GEO Group, Inc. — Q2 2010 Form 10-Q
Reporting period: Quarter and first 26 weeks ended July 4, 2010; comparisons are with the periods ended June 28, 2009. GEO operates correctional, detention, mental-health and residential-treatment facilities, as well as facility construction and design services.
Financial performance
| Metric | 13 weeks ended July 4, 2010 | 13 weeks ended June 28, 2009 | 26 weeks ended July 4, 2010 | 26 weeks ended June 28, 2009 |
|---|---|---|---|---|
| Revenue | $280.1 million | $276.4 million | $567.6 million | $535.4 million |
| Operating income | $33.0 million | $30.9 million | $67.5 million | $60.6 million |
| Net income | $17.0 million | $16.5 million | $34.7 million | $31.2 million |
| Diluted EPS | $0.35 | $0.32 | $0.69 | $0.60 |
| Operating margin | 11.8% | 11.2% | 11.9% | 11.3% |
- Quarterly revenue grew 1.3%; first-half revenue grew 6.0%. First-half operating income rose 11.5% and net income rose 11.1% year over year.
- First-half revenue growth came chiefly from International Services, up 63.1% to $90.6 million, and GEO Care, up 22.0% to $68.9 million. U.S. Corrections revenue increased 0.9% to $387.4 million. Facility construction and design revenue fell 47.2% to $20.8 million.
- Q2 international revenue benefited from new Parklea and Harmondsworth contracts and stronger currencies; GEO Care benefited from the Just Care acquisition. Lower Blackwater construction activity reduced construction-segment revenue.
- First-half operating cash flow was $85.3 million, versus $77.5 million from continuing operations in the prior-year period. Investing used $61.3 million, including $56.4 million of capital expenditures; financing used $16.5 million. Cash increased $6.3 million from year-end to $40.1 million.
Balance sheet, debt and liquidity
- At July 4, 2010, cash was $40.1 million; restricted cash totaled $38.8 million. Current assets were $258.2 million and current liabilities $166.5 million.
- Long-term debt was $523.0 million and non-recourse debt $87.4 million; current maturities of debt and capital leases were included in current liabilities. The Senior Credit Facility had $276.1 million outstanding, with $164.0 million available on its revolver after letters of credit. GEO reported covenant compliance at quarter-end.
- GEO repurchased 3.9 million shares for $77.3 million in the first half under an $80 million authorization, using cash and operating cash flow. This materially reduced financing cash flow.
- Management said cash, operating cash flow and credit availability were expected to support 2010–2011 capital needs, while warning that additional self-financed projects could require more financing. Existing development projects were estimated to require $116.8 million in remaining spending; 2010 maintenance capital expenditures were estimated at $10–15 million.
Material changes, outlook and risks
- Depreciation estimate: GEO extended the estimated lives of certain owned correctional-facility buildings from 40 to 50 years, effective January 4, 2010. The change reduced first-half depreciation by $1.8 million and increased net income by $1.1 million, or $0.02 per diluted share.
- Cornell acquisition after quarter-end: GEO acquired Cornell on August 12, 2010 for approximately $443 million, comprising about $358 million in GEO stock and $85 million cash, excluding cash acquired. GEO also repaid $181.9 million of Cornell debt and assumed $108.3 million of non-recourse debt. Purchase accounting was incomplete at filing, and meaningful combined pro forma results were not provided. GEO estimated the merger would add approximately $400 million to annual revenue, taking it above $1.5 billion, and anticipated $12–15 million of annual synergies during the year after completion; it did not expect significant synergies in 2010.
- Refinancing and leverage: A new credit agreement was entered into on August 4, with $150 million Term Loan A, $200 million Term Loan B and a $400 million revolver. Following the Cornell closing, the company reported $570 million of borrowings under the new facility and $124.6 million of revolver availability. GEO expected approximately $8 million of deferred financing-fee write-offs in Q3. The filing disclosed approximately $1.05 billion of total debt following the merger, including non-recourse debt and capital leases.
- Costs and tax: Q2 included $2.1 million of Cornell transaction costs. Management expected total transaction costs of $30–34 million, including $28–32 million in Q3 and Q4. Management estimated a 2010 effective tax rate of approximately 39%, excluding the impact of partly nondeductible merger costs.
- Contracts and operating outlook: Management cited correctional overcrowding and federal demand as opportunities, but warned that public budget pressure could lead to early releases, lower rates, reduced services, delayed payments or contract changes. Contracts at Moore Haven, Bridgeport and Graceville were ending or scheduled to end in 2010; the Melbourne Custody Center transition was completed in April. Average companywide occupancy was 95.2% for the first half.
- Contingencies: A claim by the Australian government’s insurer sought up to approximately $15.2 million plus interest; GEO had reserved an estimated probable loss but said an unfavorable outcome could materially affect results. A disputed IRS deduction could result in up to $15.4 million exposure, and a South African tax dispute carried maximum exposure of $2.6 million. The Cornell-related shareholder suit had a settlement in principle, subject to court approval.
- Other risks: Management highlighted integration and dilution risk from Cornell, substantial post-merger debt, potential impairment charges, contract retention and occupancy, government funding, litigation and insurance reserves, and foreign-exchange exposure. A 10% currency-rate change was estimated to affect financial position by about $5.1 million and next-year results by about $0.5 million.
Most important facts for investors to verify
- Actual Cornell purchase-price allocation, acquired debt, share issuance, integration costs and realized synergies versus management’s estimates.
- Post-merger leverage, interest costs, covenant headroom and available revolver capacity under the new credit agreement.
- Replacement revenue and utilization after the disclosed contract losses, and progress on new awards and facility openings.
- Whether operating cash flow can support committed construction spending, maintenance capital expenditures and debt service without additional financing.
- Developments in the Australian claim and tax disputes, as well as the adequacy of insurance and litigation reserves.