The GEO Group, Inc. — Q2 2011 Form 10-Q
Reporting period: Thirteen and twenty-six weeks ended July 3, 2011, compared with the periods ended July 4, 2010. Dollar amounts below are in millions unless noted.
Business context
GEO provides government-outsourced correctional, detention, mental-health, residential-treatment, re-entry, monitoring and transportation services in the U.S. and internationally. The quarter reflects the February 2011 acquisition of B.I. Incorporated (BI) and the August 2010 acquisition of Cornell. At quarter-end, GEO reported approximately 79,600 beds at 115 facilities and monitoring services for more than 60,000 offenders.
Financial performance
| Metric | Q2 2011 | Q2 2010 | First half 2011 | First half 2010 |
|---|---|---|---|---|
| Revenue | $407.8 | $280.1 | $799.6 | $567.6 |
| Operating income | $50.4 | $33.1 | $91.3 | $67.6 |
| Net income attributable to GEO | $21.6 | $17.0 | $38.4 | $34.7 |
| Diluted EPS | $0.33 | $0.35 | $0.59 | $0.69 |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $95.3 | $85.3 |
Reported Q2 revenue rose 45.6% year over year and operating income rose 52.5%; first-half revenue increased 40.9% and operating income 35.1%. Approximate operating margin was 12.4% in Q2 versus 11.8% a year earlier, and 11.4% for the first half versus 11.9%. Despite higher reported net income, diluted EPS declined, reflecting a substantially larger weighted-average share count following acquisitions and share issuance. Interest expense increased to $19.4 million for Q2 from $8.4 million, and to $36.4 million for the first half from $16.3 million, primarily due to acquisition-related borrowing and new notes.
Acquisitions materially affect comparability. BI contributed $30.9 million of Q2 revenue and $48.7 million for the first half since its February 10 acquisition; Cornell also added substantial revenue. On a pro forma basis assuming both acquisitions at the start of the comparative periods, revenue was $407.8 million versus $411.7 million for Q2 and $813.2 million versus $824.7 million for the first half; attributable earnings were $22.0 million versus $23.3 million and $41.6 million versus $42.6 million, respectively.
Cash, debt and liquidity
- Cash and cash equivalents were $57.5 million at July 3, up from $39.7 million at January 2. Current assets were $452.1 million and current liabilities $299.7 million; some cash and investments are restricted.
- First-half operating cash flow was $95.3 million. Capital expenditures were $87.4 million, leaving approximately $7.9 million of operating cash flow after capital expenditures. Investing cash outflow was $501.2 million, including $409.6 million for BI; financing cash inflow was $423.2 million.
- Reported long-term debt was $1.234 billion, with $184.0 million of non-recourse debt and $13.6 million of capital lease obligations also reported as non-current. The current debt and lease line was $50.6 million. Management reported $1.252 billion of borrowings, net of discount and swap, excluding non-recourse debt and capital leases.
- The $500 million revolving facility had $210.0 million drawn, $68.6 million in letters of credit and $221.4 million available at July 3. Management reported covenant compliance. Credit-facility weighted-average borrowing cost was 3.2%; the company also had $300 million of 6.625% notes due 2021 and $250 million of 7.75% notes.
Changes, outlook and risks
- Reported growth was acquisition-led. GEO Care revenue nearly tripled in Q2, primarily from Cornell and BI. International revenue also benefited from favorable currency translation. Facility Construction & Design revenue fell as construction at Blackwater River was completed.
- Average company-wide facility occupancy was 94.1% for the first half. GEO said it was pursuing state and international opportunities, but awards and new business were uncertain and dependent on government budgets and procurement decisions.
- Management estimated a 39%–40% effective tax rate for fiscal 2011. Expected 2011 maintenance capital expenditures were $20–$25 million. GEO anticipated $12–$15 million of annual Cornell synergies and $3–$5 million of annual BI synergies during the respective years following each acquisition.
- California’s criminal-justice realignment led to cancellation notices for three community-corrections facilities. GEO stated that the affected contracts generated $16.3 million of first-half revenue and expected the terminations to reduce fiscal 2012 revenue by approximately $16.3 million; it was seeking local replacement business.
- Management cited approximately $172.5 million of remaining capital needs for committed projects in its MD&A, while a commitments note stated approximately $182.9 million remained. The filing does not reconcile these estimates.
- Subsequent to quarter-end, the board authorized a share-repurchase program of up to $100 million through December 31, 2012. It is discretionary and may be funded with cash, free cash flow or revolver borrowings.
- A $6.5 million wrongful-death verdict was entered against GEO; the company planned to appeal and said it had accrued an adequate amount, with a $3 million self-insured retention. An Australian property-damage lawsuit seeks up to approximately $19.4 million plus interest; GEO is uninsured for the claim and warned an unfavorable outcome could materially affect results or cash flows. A South African tax appeal carried a stated maximum exposure of $2.6 million.
- Key operating and financial risks include government budget constraints, contract cancellations or non-renewals, occupancy and labor costs, litigation and insurance losses, integration of acquisitions, foreign-exchange movements, interest-rate exposure and debt-covenant capacity. Disclosure controls were deemed effective; internal-control assessments excluded Cornell and BI as recently acquired businesses.
Investor verification priorities
- Reconcile the two disclosed estimates of remaining committed project capital requirements and assess funding needs alongside the proposed repurchases.
- Track California facility closures, replacement contracts and the resulting revenue and asset-utilization impact.
- Review debt leverage, covenant headroom, interest-rate sensitivity and remaining revolver availability after acquisition financing and capital spending.
- Assess whether reported growth and margins translate into pro forma or organic earnings growth, given the lower pro forma revenue and earnings comparisons.
- Monitor the wrongful-death appeal, uninsured Australian claim, tax proceedings and related accrual adequacy.
- Verify acquisition integration, expected synergies, contract renewals and the status of the substantial near-term management-contract renewal schedule.