GEO

Business Context and Reporting Period

Company: The GEO Group, Inc.
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: April 4, 2010 (Thirteen weeks)
Business Overview: GEO is a leading provider of government-outsourced services specializing in the management of correctional, detention, and mental health facilities in the U.S., Australia, South Africa, the U.K., and Canada. As of April 4, 2010, the company managed 56 facilities with approximately 52,700 beds and maintained a 94.4% average occupancy rate.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Revenues increased 11.0% year-over-year. The International Services segment saw a 78.7% increase driven by new contracts in Australia (Parklea) and the U.K. (Harmondsworth) and favorable foreign exchange rates. GEO Care revenues rose 21.3% due to the acquisition of Just Care.
• Profitability: Net income increased 20.2% to $17.7 million. Operating margins improved as lower-margin contracts were terminated in the U.S. segment.
• Accounting Change: The company revised the estimated useful life of owned correctional facility buildings from 40 to 50 years, effective January 4, 2010. This reduced depreciation expense by $0.9 million and increased net income by $0.6 million for the quarter.
• Stock Repurchases: The company purchased 2.8 million shares of common stock for $53.9 million under a new $80 million repurchase program authorized in February 2010.
• Discontinued Operations: There were no discontinued operations in Q1 2010, compared to a loss of $0.4 million in Q1 2009 related to terminated contracts.

Guidance, Outlook, and Risks

• Merger with Cornell Companies: On April 19, 2010, GEO announced a definitive agreement to acquire Cornell Companies. The deal involves stock and/or cash consideration. GEO expects the merger to increase aggregate annual revenues by approximately $400 million to over $1.5 billion. The company anticipates annual synergies of $12–15 million in the year following completion.
• Capital Requirements: Remaining capital requirements for committed projects are estimated at $23.3 million for fiscal 2010. Maintenance capital expenditures are expected to range between $10.0 million and $15.0 million.
• Contract Terminations: GEO lost contracts for the Graceville and Moore Haven Correctional Facilities in Florida, terminating in late 2010. Conversely, a new 2,000-bed contract for the Blackwater River Correctional Facility was signed, with operations starting November 2010.
• Legal and Tax Risks:
  • Australian Litigation: A claim by the Commonwealth of Australia seeks up to $16.6 million in damages for property damage at former facilities. The company is uninsured for this claim.
  • IRS Examination: The IRS proposes disallowing a $15.4 million deduction from the 2005 tax year. GEO has appealed and believes it has valid defenses.
  • Merger Litigation: A stockholder class action lawsuit was filed challenging the Cornell merger, seeking an injunction that could delay or block the transaction.
• Outlook: Management expects the effective tax rate for fiscal 2010 to be between 38% and 39%. The company anticipates increased interest expense due to higher indebtedness but expects this to be partially offset by depreciation savings from the accounting change.

Investor Verification Checklist

• Merger Approval: Verify the status of shareholder approvals required for the Cornell Companies merger and the potential impact of the pending class-action lawsuit.
• Contract Renewals: Monitor the outcome of contract re-bids for facilities expiring in 2010, specifically the lost Florida contracts and the new Blackwater River facility ramp-up.
• Tax Exposure: Track the resolution of the IRS appeal regarding the $15.4 million disallowed deduction and the Australian property damage litigation.
• Liquidity and Debt: Confirm compliance with debt covenants under the Senior Credit Facility and the 7 3/4% Senior Notes, especially given the planned $300 million debt assumption from Cornell.
• Capital Expenditures: Assess the funding sources for the $23.3 million in remaining committed capital projects and potential new self-financed construction bids.