The GEO Group, Inc. — Q3 2016 Form 10-Q
Reporting period: Three and nine months ended September 30, 2016. GEO is a REIT operating correctional, detention, reentry, community-supervision, monitoring and youth-services businesses in the U.S. and internationally. Unless noted, dollar figures below are in millions.
Financial performance and position
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Revenue | $554.4 | $469.9 | $1,612.9 | $1,343.2 |
| Operating income | $72.5 | $63.0 | $197.6 | $169.0 |
| Net income attributable to GEO | $43.7 | $38.3 | $99.3 | $95.4 |
| Diluted earnings per share | $0.59 | $0.52 | $1.34 | $1.29 |
| Operating margin | 13.1% | 13.4% | 12.2% | 12.6% |
- Q3 revenue rose 18.0% year over year; operating income rose 14.9% and GEO-attributable net income rose 14.1%. Nine-month revenue increased 20.1%, while operating income increased 16.9% and attributable net income increased 4.1%.
- Q3 segment revenue growth was led by Facility Construction & Design, up 181.3% to $69.7 million, largely reflecting Ravenhall prison construction. U.S. Corrections & Detention rose 7.5% to $344.5 million; GEO Care rose 15.3% to $99.8 million; International Services rose 6.3% to $40.4 million.
- Operating expenses rose faster than revenue in Q3, to 75.0% of revenue from 73.6%. For the nine-month period they were 75.7% of revenue, versus 74.3%. GEO Care operating expenses as a share of segment revenue improved, while start-up and activity-related costs weighed on U.S. Corrections & Detention.
- Interest expense was $33.4 million in Q3 and $93.9 million for nine months. Nine-month results included a $15.9 million debt-extinguishment loss, related to redeeming the 6.625% notes. Management estimated an annual effective tax rate of approximately 11%–12%, excluding discrete items.
- Nine-month operating cash flow was negative $11.8 million, compared with positive $111.2 million in 2015. The principal drag was a $205.1 million increase in contract receivable tied to Ravenhall construction, which GEO said would remain a cash-flow use until settlement. Investing cash outflow was $160.9 million; financing cash inflow was $142.1 million.
- Cash and cash equivalents were $30.1 million at September 30, down from $59.6 million at year-end 2015. Current assets were $507.7 million and current liabilities $288.9 million. Restricted cash and investments totaled $127.1 million across current and non-current balances.
- Total debt, including non-recourse debt and capital leases, was $2.411 billion, versus $2.095 billion at year-end 2015. Long-term debt was $1.894 billion and non-recourse debt $493.3 million on the balance sheet. The company reported $371.4 million of additional Revolver borrowing capacity after outstanding borrowings and letters of credit.
- Dividends declared were $0.65 per share in Q3; the Board declared another $0.65 quarterly dividend payable November 10, 2016. Nine-month cash dividends paid were $146.0 million.
Material changes and management commentary
- The August 2016 DOJ memorandum directed the Bureau of Prisons (BOP) to decline renewals or substantially reduce the scope of private-prison contract renewals, citing the decline in the BOP inmate population. GEO disputed the supporting Inspector General analysis and argued private facilities provide safety and cost benefits. GEO cautioned that federal, state or local customers could terminate, reduce or decline to renew contracts.
- The BOP renewed GEO’s company-owned D. Ray James facility for two years through September 30, 2018, for up to 1,900 beds. The new contract provides fixed payment for 1,800 beds, down from 1,962 under the prior contract. DHS also asked its advisory council to review ICE’s use of private immigration detention.
- GEO issued $350 million of 6.00% senior notes due 2026 and used proceeds in part to tender for and redeem all $300 million of 6.625% notes due 2021, as well as for fees and general corporate purposes. The amended credit agreement increased the Revolver commitment to $900 million.
- Ravenhall construction drove contract receivable growth to $388.7 million from $174.1 million at year-end. The project’s non-recourse construction debt was approximately $478 million. GEO expects a State of Victoria payment of about $237 million upon completion and commercial acceptance, toward principal repayment.
- GEO had approximately 3,300 vacant beds at four idle facilities, with a $34.2 million carrying value and estimated 2016 annual carrying costs of $12.8 million. Management said there was no firm commitment to activate them. If all were activated at assumed historical rates and occupancy, GEO estimated annualized revenue of about $70 million and EPS improvement of $0.20–$0.25.
- Management said cash on hand, operating cash flow and credit-facility availability were expected to support capital requirements through 2017. It estimated $94.7 million of remaining capital requirements through 2017, including an approximately $84 million Ravenhall capital contribution expected in January 2017.
- Management cited government budget constraints, contract renewals and rebids, policy changes, customer concentration, operating costs, debt service, REIT qualification, foreign exchange and financing availability among key risks. A 1% increase in the average rate on the Revolver would add approximately $7.6 million to annual interest expense.
Risks, contingencies and unusual items
- A purported shareholder securities class action filed in August 2016 alleges false or misleading statements concerning GEO’s business, operations and compliance policies. GEO intends to defend the case; it recorded no accrual because a loss was not considered probable or reasonably estimable at this stage.
- A state non-income-tax audit could result in an assessment of $14.8 million plus interest if deductions are disallowed. GEO disputes the findings and recorded no accrual because a loss was not considered probable.
- DOJ policy changes were treated as an impairment-testing trigger. GEO reported no goodwill or long-lived-asset impairment in its quarter-end tests, but said future events or changed assumptions could lead to material write-downs.
- Ravenhall interest-rate swaps had a $26.9 million fair-value liability at quarter-end; nine-month unrealized loss recorded in other comprehensive income was $5.2 million.
- GEO’s disclosure controls were assessed as effective, and management reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Subsequent BOP and ICE decisions on renewals, contract scope and private-facility utilization, including the implications of the D. Ray James renewal’s lower fixed-bed commitment.
- Ravenhall project completion, commercial acceptance, State payment timing, remaining capital contributions and the effect of contract-receivable growth on operating cash flow.
- Whether operating cash generation improves while GEO funds dividends, capital requirements and debt service; also verify Revolver availability and covenant headroom.
- Developments in the securities lawsuit and state tax audit, and whether either results in an accrual or material financial exposure.
- Progress in activating idle beds and the assumptions behind management’s estimated revenue and EPS potential.
- Debt refinancing costs, variable-rate exposure, non-recourse obligations and the sustainability of the $0.65 quarterly dividend.