The GEO Group, Inc. — 2017 Q3 Form 10-Q
Business context and period. Quarterly report for the three and nine months ended September 30, 2017. GEO is a REIT providing correctional, detention, reentry, community supervision, monitoring and related services in the U.S. and internationally. Following its April 5 acquisition of Community Education Centers (CEC), GEO reported approximately 96,000 beds at 140 facilities and community supervision services for more than 185,000 people.
Key financial results
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Revenue | $566.8m | $554.4m | $1,694.4m | $1,612.9m |
| Operating income | $62.9m | $72.5m | $181.8m | $197.6m |
| Net income attributable to GEO | $38.5m | $43.7m | $109.9m | $99.3m |
| Diluted EPS | $0.31 | $0.39 | $0.91 | $0.89 |
| Operating margin | 11.1% | 13.1% | 10.7% | 12.2% |
Cash flow and liquidity. Nine-month operating cash flow was $57.8m, versus cash used of $11.8m a year earlier. Investing used $461.6m, including $353.6m for CEC and $104.1m of capital expenditures; financing provided $387.0m. Cash was $51.5m at September 30, down from $68.0m at year-end 2016. Current assets were $730.5m and current liabilities $574.8m.
Debt. Total debt, including capital leases and non-recourse debt, was $2.748bn, compared with $2.420bn at December 31, 2016. GEO had $1.042bn outstanding under its senior credit facility, about $65m of letters of credit, and $589.2m of additional revolver capacity. The weighted-average rate on facility borrowings was 3.5%. Management said it expected to comply with debt covenants and considered available cash, operating cash flow and credit capacity adequate for 2017 requirements.
REIT measures. Nine-month NAREIT FFO was $158.3m, Normalized FFO $172.3m and AFFO $225.7m, compared with $145.0m, $162.1m and $201.5m, respectively, in 2016. These are company-presented non-GAAP supplemental measures.
Material changes and drivers
- Nine-month revenue rose 5.1%; Q3 revenue rose 2.2%. CEC contributed approximately $114m of revenue and $14m of earnings from acquisition through September 30. Pro forma nine-month revenue, assuming CEC had been acquired at the start of 2016, was $1.756bn versus $1.805bn in 2016.
- CEC added scale, particularly in GEO Care, but acquisition-related operating costs and higher corporate expenses weighed on margins. Q3 G&A increased 30.9% to $49.1m; nine-month G&A rose 32.7% to $143.9m, including $17.9m of nine-month CEC transaction and transition costs.
- Q3 operating income and attributable net income declined year over year, despite higher revenue. Higher depreciation, G&A and interest expense were significant factors. Nine-month attributable net income increased, aided in part by the absence of the prior-year $15.9m debt-extinguishment loss and lower income-tax provision.
- U.S. Corrections & Detention and GEO Care revenue increased, substantially reflecting CEC and contract activity. Facility Construction & Design revenue fell as Ravenhall construction activity tapered near completion; construction margins were described as not significant.
- Average company-wide occupancy was 91.0% for the nine months, versus 92.8% in 2016, excluding idle beds and beds under development. GEO marketed about 5,400 vacant beds at five idle facilities.
- GEO issued 10.35m shares in March 2017, receiving approximately $288.1m gross proceeds, and completed a 3-for-2 stock split. The quarterly dividend increased from $0.43 to $0.47 per share; the Board declared another $0.47 dividend for October payment.
Outlook, risks and contingencies
- No consolidated revenue or earnings guidance is provided. Management cited potential growth opportunities and said it planned to bid on projects meeting its profitability and risk criteria, while warning that government budgets and willingness to use public-private partnerships could constrain growth, rates, contract renewals and collections.
- GEO expected the Ravenhall prison to reach operational readiness in Q4 2017. The project carries completion and timing risks; a $243m state payment toward project debt is due upon completion and commercial acceptance. The company also estimated $161.3m of remaining capital requirements for existing projects through 2018.
- Management expected to pursue cost savings and synergies from CEC integration, but cautioned that expected savings and increased earnings may not be fully realized or could take longer. The acquisition purchase-price allocation remained preliminary.
- Key exposures include substantial debt and variable-rate borrowing, customer budget and contract risks, facility occupancy, labor and medical costs, acquisition integration and goodwill impairment, foreign exchange, and project execution. A 1% increase in rates on credit-facility borrowings was estimated to increase annual interest expense by $10m.
- Legal matters include a Mississippi state lawsuit alleging improper conduct related to contracts; GEO recorded no accrual because loss was not considered probable or reasonably estimable at this stage. A certified class action concerning detainee work-program compensation was proceeding on appeal; GEO also recorded no accrual. A separate state tax assessment totaled about $19.6m including tax, penalties and interest; GEO protested it and recorded a reserve, but the reserve amount is not stated here.
- GEO had a $1.9m provision for Ravenhall subcontractor cost-overrun claims. It reported approximately $243.9m of total existing project commitments, including $82.6m spent through September. The filing reported no impairment indication for idle facilities.
Investor verification priorities
- Verify CEC’s post-acquisition contribution, integration costs, final purchase accounting and whether anticipated synergies materialize.
- Track the Ravenhall completion and acceptance schedule, remaining project funding, contract receivable conversion to cash, and the expected state debt payment.
- Assess whether operating cash generation can support debt service, capital needs and REIT distributions, given contract-receivable investment and the dividend burden.
- Review debt maturities, covenant headroom, variable-rate exposure and remaining revolver availability.
- Monitor the Mississippi and detainee-work litigation, the state tax assessment and related reserves, plus contract renewals, occupancy and the potential use of idle beds.