerations and may be diverted from the day-to-daybusiness operations of Cornell; and

 

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

 

Wemay face additional challenges in competing for new business and retaining orrenewing business.  These disruptions could be exacerbated by a delay inthe completion of the Merger or termination of the Merger Agreement.

 

Forthe foregoing reasons, there can be no assurance that the announcement andpendency of the Merger, or the failure of the Merger to be consummated, willnot have an adverse effect on our stock price, business, financial condition,results of operations or prospects.

 

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***The Merger Agreement limits ourability to pursue an alternative acquisition proposal and requires us to pay atermination fee of $12 million, plus expenses, if it does.***

 

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

 

***There may be a delay between GEO andCornell each receiving the necessary stockholder approvals for the Merger andthe closing of the transaction, during which time we will lose the ability toconsider and pursue alternative acquisition proposals, which might otherwise besuperior to the Merger.***

 

Followingthe GEO shareholder and Cornell stockholder approvals, the Merger Agreementprohibits us from taking any actions to review, consider or recommend anyalternative acquisition proposals, including those that could provide asuperior benefit to our stockholders when compared to the Merger.  Giventhat there could be a delay between stockholder approval and closing, the timeduring which we could be prevented from reviewing, considering or recommendingsuch proposals could be significant.

 

***A lawsuit has been filed against Cornell, membersof Cornell’s board of directors and GEO challenging the Merger, and anunfavorable judgment or ruling in this lawsuit could prevent or delay theconsummation of the Merger, result in substantial costs or both.***

 

Cornell, its directors and GEO were named in apurported stockholder class action complaint filed in Texas state court. Thecomplaint, as amended, alleged, among other things, that Cornell’sdirectors breached their fiduciary duties by entering into the Merger Agreementwithout first taking steps to obtain adequate, fair and maximum considerationfor Cornell’s stockholders by shopping the company or initiating an auctionprocess, by structuring the transaction to take advantage of Cornell’s currentlow stock valuation, and by structuring the transaction to benefit GEO whilemaking an alternative transaction either prohibitively expensive or otherwiseimpossible, that the disclosures about the Merger in the Joint ProxyStatement were misleading and/or inadequate, and that the corporate defendantsaided and abetted such breaches by Cornell’s directors.  Theplaintiffs sought, among other things, both an injunction prohibiting theMerger and a constructive trust in an unspecified amount.  As described inPart II, Item 1. Legal Proceedings above, the parties have reached a settlementin principle resolving this litigation.  However, the settlement remainssubject to confirmatory discovery, preparation and execution of a formalstipulation of settlement, final court approval of the settlement and dismissalof the action with prejudice, and there can be no assurance that suchconditions will be satisfied.

 

**ITEM 2.****                      ****Unregistered Sales of EquitySecurities and Use of Proceeds.**

 

None

 

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

 

None.

 

**ITEM 4.****                      ****Removed and Reserved.**

 

None.

 

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

 

None.

 

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

 

2.1          Amendment to Agreement andPlan of Merger dated as of July 22, 2010, by and among CornellCompanies, Inc., The GEO Group and GEO Acquisition III, Inc.(incorporated by reference from Exhibit 2.1 to the Company’s CurrentReport on Form 8-K filed with the SEC on July 22, 2010).

10.1        Form of 2010 RestrictedStock Award Agreement (Profitability and Time Based) (incorporated by referencefrom Exhibit 10.1 to the Company’s Current Report on Form 8-K filed with theSEC on March 26, 2010).

10.2        Form of 2010 RestrictedStock Award Agreement (Performance Based) (incorporated by reference fromExhibit 10.2 to the Company’s Current Report on Form 8-K filed with the SEC onMarch 26, 2010.

31.1*      Section 302Certification of Chief Executive Officer

31.2*      Section 302Certification of Chief Financial Officer

32.1**   Section 906Certification of Chief Executive Officer

32.2**   Section 906Certification of Chief Financial Officer

 

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

 

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**SIGNATURES**

 

Pursuant to the requirementsof Section 13 or 15(d) of the Securities Exchange Act of 1934, theRegistrant has duly caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.

 
| ** **                            | ** ** | **CORNELL COMPANIES, INC.**                                                                                              |
|---------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------|
|                                  |       |                                                                                                                          |
|                                  |       |                                                                                                                          |
| Date:  August 9,  2010 | By:        | /s/  James E. Hyman                                                                                                           |
|                                  |       | JAMES  E. HYMAN                                                                                                               |
|                                  |       | Chief  Executive Officer, President and Chairman of the Board (Principal Executive  Officer)                                  |
|                                  |       |                                                                                                                          |
|                                  |       |                                                                                                                          |
| Date:  August 9,  2010 | By:        | /s/  John R. Nieser                                                                                                           |
|                                  |       | JOHN  R. NIESER                                                                                                               |
|                                  |       | Senior  Vice President, Chief Financial Officer and Treasurer (Principal Financial  Officer and Principal Accounting Officer) |

 

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