GEO GROUP INC - Quarter Report: 2010 July (Form 10-Q)

THE GEO GROUP, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

1. BASIS OF PRESENTATION

The unaudited consolidated financial statements of The GEO Group, Inc., a Florida corporation (the “Company”, or “GEO”), included in this Quarterly Report on Form 10-Q have been prepared in accordance with accounting principles generally accepted in the United States and the instructions to Form 10-Q and consequently do not include all disclosures required by Form 10-K. Additional information may be obtained by referring to the Company’s Annual Report on Form 10-K for the year ended January 3, 2010. In the opinion of management, all adjustments (consisting only of normal recurring items) necessary for a fair presentation of the financial information for the interim periods reported in this Quarterly Report on Form 10-Q have been made. Results of operations for the thirteen weeks ended July 4, 2010 are not necessarily indicative of the results for the entire fiscal year ending January 2, 2011.

The accounting policies followed for quarterly financial reporting are the same as those disclosed in the Notes to Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission on February 22, 2010 for the fiscal year ended January 3, 2010.

Changes in Estimates

The Company periodically performs assessments of the useful lives of its assets. In evaluating useful lives, the Company considers how long assets will remain functionally efficient and effective, given competitive factors, economic environment, technological advancements and quality of construction. If the assessment indicates that assets can and will be used for a longer or shorter period than previously anticipated, the useful lives of the assets are revised, resulting in a change in estimate. Changes in estimates are accounted for on a prospective basis by depreciating the assets’ current carrying values over their revised remaining useful lives.

During the first quarter of 2010, the Company completed a depreciation study on its owned correctional facilities. Based on the results of the depreciation study, the Company revised the estimated useful lives of certain buildings from its historical estimate of 40 years to a revised estimate of 50 years, effective January 4, 2010. The basis for the change in the useful life of the Company’s owned correctional facilities is due to the expectation that these facilities are capable of being used for a longer period than previously anticipated based on quality of construction and effective building maintenance. The Company accounted for the change in the useful lives as a change in estimate which is accounted for prospectively beginning January 4, 2010. For the thirteen weeks and twenty-six weeks ended July 4, 2010, the change resulted in a reduction in depreciation and amortization expense, and corresponding increase to income from continuing operations, of $0.9 million and $1.8 million, an increase to net income of $0.6 million and $1.1 million, and an increase in diluted earnings per share of $0.01 and $0.02, respectively.

2. ACQUSITION OF CORNELL COMPANIES

On April 18, 2010, the Company, GEO Acquisition III, Inc., and Cornell Companies Inc., (“Cornell”), entered into a definitive merger agreement, as amended on July 22, 2010, pursuant to which the Company will acquire Cornell for stock and/or cash. Upon completion of the merger, Cornell stockholders will be entitled to receive, at their election, either (i) 1.3 shares of common stock of GEO, par value $.01 per share, for every share of Cornell common stock in the case of Cornell stockholders electing to receive stock consideration or Cornell stockholders who fail to make an election; or (ii) the right to receive cash consideration equal to the greater of (x) the fair market value of one share of GEO common stock plus $6.00 or (y) the fair market value of 1.3 shares of GEO common stock, in the case of Cornell stockholders electing to receive cash. As defined in the merger agreement, with respect to the cash consideration, the fair market value of the shares of GEO stock is based on the average closing price of GEO’s common stock for the ten consecutive trading days ending on the last trading day immediately preceding the tenth business day preceding the closing date. In order to preserve the tax-deferred treatment of the transaction, no more than 20% of the outstanding shares of Cornell common stock may be exchanged for the cash consideration. If cash elections are made with respect to more than 20% of Cornell’s shares, the excess over 20% shall be treated as if a stock election had been made with respect to these shares and will be exchanged for shares of GEO common stock. Additionally, if cash elections are made such that the aggregate cash consideration would exceed $100.0 million, then GEO may elect, in its sole discretion, to pay such excess amount in shares of GEO common stock or in cash.

On May 5, 2010, the Company, along with Cornell, filed a preliminary joint merger proxy statement and a prospectus, which was declared effective by the Securities and Exchange Commission on July 15, 2010, in order to obtain the necessary shareholder votes to consummate the merger.

On August 12, 2010, the Company acquired 100% of Cornell for stock and cash pursuant to the merger agreement executed on April 18, 2010, discussed above. GEO shareholders of record as of July 2, 2010 were entitled to vote at the special meeting on August 12, 2010. Cornell stockholders of record as of July 2, 2010 were eligible to vote and Cornell stockholders as of the election record date of July 20, 2010 were required to submit an election form indicating their election of cash or stock consideration for their outstanding shares by August 11, 2010, the day before the Cornell special meeting held on August 12, 2010. Refer to Note 18.

During the second fiscal quarter of 2010, the Company incurred $2.1 million in non-recurring direct transaction related expenses which are recorded as operating expenses in the Company’s consolidated statements of income for the thirteen and twenty-six weeks ended July 4, 2010.

3. SHAREHOLDERS’ EQUITY

Stock repurchase program

On February 22, 2010, the Company announced that its Board of Directors approved a stock repurchase program for up to $80.0 million of the Company’s common stock effective through March 31, 2011. The stock repurchase program is implemented through purchases made from time to time in the open market or in privately negotiated transactions, in accordance with applicable Securities and Exchange Commission requirements. The program may also include repurchases from time to time from executive officers or directors of vested restricted stock and/or vested stock options. During the thirteen and twenty-six weeks ended July 4, 2010, the Company purchased 1.1 million and 3.9 million shares of its common stock, respectively, at a cost of $23.4 million and $77.3 million, respectively, using cash on hand and cash flow from operating activities.

Earnings per share

Basic earnings per share is computed by dividing the income from continuing operations available to common shareholders by the weighted average number of outstanding shares of common stock. The calculation of diluted earnings per share is similar to that of basic earnings per share, except that the denominator includes dilutive common stock equivalents such as stock options and shares of restricted stock. Basic and diluted earnings per share (“EPS”) were calculated for the thirteen and twenty-six weeks ended July 4, 2010 and June 28, 2009 as follows (in thousands, except per share data):

		Thirteen Weeks Ended								Twenty-six Weeks Ended
		July 4, 2010				June 28, 2009				July 4, 2010				June 28, 2009
Income from continuing operations		$	17,017			$	16,491			$	34,689			$	31,562
Basic earnings per share from continuing operations:
Weighted average shares outstanding			48,776				50,802				49,743				50,749
Per share amount		$	0.35			$	0.32			$	0.70			$	0.62
Diluted earnings per share from continuing operations:
Weighted average shares outstanding			48,776				50,802				49,743				50,749
Effect of dilutive securities:
Stock options and restricted stock			538				1,033				737				1,035
Weighted average shares assuming dilution			49,314				51,835				50,480				51,784
Per share amount		$	0.35			$	0.32			$	0.69			$	0.61

Thirteen Weeks

For the thirteen weeks ended July 4, 2010, 25,893 weighted average shares of stock underlying options were excluded from the computation of diluted EPS because the effect would be anti-dilutive.

For the thirteen weeks ended June 28, 2009, 89,966 weighted average shares of stock underlying options and 13,807 weighted average shares of restricted stock were excluded from the computation of diluted EPS because the effect would be anti-dilutive.

Twenty-six Weeks

For the twenty-six weeks ended July 4, 2010, 38,973 weighted average shares of stock underlying options were excluded from the computation of diluted EPS because the effect would be anti-dilutive.

For the twenty-six weeks ended June 28, 2009, 121,859 weighted average shares of stock underlying options and 8,035 weighted average shares of restricted stock were excluded from the computation of diluted EPS because the effect would be anti-dilutive.

4. EQUITY INCENTIVE PLANS

The Company had awards outstanding under four equity compensation plans at July 4, 2010: The Wackenhut Corrections Corporation 1994 Stock Option Plan (the “1994 Plan”); the 1995 Non-Employee Director Stock Option Plan (the “1995 Plan”); the Wackenhut Corrections Corporation 1999 Stock Option Plan (the “1999 Plan”); and The GEO Group, Inc. 2006 Stock Incentive Plan (the “2006 Plan” and, together with the 1994 Plan, the 1995 Plan and the 1999 Plan, the “Company Plans”).

On April 29, 2009, the Company’s Board of Directors adopted and its shareholders approved several amendments to the 2006 Plan, including an amendment providing for the issuance of an additional 1,000,000 shares of the Company’s common stock which increased the total amount of shares of common stock issuable pursuant to awards granted under the plan to 2,400,000 and specifying that up to 1,083,000 of such total shares pursuant to awards granted under the plan may constitute awards other than stock options and stock appreciation rights, including shares of restricted stock. See “Restricted Stock” below for further discussion. On June 26, 2009, the Company’s Compensation Committee of the Board of Directors approved a grant of 163,000 restricted stock awards to certain employees. Additionally, on October 28, 2009, the Company’s Compensation Committee of the Board of Directors approved a grant of 439,500 stock option awards. As of July 4, 2010, the Company had 585,294 shares of common stock available for issuance pursuant to future awards that may be granted under the plan.

A summary of the activity of stock option awards issued and outstanding under Company Plans is presented below.

		July 4, 2010
						Wtd. Avg.				Wtd. Avg.				Aggregate
						Exercise				Remaining				Intrinsic
Fiscal Year		Shares				Price				Contractual Term				Value
		(in thousands)												(in thousands)
Options outstanding at January 3, 2010			2,807			$	10.26				4.80			$	32,592
Options granted			—				—				—				—
Options exercised			(1,152	)			4.23
Options forfeited/canceled/expired			(29	)			20.73
Options outstanding at July 4, 2010			1,626			$	14.36				6.09			$	10,702
Options exercisable at July 4, 2010			1,107			$	11.70				4.84			$	10,190

The Company uses a Black-Scholes option valuation model to estimate the fair value of each option awarded. For the thirteen and twenty-six weeks ended July 4, 2010, the amount of stock-based compensation expense related to stock options was $0.3 million and $0.7 million, respectively. For the thirteen and twenty-six weeks ended June 28, 2009, the amount of stock-based compensation expense related to stock options was $0.2 million and $0.5 million, respectively. As of July 4, 2010, the Company had $2.8 million of unrecognized compensation costs related to non-vested stock option awards that are expected to be recognized over a weighted average period of 2.8 years.

Restricted Stock

Shares of restricted stock become unrestricted shares of common stock upon vesting on a one-for-one basis. The cost of these awards is determined using the fair value of the Company’s common stock on the date of the grant and compensation expense is recognized over the vesting period. The shares of restricted stock granted under the 2006 Plan vest in equal 25% increments on each of the four anniversary dates immediately following the date of grant. A summary of the activity of restricted stock outstanding is as follows:

						Wtd. Avg.
						Grant Date
		Shares				Fair Value
Restricted stock outstanding at January 3, 2010			383,100			$	19.66
Granted			—				—
Vested			(155,600	)			18.25
Forfeited/canceled			(3,250	)			20.77
Restricted stock outstanding at July 4, 2010			224,250			$	20.63

During the thirteen and twenty-six weeks ended July 4, 2010, the Company recognized $0.9 million and $1.7 million, respectively, of compensation expense related to its outstanding shares of restricted stock. During the thirteen and twenty-six weeks ended June 28, 2009, the Company recognized $1.0 million and $1.9 million, respectively, of compensation expense related to its outstanding shares of restricted stock. As of July 4, 2010, the Company had $3.6 million of unrecognized compensation expense that is expected to be recognized over a weighted average period of 2.3 years.

5. DISCONTINUED OPERATIONS

The termination of any of the Company’s management contracts by expiration or otherwise, may result in the classification of the operating results of such management contract, net of taxes, as a discontinued operation. The Company reflects such events as discontinued operations so long as the financial results can be clearly identified, the operations and cash flows are completely eliminated from ongoing operations, and so long as the Company does not have any significant continuing involvement in the operations of the component after the disposal or termination transaction. The component unit for which cash flows are considered to be completely eliminated exists at the customer level.

Historically, the Company has classified operations as discontinued in the period they are announced as normally all continuing cash flows cease within three to six months of that date. During the fiscal year 2008, the Company discontinued operations at certain of its domestic and international facilities. Where significant, the results of operations, net of taxes, as further discussed below, have been reflected in the accompanying consolidated financial statements as discontinued operations for the thirteen and twenty-six weeks ended June 28, 2009. There were no continuing cash flows from these operations in the thirteen and twenty-six weeks ended July 4, 2010 and as such there are no amounts reclassified to discontinued operations.

On November 7, 2008, the Company announced its receipt of notice for the discontinuation of its contract with the State of Idaho, Department of Correction (“Idaho DOC”) for the housing of approximately 305 out-of-state inmates at the managed-only Bill Clayton Detention Center (the “Detention Center”) effective January 5, 2009. On August 29, 2008, the Company announced its discontinuation of its contract with Delaware County, Pennsylvania for the management of the county-owned 1,883-bed George W. Hill Correctional Facility effective December 31, 2008.

The following are the revenues and income (loss) related to discontinued operations for the periods presented (in thousands):

		Thirteen Weeks Ended								Twenty-six Weeks Ended
		July 4, 2010				June 28, 2009				July 4, 2010				June 28, 2009
Revenues		$	—			$	46			$	—			$	290
Net (loss) income		$	—			$	20			$	—			$	(346	)
Basic earnings per share		$	—			$	0.01			$	—			$	—
Diluted earnings per share		$	—			$	—			$	—			$	(0.01	)

6. COMPREHENSIVE INCOME

The components of the Company’s comprehensive income, net of tax, are as follows (in thousands):

		Thirteen Weeks Ended								Twenty-six Weeks Ended
		July 4, 2010				June 28, 2009				July 4, 2010				June 28, 2009
Net income		$	17,017			$	16,511			$	34,689			$	31,216
Change in foreign currency translation, net of income tax expense (benefit) of $(1,061), $2,087, $(710) and $2,275, respectively			(2,536	)			4,713				(2,358	)			5,208
Pension liability adjustment, net of income tax expense of $7, $29, $14 and $57, respectively			11				44				22				88
Unrealized gain (loss) on derivative instruments, net of income tax expense (benefit) of $(289), $451, $(302) and $512, respectively			(524	)			820				(548	)			931
Comprehensive income		$	13,968			$	22,088			$	31,805			$	37,443

7. DERIVATIVE FINANCIAL INSTRUMENTS

The Company’s primary objective in holding derivatives is to reduce the volatility of earnings and cash flows associated with changes in interest rates. The Company measures its derivative financial instruments at fair value.

In November 2009, the Company executed three interest rate swap agreements (the “Agreements”) in the aggregate notional amount of $75.0 million. In January 2010, the Company executed a fourth interest rate swap agreement in the notional amount of $25.0 million. The Company has designated these interest rate swaps as hedges against changes in the fair value of a designated portion of the 7³/4% Senior Notes due 2017 (“7³/4% Senior Notes”) due to changes in underlying interest rates. The Agreements, which have payment,

expiration dates and call provisions that mirror the terms of the Notes, effectively convert $100.0 million of the Notes into variable rate obligations. Each of the swaps has a termination clause that gives the counterparty the right to terminate the interest rate swaps at fair market value, under certain circumstances. In addition to the termination clause, the Agreements also have call provisions which specify that the lender can elect to settle the swap for the call option price. Under the Agreements, the Company receives a fixed interest rate payment from the financial counterparties to the agreements equal to 7³/4% per year calculated on the notional $100.0 million amount, while it makes a variable interest rate payment to the same counterparties equal to the three-month LIBOR plus a fixed margin of between 4.16% and 4.29%, also calculated on the notional $100.0 million amount. Changes in the fair value of the interest rate swaps are recorded in earnings along with related designated changes in the value of the Notes. Total net gains recognized and recorded in earnings related to these fair value hedges was $5.4 million and $5.8 million in the thirteen and twenty-six weeks ended July 4, 2010, respectively. As of July 4, 2010 and January 3, 2010, the fair value of the swap assets (liabilities) was $3.9 million and $(1.9) million, respectively. There was no material ineffectiveness of these interest rate swaps for the fiscal periods ended July 4, 2010.

The Company’s Australian subsidiary is a party to an interest rate swap agreement to fix the interest rate on its variable rate non-recourse debt to 9.7%. The Company has determined the swap, which has a notional amount of $50.9 million, payment and expiration dates, and call provisions that coincide with the terms of the non-recourse debt to be an effective cash flow hedge. Accordingly, the Company records the change in the value of the interest rate swap in accumulated other comprehensive income, net of applicable income taxes. Total net unrealized gain recognized in the periods and recorded in accumulated other comprehensive income, net of tax, related to these cash flow hedges was $0.5 million and $0.5 million for the thirteen and twenty-six weeks ended July 4, 2010, respectively. Total net gain recognized in the periods and recorded in accumulated other comprehensive income, net of tax, related to these cash flow hedges was $0.8 million and $0.9 million for the thirteen and twenty-six weeks ended June 28, 2009, respectively. The total value of the swap asset as of July 4, 2010 and January 3, 2010 was $1.2 million and $2.0 million, respectively, and is recorded as a component of other assets within the accompanying consolidated balance sheets. There was no material ineffectiveness of this interest rate swap for the fiscal periods presented. The Company does not expect to enter into any transactions during the next twelve months which would result in the reclassification into earnings or losses associated with this swap currently reported in accumulated other comprehensive income (loss).

During the twenty-six weeks ended June 28, 2009, one of the Company’s lenders with respect to its interest rate swap agreement, notional amount of $25.0 million of the $150.0 million 8¹/4% Senior Notes Due 2013, elected to settle the interest rate swap agreement at a price equal to the fair value of the interest rate swap on the respective call date. As a result, the Company realized cash proceeds of $1.0 million.

8. GOODWILL AND OTHER INTANGIBLE ASSETS, NET

Changes in the Company’s goodwill balances for the twenty-six weeks ended July 4, 2010 were as follows (in thousands):

						Goodwill
						Resulting from				Foreign
		Balance as of				Business				Currency				Balance as of
		January 3, 2010				Combination				Translation				July 4, 2010
U.S. corrections		$	21,692			$	—			$	—			$	21,692
International services			669				—				(42	)			627
GEO Care			17,729				41				—				17,770
Total segments		$	40,090			$	41			$	(42	)		$	40,089

On September 30, 2009, the Company’s wholly-owned mental health subsidiary, GEO Care, Inc. (“GEO Care”), acquired Just Care, Inc. (“Just Care”), a provider of detention healthcare focusing on the delivery of medical and mental health services. During the twenty-six weeks ended July 4, 2010, the Company settled certain liabilities at amounts greater than those initially recorded and as such, adjusted goodwill resulting from business combinations. The Company expects that there may be additional information about facts and circumstances surrounding the fair value of tax related assets and liabilities that will be finalized during 2010 and any resulting adjustments will be made to goodwill.

Intangible assets consisted of the following (in thousands):

		Useful Life								International
		in Years				U.S. Corrections				Services				GEO Care				Total
Facility management contracts			7-17			$	14,450			$	1,875			$	—			$	16,325
Facility management contracts acquired			1-13				—								6,600				6,600
Covenants not to compete			4				1,470				—				—				1,470
Gross carrying value of January 3, 2010							15,920				1,875				6,600				24,395
Foreign currency translation							—				483				—				483
Gross carrying value as of July 4, 2010							15,920				2,358				6,600				24,878
Accumulated amortization expense							(7,694	)			(214	)			(678	)			(8,586	)
Net carrying value at July 4, 2010						$	8,226			$	2,144			$	5,922			$	16,292

Amortization expense was $0.6 million and $1.1 million for the thirteen and twenty-six weeks ended July 4, 2010, respectively and primarily related to the U.S. corrections amortization of intangible assets for acquired management contracts. Amortization expense was $0.4 million and $0.9 million for the thirteen and twenty-six weeks ended June 28, 2009, respectively and primarily related to the U.S. corrections amortization of intangible assets for acquired management contracts. The Company’s weighted average useful life related to the acquired facility management contracts is 12.46 years.

9. FAIR VALUE OF ASSETS AND LIABILITIES

The Company is required to measure certain of its financial assets and liabilities at fair value on a recurring basis. The Company defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (“exit price”). The Company classifies and discloses its fair value measurements in one of the following categories: Level 1-unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities; Level 2-quoted prices in markets that are not active, or inputs that are observable, either directly or indirectly, for substantially the full term of the asset or liability; and Level 3- prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e., supported by little or no market activity). The Company recognizes transfers between Levels as of the actual date of the event or change in circumstances that cause the transfer.

All of the Company’s interest rate swap derivatives were in the Company’s favor as of July 4, 2010 and are presented as assets in the table below and in the accompanying balance sheet. The following tables provide a summary of the Company’s significant financial assets and liabilities carried at fair value and measured on a recurring basis as of July 4, 2010 and January 3, 2010 (in thousands):

						Fair Value Measurements at July 4, 2010
		Total Carrying				Quoted Prices in				Significant Other				Significant
		Value at				Active Markets				Observable Inputs				Unobservable
		July 4, 2010				(Level 1)				(Level 2)				Inputs (Level 3)
Assets:
Interest rate swap derivative assets		$	5,116			$	—			$	5,116			$	—
Investments other than derivatives			1,645				—				1,645				—

						Fair Value Measurements at January 3, 2010
		Total Carrying				Quoted Prices in				Significant Other				Significant
		Value at				Active Markets				Observable Inputs				Unobservable
		January 3, 2010				(Level 1)				(Level 2)				Inputs (Level 3)
Assets:
Interest rate swap derivative assets		$	2,020			$	—			$	2,020			$	—
Investments other than derivatives			1,527				—				1,527				—
Liabilities:
Interest rate swap derivative liabilities		$	1,887			$	—			$	1,887			$	—

The financial investments included in the Company’s Level 2 fair value measurements consist of an interest rate swap asset held by our Australian subsidiary, interest rate swap assets and liabilities of the Company, and also an investment in Canadian dollar denominated fixed income securities. The Australian subsidiary’s interest rate swap asset is valued using a discounted cash flow model based on projected Australian borrowing rates. The Company’s interest rate swap assets and liabilities are based on pricing models which consider prevailing interest rates, credit risk and similar instruments. The Canadian dollar denominated securities, not actively traded, are valued using quoted rates for these and similar securities.

10. FINANCIAL INSTRUMENTS

The Company’ balance sheet reflects certain financial instruments at carrying value. The following table presents the carrying values of those instruments and the corresponding fair values at July 4, 2010 and January 3, 2010:

		July 4, 2010
		Carrying				Estimated
		Value				Fair Value
Assets:
Cash and cash equivalents		$	40,135			$	40,135
Restricted cash, including short-term portion			38,813				38,813
Liabilities:
Borrowings under the Senior Credit Facility		$	276,138			$	272,448
73/4% Senior Notes			250,000				248,125
Non-recourse debt, including short-term portion			104,110				102,269

		January 3, 2010
		Carrying				Estimated
		Value				Fair Value
Assets:
Cash and cash equivalents		$	33,856			$	33,856
Restricted cash, including short-term portion			34,068				34,068
Liabilities:
Borrowings under the Senior Credit Facility		$	212,963			$	203,769
73/4% Senior Notes			250,000				255,000
Non-recourse debt, including short-term portion			113,724				113,360

The fair values of the Company’s Cash and cash equivalents and Restricted cash approximate the carrying values of these assets at July 4, 2010 and January 3, 2010. The fair values of publicly traded debt and other non-recourse debt are based on market prices, where available. The fair value of the non-recourse debt related to the Company’s Australian subsidiary is estimated using a discounted cash flow model based on current Australian borrowing rates for similar instruments. The fair value of the borrowings under the Senior Credit Facility is based on an estimate of trading value considering the Company’s borrowing rate, the undrawn spread and similar trades.

11. VARIABLE INTEREST ENTITIES

The Company evaluates its joint ventures and other entities in which it has a variable interest (a “VIE”), generally in the form of investments, loans, guarantees, or equity in order to determine if it has a controlling financial interest and is required to consolidate the entity as a result. The reporting entity with a variable interest that provides the entity with a controlling financial interest in the VIE will have both of the following characteristics: (i) the power to direct the activities of a VIE that most significantly impact the VIE’s economic performance and (ii) the obligation to absorb the losses of the VIE that could potentially be significant to the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE.

The Company does not consolidate its 50% owned South African joint venture in South African Custodial Services Pty. Limited (“SACS”), a VIE. The Company has determined it is not the primary beneficiary of SACS since it does not have the power to direct the activities of SACS that most significantly impact its performance. As such, this entity is reported as an equity affiliate. SACS was established in 2001, to design, finance and build the Kutama Sinthumule Correctional Centre and was subsequently, awarded a 25-year contract to design, construct, manage and finance a facility in Louis Trichardt, South Africa. To fund the construction of the prison, SACS obtained long-term financing from the government which is fully guaranteed, except in the event of default, for which the government provides an

80% guarantee. The Company’s maximum exposure for loss under this contract is limited to its investment in the joint venture of $9.5 million at July 4, 2010 and its guarantees related to SACS discussed in Note 13.

The Company consolidates South Texas Local Development Corporation (“STLDC”), a VIE. STLDC was created to finance construction for the development of a 1,904-bed facility in Frio County, Texas. STLDC, the owner of the complex, issued $49.5 million in taxable revenue bonds and has an operating agreement with the Company, which provides the Company with the sole and exclusive right to operate and manage the detention center. The operating agreement and bond indenture require the revenue from the contract be used to fund the periodic debt service requirements as they become due. The net revenues, if any, after various expenses such as trustee fees, property taxes and insurance premiums are distributed to the Company to cover operating expenses and management fees. The Company is responsible for the entire operations of the facility including all operating expenses and is required to pay all operating expenses whether or not there are sufficient revenues. The bonds have a ten-year term and are non-recourse to the Company. At the end of the ten-year term of the bonds, title and ownership of the facility transfers from STLDC to the Company. See Note 13.

12. NONCONTROLLING INTEREST IN SUBSIDIARY

The Company includes the results of operations and financial position of South African Custodial Management Pty. Limited (“SACM” or the “joint venture”), its majority-owned subsidiary, in its consolidated financial statements. SACM was established in 2001 to operate correctional centers in South Africa. The joint venture currently provides security and other management services for the Kutama Sinthumule Correctional Centre in the Republic of South Africa under a 25-year management contract which commenced in February 2002. The Company’s share and the second joint venture partner’s share in the profits of the joint venture is 88.75% and 11.75%, respectively. There were no changes in the Company’s ownership percentage of the consolidated subsidiary during the twenty-six weeks ended July 4, 2010. The noncontrolling interest as of July 4, 2010 and January 3, 2010 is included in Total Shareholders’ Equity in the accompanying Consolidated Balance Sheets. The net income and other comprehensive income attributable to the noncontrolling interest are not material to the Company’s results of operations and are not presented separately. This amount is included in operating expenses for all periods presented. There were no contributions from owners or distributions to owners in the twenty-six weeks ended July 4, 2010.

13. DEBT

As of July 4, 2010, the Company’s Third Amended and Restated Credit Agreement (as amended, the “Senior Credit Facility”) is comprised of a $153.1 million Term Loan B bearing interest at LIBOR plus 2.00% and maturing in January 2014 and a $330.0 million Revolver which bears interest at LIBOR plus 3.5% and matures in September 2012.

As of July 4, 2010, the Company had $153.1 million outstanding under the Term Loan B, and its $330.0 million Revolver had $123.0 million outstanding in loans, $43.0 million outstanding in letters of credit and $164.0 million available for borrowings. In August 2010, the Company terminated its Senior Credit Facility and executed a new Credit Agreement. Refer to Note 18.

Indebtedness under the Revolver bears interest in each of the instances below at the stated rate:

		Interest Rate under the Revolver
LIBOR borrowings		LIBOR plus 2.75% to 3.50%.
Base rate borrowings		Prime Rate plus 1.75% to 2.50%.
Letters of credit		2.75% to 3.50%.
Unused Revolver		0.50% to 0.75%.

The Company is required to maintain the following Total Leverage Ratios, as computed at the end of each fiscal quarter for the immediately preceding four quarter-period:

Period		Total Leverage Ratio
Through the penultimate day of fiscal year 2010			£4.00 to 1.00
From the last day of the fiscal year 2010 through the penultimate day of fiscal year 2011			£3.75 to 1.00
From the last day of the fiscal year 2011 through the penultimate day of fiscal year 2012			£3.25 to 1.00
Thereafter			£3.00 to 1.00

The Senior Credit Facility also requires the Company to maintain the following Senior Secured Leverage Ratios, as computed at the end of each fiscal quarter for the immediately preceding four quarter-period:

Period		Senior Secured Leverage Ratio
Through the penultimate day of fiscal year 2011		£3.00 to 1.00
From the last day of the fiscal year 2011 through the penultimate day of fiscal year 2012		£2.50 to 1.00
From the last day of the fiscal year 2012 through the penultimate day of fiscal year 2013		£2.25 to 1.00
Thereafter		£2.00 to 1.00

All of the obligations under the Senior Credit Facility are unconditionally guaranteed by each of the Company’s existing material domestic subsidiaries. The Senior Credit Facility and the related guarantees are secured by substantially all of the Company’s present and future tangible and intangible assets and all present and future tangible and intangible assets of each guarantor, as specified in the Senior Credit Facility Agreement. In addition, the Senior Credit Facility contains certain customary representations and warranties, and certain customary covenants that restrict the Company’s ability to be party to certain transactions, as further specified in the Senior Credit Facility Agreement. Events of default under the Senior Credit Facility include, but are not limited to, (i) the Company’s failure to pay principal or interest when due, (ii) the Company’s material breach of any representation or warranty, (iii) covenant defaults, (iv) bankruptcy, (v) cross default to certain other indebtedness, (vi) unsatisfied final judgments over a specified threshold, (vii) material environmental state of claims which are asserted against it, and (viii) a change of control. The Company’s failure to comply with any of the covenants under its Senior Credit Facility could cause an event of default under such documents and result in an acceleration of all of the outstanding senior secured indebtedness. The Company believes it was in compliance with all of the covenants of the Senior Credit Facility as of July 4, 2010.

In October 2009, the Company completed a private offering of $250.0 million in aggregate principal amount of its 7³/4% Senior Notes due 2017. These senior unsecured notes pay interest semi-annually in cash in arrears on April 15 and October 15 of each year, beginning on April 15, 2010. The Company realized net proceeds of $246.4 million at the close of the transaction, net of the discount on the notes of $3.6 million. The Company used the net proceeds of the offering to fund the repurchase of all of its 8¹/4% Senior Notes due 2013 and pay down part of the Revolver.

The 7³/4% Senior Notes and the guarantees are unsecured, senior obligations of GEO and these obligations rank as follows: pari passu with any unsecured, senior indebtedness of GEO and the guarantors; senior to any future indebtedness of GEO and the guarantors that is expressly subordinated to the notes and the guarantees; effectively junior to any secured indebtedness of GEO and the guarantors, including indebtedness under the Company’s Senior Credit Facility, to the extent of the value of the assets securing such indebtedness; and effectively junior to all obligations of the Company’s subsidiaries that are not guarantors After October 15, 2013, the Company may, at its option, redeem all or a part of the 7³/4% Senior Notes upon not less than 30 nor more than 60 days’ notice, at the redemption prices (expressed as percentages of principal amount) set forth below, plus accrued and unpaid interest and liquidated damages, if any, on the 7³/4% Senior Notes redeemed, to the applicable redemption date, if redeemed during the 12-month period beginning on October 15 of the years indicated below:

Year		Percentage
2013			103.875	%
2014			101.938	%
2015 and thereafter			100.000	%

Before October 15, 2013, the Company may redeem some or all of the 7³/4% Senior Notes at a redemption price equal to 100% of the principal amount of each note to be redeemed plus a make-whole premium together with accrued and unpaid interest and liquidated damages, if any. In addition, at any time on or prior to October 15, 2012, the Company may redeem up to 35% of the notes with the net cash proceeds from specified equity offerings at a redemption price equal to 107.750% of the aggregate principal amount of the notes to be redeemed, plus accrued and unpaid interest and liquidated damages, if any, to the date of redemption.

The indenture governing the notes contains certain covenants, including limitations and restrictions on the Company and its restricted subsidiaries’ ability to: incur additional indebtedness or issue preferred stock; make dividend payments or other restricted payments; create liens; sell assets; enter into transactions with affiliates; and enter into mergers, consolidations, or sales of all or substantially all of our assets. As of the date of the indenture, all of the Company’s subsidiaries, other than CSC of Tacoma, LLC, GEO International

Holdings, Inc., certain dormant domestic subsidiaries and all foreign subsidiaries in existence on the date of the indenture, were restricted subsidiaries. In addition, there is a cross-default provision which becomes enforceable upon failure of payment of indebtedness at final maturity. The Company’s unrestricted subsidiaries will not be subject to any of the restrictive covenants in the indenture. The Company believes it was in compliance with all of the covenants of the Indenture governing the 7³/4% Senior Notes as of July 4, 2010.

The Company has a debt service requirement related to the development of the South Texas Detention Complex, a 1,904-bed detention complex in Frio County, Texas acquired in November 2005 from Correctional Services Corporation (“CSC”). CSC was awarded the contract in February 2004 by the Department of Homeland Security, U.S. Immigration and Customs Enforcement (“ICE”) for development and operation of the detention center. In order to finance its construction STLDC was created and issued $49.5 million in taxable revenue bonds. These bonds mature in February 2016 and have fixed coupon rates between 4.34% and 5.07%. Additionally, the Company is owed $5.0 million in the form of subordinated notes by STLDC which represents the principal amount of financing provided to STLDC by CSC for initial development.

The Company has an operating agreement with STLDC, the owner of the complex, which provides it with the sole and exclusive right to operate and manage the detention center. The operating agreement and bond indenture require the revenue from the contract with ICE be used to fund the periodic debt service requirements as they become due. The net revenues, if any, after various expenses such as trustee fees, property taxes and insurance premiums are distributed to the Company to cover operating expenses and management fees. The Company is responsible for the entire operations of the facility including all operating expenses and is required to pay all operating expenses whether or not there are sufficient revenues. STLDC has no liabilities resulting from its ownership. The bonds have a ten-year term and are non-recourse to the Company and STLDC. The bonds are fully insured and the sole source of payment for the bonds is the operating revenues of the center. At the end of the ten-year term of the bonds, title and ownership of the facility transfers from STLDC to the Company. The Company has determined that it is the primary beneficiary of STLDC and consolidates the entity as a result. The carrying value of the facility as of July 4, 2010 and January 3, 2010 was $26.9 million and $27.2 million, respectively and is included in property and equipment in the accompanying balance sheets.

On February 1, 2010, STLDC made a payment from its restricted cash account of $4.6 million for the current portion of its periodic debt service requirement in relation to the STLDC operating agreement and bond indenture. As of July 4, 2010, the remaining balance of the debt service requirement under the STLDC financing agreement is $32.1 million, of which $4.8 million is due within the next twelve months. Also, as of July 4, 2010, included in current restricted cash and non-current restricted cash is $6.3 million and $9.4 million, respectively, of funds held in trust with respect to the STLDC for debt service and other reserves.

On June 30, 2003, CSC arranged financing for the construction of the Northwest Detention Center in Tacoma, Washington, referred to as the Northwest Detention Center, which was completed and opened for operation in April 2004. The Company began to operate this facility following its acquisition in November 2005. In connection with the original financing, CSC of Tacoma LLC, a wholly owned subsidiary of CSC, issued a $57.0 million note payable to the Washington Economic Development Finance Authority, referred to as WEDFA, an instrumentality of the State of Washington, which issued revenue bonds and subsequently loaned the proceeds of the bond issuance back to CSC for the purposes of constructing the Northwest Detention Center. The bonds are non-recourse to the Company and the loan from WEDFA to CSC is non-recourse to the Company. These bonds mature in February 2014 and have fixed coupon rates between 3.50% and 4.10%.

The proceeds of the loan were disbursed into escrow accounts held in trust to be used to pay the issuance costs for the revenue bonds, to construct the Northwest Detention Center and to establish debt service and other reserves. No payments were made during the thirteen weeks ended July 4, 2010 in relation to the WEDFA bond indenture. As of July 4, 2010, the remaining balance of the debt service requirement is $31.6 million, of which $5.9 million is classified as current in the accompanying balance sheet.

As of July 4, 2010, included in current restricted cash and non-current restricted cash is $7.0 million and $5.3 million, respectively, of funds held in trust with respect to the Northwest Detention Center for debt service and other reserves.

The Company’s wholly-owned Australian subsidiary financed the development of a facility and subsequent expansion in 2003 with long-term debt obligations. These obligations are non-recourse to the Company and total $40.4 million and $45.4 million at July 4, 2010 and January 3, 2010, respectively. The term of the non-recourse debt is through 2017 and it bears interest at a variable rate quoted by certain Australian banks plus 140 basis points. Any obligations or liabilities of the subsidiary are matched by a similar or corresponding commitment from the government of the State of Victoria. As a condition of the loan, the Company is required to maintain a restricted cash balance of AUD 5.0 million, which, at July 4, 2010, was $4.2 million. This amount is included in restricted cash and the annual maturities of the future debt obligation are included in non-recourse debt.

Guarantees

In connection with the creation of SACS, the Company entered into certain guarantees related to the financing, construction and operation of the prison. The Company guaranteed certain obligations of SACS under its debt agreements up to a maximum amount of 60.0 million South African Rand, or $7.8 million, to SACS’ senior lenders through the issuance of letters of credit. Additionally, SACS is required to fund a restricted account for the payment of certain costs in the event of contract termination. The Company has guaranteed the payment of 60% of amounts which may be payable by SACS into the restricted account and provided a standby letter of credit of 8.4 million South African Rand, or $1.1 million, as security for its guarantee. The Company’s obligations under this guarantee expire upon SACS’ release from its obligations in respect to the restricted account under its debt agreements. No amounts have been drawn against these letters of credit, which are included in the Company’s outstanding letters of credit under its Revolver.

The Company has agreed to provide a loan, of up to 20.0 million South African Rand, or $2.6 million, referred to as the Standby Facility, to SACS for the purpose of financing SACS’ obligations under its contract with the South African government. No amounts have been funded under the Standby Facility, and the Company does not currently anticipate that such funding will be required by SACS in the future. The Company’s obligations under the Standby Facility expire upon the earlier of full funding or SACS’s release from its obligations under its debt agreements. The lenders’ ability to draw on the Standby Facility is limited to certain circumstances, including termination of the contract.

The Company has also guaranteed certain obligations of SACS to the security trustee for SACS’ lenders. The Company secured its guarantee to the security trustee by ceding its rights to claims against SACS in respect of any loans or other finance agreements, and by pledging the Company’s shares in SACS. The Company’s liability under the guarantee is limited to the cession and pledge of shares. The guarantee expires upon expiration of the cession and pledge agreements.

In connection with a design, build, finance and maintenance contract for a facility in Canada, the Company guaranteed certain potential tax obligations of a not-for-profit entity. The potential estimated exposure of these obligations is Canadian Dollar (“CAD”) 2.5 million, or $2.4 million, commencing in 2017. The Company has a liability of $1.6 million and $1.5 million related to this exposure as July 4, 2010 and January 3, 2010, respectively. To secure this guarantee, the Company has purchased Canadian dollar denominated securities with maturities matched to the estimated tax obligations in 2017 to 2021. The Company has recorded an asset and a liability equal to the current fair market value of those securities on its consolidated balance sheet. The Company does not currently operate or manage this facility.

At July 4, 2010, the Company also had nine letters of guarantee outstanding under separate international facilities relating to performance guarantees of its Australian subsidiary totaling $8.3 million.

14. COMMITMENTS AND CONTINGENCIES

Litigation, Claims and Assessments

In June 2004, the Company received notice of a third-party claim for property damage incurred during 2001 and 2002 at several detention facilities that its Australian subsidiary formerly operated. The claim (No. SC 656 of 2006 to be heard by the Supreme Court of the Australian Capital Territory) relates to property damage caused by detainees at the detention facilities. The notice was given by the Australian government’s insurance provider and did not specify the amount of damages being sought. In August 2007, legal proceedings in this matter were formally commenced when the Company was served with notice of a complaint filed against it by the Commonwealth of Australia seeking damages of up to approximately AUD 18 million or $15.2 million, plus interest. The Company believes that it has several defenses to the allegations underlying the litigation and the amounts sought and intends to vigorously defend its rights with respect to this matter. The Company has established a reserve based on its estimate of the most probable loss based on the

facts and circumstances known to date and the advice of legal counsel in connection with this matter. Although the outcome of this matter cannot be predicted with certainty, based on information known to date and the Company’s preliminary review of the claim and related reserve for loss, the Company believes that, if settled unfavorably, this matter could have a material adverse effect on its financial condition, results of operations or cash flows. The Company is uninsured for any damages or costs that it may incur as a result of this claim, including the expenses of defending the claim.

During the fourth fiscal quarter of 2009, the Internal Revenue Service (“IRS”) completed its examination of the Company’s U.S. federal income tax returns for the years 2002 through 2005. Following the examination, the IRS notified the Company that it proposes to disallow a deduction that the Company realized during the 2005 tax year. Due to the Company’s receipt of the proposed IRS audit adjustment for the disallowed deduction, the Company reassessed the probability of potential settlement outcomes with respect to the proposed adjustment, which is now under review by the IRS’s appeals division. Based on this reassessment, the Company has provided an additional accrual of $4.9 million during the fourth quarter of 2009. The Company has appealed this proposed disallowed deduction with the IRS’s appeals division and believes it has valid defenses to the IRS’s position. However, if the disallowed deduction were to be sustained in full on appeal, it could result in a potential tax exposure to the Company of $15.4 million. The Company believes in the merits of its position and intends to defend its rights vigorously, including its rights to litigate the matter if it cannot be resolved favorably at the IRS’s appeals level. If this matter is resolved unfavorably, it may have a material adverse effect on the Company’s financial position, results of operations and cash flows.

The Company is currently under examination by the Internal Revenue Service for its U.S. income tax returns for fiscal years 2006 through 2008 and expects this examination to be concluded in 2010. Based on the status of the audit to date, the Company does not expect the outcome of the audit to have a material adverse impact on its financial condition, results of operation or cash flows.

The Company’s South Africa joint venture is in discussions with the South African Revenue Service (“SARS”) with respect to the deductibility of certain expenses for the tax periods 2002 through 2004. The joint venture operates the Kutama Sinthumule Correctional Centre and accepted inmates from the South African Department of Correctional Services in 2002. SARS has notified the Company that it proposes to disallow these deductions. The Company has appealed these proposed disallowed deductions with SARS, believes it has defenses in these matters and intends to defend its rights vigorously. However, if resolved unfavorably, the Company’s maximum exposure would be $2.6 million.

On April 27, 2010, a putative stockholder class action was filed in the District Court for Harris County, Texas by Todd Shelby against Cornell, members of the Cornell board of directors, individually, and GEO. The plaintiff filed an amended complaint on May 28, 2010. The amended complaint alleges, among other things, that the Cornell directors, aided and abetted by Cornell and GEO, breached their fiduciary duties in connection with the merger. Among other things, the amended complaint seeks to enjoin Cornell, its directors and GEO from completing the merger and seeks a constructive trust over any benefits improperly received by the defendants as a result of their alleged wrongful conduct. The parties have reached a settlement in principle, subject to confirmatory discovery, preparation and execution of a formal stipulation of settlement, final court approval of the settlement and dismissal of the action with prejudice. The settlement of this matter will not have a material adverse impact on the Company’s financial condition, results of operations or cash flows.

The nature of the Company’s business exposes it to various types of claims or litigation against the Company, including, but not limited to, civil rights claims relating to conditions of confinement and/or mistreatment, sexual misconduct claims brought by prisoners or detainees, medical malpractice claims, claims relating to employment matters (including, but not limited to, employment discrimination claims, union grievances and wage and hour claims), property loss claims, environmental claims, automobile liability claims, indemnification claims by its customers and other third parties, contractual claims and claims for personal injury or other damages resulting from contact with the Company’s facilities, programs, personnel or prisoners, including damages arising from a prisoner’s escape or from a disturbance or riot at a facility. Except as otherwise disclosed above, the Company does not expect the outcome of any pending claims or legal proceedings to have a material adverse effect on its financial condition, results of operations or cash flows.

Construction Commitments

The Company is currently developing a number of projects using company financing. The Company’s management estimates that these existing capital projects will cost approximately $214.3 million, of which $97.5 million was spent through the second quarter of 2010. The Company has future committed capital projects for which it estimates its remaining capital requirements to be approximately $116.8 million, which will be spent through fiscal years 2010 and 2011. Capital expenditures related to facility maintenance costs are expected to range between $10.0 million and $15.0 million for fiscal year 2010. In addition to these current estimated capital requirements for 2010 and 2011, the Company is currently in the process of bidding on, or evaluating potential

bids for the design, construction and management of a number of new projects. In the event that the Company wins bids for these projects and decides to self-finance their construction, its capital requirements in 2010 and/or 2011 could materially increase.

Contract Terminations

On June 22, 2010, the Company announced the discontinuation of its managed-only contract for the 520-bed Bridgeport Correctional Center in Texas following a competitive rebid process conducted by the State of Texas. The contract will terminate effective August 31, 2010.

On April 14, 2010, the Company announced the results of the rebids of two of its managed-only contracts. The State of Florida has issued a Notice of Intent to Award contracts for the 1,884-bed Graceville Correctional Facility located in Graceville, Florida and the 985-bed Moore Haven Correctional Facility located in Moore Haven, Florida to another operator. These contracts will terminate effective September 26, 2010 and August 1, 2010, respectively.

On April 4, 2010, the Company’s wholly-owned Australian subsidiary completed the transition of its management of the Melbourne Custody Center (the “Center”) to another service provider. The Center was operated on behalf of the Victoria Police to house prisoners, escort and guard prisoners for the Melbourne Magistrate Courts and to provide primary healthcare.

15. BUSINESS SEGMENT AND GEOGRAPHIC INFORMATION

Operating and Reporting Segments

The Company conducts its business through four reportable business segments: the U.S. corrections segment; the International services segment; the GEO Care segment; and the Facility construction and design segment. The Company has identified these four reportable segments to reflect the current view that the Company operates four distinct business lines, each of which constitutes a material part of its overall business. The U.S. corrections segment primarily encompasses U.S.-based privatized corrections and detention business. The International services segment primarily consists of privatized corrections and detention operations in South Africa, Australia and the United Kingdom. The GEO Care segment, which is operated by the Company’s wholly-owned subsidiary GEO Care, Inc., comprises privatized mental health and residential treatment services business, all of which is currently conducted in the U.S. The Facility construction and design segment consists of contracts with various state, local and federal agencies for the design and construction of facilities for which the Company has management contracts. Disclosures for business segments are as follows (in thousands):

		Thirteen Weeks Ended								Twenty-six Weeks Ended
		July 4, 2010				June 28, 2009				July 4, 2010				June 28, 2009
Revenues:
U.S. corrections		$	194,888			$	192,265			$	387,397			$	384,034
International services			44,708				29,870				90,590				55,549
GEO Care			34,166				27,860				68,866				56,463
Facility construction and design			6,333				26,384				20,784				39,394
Total revenues		$	280,095			$	276,379			$	567,637			$	535,440
Depreciation and amortization:
U.S. corrections		$	8,225			$	8,972			$	16,176			$	18,055
International services			420				330				855				663
GEO Care			829				328				1,681				728
Facility construction and design			—				—				—				—
Total depreciation and amortization		$	9,474			$	9,630			$	18,712			$	19,446
Operating income:
U.S. corrections		$	46,613			$	43,021			$	92,448			$	84,516
International services			3,396				1,958				5,189				3,823
GEO Care			3,488				2,787				6,834				6,266
Facility construction and design			197				126				1,145				205
Operating income from segments			53,694				47,892				105,616				94,810
General and administrative expenses			(20,655	)			(17,015	)			(38,103	)			(34,251	)
Total operating income		$	33,039			$	30,877			$	67,513			$	60,559

		July 4, 2010				January 3, 2010
Segment assets:
U.S. corrections		$	1,206,145			$	1,145,571
International services			86,689				95,659
GEO Care			61,468				107,908
Facility construction and design			6,281				13,736
Total segment assets		$	1,360,583			$	1,362,874

Pre-Tax Income Reconciliation of Segments

The following is a reconciliation of the Company’s total operating income from its reportable segments to the Company’s income before income taxes, equity in earnings of affiliates and discontinued operations, in each case, during the thirteen and twenty-six weeks ended July 4, 2010 and June 28, 2009, respectively.

		Thirteen Weeks Ended								Twenty-six Weeks Ended
		July 4, 2010				June 28, 2009				July 4, 2010				June 28, 2009
Total operating income from segments		$	53,694			$	47,892			$	105,616			$	94,810
Unallocated amounts:
General and Administrative Expenses			(20,655	)			(17,015	)			(38,103	)			(34,251	)
Net interest expense			(6,961	)			(5,555	)			(13,546	)			(11,669	)
Income before income taxes, equity in earnings of affiliates and discontinued operations		$	26,078			$	25,322			$	53,967			$	48,890

Asset Reconciliation of Segments

The following is a reconciliation of the Company’s reportable segment assets to the Company’s total assets as of July 4, 2010 and January 3, 2010, respectively.

		July 4, 2010				January 3, 2010
Reportable segment assets		$	1,360,583			$	1,362,874
Cash			40,135				33,856
Deferred income tax			17,020				17,020
Restricted cash			38,813				34,068
Total assets		$	1,456,551			$	1,447,818

Sources of Revenue

The Company derives most of its revenue from the management of privatized correctional and detention facilities. The Company also derives revenue from the management of residential treatment facilities and from the construction and expansion of new and existing correctional, detention and residential treatment facilities. All of the Company’s revenue is generated from external customers.

		Thirteen Weeks Ended								Twenty-six Weeks Ended
		July 4, 2010				June 28, 2009				July 4, 2010				June 28, 2009
Revenues:
Correctional and detention		$	239,596			$	222,135			$	477,987			$	439,583
GEO Care			34,166				27,860				68,866				56,463
Facility construction and design			6,333				26,384				20,784				39,394
Total revenues		$	280,095			$	276,379			$	567,637			$	535,440

Equity in earnings of affiliate includes the Company’s joint venture in South Africa, SACS. This entity is accounted for under the equity method of accounting and the Company’s investment in SACS is presented as a component of other non-current assets in the accompanying consolidated balance sheets.

A summary of financial data for SACS is as follows (in thousands):

		Thirteen Weeks Ended								Twenty-six Weeks Ended
		July 4, 2010				June 28, 2009				July 4, 2010				June 28, 2009
Statement of Operations Data
Revenues		$	10,994			$	9,069			$	21,755			$	16,641
Operating income			4,508				3,684				8,600				6,531
Net income			2,257				1,719				3,437				3,006

		July 4, 2010				January 3, 2010
Balance Sheet Data
Current assets		$	29,158			$	33,808
Non-current assets			44,346				47,453
Current liabilities			3,150				2,888
Non-current liabilities			51,405				53,877
Shareholders’ equity			18,949				24,496

During the twenty-six weeks ended July 4, 2010, the Company’s consolidated South African subsidiary received a dividend of $3.9 million from SACS which reduced the Company’s investment in its joint venture. As of July 4, 2010 and January 3, 2010, the Company’s investment in SACS was $9.5 million and $12.2 million, respectively. The investment is included in other non-current assets in the accompanying consolidated balance sheets.

16. BENEFIT PLANS

The Company has two non-contributory defined benefit pension plans covering certain of the Company’s executives. Retirement benefits are based on years of service, employees’ average compensation for the last five years prior to retirement and social security benefits. Currently, the plans are not funded. The Company purchased and is the beneficiary of life insurance policies for certain participants enrolled in the plans. There were no significant transactions between the employer or related parties and the plan during the period.

As of July 4, 2010, the Company had non-qualified deferred compensation agreements with two key executives. These agreements were modified in 2002, and again in 2003. The current agreements provide for a lump sum payment when the executives retire, no sooner than age 55. As of July 4, 2010, both executives had reached age 55 and are eligible to receive the payments upon retirement.

The following table summarizes key information related to the Company’s pension plans and retirement agreements. The table illustrates the reconciliation of the beginning and ending balances of the benefit obligation showing the effects during the period attributable to each of the following: service cost, interest cost, plan amendments, termination benefits, actuarial gains and losses. The Company’s liability relative to its pension plans and retirement agreements was $16.7 million and $16.2 million as of July 4, 2010 and January 3, 2010, respectively. The long-term portion of the pension liability as of July 4, 2010 and January 3, 2010 was $16.6 million and $16.0 million, respectively, and is included in Other Non-Current liabilities in the accompanying balance sheets. The assumptions used in the Company’s calculation of accrued pension costs are based on market information and the Company’s historical rates for employment compensation and discount rates, respectively.

		July 4, 2010				January 3, 2010
		(in thousands)
Change in Projected Benefit Obligation
Projected benefit obligation, beginning of period		$	16,206			$	19,320
Service cost			262				563
Interest cost			374				717
Actuarial gain			—				(1,047	)
Benefits paid			(107	)			(3,347	)
Projected benefit obligation, end of period		$	16,735			$	16,206
Change in Plan Assets
Plan assets at fair value, beginning of period		$	—			$	—
Company contributions			107				3,347
Benefits paid			(107	)			(3,347	)
Plan assets at fair value, end of period		$	—			$	—
Unfunded Status of the Plan		$	(16,735	)		$	(16,206	)
Amounts Recognized in Accumulated Other Comprehensive Income
Prior service cost			20				41
Net loss			998				1,014
Accrued pension cost		$	1,018			$	1,055

		Thirteen Weeks Ended								Twenty-six Weeks Ended
		July 4, 2010				June 28, 2009				July 4, 2010				June 28, 2009
Components of Net Periodic Benefit Cost
Service cost		$	131			$	141			$	262			$	282
Interest cost			187				179				374				359
Amortization of:
Prior service cost			10				10				20				20
Net loss			8				62				16				125
Net periodic pension cost		$	336			$	392			$	672			$	786
Weighted Average Assumptions for Expense
Discount rate			5.75	%			5.75	%			5.75	%			5.75	%
Expected return on plan assets			N/A				N/A				N/A				N/A
Rate of compensation increase			4.50	%			5.00	%			4.50	%			5.00	%

The Company expects to pay benefits of $0.2 million in its fiscal year ending January 2, 2011.

17. RECENT ACCOUNTING STANDARDS

The Company implemented the following accounting standards in the twenty-six weeks ended July 4, 2010:

In December 2009, the FASB issued ASU No. 2009-17, previously known as FAS No. 167, “Amendments to FASB Interpretation No. FIN 46(R)” (SFAS No. 167). ASU No. 2009-17 amends the manner in which entities evaluate whether consolidation is required for VIEs. The consolidation requirements under the revised guidance require a company to consolidate a VIE if the entity has all three of the following characteristics (i) the power, through voting rights or similar rights, to direct the activities of a legal entity that most significantly impact the entity’s economic performance, (ii) the obligation to absorb the expected losses of the legal entity, and (iii) the right to receive the expected residual returns of the legal entity. Further, this guidance requires that companies continually evaluate VIEs for consolidation, rather than assessing based upon the occurrence of triggering events. As a result of adoption, which was effective for the Company’s interim and annual periods beginning after November 15, 2009, companies are required to enhance disclosures about how their involvement with a VIE affects the financial statements and exposure to risks. The implementation of this standard in the twenty-six weeks ended July 4, 2010 did not have a material impact on the Company’s financial position, results of operations and cash flows.

In January 2010, the FASB issued ASU No. 2010-2 which addresses implementation issues related to changes in ownership provisions of consolidated subsidiaries, investees and joint ventures. The amendment clarifies that the scope of the decrease in ownership provisions outlined in the current consolidation guidance apply to (i) a subsidiary or group of assets that is a business or nonprofit activity, (ii) a subsidiary that is a business or nonprofit activity and is transferred to an equity method investee or joint venture and (iii) to an exchange of a group of assets that constitute a business or nonprofit activity for a noncontrolling interest in an entity. The amendment also makes certain other clarifications and expands disclosures about the deconsolidation of a subsidiary or derecognition of a group of assets within the scope of the current consolidation guidance. These amendments became effective for the Company interim and annual reporting periods beginning after December 15, 2009. The implementation of this standard did not have a material impact on the Company’s financial position, results of operations and cash flows.

In January 2010, the FASB issued ASU No. 2010-6 which requires additional disclosures relative to transfers of assets and liabilities between Levels 1 and 2 of the fair value hierarchy. Additionally, the amendment requires companies to present activity in the reconciliation for Level 3 fair value measurements on a gross basis rather than on a net basis. This update also provides clarification to existing disclosures relative to the level of disaggregation and disclosure of inputs and valuation techniques for fair value measurements that fall into either Level 2 or Level 3. This amendment became effective for the Company interim and annual reporting period after December 15, 2009, except for disclosures related to activity in Level 3 fair value measurements which are effective for the Company’s first reporting period beginning after December 15, 2010. The implementation of this standard, relative to Levels 1 and 2 of the fair value hierarchy, did not have a material impact on the Company’s financial position, results of operations and cash flows. The Company does not expect the adoption of the standard relative to Level 3 investments to have a material impact on the Company’s financial position, results of operations and cash flows.

18. SUBSEQUENT EVENTS

Contract awards

On July 26, 2010, the Company announced its signing of a contract amendment with the East Mississippi Correctional Facility Authority (“the Authority”) for the continued management of the 1,500-bed East Mississippi Correctional Facility located in Meridian, Mississippi. The amendment extends the Company’s management contract with the Authority through March 15, 2015. The Authority in turn has a concurrent contract with the Mississippi Department of Corrections for the housing of Mississippi inmates at this facility.

On July 23, 2010, the Company announced that its wholly-owned subsidiary in the United Kingdom activated the 360-bed expansion of the Harmondsworth Immigration Removal Centre in London, England increasing the total capacity of this facility from 260 beds to 620 beds. The Company began the intake of the additional detainees on July 18, 2010.

On July 21, 2010, the Company announced the execution of a new contract with the State of Georgia, Department of Corrections for the development and operation of a new 1,500-bed correctional facility to be located in Milledgeville, Georgia. Under the terms of the contract, GEO will finance, develop, and operate the new $80.0 million, 1,500-bed Facility on state-owned land pursuant to a 40-year ground lease. This facility is expected to open in the first quarter of 2012.

On July 8, 2010, we also announced the award of a contract from the California Department of Corrections and Rehabilitation (“CDCR”) for the housing of female inmates at our 200-bed McFarland Community Correctional Facility located in McFarland, California. The contract will have a term of five years with one additional five-year renewal option period. We expect to begin the intake of female inmates in third quarter 2010 following minor renovations at this facility.

Cornell acquisition

On August 12, 2010, the Company acquired 100% of Cornell’s common stock for aggregate consideration of approximately $443 million excluding the effects of cash acquired and including GEO common stock consideration of approximately $358 million, based on the closing price of the Company’s stock on August 12, 2010 of $22.70, and cash consideration of $85.0 million pursuant to a definitive merger agreement entered into on April 18, 2010, as amended on July 22, 2010, between the Company, GEO Acquisition III, Inc., and Cornell (Refer to Note 2). Also, in connection with the merger, on August 12, 2010, the Company paid $181.9 million of Cornell’s existing long-term debt, including accrued interest, and assumed $108.3 million of Cornell’s existing non-recourse debt. If the merger with Cornell had occurred before July 4, 2010, the number of shares of common stock issued and outstanding would have increased by approximately 15.8 million shares from 48.9 million shares issued and outstanding to approximately 64.7 million shares issued and outstanding. The number of shares issued in connection with the merger and the purchase price is based on the assumption that the exchange agent receives the required stock certificates by the deadline for Cornell stockholders who made their elections pursuant to the notice of guaranteed delivery procedure.

Purchase price allocation

GEO is identified as the acquiring company for US GAAP accounting purposes. Under the purchase method of accounting, the purchase price for Cornell will be allocated to Cornell’s net tangible and intangible assets based on their estimated fair values as of August 12, 2010, the date of closing and the date that GEO obtained control over Cornell. In order to determine the fair values of a significant portion of the assets acquired and liabilities assumed, the Company has engaged third party independent valuation specialists. For any other assets acquired and liabilities assumed for which the Company is not obtaining an independent valuation, the fair value determined by the Company’s management will represent the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. With the exception of any adjustments which may occur during the one-year measurement period proscribed by GAAP, the Company expects to finalize its purchase accounting with respect to the acquisition of Cornell by the end of the third quarter of the fiscal year 2010. The accounting for this acquisition was not complete at the time of this filing and accordingly, the Company has not presented the required business combination disclosures. The Company expects to record goodwill in connection with this transaction however, due to the timing of the closing of the transaction and the filing date of the Company’s Quarterly Report on Form 10-Q, it was impracticable for the Company to determine the value of any goodwill. As of the date of this filing, several significant inputs to the purchase accounting model had not been completed such as valuations for: (i) intangible assets related to the acquired management contracts, (ii) property and equipment acquired, (iii) out of market facility leases, and (iv) the settlement of a preexisting relationship between the Company and Cornell for the lease of the GEO-owned Mesa Verde Community Correctional Facility. Additionally, it was impracticable to include meaningful pro forma financial results for GEO and Cornell on a combined basis as the pro forma adjustments are expected to primarily consist of incremental interest expense related to the cash paid to the Cornell stockholders, estimates for the amortization of acquisition related intangible assets, depreciation expense based on the fair value of property and equipment acquired, income tax effects, and other revenues and expenses which will result from the purchase price allocation and determination of fair value for assets acquired and liabilities assumed.

2006 Stock Incentive Plan

On August 12, 2010, at a special meeting of the shareholders, the Company received approval from its shareholders to amend the 2006 Stock Incentive Plan to increase the number of shares of common stock subject to awards under the 2006 Plan by 2,000,000 shares from 2,400,000 to 4,400,000 shares of common stock.

New Credit Agreement

On August 4, 2010, the Company entered into a Credit Agreement between the Company, as Borrower, certain of its subsidiaries, as Guarantors, and BNP Paribas, as Lender and as Administrative Agent (together with the Term Loan A, Term Loan B and the Revolving Credit Facility, the “Credit Agreement”). The Credit Agreement is comprised of (i) a $150.0 million Term Loan A, under which borrowings were available only upon closing of the merger with Cornell, initially bearing interest at LIBOR plus 2.5% and maturing August 4, 2015, (ii) a $200.0 million Term Loan B initially bearing interest at LIBOR plus 3.25% with a LIBOR floor of 1.50% and maturing August 4, 2016 and (iii) a Revolving Credit Facility of $400.0 million initially bearing interest at LIBOR plus 2.5% and maturing August 4, 2015. On August 4, 2010, the Company borrowed $80.0 million from its Revolving Credit Facility and $200.0 million from the Term Loan B for aggregate borrowings under the Credit Agreement of $280.0 million. The Company used proceeds of $276.8 million to repay existing borrowings and accrued interest under the Third Amended and Restated Credit Agreement of $267.7 million, to pay $6.7 million for financing fees related to the Credit Agreement and to pay $2.4 million for expenses related to the unused $150.0 million commitment under the Third Amended and Restated Credit Agreement. The Company received the remaining proceeds of $3.2 million. On August 12, 2010, the Company borrowed $150.0 million under its Term Loan A and $140.0 million under the Revolving Credit Facility and used the aggregate $290.0 million in cash proceeds for $85.0 million in cash payments to Cornell’s stockholders in connection with the merger, transaction costs of $14.0 million, the repayment of $181.9 million for Cornell’s 10.75% Senior Notes due July 2012 plus accrued interest and Cornell’s Revolving Line of Credit due December 2011 plus accrued interest and retained the remaining $9.1 million.

As of August 12, 2010, the Company had $150.0 million outstanding under the Term Loan A, $200.0 million outstanding under the Term Loan B, and its $400.0 million Revolving Credit Facility had $220.0 million outstanding in loans, $55.4 million outstanding in letters of credit and $124.6 million available for borrowings. The Company intends to use future borrowings from the Revolving Credit Facility for the purposes permitted under the Credit Agreement, including for general corporate purposes.

The Company has accounted for the termination of the Third Amended and Restated Credit Agreement as an extinguishment of debt. In connection with repayment of all outstanding borrowings and termination of the Third Amended and Restated Credit Agreement, the Company expects to write-off approximately $8 million of associated deferred financing fees in the thirteen weeks ended October 3, 2010.

Contract termination

Effective September 1, 2010, the Company’s management contract for the operation of South Texas Intermediate Sanction Facility will terminate.

19. CONDENSED CONSOLIDATING FINANCIAL INFORMATION

On October 20, 2009, the Company completed an offering of $250.0 million aggregate principal amount of its 7³/4% senior notes due 2017 (the “Original Notes”). The Original Notes were sold to qualified institutional buyers in accordance with Rule 144A under the Securities Act of 1933, as amended (the “Securities Act”), and outside the United States only to non-U.S. persons in accordance with Regulation S promulgated under the Securities Act. In connection with the sale of the Original Notes, the Company entered into a Registration Rights Agreement with the initial purchasers of the Original Notes party thereto, pursuant to which the Company and its Subsidiary Guarantors (as defined below) agreed to file a registration statement with respect to an offer to exchange the Original Notes for a new issue of substantially identical notes registered under the Securities Act (the “Exchange Notes”, and together with the Original Notes, the “7³/4% Senior Notes”). The 7³/4% Senior Notes are fully and unconditionally guaranteed on a joint and several senior unsecured basis by the Company and certain of its wholly-owned domestic subsidiaries (the “Subsidiary Guarantors”).

The following condensed consolidating financial information, which has been prepared in accordance with the requirements for presentation of Rule 3-10(d) of Regulation S-X promulgated under the Securities Act, presents the condensed consolidating financial information separately for:

	(i)		The GEO Group, Inc., as the issuer of the 73/4% Senior Notes;
	(ii)		The Subsidiary Guarantors, on a combined basis, which are 100% owned by The GEO Group, Inc., and which are guarantors of the 73/4% Senior Notes;

	(iii)		The Company’s other subsidiaries, on a combined basis, which are not guarantors of the 73/4% Senior Notes (the “Subsidiary Non-Guarantors”);
	(iv)		Consolidating entries and eliminations representing adjustments to (a) eliminate intercompany transactions between or among the Company, the Subsidiary Guarantors and the Subsidiary Non-Guarantors and (b) eliminate the investments in the Company’s subsidiaries; and
	(v)		The Company and its subsidiaries on a consolidated basis.

CONDENSED CONSOLIDATING BALANCE SHEET
(dollars in thousands)
(unaudited)

		As of July 4, 2010
						Combined				Combined
						Subsidiary				Non-Guarantor
		The GEO Group Inc.				Guarantors				Subsidiaries				Eliminations				Consolidated
ASSETS
Cash and cash equivalents		$	12,436			$	366			$	27,333			$	—			$	40,135
Restricted cash			—				—				13,306				—				13,306
Accounts receivable, net			103,237				44,344				26,618				—				174,199
Deferred income tax asset, net			12,197				1,354				3,469				—				17,020
Other current assets, net			4,021				2,149				7,339				—				13,509
Total current assets			131,891				48,213				78,065				—				258,169
Restricted Cash			3,719				—				21,788				—				25,507
Property and Equipment, Net			407,746				551,750				71,062				—				1,030,558
Assets Held for Sale			3,083				1,265				—				—				4,348
Direct Finance Lease Receivable			—				—				32,848				—				32,848
Intercompany Receivable			17,811				14,305				1,697				(33,813	)			—
Goodwill			34				39,428				627				—				40,089
Intangible Assets, Net			—				14,148				2,144				—				16,292
Investment in Subsidiaries			693,137				—				—				(693,137	)			—
Other Non-Current Assets			25,699				1,927				21,114				—				48,740
		$	1,283,120			$	671,036			$	229,345			$	(726,950	)		$	1,456,551
Current Liabilities
Accounts payable		$	25,542			$	10,379			$	8,980			$	—			$	44,901
Accrued payroll and related taxes			7,959				4,523				12,476				—				24,958
Accrued expenses			57,716				2,097				17,206				—				77,019
Current portion of debt			3,650				747				15,274				—				19,671
Total current liabilites			94,867				17,746				53,936				—				166,549
Deferred Income Tax Liability			6,652				—				408				—				7,060
Intercompany Payable			1,697				14,500				17,616				(33,813	)			—
Other Non-Current Liabilities			29,964				1,494				42				—				31,500
Capital Lease Obligations			—				14,087				—				—				14,087
Long-Term Debt			523,034				—				—				—				523,034
Non-Recourse Debt			—				—				87,415				—				87,415
Commitments & Contingencies (Note 14)
Total Shareholders’ Equity			626,906				623,209				69,928				(693,137	)			626,906
		$	1,283,120			$	671,036			$	229,345			$	(726,950	)		$	1,456,551

CONDENSED CONSOLIDATING BALANCE SHEET
(dollars in thousands)

		As of January 3, 2010
						Combined				Combined
						Subsidiary				Non-Guarantor
		The GEO Group Inc.				Guarantors				Subsidiaries				Eliminations				Consolidated
ASSETS
Cash and cash equivalents		$	12,376			$	5,333			$	16,147			$	—			$	33,856
Restricted cash			—				—				13,313				—				13,313
Accounts receivable, net			110,643				53,457				36,656				—				200,756
Deferred income tax asset, net			12,197				1,354				3,469				—				17,020
Other current assets, net			4,428				2,311				7,950				—				14,689
Total current assets			139,644				62,455				77,535				—				279,634
Restricted Cash			2,900				—				17,855				—				20,755
Property and Equipment, Net			438,504				489,586				70,470				—				998,560
Assets Held for Sale			3,083				1,265				—				—				4,348
Direct Finance Lease Receivable			—				—				37,162				—				37,162
Intercompany Receivable			3,324				13,000				1,712				(18,036	)			—
Goodwill			34				39,387				669				—				40,090
Intangible Assets, Net			—				15,268				2,311				—				17,579
Investment in Subsidiaries			650,605				—				—				(650,605	)			—
Other Non-Current Assets			23,431				—				26,259				—				49,690
		$	1,261,525			$	620,961			$	233,973			$	(668,641	)		$	1,447,818
Current Liabilities
Accounts payable		$	35,949			$	6,622			$	9,285			$	—			$	51,856
Accrued payroll and related taxes			6,729				5,414				13,066				—				25,209
Accrued expenses			55,720				2,890				22,149				—				80,759
Current portion of debt			3,678				705				15,241				—				19,624
Total current liabilites			102,076				15,631				59,741				—				177,448
Deferred Income Tax Liability			6,652				—				408				—				7,060
Intercompany Payable			1,712				—				16,324				(18,036	)			—
Other Non-Current Liabilities			32,127				1,015				—				—				33,142
Capital Lease Obligations			—				14,419				—				—				14,419
Long-Term Debt			453,860				—				—				—				453,860
Non-Recourse Debt			—				—				96,791				—				96,791
Commintments & Contingencies (Note 14)
Total Shareholders’ Equity			665,098				589,896				60,709				(650,605	)			665,098
		$	1,261,525			$	620,961			$	233,973			$	(668,641	)		$	1,447,818