GEO

Business Context and Reporting Period

Company: The GEO Group, Inc.
Filing Type: Form 10-K (Annual Report)
Reporting Period: Fiscal year ended December 31, 2006
Business Overview: GEO is a leading provider of government-outsourced services specializing in the management of correctional, detention, and mental health/residential treatment facilities in the U.S., Australia, South Africa, the U.K., and Canada. As of December 31, 2006, the company operated 62 facilities with over 54,000 beds under management or contract, maintaining an average occupancy rate of 96.1%.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Revenues increased 40.5% to $860.9 million, driven primarily by the November 2005 acquisition of Correctional Services Corporation (CSC), which added $104.5 million in revenue, and the expansion of the GEO Care segment (mental health services), which grew 115.8% due to four new contracts.
• Profitability Surge: Operating income jumped from $7.9 million in 2005 to $64.2 million in 2006. The 2005 results were significantly depressed by a $20.9 million impairment charge related to the Michigan Correctional Facility and a $4.3 million charge for the Jena facility lease obligation.
• Debt Reduction: In June 2006, the company completed a follow-on public offering raising approximately $100 million. Proceeds were used to repay the entire term loan portion of its Senior Credit Facility ($74.6 million), reducing consolidated long-term debt significantly.
• Stock Split: A 3-for-2 stock split was effected in October 2006, increasing shares outstanding from 13.0 million to 19.5 million.

Guidance, Outlook, and Risks

Recent Developments and Outlook

• CPT Acquisition: On January 24, 2007 (post-fiscal year end), GEO completed the acquisition of CentraCore Properties Trust (CPT) for approximately $427.6 million. This was financed via a new $365 million Term Loan B and cash on hand. This acquisition eliminates future lease expenses for 11 facilities but increases depreciation and interest expenses.
• Capital Expenditures: Management anticipates capital expenditures between $50 million and $150 million for the next 12 months, including expansions at Val Verde and Lawton facilities.
• Contract Renewals: Nine contracts representing 14.5% of 2006 revenues are scheduled to expire or be up for re-bid in 2007. While historical renewal rates exceed 90%, there is no assurance of renewal on favorable terms.

Risks and Contingencies

• High Indebtedness: Following the CPT acquisition, total consolidated long-term indebtedness increased to approximately $515 million. The company faces significant debt service obligations and restrictive covenants regarding leverage ratios and capital expenditures.
• Legal Proceedings:
  • Texas Wrongful Death: A $51.7 million judgment was entered against GEO in September 2006. The company believes it is fully insured under a legacy program and has not reserved for the amount, though it is appealing the verdict.
  • Florida Overbilling Allegations: A lawsuit alleges $12.7 million in overbilling to the State of Florida. The state agency settled a related audit for $0.3 million, but the litigation remains pending.
  • Michigan Facility: GEO is appealing a summary judgment regarding the termination of its lease for the Michigan Correctional Facility, which was closed by the state in 2005.
• Regulatory and Political Risk: The business is subject to government appropriations, potential contract terminations without cause, and public resistance to privatization. Changes in crime rates or sentencing laws could reduce demand for facilities.

Key Facts for Investor Verification

• Debt Covenants: Verify compliance with the new Amended Senior Credit Facility covenants (Total Leverage Ratio max 5.50:1 through 2008) following the $365 million borrowing for the CPT acquisition.
• Insurance Coverage: Confirm the status of the $51.7 million Texas wrongful death judgment appeal and the adequacy of the legacy insurance coverage from The Wackenhut Corporation.
• Contract Renewals: Monitor the re-bid process for the nine contracts expiring in 2007, which represent a significant portion of revenue.
• South African Tax Law: Assess the impact of new South African legislation removing tax exemptions for Public Private Partnerships, which is estimated to result in a one-time tax charge of up to $2.3 million in Q1 2007.
• Occupancy Rates: Verify that the 96.1% occupancy rate is sustainable, as revenue is largely per-diem based and fixed costs are high.