GEO Group, Inc. — Q3 2010 Form 10-Q
Business context and reporting period. The filing covers the 13 and 39 weeks ended October 3, 2010, compared with periods ended September 27, 2009. GEO provides government-outsourced correctional, detention, mental-health and residential-treatment services, as well as facility construction. It completed its acquisition of Cornell Companies on August 12, 2010; results include Cornell only from that date. At quarter-end GEO managed and/or owned approximately 79,000 beds at 116 facilities, including projects under development. Unless otherwise noted, amounts below are in U.S. dollars.
Financial highlights
| Metric | 13 weeks ended Oct. 3, 2010 | 13 weeks ended Sept. 27, 2009 | 39 weeks ended Oct. 3, 2010 | 39 weeks ended Sept. 27, 2009 |
|---|---|---|---|---|
| Revenue | $327.9 million | $294.9 million | $895.6 million | $830.3 million |
| Operating income | $29.5 million | $35.2 million | $97.1 million | $95.9 million |
| Net income attributable to GEO | $5.3 million | $19.3 million | $40.0 million | $50.5 million |
| Diluted EPS | $0.09 | $0.37 | $0.75 | $0.98 |
| Operating cash flow | — | $103.6 million | $79.3 million | |
| Capital expenditures | — | $68.3 million | $113.7 million |
- Quarterly operating margin was approximately 9.0% versus 11.9%; nine-month margin was approximately 10.8% versus 11.5%. Quarterly net margin was approximately 1.6% versus 6.5%; nine-month net margin was approximately 4.5% versus 6.1%.
- Quarterly G&A rose to $33.9 million from $15.7 million, reflecting Cornell-related costs. Nine-month G&A was $72.0 million versus $49.9 million. Operating income also absorbed higher depreciation and interest and a $7.9 million debt-extinguishment loss in 2010.
- At October 3, cash and equivalents were $53.8 million; restricted cash and investments totaled $79.9 million. Current assets were $408.3 million and current liabilities $271.0 million. The current ratio was approximately 1.51, compared with 1.58 at January 3.
- Long-term debt was $802.5 million and non-recourse debt $191.6 million, plus current debt obligations. Management reported $812.0 million in borrowings at October 3, excluding non-recourse debt and capital leases. The new $400 million revolving facility had $133.6 million available after loans and letters of credit.
- Operating cash flow increased year over year; investing cash outflow was $330.3 million, principally the Cornell acquisition and capital spending. Financing provided $244.2 million. Cash increased $19.9 million during the 39-week period. Operating cash flow less capital expenditures was approximately $35.3 million.
Material changes versus prior periods
- Revenue rose 11.2% in the quarter and 7.9% year to date. Cornell contributed $53.6 million of revenue and $4.5 million of net income from acquisition through October 3. GEO said its revenue increase also reflected growth in international services and GEO Care; construction revenue declined as Blackwater River construction neared completion.
- Despite higher revenue, attributable net income fell to $5.3 million for the quarter and $40.0 million year to date, from $19.3 million and $50.5 million, respectively. Merger expenses, higher interest expense, and the debt-extinguishment charge weighed on results. The quarterly effective tax rate was 66.2%, versus 38.5%; management attributed the increase largely to merger costs that were partly nondeductible.
- The Cornell transaction’s aggregate consideration was $618.3 million, net of acquired cash, including $357.8 million of stock consideration. The preliminary purchase-price allocation recorded $204.4 million of goodwill. GEO issued shares and assumed liabilities as part of the acquisition.
- GEO completed its $80 million share-repurchase program, repurchasing approximately 4.0 million shares during the 39 weeks. Weighted-average diluted shares increased to 58.2 million for the quarter from 52.0 million, reflecting primarily the Cornell stock consideration.
- GEO replaced its prior credit facility in August with a $750 million facility comprising term loans and a revolver. Debt increased substantially relative to January 3, in part to fund Cornell and refinance existing obligations.
Outlook, commentary and risks
- Management expected Cornell to increase annual revenue by approximately $400 million, bringing the combined company to approximately $1.5 billion in annual revenue. It anticipated $12–15 million in annual synergies during the year following the merger, with potential for additional savings. These are forward-looking estimates, not guarantees.
- Management estimated a 2010 effective tax rate of approximately 42.6% including merger-related nondeductible expenses and 39.5% excluding them. It expected additional fourth-quarter merger transaction costs of $3–4 million; total transaction costs were estimated at $27–28 million, including debt-extinguishment costs.
- Committed projects were estimated to require $133.2 million in remaining funding through fiscal 2010 and 2011; maintenance capital spending for 2010 was estimated at $10–15 million. Management said available cash, operating cash flow and revolver capacity should cover disclosed needs, but additional self-financed project awards could require more capital.
- Post-quarter developments included inmate intake at D. Ray James and Blackwater River, a California contract for up to 2,580 inmates at North Lake involving a planned $60 million expansion, and selection for California contracts at two community facilities, subject to final approval.
- Risks include government budget constraints, delayed customer payments, contract losses or nonrenewals, occupancy and labor costs, successful Cornell integration, project financing and construction execution, foreign exchange and interest-rate exposure, and insurance and litigation claims. GEO reported a 94.9% average company-wide occupancy rate for the 39 weeks.
- Notable contingencies include an Australian property-damage lawsuit seeking up to approximately $17.5 million plus interest, for which GEO is uninsured; a disputed IRS deduction with potential exposure of $15.4 million against which a $4.9 million accrual had been recorded; and a favorable South African tax ruling subject to appeal, with maximum exposure of $2.6 million. GEO also disclosed ongoing operational claims and guarantees.
- GEO said it was in compliance with its credit-agreement and senior-note covenants at October 3. The credit agreement includes leverage and interest-coverage limits; a one-percentage-point increase in applicable rates was estimated to increase annual interest expense by $6.2 million on then-current credit-agreement borrowings. Disclosure controls were deemed effective; Cornell’s internal controls were still being assessed and integrated.
Most important facts for investors to verify
- How much of reported growth and future earnings reflects Cornell, and whether the anticipated $12–15 million of synergies are achieved after integration costs.
- Current debt, revolver availability, covenant headroom and interest-rate sensitivity, including the effect of any further capital-intensive awards.
- Cash conversion and working-capital trends, especially receivables and the reported payment delays from California and other state customers.
- Progress, costs, customer commitments and opening schedules for projects under construction, including North Lake and other facilities without contracted expansion-bed demand.
- Developments in the Australian litigation, IRS appeal, South African tax ruling, and any material changes in insurance reserves or other contingencies.
- The effect of contract terminations, renewal outcomes, occupancy, and government budget actions on revenues and operating margins.