CORNELL COMPANIES INC - 10-K Annual Report

Back to GetFilings.com

================================================================================

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549

FORM 10-K

ANNUAL REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

FOR FISCAL YEAR ENDED DECEMBER 31, 2001 COMMISSION FILE NUMBER 1-14472

CORNELL COMPANIES, INC.
----------------------------------------------------
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

DELAWARE 76-0433642
-------------------------------- ------------------
(STATE OR OTHER JURISDICTION (I.R.S. EMPLOYER
OF INCORPORATION OR ORGANIZATION) IDENTIFICATION NO.)

1700 WEST LOOP SOUTH, SUITE 1500, HOUSTON, TEXAS 77027
- ------------------------------------------------ ------------------
(ADDRESS OF PRINCIPAL EXECUTIVE OFFICES) (ZIP CODE)

REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE (713) 623-0790

SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:

TITLE OF EACH CLASS NAME OF STOCK EXCHANGE
------------------- ----------------------
COMMON STOCK, $.001 PAR VALUE PER SHARE NEW YORK STOCK EXCHANGE
PREFERRED STOCK PURCHASE RIGHTS NEW YORK STOCK EXCHANGE

SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:

NONE

Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days.
Yes ( X ) No ( )

Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will be not contained,
to the best of Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. ( ).

At March 28, 2002, Registrant had outstanding 13,056,903 shares of its
common stock. The aggregate market value of the Registrant's voting stock held
by non-affiliates at this date was approximately $134,805,000 based on the
closing price of $10.80 per share as reported on the New York Stock Exchange.
For purposes of the foregoing calculation, all directors and officers of the
Registrant have been deemed to be affiliates, but the Registrant disclaims that
any of such directors or officers is an affiliate.

Documents Incorporated by Reference

Portions of the Proxy Statement for 2002 Annual Meeting of Stockholders. Part III

================================================================================

PART I

BUSINESS

COMPANY OVERVIEW

Cornell Companies, Inc. (the "Company") is a leading provider of
privatized correctional, treatment and educational services outsourced by
federal, state and local government agencies. As the successor to entities that
began developing adult secure institutional facilities in 1984, pre-release
correctional and treatment facilities in 1974 and juvenile facilities in 1973,
the Company provides a diversified portfolio of services for adults and
juveniles through three operating divisions: (1) adult secure institutional
services; (2) juvenile treatment, educational and detention services and (3)
pre-release correctional and treatment services. These services include
incarceration and detention, transition from incarceration, drug and alcohol
treatment programs, behavioral rehabilitation and treatment, and K-12 education.
The Company provides these essential services through its 69 facilities, in
operation or under development, in 13 states and the District of Columbia. As of
December 31, 2001, the Company's contracts for these facilities provided for a
total service capacity of 15,444. The Company's service capacity is comprised of
the number of beds available for service upon completion of construction of
residential facilities and the average program capacity of non-residential
community-based programs.

INDUSTRY BACKGROUND

PRIVATIZATION

Correctional and detention services are an essential government
function. In the United States, as prison populations increase and federal,
state and local governments face continuing pressure to control costs and
improve the service quality, there is a growing trend toward outsourcing and
privatization of government services and functions, including correctional and
detention services. Outsourcing and privatization has historically faced
opposition in the U.S.; however, public and government acceptance has increased
as standards of service improve and cost-savings are provided to the government.

While juvenile and pre-release services have been privatized for
decades, the adult private prison industry in the U.S. began in 1984 as public
authorities began to respond to overcrowding pressures and budgetary
constraints, and to explore more efficient means of incarceration. Prison
management companies offer a range of services that governments have
historically provided to house and care for the needs of offenders. These
services include facility design, construction management, health-care, food
service, security, transportation, education and rehabilitation. Governments
engaging private companies typically seek to receive these services at a lower
cost than a public authority could provide.

THE PRISON POPULATION AND OVERCROWDING

The Federal Bureau of Prisons ("FBOP") believes that private prison
facilities complement FBOP operations and utilizes private operators as a way to
help handle a projected growth of federal inmates in the coming years.

Males between 14 and 24 years of age have demonstrated the highest
propensity for criminal behavior. This at-risk population in the United States
is projected to increase in the coming years. The U.S. Bureau of the Census
estimates this population segment leveled out in 1995 at 20.4 million, but will
increase to 23.2 million by 2005.

Prison overcrowding is difficult to measure because there are no
uniform means to determine capacity.

-2-

According to the Bureau of Justice Statistics, it is estimated that at mid-year
2001, the federal prison system was operating at 131% of capacity and that state
prisons were at an average of 100% to 115% of capacity depending on the capacity
measure. Management believes that strategic construction in over crowded markets
will provide new beds to alleviate overcrowding and meet growth estimates.

CALIFORNIA'S PROPOSITION 36

Proposition 36 became law in California in June 2001. Generally, this
new initiative substitutes treatment for prison sentences for certain crimes,
such as first time drug offenses. Management believes this new initiative in
California is part of a trend in the U.S. to provide treatment to first time
offenders rather than incarceration. As a long-time leading provider in
treatment and educational services, management believes that the Company is well
positioned to benefit from this trend without significant additional capital
investment.

OPERATIONS

Pursuant to the terms of its management contracts, the Company is
responsible for the overall operation of its facilities, including staff
recruitment, general facility administration, security and supervision of the
offenders or clients and facility maintenance. The Company also provides a
variety of rehabilitative and educational programs at many of its facilities.

The Company provides this diversified portfolio of essential services
for adults and juveniles through three operating divisions: (1) adult secure
institutional services; (2) juvenile treatment, educational and detention
services and (3) pre-release correctional and treatment services.

ADULT SECURE INSTITUTIONAL SERVICES DIVISION

The Company's adult secure institutional division provides maximum,
medium, and low-security incarceration. This division is committed to ensuring
public safety through the operation of a secure environment and offenders are
provided with a variety of programming and services geared toward a successful
return to the community and a subsequent reduction in recidivism. At December
31, 2001, the Company operated or had under development nine facilities with a
total service capacity of 7,351 beds that provide, or will provide, adult secure
institutional services for incarcerated adults.

The adult secure institutional division provides:

o low to maximum-security incarceration services;

o integrated facility development and operational services;

o state-of-the-art correctional technology including electronic
controls and surveillance equipment;

o basic education such as preparation and testing for the high
school equivalency exam, or GED, English as a second language,
or ESL, classes and Adult Basic Education, or ABE;

o health care including medical, dental, behavioral health and
psychiatric services;

o individual and group counseling;

o substance abuse treatment including detoxification, testing,
counseling, 12-step programs and relapse prevention services;

-3-

o life skills training including training relating to proper
hygiene, personal finance and parenting skills;

o institutional food services; and

o recreational activities such as exercise programs, hobby and
craft and leisure activities.

According to reports issued by the United States Department of Justice,
Bureau of Justice Statistics, or the BJS, the number of adult offenders housed
in federal and state prison facilities and in local jails increased from 742,579
at December 31, 1985 to 1,965,495 at June 30, 2001. The average annual increase
of offenders in custody from 1990 to 2000 was 5.8%.

According to the Private Adult Correctional Facility Census, the design
capacity of privately managed adult secure institutional facilities in operation
or under construction worldwide increased from 20,687 beds at December 31, 1992
to 142,521 beds at September 30, 2001, a compound annual growth rate of
approximately 24%. According to the American Correctional Association, between
1999 and 2000, the adult prison management industry, encompassing federal and
state prisons and local jails, spent over $50 billion to house its incarcerated
population. At June 30, 2001, private prisons held approximately 6.1% of all
state inmates and 11.9% of federal inmates.

JUVENILE TREATMENT, EDUCATIONAL AND DETENTION SERVICES DIVISION

The Company's juvenile division provides residential, community-based,
behavioral health and alternative education programs to juveniles, typically
between the ages of ten and 17. In addition to meaningful treatment options, the
programs also develop continuing care plans which help bridge the juvenile back
to the community. Under the names "Cornell Abraxas" and "Cornell Interventions,"
the Company offers programs to meet the multiple needs of troubled juveniles. At
December 31, 2001, the Company operated or had contracts to operate 21
residential facilities and 17 non-residential community-based programs serving
an aggregate capacity of approximately 4,472 youths.

Juvenile treatment, educational and detention services consist
primarily of programs that are designed to lead to rehabilitation while
providing public safety and holding juveniles accountable for their decisions
and behavior. The Company operates primarily within a restorative justice model.
The basic philosophy is that merely serving time in an institution does not
relieve juvenile offenders of the obligation to repay their victims and that
incarceration alone does not compensate for the societal impact of crimes. The
use of a balanced approach gives equal emphasis to accountability, competency
development and community protection.

The juvenile division provides:

o diverse treatment settings including settings that are
physically-secure, staff-secure and community-based;

o specialized treatment for special populations including
females, drug sellers, sex offenders, firesetters and
families;

o individualized treatment planning and case management;

o counseling including individual, group and family therapy,
cognitive behavior therapy and stress and anger management;

-4-

o substance abuse treatment and relapse prevention and education
services;

o life skills training such as training relating to proper
hygiene, personal finance and parenting skills;

o accredited alternative and special educational programs;

o gender-specific programs;

o employment training and assistance;

o medical services; and

o wilderness training programs and nationally accredited ropes
course challenges.

The juvenile corrections industry is estimated at $5 to $7 billion
annually and consists of at least 108,000 residential beds. The juvenile
treatment and educational components of the juvenile corrections industry are
estimated to be far larger. This market segment is fragmented with several
thousand providers across the country, most of which are small and operate in a
specific geographic area.

The juvenile corrections industry has expanded rapidly in recent years
as the need for services for at-risk and adjudicated youth has risen. According
to the American Correctional Association's Directory of Adult and Juvenile
Correctional Departments, Institutions, Agencies, and Probation and Parole
Authorities, state spending in the juvenile corrections industry increased at a
compound annual growth rate of 15.7% from 1993 to 1999.

PRE-RELEASE CORRECTIONAL AND TREATMENT SERVICES DIVISION

The Company's pre-release division provides community-based services
including job placement and treatment and education programs as an alternative
to incarceration as well as to aid in the successful transition from a
correctional facility back into society. At December 31, 2001, the Company
operated or had contracts to provide pre-release correctional and treatment
services within 18 residential facilities and six non-residential community
based programs with an aggregate service capacity of 3,621. The pre-release area
is primarily comprised of individuals who have been granted parole or sentenced
to probation. Probationers (individuals sentenced for an offense without
incarceration) and parolees (individuals released prior to the completion of
their sentence) are typically placed in pre-release settings. These individuals
typically spend three to six months in halfway houses until they are prepared to
re-enter society.

The pre-release division provides:

o minimum-security and staff-secure residential services;

o home confinement and electronic monitoring;

o employability training and assistance such as preparing for,
securing and maintaining employment;

o basic education including preparation and testing for the GED,
ABE, computer courses, college-level courses and extensive
libraries;

o vocational training such as training in the culinary arts and
construction;

-5-

o counseling including individual, group and family therapy,
cognitive behavior therapy and stress and anger management;

o substance-abuse treatment including detoxification, testing,
counseling, 12-step programs and relapse prevention services;
and

o life skills training including training related to proper
hygiene, securing appropriate housing, personal finance and
parenting skills.

Expenditures in the pre-release correctional services industry are
estimated at $3.9 billion annually and consist of approximately 50,000
residential beds. This market segment is extremely fragmented with several
thousand providers across the country, most of which are small and operate in a
specified geographic area.

Similar to the adult secure institutional and the juvenile service
segments, the area of pre-release correctional services has experienced
substantial growth. According to the BJS, the number of parolees increased from
531,407 at December 31, 1990 to 725,527 at December 31, 2000, a compound annual
growth rate of 3.1%. During the same period, the number of individuals on
probation increased from approximately 2.7 million to 3.8 million, a compound
annual growth rate of 3.5%. The probation and parole populations represent
approximately 70% of the total number of adults under correctional supervision
in the United States.

MARKETING AND BUSINESS DEVELOPMENT

The Company's principal customers are federal, state and local
government agencies responsible for adult and juvenile corrections, treatment
and educational services. The development process for obtaining facility
management contracts consists of several steps including issuance of a request
for proposal, or RFP, by a contracting agency, submission of a response to the
RFP by the Company, the award of the contract by a government agency and the
commencement of construction or operation of the facility. These agencies
generally procure services from the private sector by issuing an RFP to which a
number of companies may respond. In addition to costs, government agencies
consider numerous other factors including bidders' experience and qualifications
when awarding contracts.

As part of the process of responding to RFPs, the Company's management
meets with appropriate personnel from the requesting agency to best determine
the agency's distinct needs. The Company may also receive inquiries from or on
behalf of government agencies considering privatization of certain facilities or
that have already decided to contract with private providers. When the Company
receives such an inquiry, the Company determines whether there is a need for its
services and whether the legal and political climate in which the government
agency operates is conducive to serious consideration of privatization. The
Company then conducts an initial cost analysis to further determine project
feasibility.

If the Company believes the project is consistent with its strategic
business plan, the Company will submit a written response to the RFP. When
responding to RFPs, the Company incurs costs, typically ranging from $10,000 to
$100,000 per proposal, to determine the prospective client's distinct needs and
prepare a detailed response to the RFP. In addition, the Company may incur
substantial costs to acquire options to lease or purchase land for a proposed
facility and engage outside consulting and legal expertise related to a
particular RFP. The preparation of a response to an RFP typically takes from
five to fifteen weeks. The bidding and award process for an RFP typically takes
from three to nine months. Generally, if the facility for which an award has
been made must be constructed, the Company will begin operation of the newly
constructed facility between 12 and 24 months after the contract award.

-6-

When a contract requires construction of a new facility, the Company's
success depends, in part, upon its ability to acquire real property on desirable
terms and at satisfactory locations. The Company anticipates that a large
majority of new facilities will be constructed in rural areas. To the extent
that these locations are in or near populous areas, management anticipates legal
action and other forms of opposition from residents in areas surrounding certain
proposed sites. The Company may incur significant expenses in responding to such
opposition and there can be no assurance of success. In addition, the Company
may choose not to bid in response to an RFP or may determine to withdraw a bid
if legal action or other forms of opposition are anticipated.

CONTRACTS

The Company's facility management contracts generally provide that the
Company will be compensated at an occupant per diem rate, fees for treatment
service, guaranteed take-or-pay or cost-plus reimbursement. Factors that the
Company considers in determining the per diem rate to charge include (1) the
programs specified by the contract and the related staffing levels, (2) wage
levels customary in the respective geographic areas, (3) whether the proposed
facility is to be leased or purchased and (4) the anticipated average occupancy
levels which the Company believes could reasonably be maintained. Compensation
is invoiced in accordance with the applicable contract and is typically paid to
the Company on a monthly basis. Some of the Company's juvenile education
contracts provide for annual payments.

The Company aggressively pursues new contracts that leverage its
existing infrastructure and capabilities and meet the Company's stringent
profitability criteria. Since the beginning of 1999, the Company has won 11
contracts that are expected to contribute more than $60 million in annualized
recurring revenues when all facilities commence operations. The Company has
increased its focus on guaranteed take-or-pay contracts, which provide a fixed
minimum revenue stream regardless of occupancy and thereby add increased
stability and predictability to the Company's revenue stream. Approximately 96%
of these new contract revenues have been from take-or-pay contracts.

QUALITY OF OPERATIONS

Independent accreditation by various oversight and regulatory
organizations is designed to show that a facility meets nationally accepted
professional standards for quality of operation, facility design, management,
and maintenance. Accrediting entities include the American Correctional
Association, or ACA, for the adult secure and pre-release sectors, and the Joint
Commission on Accreditation of Healthcare Organizations, Departments of Public
Welfare, Departments of Protective and Regulatory Services, and Departments of
Human Services and Education for the juvenile sector. ACA standards are the
national benchmark for the effective operation of correctional systems
throughout the United States and address services, programs, and operations
essential to good correctional management including administrative and fiscal
controls, staff training and development, physical plant, safety and emergency
procedures, sanitation, food service, and rules and discipline. ACA
accreditation is important to the courts as an indicator of improved conditions
for adult prisons under court order. It is the Company's policy that all of its
facilities' daily operations be performed in accordance with accreditation
standards. Accreditation and the standards of service required thereby also
contribute to the public's increased acceptance of the Company and its provision
of privatized corrections services.

Internal quality control, conducted by the Company's senior facility
staff and executive officers, takes the form of periodic operational,
programming and fiscal audits, facility inspections, regular review of logs,
reports and files and strict maintenance of personnel standards, including an
active training program. Each of the Company's facilities develops its own
training plan that is reviewed, evaluated and updated annually. All adult
correctional officers undergo a minimum 40-hour orientation upon their hiring
and receive

-7-

academy-level training amounting to 120 hours and on-the-job training of up to
80 hours. Each correctional officer also receives up to 40 hours of continuing
training and education annually. All juvenile treatment employees undergo a
minimum 80-hour orientation upon their hiring and also receive up to 40 hours of
continuing training and education annually.

FACILITIES

As of December 31, 2001, the Company had contracts to operate 69
facilities, including the Moshannon Valley Correctional Center, which is under
development. Reference is made to "Management's Discussion and Analysis -
Liquidity and Capital Resources - New Facilities and Project Under Development"
for a discussion of the status of the Moshannon Valley Correctional Center. In
addition to providing management services, the Company has been involved in the
development, design and/or construction of many of these facilities.

The Company controls, through outright ownership or long-term leases,
operating facilities representing a large majority of its revenues. Management
believes that such control increases the likelihood of contract renewal, allows
the Company to expand existing facilities and capture higher margins, and
enhances the Company's ability to win new contracts. In addition, long-term
control of its operating facilities allows the Company to better control
operating margins and reduce cost escalation pressures.

The following table summarizes certain additional information with
respect to facilities under operation or development by the Company as of
December 31, 2001. As indicated, the majority of the facilities to which the
Company provides services are either owned or leased by the Company. Facilities
that are leased are generally under terms ranging from one to 45 years.

-8-

-9-

-10-

-11-

(1) Total service capacity is comprised of the beds available for service
upon completion of construction of residential facilities and the
average program capacity of the non-residential community-based
facilities. In certain cases, the management contract for a facility
provides for a lower number of beds.
(2) Date from which the Company, or its predecessor, has had a contract for
services on an uninterrupted basis.
(3) The Company does not incur any facility use costs for facilities which
the Company only has a management contract.
(4) The City of Big Spring entered into the Intergovernmental Agreement
with the FBOP for an indefinite term (until modified or terminated)
with respect to the Big Spring Complex, which began operations during
1989. The Big Spring Operating Agreement, as amended, has a term
through 2047 including renewal options at the Company's discretion,
pursuant to which the Company manages the Big Spring Complex for the
City of Big Spring. The portion of the Big Spring Operating Agreement
relating to the Cedar Hill Unit has a term of 30 years with four
five-year renewal options at the Company's discretion.
(5) Facility was sold on August 14, 2001 to Municipal Corrections Finance,
L.P. ("MCF") as part of the Company's August 2001 sale/leaseback
transaction.
(6) The prison is operated pursuant to a one-year contract with nine
one-year renewal options between the Oklahoma Department of Corrections
and the Hinton Economic Development Authority, or HEDA. HEDA in turn
has subcontracted the operations to the Company under a 30-year
operating contract with four five-year renewals.
(7) In April 1999, the Company was awarded a contract to design, build and
operate the Moshannon Valley Correctional Center and immediately
commenced construction and activation activities. In June 1999, the
FBOP issued a Stop-Work Order pending a re-evaluation of their
environmental documentation supporting the decision to award the
contract. The environmental study was completed with a finding of no
significant impact. The Stop-Work Order was lifted by the FBOP on
August 9, 2001. In September 1999, the Company received correspondence
from the Office of the Attorney General of the Commonwealth of
Pennsylvania indicating its belief that the operation of a private
prison in Pennsylvania is unlawful. The Company and the FBOP have had,
and continue to have, discussions with the Attorney General's staff
regarding these and related issues. Management anticipates that these
discussions will be resolved in the near-term. As of December 31, 2001,
the Company had incurred approximately $14.9 million for construction
and land development costs and capitalized interest for the Moshannon
Valley Correctional Center. According to the FBOP contract, as amended,
the Company must complete the construction of the project by April 15,
2002. The Company will not be able to complete construction within that
time frame. While the FBOP has not asserted any default or made any
claim, if the Company is not able to negotiate a contract amendment
with the FBOP, then the FBOP may have the right to assert that the
Company has not completed construction of the project within the time
frame provided in the FBOP contract, as amended. In the event that the
FBOP desires to continue with the Moshannon Valley Correctional Center,
management expects that the contract will be amended to address cost
and construction timing matters resulting from the extended delay. In
the event that the FBOP decides not to continue with the Moshannon
project and terminates the contract, management believes that the
Company has the right to recover its invested costs. In the event any
portion of these costs are determined not to be reimbursed upon
contract termination, such costs would be expensed.
(8) The Cornell Interventions programs/facilities contract with numerous
agencies throughout Illinois. Initial contract dates vary by agency and
range from 1974 to 1997.
(9) The Company manages a therapeutic community drug and alcohol program
within the state-operated Southwestern Illinois Correctional Center.

COMPETITION

The Company's industry is currently characterized by a few large
national operators focused primarily in the adult secure institutional sector
and by a large number of smaller operators in the juvenile and pre-release
sectors. Management believes its principal competitors are Corrections
Corporation of America and Wackenhut Corrections Corporation.

This high degree of concentration in the adult secure institutional
sector is in contrast to the juvenile and pre-release sectors, where
approximately 10,000 to 15,000 juvenile facilities and 2,000 local and regional
pre-release facilities, approximately 600 of which are privately operated, are
in operation nationwide.

-12-

EMPLOYEES

At December 31, 2001, the Company had approximately 3,600 full-time
employees and 283 part-time employees. The Company employs management,
administrative and clerical, security, educational and counseling services,
health services and general maintenance personnel. Approximately 375 employees
at four of the Company's facilities are represented by unions. The Company
believes its relations with its employees are good.

REGULATIONS

The industry in which the Company operates is subject to federal, state
and local regulations administered by a variety of regulatory authorities.
Generally, prospective providers of correctional, detention and pre-release
services must comply with a variety of applicable state and local regulations,
including education, healthcare and safety regulations. The Company's contracts
frequently include extensive reporting requirements and require supervision with
on-site monitoring by representatives of contracting governmental agencies.

In addition to regulations requiring certain contracting governmental
agencies to enter into a competitive bidding procedure before awarding
contracts, the laws of certain jurisdictions may also require the Company to
award subcontracts on a competitive basis or to subcontract with businesses
owned by women or members of minority groups.

BUSINESS CONCENTRATION

For the years ended December 31, 2001, 2000 and 1999, 20.8%, 18.5% and
19.8%, respectively, of the Company's consolidated revenues were derived from
multiple contracts with the FBOP.

INSURANCE

The Company maintains a $10 million per occurrence per facility general
liability insurance policy for all its operations. The Company also maintains
insurance in amounts it deems adequate to cover property and casualty risks,
workers' compensation and directors' and officers' liability.

The Company's contracts and the statutes of certain states in which the
Company operates typically require the maintenance of insurance by the Company.
The Company's contracts provide that, in the event the Company does not maintain
such insurance, the contracting agency may terminate its agreement with the
Company. The Company believes that it is in compliance in all material respects
with these requirements.

ITEM 2. PROPERTIES

The Company leases corporate headquarters office space in Houston,
Texas and regional administrative offices in Ventura, California, Pittsburgh,
Pennsylvania and Chicago, Illinois. The Company also leases various facilities
it is currently operating or developing. For a listing of owned and leased
facilities, see "Business - Facilities."

ITEM 3. LEGAL PROCEEDINGS

In March 2002, the Company, Steven W. Logan and John L. Hendrix,
were named as defendants in two lawsuits styled GRAYDON WILLIAMS, ON BEHALF
OF HIMSELF AND ALL OTHERS SIMILARLY SITUATED V. CORNELL COMPANIES, INC, ET
AL., No. H-02-0866, in the United States District Court for the

-13-

Southern District of Texas, Houston Division, and RICHARD PICARD, ON BEHALF OF
HIMSELF AND ALL OTHERS SIMILARLY SITUATED V. CORNELL COMPANIES, INC., ET AL.,
No. H-02-1075, in the United States District Court for the Southern District of
Texas, Houston Division. The aforementioned lawsuits are putative class action
lawsuits brought on behalf of all purchasers of the Company's common stock
between March 6, 2001 and March 5, 2002. The lawsuits involve disclosures made
concerning two prior transactions executed by the Company: the August 2001
sale/leaseback transaction and the 2000 synthetic lease transaction.
The plaintiffs allege that the defendants violated Section 10(b) of the
Securities Exchange Act of 1934 (the "Exchange Act"), Rule 10b-5 promulgated
under Section 10(b) of the Exchange Act, and/or Section 20(a) of the Exchange
Act. The Company believes that it has good defenses to each of the plaintiffs'
claims and intends to vigorously defend against each of the claims.

Also in March 2002, the Company, its directors, and its independent
auditor Arthur Andersen LLP, were sued in a derivative action styled as WILLIAM
WILLIAMS DERIVATIVELY AND ON BEHALF OF NOMINAL DEFENDANT CORNELL COMPANIES, INC.
V. ANTHONY R. CHASE, ET AL., No. 2002-15614, in the 127th Judicial District
Court of Harris County, Texas. The lawsuit alleges breaches of fiduciary duty by
all of the individual defendants and asserts breach of contract and professional
negligence claims only against Arthur Andersen LLP. The Company believes that it
has good defenses to each of the plaintiff's claims and intends to vigorously
defend against each of the claims.

While the plaintiffs in these cases have not quantified their claim of
damages and the outcome of the matters discussed above cannot be predicted with
certainty, based on information known to date, management believes that the
ultimate resolution of these matters will not have a material adverse effect on
the Company's financial position, operating results or cash flow.

The Company currently and from time to time is subject to claims and
suits arising in the ordinary course of business, including claims for damages
for personal injuries or for wrongful restriction of, or interference with,
offender privileges and employment matters.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to the Company's security holders during the
fourth quarter of 2001.

-14-

PART II

ITEM 5. MARKET FOR CORNELL COMPANIES, INC. COMMON STOCK AND RELATED STOCKHOLDER
MATTERS

The common stock of the Company is currently listed on the New York
Stock Exchange ("NYSE") under the symbol "CRN." As of March 31, 2002, there were
approximately 34 record holders of common stock. The quarterly high and low
closing sales prices for the common stock from January 1, 2000 through March 31,
2002 are shown below:

The Company has never declared or paid cash dividends on its capital
stock. The Company currently intends to retain excess cash flow, if any, for use
in the operation and expansion of its business and does not anticipate paying
cash dividends on the common stock in the foreseeable future. The payment of
dividends is within the discretion of the Board of Directors and is dependent
upon, among other factors, the Company's results of operations, financial
condition, capital requirements, restrictions, if any, imposed by financing
commitments and legal requirements. The Company's Amended and Restated Credit
Agreement, dated as of July 21, 2000 ("2000 Credit Facility"), currently
prohibits the payment of dividends. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations -- Liquidity and Capital
Resources--Long-Term Credit Facilities".

-15-

ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA

The selected consolidated financial data should be read in conjunction
with the Company's Consolidated Financial Statements and Notes thereto and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" included elsewhere in this report.

-16-

NOTES TO SELECTED CONSOLIDATED FINANCIAL DATA

(1) The Company restated its financial statements for the year ended
December 31, 2000 and for the nine months ended September 30, 2001. See
Notes 2 and 13 to the Consolidated Financial Statements for additional
information.
(2) Includes the operations of Interventions-Illinois acquired in November
1999.
(3) Includes the operations of the Great Plains Correctional Facility
acquired in January 1998 and the Alaska facilities purchased from
Allvest in August 1998.
(4) Includes the operations of Interventions-Texas and Abraxas acquired in
January 1997 and September 1997, respectively.
(5) The Company's service capacity is comprised of the number of beds
available for service upon completion of construction of residential
facilities and the average program capacity of non-residential
community-based programs.
(6) The Utah Department of Corrections ("Utah DOC") selected the Company's
bid in June 1999 for the 490 bed Timpie Valley Correctional Facility
subject to final contract negotiations. In 2000, the Utah DOC declined
to pursue this project, therefore the Company's service capacity was
reduced accordingly.
(7) Occupancy percentages are based on contracted service capacity of
residential facilities in operation. Since certain facilities have
service capacities that exceed contracted capacities, occupancy
percentages can exceed 100% of contracted capacity.
(8) Occupancy percentages reflect less than normalized occupancy during the
start-up phase of any applicable facility, resulting in a lower average
occupancy in periods when the Company has substantial start-up
activities.

-17-

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

GENERAL

The Company is a leading provider of privatized correctional, treatment
and educational services outsourced by federal, state and local government
agencies. The Company provides a diversified portfolio of services for adults
and juveniles through its three operating divisions: (1) adult secure
institutional services; (2) juvenile treatment, education and detention services
and (3) pre-release correctional and treatment services. As of December 31,
2001, the Company had contracts to operate 69 facilities with a total service
capacity of 15,444. The Company's facilities are located in 13 states and the
District of Columbia.

The following table sets forth for the periods indicated total service
capacity, the service capacity and contracted beds in operation at the end of
the periods shown and the average occupancy percentages.

(1) The Company's service capacity is comprised of the number of beds
available for service upon completion of construction of residential
facilities and the average program capacity of non-residential
community-based programs.
(2) The Utah DOC selected the Company's bid in June 1999 for the 490 bed
Timpie Valley Correctional Facility subject to final contract
negotiations. In 2000, the Utah DOC declined to pursue this project,
therefore the Company's service capacity was reduced accordingly.
(3) Occupancy percentages are based on contracted service capacity of
residential facilities in operation. Since certain facilities have
service capacities that exceed contracted capacities, occupancy
percentages can exceed 100% of contracted capacity.
(4) Occupancy percentages reflect less than normalized occupancy during the
start-up phase of any applicable facility, resulting in a lower average
occupancy in periods when the Company has substantial start-up
activities.

From 1994 to 1999 the Company completed eight acquisitions. The
acquisitions have generally targeted companies that assist the Company in
penetrating new markets, diversifying its revenues and establishing a nationally
recognized presence. To fulfill this strategy, the Company has acquired
companies that have a reputation for high quality in the corrections and
treatment industry.

The Company derives substantially all its revenues from providing
corrections, treatment and educational services outsourced by federal, state and
local government agencies in the United States. Revenues for the Company's
services are generally recognized on a per diem rate based upon the number of
occupant days or hours served for the period, on a guaranteed take-or-pay basis
or on a cost-plus reimbursement basis.

Factors which the Company considers in determining the per diem rate to
charge include (1) the programs specified by the contract and the related
staffing levels; (2) wage levels customary in the respective geographic areas;
(3) whether the proposed facility is to be leased or purchased and (4) the
anticipated average occupancy levels which the Company believes could reasonably
be maintained.

-18-

Although the Company has experienced higher operating margins in its
adult secure institutional and pre-release divisions as compared to the juvenile
division, the Company's operating margins generally vary from facility to
facility based on whether the facility is owned or leased, the level of
competition for the contract award, the proposed length of the contract, the
occupancy levels for a facility, the level of capital commitment required with
respect to a facility, the anticipated changes in operating costs over the term
of the contract, and the Company's ability to increase contract revenues. The
Company has and expects to experience interim period operating margin
differences due to the number of calendar days in the period, higher payroll
taxes in the first half of the year, and salary and wage increases that are
incurred prior to certain contract revenue increases.

The Company is responsible for all facility operating expenses, except
for certain debt service and lease payments with respect to facilities for which
the Company has only a management contract (11 facilities in operation at
December 31, 2001).

A majority of the Company's facility operating expenses consist of
fixed costs. These fixed costs include lease and rental expense, insurance,
utilities and depreciation. As a result, when the Company commences operation of
new or expanded facilities, fixed operating expenses increase. The amount of the
Company's variable operating expenses, including food, medical services,
supplies and clothing, depend on occupancy levels at the facilities operated by
the Company. The Company's largest single operating expense, facility payroll
expense and related employment taxes and costs, has both a fixed and a variable
component. The Company can adjust the staffing levels and payroll expense to a
certain extent based on occupancy at a facility, but a minimum fixed number of
employees is required to operate and maintain any facility regardless of
occupancy levels. Personnel costs are subject to increase in tightening labor
markets based on local economic and other conditions.

Following a contract award, the Company incurs pre-opening and start-up
expenses including payroll, benefits, training and other operating costs prior
to opening a new or expanded facility and during the period of operation while
occupancy is ramping up. These costs vary by contract. Since pre-opening and
start-up costs are factored into the revenue per diem rate that is charged to
the contracting agency, the Company typically expects to recover these upfront
costs over the life of the contract. Because occupancy rates during a facility's
start-up phase typically result in capacity under-utilization for at least 90 to
180 days, the Company may incur additional post-opening start-up costs. The
Company does not anticipate post-opening start-up costs at facilities operating
under any future contracts with the FBOP because these contracts are currently
take-or-pay, meaning that the FBOP will pay the Company at least 95% of the
contractual monthly revenue once the facility opens regardless of actual
occupancy.

Newly opened facilities are staffed according to contract requirements
when the Company begins receiving offenders or clients. Offenders or clients are
typically assigned to a newly opened facility on a phased-in basis over a one-
to six-month period, although certain programs require a longer time period to
reach break-even occupancy levels. The Company incurs start-up operating losses
at new facilities until break-even occupancy levels are reached. Although the
Company typically recovers these upfront costs over the life of the contract,
quarterly results can be substantially affected by the timing of the
commencement of operations as well as development and construction of new
facilities.

Working capital requirements generally increase immediately prior to
the Company's commencing management of a new or expanded facility as the Company
incurs start-up costs and purchases necessary equipment and supplies before
facility management revenue is realized.

In January 1999, the Company adopted Statement of Position 98-5,
"Reporting on the Costs of Start-Up Activities," or SOP 98-5, and recorded a
net-of-tax charge of approximately $3.0 million for the cumulative

-19-

effect of a change in accounting principle. As a result of the Company's
adoption of SOP 98-5, the Company began to expense pre-opening and start-up
costs as incurred.

General and administrative expenses consist primarily of costs for the
Company's corporate and administrative personnel who provide senior management,
finance, accounting, human resources, payroll, information systems and other
services and costs of business development.

RECENT DEVELOPMENTS

On February 6, 2002, the Company announced that a Special Committee
of the Audit Committee of the Board of Directors had been formed to review
the accounting treatment for its August 2001 sale/leaseback transaction (the
"2001 Sale and Leaseback Transaction"). The Company entered into a retainer
agreement with an investment bank dated September 2001, which, as amended,
provides that (1) the Company pay the investment bank a non-refundable
retainer fee of $3.65 million to provide financial advisory services
concerning separate future financing vehicles and the strategic development
of the Company's business and (2) the retainer will be applied on a mutually
agreed upon basis toward future contingent fees associated with investment
banking services that may be provided to the Company. The review focused on
whether the retainer agreement and the payment of the fee affected the
previously reported accounting treatment for the 2001 Sale and Leaseback
Transaction.

The Special Committee, which was composed solely of independent
directors, retained independent counsel, who retained an accounting advisor,
to assist the Special Committee in its review. The Special Committee was
formed and conducted its review in response to correspondence dated January
31, 2002 and February 1, 2002 from the Company's independent auditors to its
Audit Committee regarding the 2001 Sale and Leaseback Transaction. In the
course of its review and pursuant to a third letter from the Company's
independent auditors addressed to the Company's Chairman dated February 21,
2002, the Special Committee also reviewed the accounting treatment for the
Company's 2000 synthetic lease transaction. The review of the synthetic lease
transaction focused on whether a fee was paid pursuant to an engagement
letter between the Company and two financial institutions participating in
the transaction and the impact of the fee on the previously reported
accounting treatment.

At the conclusion of its review, among other things, the Special
Committee recommended to the Board of Directors that:

o based on various considerations, the Company's financial statements for
2000 and the first three quarters of 2001 should be restated to reflect
the consolidation of the 2001 Sale and Leaseback Transaction and the
2000 synthetic lease transaction; and

o actions should be taken to strengthen further the Company's internal
controls.

While the Company believes there are reasonable arguments supporting
the previously reported accounting treatment of the 2001 Sale and Leaseback
Transaction and the 2000 synthetic least transaction, following discussions
with its independent auditors and its advisors, and in view of anticipated
changes in accounting rules, the market and regulatory environment currently
existing and a desire to reach a final resolution of these matters as quickly
as possible, the Company decided to consolidate both transactions for
financial accounting purposes. As a result, the Company has restated its
financial statements for 2000 and the first three quarters of 2001 to reflect
the consolidation of the 2001 Sale and Leaseback Transaction and the 2000
synthetic lease transaction.

These restatements are reflected in the selected unaudited quarterly
financial data set forth in Note 14 to the Consolidated Financial Statements.
The restatements of the financial data for the year ended and as

-20-

of December 31, 2000 are reflected in the audited financial statements included
herewith.

On April 16, 2002, the Board of Directors amended the Company's
Bylaws. Among other things, the amendments establish an executive chairman
position, clarify specific levels of authority for members of senior
management and identify appropriate limits on such authority. Pursuant to
board action, Harry J. Phillips, Jr., the Company's Chairman, will serve as
the Executive Chairman of the Company, Steven W. Logan will serve as
President, Thomas R. Jenkins will continue to serve as the Chief Operating
Officer of the Company, and John L. Hendrix will continue to serve as the
Chief Financial Officer of the Company. The Board of Directors is considering
additional actions to strengthen further the Company's internal controls.

As a result of the Company's Special Committee review of certain
Company transactions, the restatement of the Company's 2000 and 2001 financial
statements and related matters, management expects to recognize a non-recurring
pre-tax charge of approximately $1.6 million for legal, accounting and other
professional fees for the quarter ended March 31, 2002. See Notes 2 and 13 to
the Consolidated Financial Statements.

Additionally, certain waivers and amendments to the Company's credit
agreements were obtained by the Company in connection with the restatement of
its financial statements during the first quarter of 2002. As a result of these
waivers and amendments, the Company will recognize a pre-tax charge to interest
expense of approximately $800,000 for the quarter ended March 31, 2002 for
lenders' fees and related professional fees.

RESULTS OF OPERATIONS

The Company's historical operating results reflect a significant
expansion of the Company's business. Material fluctuations in the Company's
results of operations are principally the result of the timing and effect of
acquisitions, the level of new contract development activity conducted by the
Company, and occupancy rates at Company-operated facilities and extraordinary
and non-recurring charges. The Company's acquisitions have been accounted for
using the purchase method of accounting, whereby the operating results of the
acquired businesses have been reported in the Company's operating results since
the date of acquisition.

The following table sets forth for the periods indicated the
percentages of revenues represented by certain items in the Company's historical
consolidated statements of operations:

-21-

YEAR ENDED DECEMBER 31, 2001 COMPARED TO YEAR ENDED DECEMBER 31, 2000 (RESTATED)

REVENUES. Revenues increased 17.3% to $265.3 million for the year ended
December 31, 2001 from $226.1 million for the year ended December 31, 2000.

Adult secure institutional division revenues increased 9.5% to $99.8
million for the year ended December 31, 2001 from $91.2 million for the year
ended December 31, 2000 due principally to (1) the final 550 bed expansion at
the D. Ray James Prison which began housing inmates late in the first quarter of
2000 and reached a full occupancy level late in the second quarter of 2000, (2)
per diem rate increases realized in 2001, (3) the commencement of a management
contract at the Valencia County Detention Center in the fourth quarter of 2000
and (4) increased occupancy at the Great Plains Correctional Facility as
compared to the year ended December 31, 2000. The increase in revenue was
offset, in part, by a reduction in occupancy at the Santa Fe County Detention
Center. The Company's contract to manage the Santa Fe County Detention Center
expired effective September 30, 2001. Revenues for the Santa Fe County Detention
Center were $5.1 million for the nine months ended September 30, 2001. There
were no revenues attributable to start-up operations for the year ended December
31, 2001. Additionally, during the fourth quarter of 2000, the Company entered
into a license agreement with its construction contractor that conveyed certain
rights to the design of an adult secure institution. A non-recurring license
agreement payment of $950,000 was recognized as revenue by the Company. The
Company has not licensed such designs in prior years and does not expect to
generate significant revenues from such activity in future periods. Revenues
attributable to start-up operations for the year ended December 31, 2000 were
$44,000 and related to the expansion of the D. Ray James Prison. Average
occupancy, excluding start-up operations in 2000, was 97.0% for the year ended
December 31, 2001 compared to 97.6% for the year ended December 31, 2000.

Juvenile division revenues increased 35.1% to $116.3 million for the
year ended December 31, 2001 from $86.0 million for the year ended December 31,
2000 principally due to (1) the opening of the New Morgan Academy in the fourth
quarter of 2000, (2) the commencement of a management contract at the Alexander
Youth Center in the third quarter of 2001, (3) the opening of the William Penn
Harrisburg Alternative School in the third quarter of 2001, (4) increased
occupancy at the Cornell Abraxas Center for Adolescent Females, or ACAF, due to
a facility expansion completed early in 2001, (5) increased occupancy at various
facilities including the Griffin Juvenile facility and (6) the commencement of a
management contract at the Schaffner Youth Center. Revenues attributable to
start-up operations were $2.8 million for the year ended December 31, 2001 and
related to the operations of the New Morgan Academy and an expansion of ACAF.
Revenues attributable to start-up operations were $1.2 million for the year
ended December 31, 2000 and related to the operations of the New Morgan Academy.
Average occupancy, excluding start-up operations, was 91.2% for the year ended
December 31, 2001 compared to 91.3% for the year ended December 31, 2000.

Pre-release division revenues increased to $49.2 million for the year
ended December 31, 2001 from $48.9 million for the year ended December 31, 2000
due to increased average occupancy at various facilities offset by a reduction
in revenue due to the terminations of the San Diego Center and Durham Treatment
Center contracts as of January 31, 2001 and June 30, 2001, respectively. Average
occupancy was 98.6% for the year ended December 31, 2001 compared to 94.2% for
the year ended December 31, 2000.

OPERATING EXPENSES. Operating expenses increased 17.9% to $205.8
million for the year ended December 31, 2001 from $174.6 million for the year
ended December 31, 2000.

Adult secure institutional division operating expenses increased 9.4%
to $74.6 million for the year ended December 31, 2001 from $68.2 million for the
year ended December 31, 2000 due principally to (1) the final 550 bed expansion
of the D. Ray James Prison, which began housing inmates late in the first
quarter of 2000

-22-

and reached a full occupancy level late in the second quarter of 2000, (2)
increased personnel costs due to contractual wage increases at the Big Spring
Complex associated with receiving an increase in per diem revenue, (3) the
commencement of a management contract at the Valencia County Detention Center in
the fourth quarter of 2000 and (4) increased operating expenses at the Great
Plains Correctional Facility due to increased occupancy as compared to the year
ended December 31, 2000. The increase in operating expenses was offset, in part,
by a reduction in occupancy at the Santa Fe County Detention Center. The
Company's contract to manage the Santa Fe County Detention Center expired
effective September 30, 2001. For the year ended December 31, 2000, secure
division operating expenses included a provision for bad debts of approximately
$1.2 million related to the Santa Fe County Detention Center. As a percentage of
adult secure institutional division revenues, excluding start-up operations and
the $950,000 license agreement revenue in 2000, adult secure institutional
division operating expenses were 74.8% for the year ended December 31, 2001
compared to 75.0% for the year ended December 31, 2000.

Juvenile division operating expenses increased 27.8% to $93.8 million
for the year ended December 31, 2001 from $73.4 million for the year ended
December 31, 2000. The increase in operating expenses was due to (1) the opening
of the New Morgan Academy in the fourth quarter of 2000, (2) the commencement of
a management contract at the Alexander Youth Center in the third quarter of
2001, (3) the opening of the William Penn Harrisburg Alternative School in the
third quarter of 2001, (4) increased operating expenses at ACAF due to a
facility expansion, (5) the commencement of a management contract at the
Schaffner Youth Center and (6) increased occupancy at various facilities
including the Griffin Juvenile Facility. As a percentage of juvenile division
revenues, excluding start-up operations, juvenile division operating expenses
were 82.7% for the year ended December 31, 2001 compared to 84.4% for the year
ended December 31, 2000. The decline in the 2001 operating margin was due
principally to the operations of the Alexander Youth Center.

Pre-release division operating expenses increased 4.5% to $37.4 million
for the year ended December 31, 2001 from $35.8 million for the year ended
December 31, 2000 due principally to increased average occupancy at various
facilities offset, in part, by a reduction to operating expenses due to the
termination of the San Diego Center and Durham Treatment Center contracts as of
January 31, 2001 and June 30, 2001, respectively. As a percentage of pre-release
division revenues pre-release division operating expenses were 76.1% for the
year ended December 31, 2001 compared to 73.1% for the year ended December 31,
2000. The decline in the 2001 operating margin was due principally to increased
personnel and employee retention costs and utility costs due to the termination
of the San Diego Center and Durham Treatment Center contracts as of January 31,
2001 and June 30, 2001, respectively.

PRE-OPENING AND START-UP EXPENSES. Pre-opening and start-up expenses
were $3.9 million for the year ended December 31, 2001 and were attributable to
the pre-opening and start-up activities of the New Morgan Academy, which opened
in the fourth quarter of 2000, and an expansion of ACAF. Pre-opening and
start-up expenses were $2.3 million for the year ended December 31, 2000 and
were attributable to the pre-opening and start-up activities of the New Morgan
Academy, the final 550 bed expansion at the D. Ray James Prison in the first
quarter of 2000 and the Moshannon Valley Correctional Center. Revenues
associated with start-up operations were $2.8 million and $1.3 million for the
years ended December 31, 2001 and 2000, respectively.

DEPRECIATION AND AMORTIZATION. Depreciation and amortization increased
24.3% to $9.3 million for the year ended December 31, 2001 from $7.5 million for
the year ended December 31, 2000. The increase was due to (1) depreciation
related to the New Morgan Academy which began operations in the fourth quarter
of 2000, (2) the completion of a 150 bed expansion at the Big Spring Complex in
the first quarter of 2001, (3) the purchase and renovation of a building for the
expansion of ACAF, (4) depreciation of furniture and equipment purchased for the
New Morgan Academy, (5) the write-off of leasehold improvements at the

-23-

Durham Treatment Center due to its contract termination and (6) various facility
improvements and furniture and equipment purchases.

GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative
expenses increased 27.2% to $15.3 million for the year ended December 31, 2001
from $12.0 million for the year ended December 31, 2000. Included in general and
administrative expenses for the year ended December 31, 2001 were non-recurring
charges of $668,000 related to the write-off of deferred acquisition costs
associated with the Fort Greeley, Alaska project and a $200,000 charge for legal
costs related to the class action lawsuits. The remaining increase in general
and administrative expenses resulted primarily from retention and incentive
bonus costs, costs for additional personnel providing public affairs and
business development services, certain consulting and legal costs and other
administrative infrastructure costs. Excluding the $668,000 and $200,000 charges
in the 2001 period, general and administrative expenses were 5.4% and 5.5% of
revenues for the year ended December 31, 2001 and 2000, respectively.

INTEREST. Interest expense, net of interest income, increased to $20.9
million for the year ended December 31, 2001 from $16.4 million for the year
ended December 31, 2000. In August 2001, MCF issued $197.4 million of 8.47%
bonds due in August 2016 in connection with the 2001 Sale and Leaseback
Transaction. Proceeds from the 2001 Sale and Leaseback Transaction were used by
the Company, in part, to repay $70.0 million outstanding under the Company's
revolving line of credit and $50.0 million of outstanding 7.74% Senior Secured
Notes. Additionally, in December 2001, the Company repaid $39.4 million of
12.875% notes under its Note and Equity Purchase Agreement ("Subordinated
Notes") with proceeds from an offering and sale of its common stock. For the
year ended December 31, 2001, interest expense increased due to (1) the
increased borrowings of MCF, (2) increased borrowings under the Company's
synthetic lease to finance the construction of the New Morgan Academy which
began operations in the fourth quarter of 2000, and (3) a non-recurring charge
of $818,000 to write-off a portion of unamortized deferred debt issuance costs
related to the Company's 2000 Credit Facility as a result of the repayment of
all outstanding borrowings and an associated reduction in the credit commitment.
For the year ended December 31, 2001 the Company capitalized interest of $1.3
million related to the construction of the Moshannon Valley Correctional Center.
Capitalized interest for the year ended December 31, 2000 was $2.0 million and
related to the construction of the New Morgan Academy and the Moshannon Valley
Correctional Center.

MINORITY INTEREST IN LOSSES OF CONSOLIDATED SPECIAL PURPOSE ENTITIES.
Minority interest in consolidated special purpose entities represents third
party equity contributed to the special purpose entities consolidated by the
Company for financial reporting purposes. Minority interest is adjusted for
income and losses of the special purpose entities. When the cumulative losses of
MCF exceed the equity which is recorded as minority interest by the Company, the
excess losses will be recorded in the Company's Consolidated Statement of
Operations. Notwithstanding any additional third party equity contributions,
management estimates that the cumulative losses of MCF will exceed the recorded
minority interest of MCF during the first quarter of 2002. The cumulative
losses of the Synthetic Lease Investor exceeded the recorded minority interest
of the Synthetic Lease Investor during the third quarter of 2001.

INCOME TAXES. For the years ended December 31, 2001 and 2000, the
Company recognized a provision for income taxes at an estimated effective rate
of 42.0% and 41.0%, respectively. The increase in the effective rate was due to
increased taxable income in certain states having higher rates.

YEAR ENDED DECEMBER 31, 2000 (RESTATED) COMPARED TO YEAR ENDED DECEMBER 31, 1999

REVENUES. Revenues increased 27.7% to $226.1 million for the year ended
December 31, 2000 from $177.0 million for the year ended December 31, 1999.

-24-

Adult secure institutional division revenues increased 19.9% to $91.2
million for the year ended December 31, 2000 from $76.0 million for the year
ended December 31, 1999 due principally to (1) the final 550 bed expansion of
the D. Ray James Prison which began housing inmates late in the first quarter of
2000 and reached a full occupancy level late in the second quarter of 2000, (2)
the opening of the additional 450 bed second phase of the D. Ray James Prison in
the first quarter of 1999, (3) expansions at the Big Spring Complex completed in
the fourth quarter of 1999 and the first quarter of 2000 and (4) the opening of
the Valencia County Detention Center in the fourth quarter of 2000. These
revenue increases were offset, in part, by reductions in occupancy at certain
facilities including a temporary reduction at the Great Plains Correctional
Facility. As of December 31, 2000, occupancy at these facilities had returned to
normal occupancy levels. Additionally, during the fourth quarter of 2000, the
Company entered into a license agreement with its construction contractor that
conveyed certain rights to the design of an adult secure institution. A
non-recurring license agreement payment of $950,000 was recognized as revenue by
the Company. The Company has not licensed such designs in prior years and does
not expect to generate significant revenues from such activity in future
periods. Revenues attributable to start-up operations were approximately $44,000
and $866,000 for the years ended December 31, 2000 and 1999, respectively, and
related primarily to the D. Ray James Prison expansions.

Juvenile division revenues increased 28.2% to $86.0 million for the
year ended December 31, 2000 from $67.1 million for the year ended December 31,
1999 due to (1) the operations of the juvenile facilities and programs acquired
from Interventions - Illinois in November 1999, (2) increased occupancy at the
Cornell Abraxas I facility due to a facility expansion completed in the fourth
quarter of 1999, (3) the opening of the Cornell Abraxas Youth Center late in the
first quarter of 1999, (4) increased occupancy at certain facilities including
the Santa Fe County Juvenile Detention Facility and the Griffin Juvenile
Facility, (5) the opening of the New Morgan Academy in the fourth quarter of
2000, and (6) the addition of various new programs during 1999 including two new
non-residential mental health programs and one new residential mental health
program in Pennsylvania. Revenues attributable to start-up operations were $1.2
million and $432,000, for the years ended December 31, 2000 and 1999,
respectively. For the year ended December 31, 2000, revenues attributable to
start-up operations related primarily to the New Morgan Academy. For the year
ended December 31, 1999 revenues attributable to start-up operations related to
the opening of two new residential facilities and three new non-residential
programs.

Pre-release division revenues increased 44.4% to $48.9 million for the
year ended December 31, 2000 from $33.8 million for the year ended December 31,
1999 due principally to (1) the operations of the pre-release facilities and
programs acquired from Interventions - Illinois in November 1999, (2) the
opening of a new facility in Nome, Alaska late in the third quarter of 1999, and
(3) increased occupancy at various facilities including the Leidel Comprehensive
Sanctions Center, the Reid Community Correctional Center and the Dallas County
Judicial Treatment Center. Revenues attributable to start-up operations were $0
and $122,000 for the years ended December 31, 2000 and 1999, respectively.
Revenues attributable to start-up operations for the year ended December 31,
1999 related to the new facility in Nome, Alaska.

OPERATING EXPENSES. Operating expenses increased 28.5% to $174.6
million for the year ended December 31, 2000 from $135.9 million for the year
ended December 31, 1999. For the years ended December 31, 2000 and 1999,
operating expenses included approximately $3.9 million and $308,000,
respectively, of rent expense resulting from the sale and leaseback of certain
owned furniture and equipment during the fourth quarter of 1999. This operating
rent expense was largely offset by a reduction of depreciation and interest
expense.

Adult secure institutional division operating expenses increased 23.8%
to $68.2 million for the year ended December 31, 2000 from $55.1 million for the
year ended December 31, 1999 due principally to (1) the final 550 bed expansion
of the D. Ray James Prison, which began housing inmates late in the first
quarter

-25-

of 2000 and reached a full occupancy level late in the second quarter of 2000,
(2) the opening of the additional 450 bed second phase of the D. Ray James
Prison in the first quarter of 1999, (3) increased occupancy at the Big Spring
Complex due to expansions completed in the fourth quarter of 1999 and the first
quarter of 2000, and (4) the opening of the Valencia County Detention Center in
the fourth quarter of 2000. As a percentage of adult secure institutional
division revenues, excluding start-up operations and the $950,000 license
agreement revenue, adult secure institutional division operating expenses were
75.0% for the year ended December 31, 2000 compared to 70.1% for the year ended
December 31, 1999. The 2000 operating margin was impacted unfavorably due to (1)
the sale and leaseback of certain owned furniture and equipment during the
fourth quarter of 1999, (2) a reduction in occupancy at the Great Plains
Correctional Facility offset, in part, by the expansion of the D. Ray James
Prison, (3) a $1.2 million bad debt provision related to a Santa Fe County Adult
Detention Facility contract dispute and (4) a reduction to operating expenses
during the year ended December 31, 1999 of $1.0 million at the Santa Fe County
Adult Detention Facility resulting from a cost sharing agreement with the
Company's construction contractor.

Juvenile division operating expenses increased 27.4% to $73.4 million
for the year ended December 31, 2000 from $57.6 million for the year ended
December 31, 1999. The increase in operating expenses was due to (1) the
juvenile facilities and programs acquired from Interventions - Illinois in
November 1999, (2) increased occupancy at the Cornell Abraxas I facility due to
a facility expansion completed in the fourth quarter of 1999, (3) the opening of
the Cornell Abraxas Youth Center late in the first quarter of 1999, (4)
increased occupancy at certain facilities including the Santa Fe County Juvenile
Detention Facility and the Griffin Juvenile Facility, (5) the opening of the New
Morgan Academy in the fourth quarter of 2000, and (6) the addition of various
programs including two new non-residential mental health programs and one
residential mental health facility in Pennsylvania. As a percentage of juvenile
division revenues, excluding start-up operations, juvenile division operating
expenses were 84.4% for the year ended December 31, 2000 compared to 85.3% for
the year ended December 31, 1999. The improved operating margin for the year
ended December 31, 2000 compared to the year ended December 31, 1999 was due
principally to the higher occupancy levels and revenue of certain facilities
including Cornell Abraxas I, the Cornell Abraxas Youth Center, the Griffin
Juvenile Facility and the Santa Fe County Juvenile Detention Facility. These
operating margin improvements were offset, in part, by a margin reduction due to
the sale and leaseback of certain owned furniture and equipment during the
fourth quarter of 1999.

Pre-release division operating expenses increased 37.8% to $35.7
million for the year ended December 31, 2000 from $25.9 million for the year
ended December 31, 1999 due principally to (1) the pre-release facilities and
programs acquired from Interventions - Illinois in November 1999, (2) the
opening of a new facility in Nome, Alaska late in the third quarter of 1999 and
(3) increased occupancy at various facilities including the Leidel Comprehensive
Sanctions Center, the Reid Community Correctional Center and the Dallas County
Judicial Treatment Center. As a percentage of pre-release division revenues,
excluding start-up operations, pre-release division operating expenses were
73.1% for the year ended December 31, 2000 compared to 75.4% for the year ended
December 31, 1999. The improved operating margin for the year ended December 31,
2000 compared to the year ended December 31, 1999 was due principally to higher
occupancy and revenues at certain facilities. These operating margin
improvements were offset, in part, by margin reductions due to the sale and
leaseback of certain owned furniture and equipment during the fourth quarter of
1999.

PRE-OPENING AND START-UP EXPENSES. Pre-opening and start-up expenses
were $2.3 million for the year ended December 31, 2000 and were primarily
attributable to the pre-opening and start-up activities of the New Morgan
Academy which opened in the fourth quarter of 2000 and the final 550 bed
expansion at the D. Ray James Prison in the first quarter of 2000. Pre-opening
and start-up expenses were $2.9 million for the year ended December 31, 1999 and
were attributable to the pre-opening and start-up activities of an additional
450 beds in the D. Ray James Prison, the Cornell Abraxas Youth Center during the
first quarter

-26-

of 1999 and other new juvenile programs in Pennsylvania and a new pre-release
facility in Alaska. Revenues associated with start-up operations were $1.3
million and $1.5 million for the years ended December 31, 2000 and 1999,
respectively.

DEPRECIATION AND AMORTIZATION. Depreciation and amortization increased
24.2% to $7.5 million for the year ended December 31, 2000 from $6.0 million for
the year ended December 31, 1999 due to (1) depreciation of buildings, furniture
and equipment and amortization of non-compete agreements related to the
acquisition of Interventions - Illinois in November 1999, (2) the completion of
the expansions at the Big Spring Complex, (3) the completion of the additional
450 bed expansion in the first quarter of 1999 and the final 550 bed expansion
in the first quarter of 2000 of the D. Ray James Prison, and (4) depreciation
related to the New Morgan Academy and Taylor Street Center buildings financed
through the Company's Synthetic Lease financing agreement. These increases were
partially offset due to the sale and leaseback of certain owned furniture and
equipment during the fourth quarter of 1999 and due to the Company's change in
the estimated useful lives of certain adult secure institutions effective July
1, 1999.

GENERAL AND ADMINISTRATIVE EXPENSES. General and administrative
expenses increased 21.1% to $12.0 million for the year ended December 31, 2000
from $9.9 million for the year ended December 31, 1999. The increase in general
and administrative expenses resulted principally from the centralization of
certain administrative functions and increases in public relations efforts and
information technology infrastructure. Additionally, for the years ended
December 31, 2000 and 1999, general and administrative expenses included
approximately $820,000 and $93,000, respectively, of rent expense resulting from
the sale and leaseback of certain owned furniture and equipment during the
fourth quarter of 1999. This rent expense was largely offset by a reduction of
depreciation and interest expense. Excluding the rent expense resulting from the
1999 sale and leaseback of certain furniture and equipment, general and
administrative expenses for the year ended December 31, 2000 increased 13.9%
compared to the year ended December 31, 1999.

INTEREST. Interest expense, net of interest income, increased to $16.4
million for the year ended December 31, 2000 from $8.4 million for the year
ended December 31, 1999 due principally to (1) increased borrowings to fund the
acquisition of Interventions - Illinois in November 1999, various facility
expansions and the associated increases in working capital, (2) increased
borrowings to fund the construction of the New Morgan Academy and the Moshannon
Valley Correctional Center and (3) increases in base interest rates and the
Company's interest rate margin on its 2000 Credit Facility (see Note 6 to the
Consolidated Financial Statements). Capitalized interest for the year ended
December 31, 2000 was $2.0 million and related to the construction of the New
Morgan Academy and the Moshannon Valley Correctional Center and expansions at
the Big Spring Complex. During the year ended December 31, 1999, the Company
capitalized interest totaling $1.2 million related to the construction of the D.
Ray James Prison.

MINORITY INTEREST IN LOSSES OF CONSOLIDATED SPECIAL PURPOSE ENTITIES.
Minority interest in consolidated special purpose entities represents third
party equity contributed to the special purpose entity. Minority interest is
adjusted for income and losses of the special purpose entity. When the
cumulative losses of a special purpose entity exceed the equity which is
recorded as minority interest by the Company, the excess losses are recorded in
the Company's Consolidated Statements of Operations. The cumulative losses of
the Synthetic Lease Investor exceeded the recorded minority interest of the
Synthetic Lease Investor during the third quarter of 2001.

INCOME TAXES. For the year ended December 31, 2000 and 1999, the
Company recognized a provision for income taxes at an estimated effective rate
of 41% and 40%, respectively. The increase in the estimated effective tax rate
for the year ended December 31, 2000 as compared to the year ended December 31,
1999 was due primarily to increased taxable income in certain higher taxing
states.

-27-

LIQUIDITY AND CAPITAL RESOURCES

GENERAL. The Company's primary capital requirements are for (1)
construction of new facilities, (2) expansions of existing facilities, (3)
working capital, (4) pre-opening and start-up costs related to new operating
contracts, (5) acquisitions, (6) information systems hardware and software, and
(7) furniture, fixtures and equipment. Working capital requirements generally
increase immediately prior to the Company commencing management of a new
facility as the Company incurs start-up costs and purchases necessary equipment
and supplies before facility management revenue is realized.

2001 COMMON STOCK OFFERING. On November 30, 2001 the Company completed
an offering of its common stock. Net proceeds to the Company from the sale of
the 3,450,000 newly issued shares were approximately $43.8 million. The Company
used a portion of the proceeds to repay outstanding borrowings of $39.4 million
and retired the notes under its Note and Equity Purchase Agreement (the
"Subordinated Notes") entered into in July 2000.

2001 SALE AND LEASEBACK TRANSACTION. On August 14, 2001, the Company
completed the 2001 Sale and Leaseback Transaction, an arms' length sale and
leaseback transaction involving 11 of its real estate facilities. The Company
sold the facilities to an unaffiliated company, Municipal Corrections Finance
L.P. ("MCF"), and is leasing them back for an initial period of 20 years,
with approximately 25 years of additional renewal period options.

MCF is an unaffiliated special purpose entity ("SPE"). Under current
accounting rules, an SPE must maintain at least a 3% ownership interest
throughout the life of the lease. In September 2001, the Company entered into a
separate retainer agreement, thereafter amended, with affiliates of the equity
investor in MCF ("MCF Equity Investor"), and in November 2001, paid the retainer
fee of $3.65 million for financial advisory services for separate potential
future financing projects and the strategic development of the Company's
business. The retainer will be applied on a mutually agreed upon basis toward
future contingent fees associated with investment banking services that are
expected to be provided to the Company. Under certain accounting
interpretations, this retainer has been deemed to reduce the equity investment
in MCF to below the required 3% level. Therefore, for financial reporting
purposes only, the Company has consolidated the assets, liabilities, and results
of operations of MCF in the Company's accompanying consolidated financial
statements beginning August 14, 2001. As a result of consolidating the assets
and liabilities of MCF, the Company's consolidated financial statements reflect
the depreciation expense on the associated properties and interest expense on
the bond debt of MCF used to finance MCF's acquisition of the 11 facilities in
the 2001 Sale and Leaseback Transaction.

MCF issued $197.4 million of 8.47% bonds due August 2016. The Company
used $120.0 million of the $173 million of proceeds received by the Company from
the sale of such facilities to repay the Company's long-term senior debt and
invested the remaining proceeds of approximately $53.0 million in short-term
securities.

The Company's consolidated financial statements include the financial
statements of MCF as of August 14, 2001 and thereafter. See Note 2 to the
consolidated financial statements for discussion of the sale-leaseback
transaction, the consolidation of MCF, and the restatement of the Company's
financial statements for the quarter ended September 30, 2001.

LONG-TERM CREDIT FACILITIES. On August 14, 2001, the Company repaid
$70.0 million outstanding under its revolving line of credit with a portion of
the proceeds from the 2001 Sale and Leaseback Transaction. In connection with
the repayment, the Company amended its 2000 Credit Facility, which now provides
for borrowings of up to $45.0 million under a revolving line of credit. The
commitment amount is reduced by

-28-

$1.6 million quarterly beginning July 2002. The amended 2000 Credit Facility
matures in July 2005 and bears interest, at the election of the Company, at
either the prime rate plus a margin of 2.0%, or a rate which is 3.0% above the
applicable LIBOR rate. The amended 2000 Credit Facility is secured by
substantially all of the Company's assets, including the stock of all of the
Company's subsidiaries; does not permit the payment of cash dividends; and
requires the Company to comply with certain leverage, net worth and debt service
coverage covenants. Due in part to the consolidation of MCF as of August 14,
2001, the Company was not in compliance with certain covenants required by the
2000 Credit Facility. On April 5, 2002, the 2000 Credit Facility was amended to
waive such non-compliance and to revise the covenants to levels that accommodate
the Company's consolidation of special purpose entities in its Consolidated
Balance Sheet and Statements of Operations. As a result of this waiver and
amendment, the Company paid fees and will recognize a pre-tax charge to interest
expense of approximately $800,000 during the first quarter of 2002. On April 11,
2002, the Company obtained a waiver from the lenders under the 2000 Credit
Facility regarding the pending contractual default for the Moshannon Valley
Correctional Center's construction delay.

As a result of the reduction of the revolving line of credit commitment
in August 2001, the Company recognized a non-recurring charge of approximately
$818,000 to interest expense representing a portion of the unamortized deferred
debt issuance costs related to the 2000 Credit Facility.

Additionally, the amended 2000 Credit Facility provides the Company
with the ability to enter into lease financing arrangements for the acquisition
or development of operating facilities. This lease financing arrangement
provides for funding to the lessor under the leases of up to $100.0 million, of
which approximately $49.9 million had been utilized as of December 31, 2001. The
Company expects to utilize the remaining capacity under this lease financing
arrangement to complete construction of the Moshannon Valley Correctional
Center. The Company pays commitment fees at a rate of 0.5% annually for the
unused portion of the lease financing capacity.

The Company's lease financing arrangement under its 2000 Credit
Facility is a "synthetic lease". A synthetic lease is a form of lease financing
that qualifies for operating lease accounting treatment and, when all criteria
pursuant to generally accepted accounting principles (GAAP) are met, is kept
"off-balance sheet". Under such a structure, the owner/lessor of the properties
("Synthetic Lease Investor") could be considered a virtual SPE when it obtains
debt and equity capital to finance the project(s) and leases the projects to a
company. This financial structure was used to finance the construction of the
New Morgan Academy completed in the first quarter of 2001, the acquisition of
the Taylor Street Center building in early 1999, and the construction-to-date of
the Moshannon Valley Correctional Center which is still in process. The
synthetic lease used to finance the above projects was originally entered into
in December 1998 and was amended in July 2000 whereby the available financing
was increased from $40 million to $100 million and the lease term extended to
July 2005.

Under current accounting rules, the Synthetic Lease Investor in a
virtual SPE must maintain at least a 3% equity ownership interest in the
property throughout the life of the lease. The Company's synthetic lease
documents, as amended in July 2000, provide for the equity investor to fund 3.5%
of project costs. There are provisions in the lease and related credit documents
for the lenders and Synthetic Lease Investor to fund and be paid interest, yield
and fees. Under current GAAP rules, the payment of any yield and fees to the
investors is required to be treated as a return of capital rather than a return
on capital.

The Synthetic Lease Investor for the above projects received certain
customary payments to assist as co-arranger in the structure of the initial $40
million synthetic lease facility in 1998 and in July 2000 when the synthetic
lease facility was increased to $100 million. Although the Company does not
believe the lessor is a special purpose entity, the lessor could be considered
as a "virtual" special purpose entity under certain accounting interpretations.
Therefore, these payments could be interpreted to reduce the Synthetic Lease

-29-

Investor's equity ownership in the leased projects below the required 3% level
as of the second quarter of 2000. If that were the case, these synthetic leases
would no longer qualify for off-balance sheet treatment beginning in the second
quarter of 2000. Accordingly, the assets and liabilities and results of
operations of the synthetic lease owned by the Synthetic Lease Investor are
consolidated in the Company's financial statements beginning in the second
quarter of 2000. See "-Recent Developments."

As a result of consolidating the synthetic lease assets and
liabilities, the Company's accompanying consolidated financial statements
reflect the depreciation expense on the associated properties and interest
expense related to the Synthetic Lease Investor's debt, instead of rent expense.

The Synthetic Lease Investor's Note A and Note B have total credit
commitments of $81.4 million and $15.1 million, respectively. The Synthetic
Lease Investor's Notes A and B are cross collateralized with the Company's
revolving line of credit and contain cross default provisions.

On August 14, 2001, the Company repaid the $50.0 million of outstanding
7.74% Senior Secured Notes with a portion of the proceeds from the 2001 Sale and
Leaseback Transaction.

EXTRAORDINARY CHARGES. In August 2001, the Company used a portion of
the net proceeds from the 2001 Sale and Leaseback Transaction to retire $50.0
million of outstanding 7.74% Senior Secured Notes which had a maturity date of
July 15, 2010. As a result, the Company recognized an extraordinary charge of
$479,000 (net of related income taxes of $333,000) in the third quarter of 2001
due to the write-off of unamortized deferred debt issuance costs related to the
Senior Secured Notes.

In December 2001, the Company repaid the $39.4 million outstanding on
its Subordinated Notes which had a maturity date of July 21, 2007. As a result,
the Company recognized an extraordinary charge of $2.5 million (net of related
income taxes of $1.7 million) in the fourth quarter of 2001 comprised of the
write-offs of unamortized deferred debt issuance costs and debt discount and
assessed contractual prepayment fees.

NEW FACILITIES AND PROJECT UNDER DEVELOPMENT. The New Morgan Academy
was completed and became operational in two phases during the fourth quarter of
2000 and the first quarter of 2001.

In April 1999, the Company was awarded a contract to design, build and
operate a 1,095 bed prison for the FBOP in Moshannon Valley, Pennsylvania (the
"Moshannon Valley Correctional Center"). Construction and activation activities
commenced immediately. In June 1999, the FBOP issued a Stop-Work Order pending a
re-evaluation of their environmental documentation supporting the decision to
award the contract. The environmental study was completed with a finding of no
significant impact and the Stop-Work Order was lifted by the FBOP on August 9,
2001.

In September 1999, the Company received correspondence from the Office
of the Attorney General of the Commonwealth of Pennsylvania indicating its
belief that the operation of a private prison in Pennsylvania is unlawful. The
Company and the FBOP have had, and continue to have, discussions with the
Attorney General's staff regarding these and related issues. Management
anticipates that these discussions will be resolved in the near-term. As of
December 31, 2001, the Company had incurred approximately $14.9 million for
construction and land development costs and capitalized interest for the
Moshannon Valley Correctional Center. According to the FBOP contract, as
amended, the Company must complete the construction of the project by April 15,
2002. The Company will not be able to complete construction within that time
frame. While the FBOP has not asserted any default or made any claim, if the
Company is not able to negotiate a contract amendment with the FBOP, then the
FBOP may have the right to assert that the Company has not completed
construction of the project within the time frames provided in the FBOP
contract, as amended. In the event that the FBOP desires to continue with the
Moshannon Valley Correctional Center, management

-30-

expects that the contract will be amended to address cost and construction
timing matters resulting from the extended delay. In the event that the FBOP
decides not to continue with the Moshannon project and terminates the contract,
management believes that the Company has the right to recover its invested
costs. In the event any portion of these costs are determined not to be
reimbursed upon contract termination, such costs would be expensed.

At December 31, 2001, accounts receivable include costs totaling $1.4
million for direct costs incurred by the Company since the issuance of the
Stop-Work Order in June 1999 for payroll and other operating costs related to
the Moshannon Valley Correctional Center. These costs were incurred with the
understanding that such costs would be reimbursed. Although no formal written
agreement exists, management believes that these costs will be reimbursed by the
FBOP in the near term. In the event any portion of these costs are not
reimbursed, such costs will be expensed if they are determined not to be
reimbursable.

Development and construction costs for the New Morgan Academy and the
Moshannon Valley Correctional Center have been financed with the Company's
synthetic lease financing arrangement discussed under "Long-Term Credit
Facilities".

CAPITAL EXPENDITURES. Capital expenditures for the year ended December
31, 2001 were $14.2 million and related primarily to (1) a 150 bed expansion at
the Big Spring Complex, (2) construction costs for the New Morgan Academy and
the Moshannon Valley Correctional Center, (3) the purchase and renovation of a
building and related furniture and equipment purchases for an expansion at ACAF,
(4) purchases of furniture and equipment for the New Morgan Academy and (5)
various facility improvements and furniture and equipment purchases.

FUTURE LIQUIDITY. Management believes that the Company's existing cash
and cash equivalents and cash flows generated from operations, together with the
revolving credit available under the 2000 Credit Facility and the lease
financing capacity thereunder, will provide sufficient liquidity to meet the
Company's committed capital and working capital requirements for currently
awarded and certain potential future contracts. To the extent the Company's cash
and current financing arrangements do not provide sufficient financing to fund
construction costs related to future adult secure institutional contract awards
or significant facility expansions, the Company anticipates obtaining additional
sources of financing to fund such activities. However, there can be no assurance
that such financing will be available, or will be available on terms favorable
to the Company.

CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS. The Company has
assumed various financial obligations and commitments in the ordinary course of
conducting its business. The Company has contractual obligations requiring
future cash payments under its existing contractual arrangements, such as
management, consultative and non-competition agreements.

The Company maintains operating leases in the ordinary course of its
business activities. These leases include those for operating facilities, office
space and office and operating equipment, and the terms of the agreements vary
from 2002 until 2075. As of December 31, 2001, the Company's total commitment
under operating leases were approximately $38.2 million.

-31-

The following table details the Company's known future cash payments
(on an undiscounted basis) related to various contractual obligations as of
December 31, 2001 (in thousands):

The Company enters into letters of credit in the ordinary course of
operating and financing activities. As of December 31, 2001, the Company had
outstanding letters of credit of $1.2 million related to insurance and other
operating activities. The following table details the Company's letter of credit
commitments as of December 31, 2001 (in thousands):

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The discussion and analysis of financial condition and results of
operations are based upon consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepts in the
United States. The preparation of these financial statements require that
management make estimates and judgments that affect the reported amounts of
assets, liabilities, revenues and expenses, and related disclosure of contingent
assets and liabilities. The Company evaluates its estimates on an on-going
basis, based on historical experience and on various other assumptions that are
believed to be reasonable under the circumstances. Actual results may differ
from these estimates under different assumptions or conditions.

The Company believes the following critical accounting policies affect
its more significant adjustments and estimates used in the preparation of its
consolidated financial statements.

The Company extends credit to the government agencies contracted with
other parties in the normal course of business. Further, the Company regularly
reviews outstanding receivables, and provides estimated losses through an
allowance for doubtful accounts. In evaluating the level of established
reserves, the Company makes judgments regarding its customers' ability to make
required payments, economic events and other factors. As the financial condition
of these parties change, circumstances develop or additional information becomes
available, adjustments to the allowance for doubtful accounts may be required.

Deferred tax assets and liabilities are recognized for the difference
between the book basis and tax basis of its net assets. In providing for
deferred taxes, the Company considers current tax regulations, estimates

-32-

of future taxable income and available tax planning strategies. If tax
regulations, operating results or the ability to implement tax planning
strategies vary, adjustments to the carrying value of deferred tax assets and
liabilities may be required.

The Company maintains coverage for various aspects of our business and
operations. The Company retains a portion of losses that occur through the use
of deductibles and retention under self-insurance programs. The Company
regularly reviews the estimates of reported and unreported claims and provides
for losses through insurance reserves. As claims develop and additional
information becomes available, adjustments to loss reserves may be required.

INFLATION

Other than personnel and offender medical costs at certain facilities
during 2001, management believes that inflation has not had a material effect on
the Company's results of operations during the past three years. Most of the
Company's facility management contracts provide for payments to the Company of
either fixed per diem fees or per diem fees that increase by only small amounts
during the term of the contracts. Inflation could substantially increase the
Company's personnel costs (the largest component of operating expenses) or other
operating expenses at rates faster than any increases in contract revenues.

RISK FACTORS AND CAUTIONARY STATEMENT FOR PURPOSES OF THE "SAFE HARBOR"
PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995

This report contains or incorporates by reference forward-looking
statements within the meaning of the Private Securities Litigation Reform Act of
1995. These statements are based on current plans and expectations of management
and involve risks and uncertainties that could cause actual future activities
and results of operations to be materially different from those set forth in the
forward-looking statements. Important factors that could cause actual results to
differ include, among others, (1) risks associated with acquisitions and the
integration thereof (including the ability to achieve administrative and
operating cost savings and anticipated synergies), (2) the timing and costs of
expansions of existing facilities, (3) changes in governmental policy to
eliminate or discourage the privatization of correctional, detention and
pre-release services in the United States, (4) availability of debt and equity
financing on terms that are favorable to the Company, (5) fluctuations in
operating results because of occupancy, competition (including competition from
two competitors that are substantially larger than the Company), increases in
cost of operations, fluctuations in interest rates and risks of operations and
(6) significant charges to operating expense of deferred costs associated with
financing and other projects in development if management determines that one or
more of such projects is unlikely to be successfully concluded.

Where any forward-looking statement includes a statement of the
assumptions or bases underlying the forward-looking statement, the Company
cautions that, while it believes these assumptions or bases to be reasonable and
in good faith, assumed facts or bases almost always vary from the actual
results, and differences between assumed facts or bases and actual results can
be material, depending upon the circumstances. Where, in any forward-looking
statement, the Company or its management express an expectation or belief as to
future results, that expectation or belief is expressed in good faith and is
believed to have a reasonable basis. The Company cannot assure you, however,
that the statement of expectation or belief will result or be achieved or
accomplished. The words "believe," "expect," "estimate," "anticipate" and
similar expressions will generally identify forward-looking statements. All of
the Company's forward-looking statements, whether written or oral, are expressly
qualified by these cautionary statements and any other cautionary statements
that may accompany such forward-looking statements. In addition, the Company
disclaims any obligation to update any forward-looking statements to reflect
events or circumstances after the date of this report.

-33-

With this in mind, you should consider the risks discussed elsewhere in
this report and other documents the Company files with the Commission from time
to time and the following important factors that could cause actual results to
differ materially from those expressed in any forward-looking statement made by
the Company or on its behalf.

PUBLIC RESISTANCE TO PRIVATIZATION OF CORRECTIONAL AND DETENTION FACILITIES
COULD RESULT IN THE COMPANY'S INABILITY TO OBTAIN NEW CONTRACTS OR THE LOSS OF
EXISTING CONTRACTS.

Management of correctional and detention facilities by private entities
has not achieved complete acceptance by either the government or the public. The
movement toward privatization of correctional and detention facilities has also
encountered resistance from certain groups, such as labor unions, local
sheriff's departments, and groups believing that correctional and detention
facility operations should only be conducted by government agencies. Changes in
the dominant political party in any market in which correctional facilities are
located could have an adverse impact on privatization. Further, some government
agencies are not legally permitted to delegate their traditional management
responsibilities for correctional and detention facilities to private companies.

Any of these resistances may make it more difficult for the Company to
renew or maintain existing contracts, to obtain new contracts or sites on which
to operate new facilities or to develop or purchase facilities and lease them to
government or private entities, any or all of which could have a material
adverse effect on the Company's business.

THE COMPANY IS SUBJECT TO THE SHORT-TERM NATURE OF GOVERNMENT CONTRACTS.

Many governmental agencies are legally limited in their ability to
enter into long-term contracts that would bind elected officials responsible for
future budgets. Therefore, many contracts with government agencies typically
either have a very short term or are subject to termination on short notice
without cause. In addition, the Company's contracts with government agencies may
contain one or more renewal options that may be exercised only by the
contracting government agency. No assurance can be given that any agency will
exercise a renewal option in the future. The non-renewal or termination of any
of the Company's significant contracts with governmental agencies could
materially adversely affect the Company's financial condition, results of
operation and liquidity, including its ability to secure new facility management
contracts from others.

THE COMPANY IS DEPENDENT ON GOVERNMENT APPROPRIATIONS. IF GOVERNMENT
APPROPRIATION LEVELS ARE REDUCED, THE COMPANY'S BUSINESS MAY BE HARMED.

The Company's cash flow is subject to the receipt of sufficient funding
of and timely payment by contracting governmental entities. If the appropriate
governmental agency does not receive sufficient appropriations to cover its
contractual obligations, a contract may be terminated or the amounts payable to
the Company may be deferred or reduced. Any delays in payment, or the
termination of a significant contract, could have an adverse effect on the
Company's cash flow and financial condition. Moreover, as a result of the
slowing economy and the events of September 11, 2001, federal, state and local
governments may encounter unusual budgetary constraints and there is a risk that
spending on outsourced services provided by the Company may be curtailed.

THE COMPANY'S ABILITY TO WIN NEW CONTRACTS TO DEVELOP AND MANAGE CORRECTIONAL,
DETENTION AND TREATMENT FACILITIES DEPENDS ON MANY FACTORS OUTSIDE ITS CONTROL.

-34-

The Company's growth is generally dependent upon its ability to win new
contracts to develop and manage new correctional, detention and treatment
facilities. This depends on a number of factors the Company cannot control,
including crime rates and sentencing patterns in various jurisdictions.
Accordingly, the demand for the Company's facilities could be adversely affected
by the relaxation of enforcement efforts, leniency in conviction and sentencing
practices or through the legal decriminalization of certain activities that are
currently proscribed by criminal laws. For instance, any changes with respect to
drugs and controlled substances or illegal immigration could affect the number
of persons arrested, convicted and sentenced, thereby potentially reducing
demand for correctional facilities to house them. Similarly, reductions in crime
rates could lead to reductions in arrests, convictions and sentences requiring
correctional facilities. The Bureau of Justice Statistics reports that the level
of violent crime in the United States has declined steadily since 1994 and the
level of property crime is at the lowest level since 1974. However, the number
of detained offenders has grown steadily during that period.

While the Company believes that governments will continue to privatize
correctional, detention and treatment facilities, the Company believes the rate
of growth experienced in the state private corrections industry during the late
1980's and early 1990's is moderating. Certain jurisdictions recently have
required successful bidders to make a significant capital investment in
connection with the financing of a particular project, a trend that could
require the Company to have sufficient capital resources to compete effectively.
The Company may not be able to obtain these capital resources when needed.
Additionally, the Company's success in obtaining new awards and contracts may
depend, in part, upon its ability to locate land that can be leased or acquired
under favorable terms. Otherwise desirable locations may be in or near populated
areas and, therefore, may generate legal action or other forms of opposition
from residents in areas surrounding a proposed site.

THE COMPANY'S PROFITABILITY MAY SUFFER IF THE NUMBER OF OFFENDERS OCCUPYING ITS
CORRECTIONAL, DETENTION AND TREATMENT FACILITIES DECREASES.

The Company's correctional, detention and treatment facilities are
dependent upon government agencies supplying offenders. A substantial portion of
the Company's revenues is generated under contracts that specify a net rate per
day per resident, or a per diem rate, sometimes with no minimum guaranteed
occupancy levels, even though most correctional facility cost structures are
relatively fixed. Under such a per diem rate structure, a decrease in occupancy
levels at a particular facility could have a material adverse effect on the
financial condition and results of operations at such facility.

A FAILURE TO COMPLY WITH EXISTING REGULATIONS COULD RESULT IN MATERIAL PENALTIES
OR NON-RENEWAL OR TERMINATION OF THE COMPANY'S CONTRACTS TO MANAGE CORRECTIONAL,
DETENTION AND TREATMENT FACILITIES.

The Company's industry is subject to a variety of federal, state and
local regulations, including education, health care and safety regulations,
which are administered by various regulatory authorities. The Company may not
always successfully comply with these regulations, and failure to comply could
result in material penalties or non-renewal or termination of facility
management contracts. The contracts typically include extensive reporting
requirements and supervision and on-site monitoring by representatives of
contracting government agencies. Corrections officers are customarily required
to meet certain training standards, and in some instances facility personnel are
required to be licensed and subject to background investigation. Certain
jurisdictions also require the subcontracts to be awarded on a competitive basis
or to subcontract with businesses owned by members of minority groups. The
Company's facilities are also subject to operational and financial audits by the
governmental agencies with which the Company has contracts. The failure to
comply with any applicable laws, rules or regulations and the loss of any
required license could adversely affect the financial condition and results of
operations at the Company's affected facilities.

-35-

GOVERNMENT AGENCIES MAY INVESTIGATE AND AUDIT THE COMPANY'S CONTRACTS AND, IF
ANY IMPROPRIETIES ARE FOUND, THE COMPANY MAY BE REQUIRED TO REFUND REVENUES IT
HAS RECEIVED, TO FOREGO ANTICIPATED REVENUES AND MAY BE SUBJECT TO PENALTIES AND
SANCTIONS, INCLUDING PROHIBITIONS ON THE COMPANY'S BIDDING IN RESPONSE TO
REQUESTS FOR PROPOSALS, OR RFPS.

Certain of the government agencies the Company contracts with have the
authority to audit and investigate the Company's contracts with them. As part of
that process, the government agency reviews the Company's performance on the
contract, its pricing practices, its cost structure and its compliance with
applicable laws, regulations and standards. If the agency determines that the
Company has improperly allocated costs to a specific contract, the Company may
not be reimbursed for those costs and the Company could be required to refund
the amount of any such costs that have been reimbursed. If a government audit
uncovers improper or illegal activities by the Company or the Company otherwise
determines that these activities have occurred, the Company may be subject to
civil and criminal penalties and administrative sanctions, including termination
of contracts, forfeitures of profits, suspension of payments, fines and
suspension or disqualification from doing business with the government. Any
adverse determination could adversely impact the Company's ability to bid in
response to RFPs in one or more jurisdictions.

IF THE COMPANY FAILS TO SATISFY ITS CONTRACTUAL OBLIGATIONS, THE COMPANY'S
ABILITY TO COMPETE FOR FUTURE CONTRACTS AND ITS FINANCIAL CONDITION MAY BE
ADVERSELY AFFECTED.

The Company's failure to comply with contract requirements or to meet
its client's performance expectations when performing a contract could
materially and adversely affect the Company's financial performance and its
reputation, which, in turn, would impact the Company's ability to compete for
new contracts. The Company's failure to meet contractual obligations could also
result in substantial actual and consequential damages. In addition, the
Company's contracts often require it to indemnify clients for the Company's
failure to meet performance standards. Some of the Company's contracts contain
liquidated damages provisions and financial penalties related to performance
failures. Although the Company has liability insurance, the policy limits may
not be adequate to provide protection against all potential liabilities.

NEW COMPETITORS IN THE COMPANY'S INDUSTRY MAY ADVERSELY AFFECT THE PROFITABILITY
OF THE COMPANY'S BUSINESS.

The Company must compete on the basis of cost, quality and range of
services offered, experience in managing facilities, reputation of personnel and
ability to design, finance and construct new facilities on a cost effective
competitive basis. While there are barriers for companies seeking to enter into
the management and operation of correctional, detention and treatment
facilities, there can be no assurance that these barriers will be sufficient to
limit additional competition.

A DISTURBANCE IN ONE OF THE COMPANY'S FACILITIES COULD RESULT IN CLOSURE OF A
FACILITY OR HARM TO THE COMPANY'S BUSINESS.

An escape, riot or other disturbance at one of the Company's facilities
could adversely effect the financial condition, results of operations and
liquidity of the Company's operations. Among other things, the adverse publicity
generated as a result of an event could adversely affect the Company's ability
to retain an existing contract or obtain future ones. In addition, if such an
event were to occur, there is a possibility that the facility where the event
occurred may be shut down by the relevant governmental agency. A closure of
certain of the Company's facilities could adversely affect the financial
condition, results of operations and liquidity of the Company's operations.

-36-

TERRORIST ATTACKS, SUCH AS THE ATTACKS THAT OCCURRED IN NEW YORK AND WASHINGTON,
D.C. ON SEPTEMBER 11, 2001, AND OTHER ACTS OF VIOLENCE OR WAR MAY AFFECT THE
MARKETS IN WHICH THE COMPANY'S COMMON STOCK TRADES, THE MARKETS IN WHICH THE
COMPANY OPERATES AND THE COMPANY'S PROFITABILITY.

Terrorist attacks may negatively affect the Company's operations. There
can be no assurance that there will not be further terrorist attacks against the
United States or United States businesses. As a result of terrorism, the United
States may enter into a protracted armed conflict, which could have a further
impact on the Company's business. In addition, terrorists attacks in the United
States may increase demand for trained security personnel, which could increase
the Company's operating costs. Political and economic instability in some
regions of the world may also result and could negatively impact the Company's
business. In addition, any of these events may affect the markets in which the
Company's common stock trades. The consequences of any of these armed conflicts
are unpredictable and the Company may not be able to foresee events that could
have an adverse effect on its business.

INACCURATE, MISLEADING OR NEGATIVE MEDIA COVERAGE COULD ADVERSELY AFFECT THE
COMPANY'S REPUTATION AND ITS ABILITY TO BID FOR GOVERNMENT CONTRACTS.

The media frequently focuses its attention on private operators'
contracts with government agencies. If the media coverage is negative, it could
influence government officials to slow the pace of outsourcing government
services, which could reduce the number of RFPs. The media may also focus its
attention on the activities of political consultants engaged by the Company,
even when their activities are unrelated to the Company's business, and the
Company may be tainted by adverse media coverage about their activities.
Moreover, inaccurate, misleading or negative media coverage about the Company
could harm its reputation and, accordingly, its ability to bid for and win
government contracts.

THE COMPANY MAY INCUR SIGNIFICANT COSTS BEFORE RECEIVING RELATED REVENUES, WHICH
COULD RESULT IN CASH SHORTFALLS.

When the Company is awarded a contract to manage a government program,
it may incur significant expenses before the Company receives contract payments.
These expenses include leasing office space, purchasing office equipment and
hiring and training personnel. As a result, in certain large contracts where the
government does not fund program pre-opening and start-up costs, the Company may
be required to invest significant sums of money before receiving related
contract payments. In addition, payments due to the Company from government
agencies may be delayed due to billing cycles or as a result of failures to
approve governmental budgets and finalize contracts in a timely manner.

THE COMPANY MAY BE UNABLE TO ATTRACT AND RETAIN SUFFICIENT QUALIFIED PERSONNEL
NECESSARY TO SUSTAIN ITS BUSINESS.

The Company's delivery of services is labor-intensive. When the Company
is awarded a government contract, the Company must hire operating management,
security, case management and other personnel. The success of the Company's
business requires that the Company attract, develop, motivate and retain these
personnel. The Company's inability to hire sufficient personnel on a timely
basis or the loss of significant numbers of personnel could adversely affect its
business.

IF THE COMPANY IS UNABLE TO MANAGE ITS GROWTH, ITS PROFITABILITY WILL BE
ADVERSELY AFFECTED.

Sustaining the Company's growth has placed significant demands on the
Company's management as well as on its administrative, operational and financial
resources. For the Company to continue to manage its growth, the Company must
continue to improve its operational, financial and management information

-37-

systems and expand, motivate and manage its workforce. If the Company's growth
comes at the expense of providing quality service and generating reasonable
profits, the Company's ability to successfully bid for contracts and its
profitability will be adversely affected.

UNSUCCESSFUL FINANCING OR ACQUISITION PROJECTS MAY RESULT IN CHARGES TO EXPENSE
FOR DEFERRED COSTS.

If the Company determines that one or more financing or acquisition
projects is unlikely to be successfully concluded, the Company could incur
significant charges to expense for deferred costs associated with such projects.

IF THE COMPANY DOES NOT SUCCESSFULLY INTEGRATE THE BUSINESSES THAT IT ACQUIRES,
THE COMPANY'S RESULTS OF OPERATIONS COULD BE ADVERSELY AFFECTED.

The Company may be unable to manage businesses that it may acquire
profitably or integrate them successfully without incurring substantial
expenses, delays or other problems that could negatively impact the Company's
results of operations.

Moreover, business combinations involve additional risks, including:

o diversion of management's attention;
o loss of key personnel;
o assumption of unanticipated legal or financial liabilities;
o the Company's becoming significantly leveraged as a result of
the incurrence of debt to finance an acquisition;
o unanticipated operating, accounting or management difficulties
in connection with the acquired entities;
o amortization or charges of acquired intangible assets,
including goodwill; and
o dilution to the Company's earnings per share.

Also, client dissatisfaction or performance problems with an acquired
business could materially and adversely affect the Company's reputation as a
whole. Further, the acquired businesses may not achieve the revenues and
earnings the Company anticipated.

BECAUSE FEDERAL ENVIRONMENTAL LAWS IMPOSE STRICT AS WELL AS JOINT AND SEVERAL
LIABILITY FOR CLEAN UP COSTS, UNFORESEEN ENVIRONMENTAL RISKS COULD PROVE TO BE
COSTLY.

The Company's facilities may be subject to unforeseen environmental
risks. The federal Comprehensive Environmental Response, Compensation, and
Liability Act, as amended, or CERCLA, imposes strict, as well as joint and
several, liability for certain environmental cleanup costs on several classes of
potentially responsible parties, including current owners and operators of the
property and, in some cases, lenders who did not cause or contribute to the
contamination. Furthermore, liability under CERCLA is not limited to the
original or unamortized principal balance of a loan or to the value of the
property securing a loan. Other federal and state laws in certain circumstances
may impose liability for environmental remediation, which costs may be
substantial. Moreover, certain federal statutes and certain states by statute
impose a lien for any cleanup costs incurred by such state on the property that
is the subject of such cleanup costs. All subsequent liens on such property
generally are subordinated to such an environmental lien and, in some states,
even prior recorded liens are subordinated to environmental liens.

-38-

THE COMPANY IS THE SUBJECT OF CLASS ACTION LAWSUITS THAT, IF DECIDED AGAINST IT,
COULD HAVE A NEGATIVE EFFECT ON ITS FINANCIAL CONDITION, RESULTS OF OPERATIONS
AND FUTURE PROSPECTS.

In March 2002, the Company, Steven W. Logan and John L. Hendrix,
were named as defendants in two lawsuits styled GRAYDON WILLIAMS, ON BEHALF
OF HIMSELF AND ALL OTHERS SIMILARLY SITUATED V. CORNELL COMPANIES, INC, ET
AL., No. H-02-0866, in the United States District Court for the Southern
District of Texas, Houston Division, and RICHARD PICARD, ON BEHALF OF HIMSELF
AND ALL OTHERS SIMILARLY SITUATED V. CORNELL COMPANIES, INC., ET AL., No.
H-02-1075, in the United States District Court for the Southern District of
Texas, Houston Division. The aforementioned lawsuits are putative class
action lawsuits brought on behalf of all purchasers of the Company's common
stock between March 6, 2001 and March 5, 2002. The lawsuits involve
disclosures made concerning two prior transactions executed by the Company:
the 2001 Sale and Leaseback Transaction and the 2000 synthetic lease
transaction. The plaintiffs allege that the defendants violated Section 10(b)
of the Exchange Act, Rule 10b-5 promulgated under Section 10(b) of the
Exchange Act, and/or Section 20(a) of the Exchange Act. The Company believes
that it has good defenses to each of the plaintiffs' claims and intends to
vigorously defend against each of the claims.

Also in March 2002, the Company, its directors, and its independent
auditor Arthur Andersen LLP, were sued in a derivative action styled as WILLIAM
WILLIAMS DERIVATIVELY AND ON BEHALF OF NOMINAL DEFENDANT CORNELL COMPANIES, INC.
V. ANTHONY R. CHASE, ET AL., No. 2002-15614, in the 127th Judicial District
Court of Harris County, Texas. The lawsuit alleges breaches of fiduciary duty by
all of the individual defendants and asserts breach of contract and professional
negligence claims only against Arthur Andersen LLP. The Company believes that it
has good defenses to each of the plaintiff's claims and intends to vigorously
defend against each of the claims.

While the plaintiffs in these cases have not quantified their claim
of damages and the outcome of the matters discussed above cannot be predicted
with certainty, based on information known to date, management believes that
the ultimate resolution of these matters will not have a material adverse
effect on the Company's financial position, operating results or cash flow.

Certain insurance policies held by the Company to cover potential
director and officer liability may limit the Company's cash outflows in the
event of a decision adverse to the Company in the matters discussed above.
However, if an adverse decision in these matters exceeds the insurance
coverage or if the insurance coverage is deemed not to apply to these
matters, an adverse decision to the Company in this matter could have a
material adverse effect on the Company, its financial position, its operating
results or cash flow.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

In the normal course of business, the Company is exposed to market
risk, primarily from changes in interest rates. The Company continually monitors
exposure to market risk and develops appropriate strategies to manage this risk.
The Company is not exposed to any other significant market risks, including
commodity price risk, foreign currency exchange risk or interest rate risks from
the use of derivative financial instruments. Management does not use derivative
financial instruments for trading or to speculate on changes in interest rates
or commodity prices.

INTEREST RATE EXPOSURE

The Company's exposure to changes in interest rates primarily results
from its long-term debt with both fixed and floating interest rates. The debt on
the Company's consolidated financial statements with fixed interest rates
consists of the 8.47% Bonds issued by MCF in August 2001 in connection with the
2001

-39-

Sale and Leaseback Transaction. At December 31, 2001, approximately 19.6%
($48.2 million of debt outstanding to the Synthetic Lease Investor) of the
Company's consolidated long-term debt was subject to variable interest rates.
The detrimental effect of a hypothetical 100 basis point increase in interest
rates would be to reduce income before provision for income taxes by
approximately $720,000 for the year ended December 31, 2001. At December 31,
2001, the fair value of the Company's consolidated fixed rate debt approximated
carrying value based upon discounted future cash flows using current market
prices.

-40-

REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To the Board of Directors of
Cornell Companies, Inc.:

We have audited the accompanying consolidated balance sheets of Cornell
Companies, Inc. and subsidiaries as of December 31, 2001 and 2000 (as restated,
see Notes 2 and 13), and the related consolidated statements of operations,
stockholders' equity and cash flows for each of the three years in the period
ended December 31, 2001. These financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.

We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.

In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of Cornell Companies,
Inc. and subsidiaries as of December 31, 2001 and 2000, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2001, in conformity with accounting principles generally accepted
in the United States.

ARTHUR ANDERSEN LLP

Houston, Texas
April 16, 2002

-41-

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

CORNELL COMPANIES, INC.
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)

The accompanying notes are an integral part of these consolidated
financial statements.

-42-

CORNELL COMPANIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)

The accompanying notes are an integral part of these consolidated
financial statements.

-43-

CORNELL COMPANIES, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS, EXCEPT SHARE DATA)

The accompanying notes are an integral part of these consolidated
financial statements.

-44-

CORNELL COMPANIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)

The accompanying notes are an integral part of these consolidated
financial statements.

-45-

CORNELL COMPANIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. DESCRIPTION OF THE BUSINESS

Cornell Companies, Inc. (collectively with its subsidiaries and
consolidated special purpose entities, the "Company"), a Delaware corporation,
provides to governmental agencies the integrated development, design,
construction and management of facilities within three operating divisions: (1)
adult secure institutional, correctional and detention services, (2) juvenile
treatment, educational and detention services and (3) pre-release correctional
and treatment services.

2. RESTATEMENT OF FINANCIAL STATEMENTS

The Company's lease financing arrangement under its 2000 Credit
Facility is a "synthetic lease". A synthetic lease is a form of lease financing
that qualifies for operating lease accounting treatment and, when all criteria
pursuant to generally accepted accounting principles (GAAP) are met, is kept
"off-balance sheet". Under such a structure, the owner/lessor of the properties
("Synthetic Lease Investor") could be considered as a virtual special purpose
entity when it obtains debt and equity capital to finance the acquisition or
construction of project(s) and leases the projects to a company. This financial
structure was used to finance the construction of the New Morgan Academy
completed in the first quarter of 2001, the acquisition of the Taylor Street
Center building in early 1999, and the construction-to-date of the Moshannon
Valley Correctional Center. The synthetic lease used to finance the above
projects was executed in December 1998 and was amended in July 2000 whereby the
available financing was increased from $40 million to $100 million and the lease
term extended to July 2005.

Under current accounting rules, a Synthetic Lease Investor in a
synthetic lease treated as a special purpose entity must maintain at least a 3%
equity ownership interest in the property throughout the life of the lease. The
Company's synthetic lease documents, as amended in July 2000, provide for the
equity investor to fund 3.5% of project costs. There are provisions in the lease
and related credit documents for the lenders and Synthetic Lease Investor to
fund and be paid interest, yield and fees. Under current GAAP rules, the payment
of any yield and fees to the investors is required to be treated as a return of
capital rather than a return on capital.

The Synthetic Lease Investor for the above projects received certain
customary payments to assist as co-arranger in the structure of the initial $40
million synthetic lease facility in 1998 and in July 2000 when the synthetic
lease facility was increased to $100 million. Although the Company does not
believe the lessor is a special purpose entity, the lessor is considered as a
"virtual" special purpose entity under certain accounting interpretations.
Therefore, these payments could be interpreted to reduce the Synthetic Lease
Investor's equity ownership in the leased projects below the required 3% level
as of the second quarter of 2000. If this were the case, these synthetic leases
no longer qualified for off-balance sheet treatment beginning in the second
quarter of 2000. Accordingly, the assets and liabilities and results of
operations of the synthetic lease owned by the Synthetic Lease Investor are
consolidated in the Company's financial statements. See Note 13.

As a result of consolidating the synthetic lease assets and
liabilities, the Company's accompanying consolidated financial statements
reflect, among other things, the depreciation expense on the associated
properties and interest expense related to the Synthetic Lease Investor's debt,
instead of rent expense.

-46-

The Company's 2000 consolidated financial statements have been restated
as follows to reflect the consolidation of the synthetic lease (in thousands,
except per share data):

On August 14, 2001, the Company completed an arms' length sale and
leaseback transaction involving 11 of its real estate facilities (the "2001 Sale
and Leaseback Transaction"). The Company sold the facilities to an unaffiliated
company, Municipal Corrections Finance, L.P. ("MCF"), and is leasing them back
for an initial period of 20 years, with approximately 25 years of additional
renewal period options. The Company received $173.0 million of proceeds from the
sale of the facilities. The proceeds were used to repay $120.0 million of the
Company's long-term debt and the remainder invested in short-term securities.

MCF is an unaffiliated special purpose entity ("SPE"). Under current
accounting rules, a SPE must maintain at least a 3% equity ownership interest
throughout the life of the lease. In September 2001, the Company entered into
a separate retainer agreement, as amended, with affiliates of the equity
investor in MCF ("MCF Equity Investor"), and in November 2001, paid the
related retainer fee of $3.65 million for financial advisory services related
to specific separate potential future financing projects and the strategic
development of the Company's business. The retainer will be applied on a
mutually agreed upon basis toward future contingent fees associated with
investment banking services that are expected to be provided to the Company.
Under certain accounting interpretations, this retainer has been deemed to
reduce the equity investment in MCF to below the required 3% level. In view
of anticipated changes in accounting rules, the market and the regulatory
environment currently existing, and a desire to reach a final resolution of
this matter as quickly as possible, the Company has consolidated the assets,
liabilities, and results of operations of MCF in the Company's accompanying
consolidated financial statements beginning August 14, 2001. As a result

-47-

of consolidating the assets and liabilities of MCF, the Company's consolidated
financial statements reflect, among other things, the depreciation expense on
the associated properties and interest expense on the bond debt of MCF used to
finance MCF's acquisition of the 11 facilities in the 2001 Sale and Leaseback
Transaction. For income tax purposes, the Company recognizes rent expense
pursuant to the terms of its lease with MCF and does not consolidate the assets,
liabilities or results of operations of MCF.

All applicable amounts relating to the aforementioned restatements have
been reflected in the consolidated financial statements and notes thereto. See
Note 14 for a summary of the restated selected quarterly financial data.

3. SIGNIFICANT ACCOUNTING POLICIES

CONSOLIDATION

The accompanying consolidated financial statements include the accounts
of the Company, its wholly-owned subsidiaries, and interests in partnerships
which are special purpose entities or may be "virtual" special purpose entities
for which the Company owns no partnership interest, but for financial reporting
purposes only, has consolidated such special purpose entities as discussed in
Note 2. All significant intercompany balances and transactions have been
eliminated. Minority interest in consolidated special purpose entities
represents third party equity contributed to the special purpose entities.
Minority interest is adjusted for income and losses allocable to the owners of
the special purpose entities. Should the cumulative losses of the special
purpose entity exceed the equity which is recorded as minority interest by the
Company, the excess losses are recorded in the Company's Statement of
Operations.

CASH AND CASH EQUIVALENTS

The Company considers all highly liquid unrestricted investments with
original maturities of three months or less to be cash equivalents. The Company
invests its available cash balances in short term money market amounts and
commercial paper.

ACCOUNTS RECEIVABLE

The Company increased its allowance for doubtful accounts during the
years ended December 31, 2001, 2000 and 1999 by $1.3 million, $2.4 million and
$1.0 million, respectively. Write-offs totaling $0.9 million, $2.8 million and
$1.2 million were charged against the allowance during the periods ended
December 31, 2001, 2000 and 1999, respectively.

At December 31, 2001, accounts receivable include costs totaling $1.4
million for direct costs incurred by the Company since the issuance of a
Stop-Work Order by the Federal Bureau of Prisons ("FBOP") in June 1999 for
payroll and other operating costs related to the Moshannon Valley Correctional
Center. These costs were incurred at the direction of the FBOP with the
understanding that such costs would be reimbursed. Although no formal written
agreement exists, management believes that these costs will be reimbursed by the
FBOP. In the event any portion of these costs are not reimbursed by the FBOP,
such costs will be expensed if they are determined not to be reimbursable.

RESTRICTED ASSETS

Included in restricted assets at December 31, 2001 was approximately
$10.2 million of MCF's restricted cash accounts. MCF's restricted accounts are
comprised principally of a debt service fund used to segregate rental payment
funds from the Company to MCF for MCF's semi-annual debt service. MCF's funds
are

-48-

invested in short term certificates of deposit, money market accounts and
commercial paper.

For certain facilities, the Company maintains bank accounts for
restricted cash belonging to offenders or residents, commissary operations, an
equipment replacement fund used in state programs and a restoration fund for
certain facilities. These bank accounts and commissary inventories are
collectively referred to as restricted assets and the corresponding obligations
are included in accrued liabilities in the accompanying financial statements.

CHANGE IN ACCOUNTING FOR SUPPLIES INVENTORY

In fiscal year 2001, management changed its method of accounting for
supplies whereby the Company capitalizes durable operating supplies' purchases
such as uniforms, linens and books and amortizes these costs to operating
expense over an estimated period of benefit of 18 months. Management believes
this new treatment more accurately matches expenses and revenue. Effective
January 1, 2001, the Company capitalized a portion of previously expensed
supplies and recognized a benefit in the consolidated statements of operations
of approximately $770,000 (net of related income taxes of $535,000) for a
cumulative effect of a change in accounting principle. For the year ended
December 31, 2000, the pro forma impact of this change in accounting would have
been immaterial.

PROPERTY AND EQUIPMENT

Property and equipment are recorded at cost. Ordinary maintenance and
repair costs are expensed, while renewal and betterment costs are capitalized.
Prepaid facility use cost, which resulted from the July 1996 acquisition of the
Big Spring Complex and the December 1999 transfer of ownership of the Great
Plains Correctional Facility to a leasehold interest, is being amortized over 50
years using the straight-line method. Buildings and improvements are depreciated
over their estimated useful lives of 30 to 50 years using the straight-line
method. Furniture and equipment are depreciated over their estimated useful
lives of 3 to 10 years using the straight-line method. Amortization of leasehold
improvements is recorded using the straight-line method based upon the shorter
of the life of the asset or the term of the respective lease.

CAPITALIZED INTEREST

The Company capitalizes interest on facilities while under development
and construction. Interest capitalized for the years ended December 31, 2001,
2000 and 1999 was $1.3 million, $2.0 million and $1.2 million, respectively.

DEBT SERVICE RESERVE FUND

The debt service reserve fund was established at the closing of MCF's
bond issuance and is to be used solely for MCF's debt service to the extent that
funds in MCF's debt services are insufficient. The debt service reserve fund is
invested in short term commercial instruments and earns a guaranteed rate of
return of 3.0%. See Note 11.

INTANGIBLE ASSETS

Goodwill represents the excess of the cost of acquired businesses over
the fair value of the net tangible and identified intangible assets. Goodwill is
amortized using the straight-line method over 20 years, which represents
management's estimation of the related benefit to be derived from the acquired
businesses. The carrying value of goodwill is reviewed periodically if events
and circumstances suggest that it may be permanently impaired. If the review
indicates that goodwill will not be recoverable, as determined by the

-49-

undiscounted cash flow method, the asset will be reduced to its estimated
recoverable value. Accumulated amortization of goodwill was $3.6 million and
$2.9 million as of December 31, 2001 and 2000, respectively.

Non-compete agreements have been obtained primarily through
acquisitions of businesses and are amortized over periods of 9 to 10 years using
the straight-line method. Accumulated amortization of non-compete agreements was
$2.0 million and $1.2 million at December 31, 2001 and 2000, respectively.

Intangible assets were as follows (in thousands):

In June 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 141, "Business
Combinations" and SFAS No. 142, "Goodwill and Other Intangible Assets",
effective for fiscal years beginning after December 15, 2001. The new rules
require that the purchase method of accounting be used for all business
combinations initiated after June 30, 2001 and also specifies the criteria for
the recognition of intangible assets separately from goodwill. Under the new
rules, goodwill will no longer be amortized but will be subject to an impairment
test at least annually. During the years ended December 31, 2001, 2000 and 1999,
goodwill amortization was $646,000, $650,000 and $566,000, respectively. Other
intangible assets that meet the new criteria will continue to be amortized over
their useful lives. The Company will apply the new rules on accounting for
goodwill and other intangible assets on January 1, 2002. Other than goodwill no
longer being amortized, management estimates the adoption of SFAS No. 141 will
have no impact on the Company at transition.

Based upon preliminary calculations, management estimates that the
adoption of SFAS No. 142 will result in a cumulative effect of change in
accounting principle charge of up to approximately $1.0 million (unaudited),
net of tax, on January 1, 2002.

DEFERRED COSTS

In April 1998, the American Institute of Certified Public Accountants
issued SOP 98-5, "Reporting on the Costs of Start-Up Activities," which requires
entities to expense start-up costs as incurred and to expense previously
capitalized start-up costs as a cumulative effect of a change in accounting
principle in the year adopted. In January 1999, the Company adopted SOP 98-5 and
recorded a net of tax charge of $3.0 million for the cumulative effect of a
change in accounting principle.

Costs incurred related to obtaining debt financing are capitalized and
amortized over the term of the related indebtedness. At December 31, 2001, the
Company and its consolidated special purpose entities had net deferred debt
issuance costs of approximately $9.4 million.

REALIZATION OF LONG-LIVED ASSETS

SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and
Long-Lived Assets to be Disposed Of, " requires that long-lived assets be
probable of future recovery in their respective carrying amounts as of each
balance sheet date. Management of the Company believes its long-lived assets are

-50-

realizable and that an impairment allowance is not necessary as of December 31,
2001 and 2000 pursuant to the provisions of SFAS No. 121.

In October 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." SFAS No. 144 supersedes SFAS No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of." For assets held and used in operations, SFAS No. 144
follows the framework established in SFAS No. 121, which provides for the
evaluation of impairment based on undiscounted cash flows. The Company's
adoption of SFAS No. 144 on January 1, 2002 is not expected to have a material
impact on the Company's financial position and results of operations.

REVENUE RECOGNITION

Substantially all revenues are derived from contracts with federal,
state and local government agencies, which pay either per diem rates based upon
the number of occupant days or hours served for the period, on a take-or-pay
basis or cost-plus reimbursement. Revenues are recognized as services are
provided.

In December 1999, the Securities and Exchange Commission ("SEC") issued
Staff Accounting Bulletin No. 101, "Revenue Recognition" ("SAB No. 101"), which
provides guidance on the recognition, presentation, and disclosure of revenue in
financial statements filed with the SEC. SAB No. 101 outlines the basic criteria
that must be met to recognize revenue and provides guidance for disclosure
related to revenue recognition policies. Management believes its revenue
recognition practices are in conformity with the guidelines prescribed in SAB
No. 101.

INCOME TAXES

The Company utilizes the liability method of accounting for income
taxes as required by SFAS No. 109, "Accounting for Income Taxes." Under this
method, deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying values of existing assets and liabilities and their respective tax
bases based on enacted tax rates.

USE OF ESTIMATES

The Company's financial statements are prepared in accordance with
GAAP. Financial statements prepared in accordance with GAAP require the use of
management estimates and assumptions that affect the reported amounts of assets
and liabilities, and the disclosure of contingent assets and liabilities at the
date of the financial statements. Additionally, management estimates affect the
reported amounts of revenues and expenses in the reporting period. Actual
results could differ from those estimates. The significant estimates made by
management in the accompanying financial statements include the allowance for
doubtful accounts and accruals for insurance and legal costs.

BUSINESS CONCENTRATION

Contracts with federal, state and local governmental agencies account
for nearly all of the Company's revenues. The loss of, or a significant decrease
in, business from one or more of these governmental agencies could have a
material adverse effect on the Company's financial condition and results of
operation. For the years ended December 31, 2001, 2000 and 1999, 21.0%, 18.5%
and 19.8%, respectively, of the Company's consolidated revenues were derived
from contracts with the FBOP.

-51-

FINANCIAL INSTRUMENTS

The Company considers the fair value of all its financial instruments
not to be materially different from their reported carrying values at the end of
each year based on management's estimate of the Company's ability to borrow
funds under terms and conditions similar to those of the Company's existing
debt.

ACCOUNTING FOR STOCK-BASED COMPENSATION

The Company accounts for its stock-based compensation plans under
Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees." In accordance with SFAS No. 123, "Accounting for Stock-Based
Compensation," certain pro forma disclosures are provided in Note 10 to the
Consolidated Financial Statements. Accordingly, deferred compensation is
recorded for stock-based compensation grants to employees based on the excess of
the estimated fair value of the common stock on the measurement date over the
exercise price. If the exercise price of the stock-based compensation grant is
equal to the fair market value of the Company's stock on the date of grant, no
compensation expense is recorded. The deferred compensation is amortized over
the vesting period of each unit of stock-based compensation.

EARNINGS PER SHARE

Basic earnings per share ("EPS") is computed by dividing net income by
the weighted average number of shares of common stock outstanding during the
year. Diluted EPS reflects the potential dilution from the exercise or
conversion of securities, such as stock options and warrants, into common stock.

DERIVATIVE INSTRUMENTS

Derivative instruments are recognized in accordance with the provisions
of SFAS Nos. 133 and 138, "Accounting for Derivative Instruments and Hedging
Activities", as amended. The Company has only entered into derivative contracts
that are classified as non-hedge derivatives. These non-hedge are recorded at
their fair value with changes in fair value reported in current-period earnings.

4. ACQUISITIONS

In November 1999, the Company acquired certain of the adult and
juvenile behavioral health and correctional assets of Interventions, a
not-for-profit corporation headquartered in Chicago, Illinois, and BHS
Consulting Corporation ("BHS"), a for-profit firm that provides management
services to Interventions. The assets acquired included more than 30 programs
provided throughout Illinois and the real properties of seven facilities. The
aggregate purchase price for the transactions was approximately $31.8 million
including transaction costs. The Company financed the transaction with
borrowings under a bridge loan. See Note 8 to the Consolidated Financial
Statements.

The acquisition costs and the estimated fair market value of the
aggregate assets acquired and liabilities assumed associated with the
Interventions and BHS acquisitions were as follows (in thousands):

Cash paid....................................... $ 30,889
Transaction costs............................... 897
---------
Total purchase price........................ $ 31,786
=========
Net assets acquired --
Prepaids and other current assets............. $ 69
Property and equipment........................ 23,883
Intangible assets............................. 8,735
Accrued liabilities........................... (901)
---------
$ 31,786
=========

-52-

The Company's acquisitions have been accounted for as purchases;
therefore, the accompanying statements of operations reflect the results of
operations since the respective acquisition dates.

The unaudited consolidated results of operations on a pro forma basis
as though the 1999 acquisitions had occurred as of the beginning of the
Company's fiscal year 1999 were as follows (in thousands, except per share
data):

Total revenues.................................. $ 195,945
Net income...................................... 3,237
Net earnings per share
- Basic....................................... $ .34
- Diluted..................................... $ .34

5. PROPERTY AND EQUIPMENT

Property and equipment were as follows (in thousands):

Construction in progress at December 31, 2001 and 2000, consisted
primarily of construction costs attributable to the Moshannon Valley
Correctional Center. Construction in progress at December 31, 2000 included a
portion of costs for the New Morgan Academy that was partially completed.

The Company utilizes an unrelated privately owned construction company
("Construction Contractor") as its preferred contractor for construction
projects. The Construction Contractor has received contracts to construct
facilities, which the Company owns and/or operates, totaling approximately $0
million, $3.5 million and $68.5 million during the years ended December 31,
2001, 2000 and 1999, respectively. Management believes the Company is a
substantial customer of the Construction Contractor. During the fourth quarter
of 2000, the Company entered into a license agreement with this construction
contractor that conveyed certain rights to the design of an adult secure
institution. A non-recurring license agreement payment of $950,000 was
recognized as revenue by the Company. The Company has not licensed such designs
in prior years and does not expect to generate significant revenues from such
activity in future periods. During the year ended December 31, 1999, this
Construction Contractor paid the Company $1.0 million related to a cost-sharing
agreement in connection with the operations of the Santa Fe County Adult
Detention Facility because the operating margins had not reached certain levels
until June 1999. These cost-sharing payments were reported by the Company as a
reduction of operating expenses. The Construction Contractor has no obligation
to make any further cost-sharing payments.

-53-

6. ACCOUNTS PAYABLE AND ACCRUED LIABILITIES

Accounts payable and accrued liabilities consisted of the following (in
thousands):

7. INCOME TAXES

The following is an analysis of the Company's deferred tax assets and
liabilities (in thousands):

The components of the Company's income tax provision were as follows
(in thousands):

-54-

The following is a reconciliation of taxes at the statutory federal income tax
rate of 35% to the income tax provision recorded by the Company (in thousands):

8. CREDIT FACILITIES

The Company's long-term debt consisted of the following (in thousands):

On August 14, 2001, the Company repaid $70.0 million outstanding under
its revolving line of credit with a portion of the proceeds from the 2001 Sale
and Leaseback Transaction. In connection with the repayment, the Company amended
its 2000 Credit Facility, which now provides for borrowings of up to $45.0
million under a revolving line of credit. The commitment amount is reduced by
$1.6 million quarterly beginning in July 2002. The amended 2000 Credit Facility
matures in July 2005 and bears interest, at the election of the Company, at
either the prime rate plus a margin of 2.0%, or a rate which is 3.0% above the
applicable LIBOR rate. The amended 2000 Credit Facility is secured by
substantially all of the Company's

-55-

assets, including the stock of all of the Company's subsidiaries; does not
permit the payment of cash dividends; and requires the Company to comply with
certain leverage, net worth and debt service coverage covenants. Due to the
consolidation for financial reporting purposes of MCF as of August 14, 2001, the
Company was not in compliance with certain leverage ratio covenants. On April 5,
2002, the 2000 Credit Facility was amended to waive such non-compliance and to
revise the covenants to levels that accommodate the Company's consolidation of
special purpose entities in its consolidated balance sheet and statement of
operations. As a result of this waiver and amendment, the Company will recognize
a pre-tax charge to interest expense of approximately $800,000 during the first
quarter of 2002 for lender fees and other professional fees. On April 11, 2002,
the Company obtained a waiver from the lenders under the 2000 Credit Facility
regarding the pending contractual default for the Moshannon Valley Correctional
Center's construction delay.

As a result of the reduction of the revolving line of credit
commitment, the Company recognized a charge of $818,000 to interest expense
representing a portion of the unamortized deferred debt issuance costs related
to the 2000 Credit Facility.

Additionally, the amended 2000 Credit Facility provides the Company
with the ability to enter into synthetic lease agreements for the acquisition or
development of operating facilities. This synthetic lease financing arrangement
provides for funding to the lessor under the operating leases of up to $100.0
million, of which approximately $49.9 million had been utilized as of December
31, 2001. The Company expects to utilize the remaining capacity under this
synthetic lease financing arrangement to complete construction of the Moshannon
Valley Correctional Center. The Synthetic Lease Investor's Note A and Note B
have total credit commitments of $81.4 million and $15.1 million, respectively.
The Company pays commitment fees at a rate of 0.5% annually for the unused
portion of the synthetic lease financing capacity. The Synthetic Lease
Investor's Notes A and B are cross collateralized with the Company's revolving
line of credit and contain cross default provisions.

On August 14, 2001, MCF issued $197.4 million of 8.47% taxable revenue
bonds due August 1, 2016. Interest on the bonds is payable by MCF semiannually
on February 1 and August 1, commencing February 1, 2002, and principal is
payable by MCF in annual installments commencing August 1, 2002.

On August 14, 2001, the Company repaid the $50.0 million of outstanding
7.74% Senior Secured Notes with a portion of the proceeds from the 2001 Sale and
Leaseback Transaction. See Note 2 to the consolidated financial statements.

On November 30, 2001 the Company completed an offering of its common
stock. Net proceeds to the Company from the sale of 3,450,000 newly issued
shares was approximately $43.8 million. The Company used a portion of the
proceeds to repay outstanding borrowings of $39.4 million and retired the notes
under the Company's Note and Equity Purchase Agreements (the "Subordinated
Notes") entered into in July 2000.

As a result of the early retirement of the Subordinated Notes, the
Company recognized extraordinary charges of $2.9 million, net of income tax of
$2.0 million due to the write-off of related unamortized deferred debt issuance
costs and debt discount and assessed contractual prepayment fees.

-56-

Scheduled maturities of long-term debt were as follows (in thousands):

9. COMMITMENTS AND CONTINGENCIES

OPERATING LEASES

The Company leases office space, and certain facilities and furniture
and equipment under long-term operating leases. Rent expense for all operating
leases for the years ended December 31, 2001, 2000 and 1999, was approximately
$11.4 million, $9.7 million and $5.4 million, respectively. In November 1999,
the Company entered into an agreement for the sale and leaseback of certain of
its furniture and equipment. The Company has purchase and lease renewal options
at projected future fair market values under the agreements. The leases are
classified as operating leases. At the date of sale, furniture and equipment
with carrying values totaling $11.8 million were sold and the gains realized on
the sale totaling $7.3 million were deferred and are being amortized as a credit
to rent expense over the lease term. The increase in 2000 rent expense compared
to 1999 was due principally to rent expense resulting from this sale and
leaseback transaction.

Under the 2000 Credit Facility, the Company entered into operating
lease agreements with what could be considered as a "virtual" special purpose
entity for the acquisition or development of operating facilities. This
synthetic lease financing arrangement provides for funding from the "virtual"
special purpose entity under the operating leases of up to $100.0 million, of
which approximately $49.9 million had been utilized at December 31, 2001. The
remaining capacity under this synthetic lease financing arrangement is expected
to be utilized to complete construction of the Moshannon Valley Correctional
Center. At December 31, 2001, approximately $15.0 million of this synthetic
lease financing arrangement had been utilized for construction costs for the
Moshannon Valley Correctional Center. The leases under this arrangement each
have a term of the lesser of five years or July 2005, include purchase and
renewal options, and provide for residual value guarantees for each lease which
average 81.4% of the total cost and would be due by the Company upon termination
of the leases. Upon termination of a lease, the Company could either exercise a
purchase option, or the facilities could be sold to a third party. The Company
expects the fair market value of the leased facilities to substantially reduce
or eliminate the Company's potential obligation under the residual value
guarantee. At December 31, 2001, there were two operating leases under this
arrangement. Lease payments under the lease financing arrangements are variable
and are adjusted for changes in interest rates.

Because the long-term debt of the "virtual" special purpose entity
related to the lease agreements described above and of MCF is consolidated in
the Company's Financial Statements as described in Note 2 and 8 to the
Consolidated Financial Statements, the related rental commitments under these
leases are not included in the following table.

-57-

As of December 31, 2001, the Company had the following rental
commitments under noncancelable operating leases (in thousands):

For the year ending December 31,
2002......................................... $ 8,176,801
2003......................................... 6,277,625
2004......................................... 1,975,537
2005......................................... 1,384,310
2006......................................... 753,516
Thereafter................................... 11,408,508
-------------
Total...................................... $ 29,976,297
=============

401(k) PLAN

The Company has a defined contribution 401(k) plan. The Company's
matching contribution currently represents 50% of a participant's contribution,
up to the first 6% of the participant's salary. For the years ended December 31,
2001, 2000 and 1999, the Company recorded $1.1 million, $923,000 and $754,000,
respectively, of contribution expense.

LEGAL PROCEEDINGS

In March 2002, the Company, Steven W. Logan and John L. Hendrix, were
named as defendants in two lawsuits styled GRAYDON WILLIAMS, ON BEHALF OF
HIMSELF AND ALL OTHERS SIMILARLY SITUATED V. CORNELL COMPANIES, INC, ET AL., No.
H-02-0866, in the United States District Court for the Southern District of
Texas, Houston Division, and RICHARD PICARD, ON BEHALF OF HIMSELF AND ALL OTHERS
SIMILARLY SITUATED V. CORNELL COMPANIES, INC., ET AL., No. H-02-1075, in the
United States District Court for the Southern District of Texas, Houston
Division. The aforementioned lawsuits are putative class action lawsuits brought
on behalf of all purchasers of the Company's common stock between March 6, 2001
and March 5, 2002. The lawsuits involve disclosures made concerning two prior
transactions executed by the Company: the 2001 Sale and Leaseback Transaction
and the 2000 synthetic lease transaction. The plaintiffs allege that the
defendants violated Section 10(b) of the Securities Exchange Act of 1934 (the
"Exchange Act"), Rule 10b-5 promulgated under Section 10(b) of the Exchange Act,
and/or Section 20(a) of the Exchange Act. The Company believes that it has good
defenses to each of the plaintiffs' claims and intends to vigorously defend
against each of the claims.

Also in March 2002, the Company, its directors, and its independent
auditor Arthur Andersen, were sued in a derivative action styled as WILLIAM
WILLIAMS DERIVATIVELY AND ON BEHALF OF NOMINAL DEFENDANT CORNELL COMPANIES, INC.
V. ANTHONY R. CHASE, ET AL., No. 2002-15614, in the 127th Judicial District
Court of Harris County, Texas. The lawsuit alleges breaches of fiduciary duty by
all of the individual defendants and asserts breach of contract and professional
negligence claims only against Arthur Andersen. The Company believes that it has
good defenses to each of the plaintiff's claims and intends to vigorously defend
against each of the claims.

While the plaintiffs in these cases have not quantified their claim of
damages and the outcome of the matters discussed above cannot be predicted with
certainty, based on information known to date, management believes that the
ultimate resolution of these matters will not have a material adverse effect on
the Company's financial position, operating results or cash flow.

The Company currently and from time to time is subject to claims and
suits arising in the ordinary course of business, including claims for damages
for personal injuries or for wrongful restriction of, or interference with,
offender privileges and employment matters.

-58-

10. STOCKHOLDERS' EQUITY

COMMON STOCK OFFERING

On November 30, 2001, the Company completed an offering of its Common
Stock. Net proceeds to the Company from the sale of the 3,450,000 shares of
newly issued Common Stock were approximately $43.8 million. Proceeds from the
offering were used to repay indebtedness of $39.4 million and retired the notes
under the Note and Equity Purchase Agreement dated July 21, 2000 with the
remainder for general working capital purposes.

STOCKHOLDER RIGHTS PLAN

On May 1, 1998, the Company adopted a stockholder rights plan. Under
the plan, each stockholder of record at the close of the business day on May 11,
1998, received one Preferred Stock Purchase Right ("Right") for each share of
common stock held. The Rights expire on May 1, 2008. Each Right initially
entitles the stockholder to purchase one one-thousandth of a Series A Junior
Participating Preferred Share for $120.00. Each Preferred Share has terms
designed to make it economically equivalent to one thousand common shares. The
Rights will become exercisable only in the event a person or group acquires 15%
or more of the Company's common stock or commences a tender or exchange offer
which, if consummated, would result in that person or group owning 15% or more
of the Company's common stock. If a person or group acquires a 15% or more
position in the Company, each Right (except those held by the acquiring party)
will then entitle its holder to purchase, at the exercise price, common stock of
the Company having a value of twice the exercise price. The effect will be to
entitle the holder to buy the common stock at 50% of the market price. Also, if
following an acquisition of 15% or more of the Company's common stock, the
Company is acquired by that person or group in a merger or other business
combination transaction, each Right would then entitle its holder to purchase
common stock of the acquiring company having a value of twice the exercise
price. The effect will be to entitle the Company's stockholders to buy stock in
the acquiring company at 50% of the market price. The Company may redeem the
Rights at $0.01 per Right at any time prior to the acquisition of 15% or more of
its common stock by a person or group.

PREFERRED STOCK

Preferred stock may be issued from time to time by the Board of
Directors of the Company, which is responsible for determining the voting,
dividend, redemption, conversion and liquidation features of any preferred
stock.

OPTIONS

In December 2000, the Company adopted the 2000 Broad-Based Employee
Plan ("2000 Plan"). Pursuant to the 2000 Plan, the Company may grant
non-qualified stock options for up to the greater of 515,232 shares or 4% of the
aggregate number of shares of common stock outstanding. The 2000 Plan options
vest up to five years and expire ten years from the grant date. In May 1996, the
Company adopted the 1996 Stock Option Plan and amended and restated the plan in
April 1998 ("1996 Plan"). Pursuant to the 1996 Plan, the Company may grant
non-qualified and incentive stock options for up to the greater of 1,932,119
shares or 15% of the aggregate number of shares of common stock outstanding. The
1996 Plan options vest up to seven years and expire seven to ten years from the
grant date. The Compensation Committee of the Board of Directors, which is
comprised of independent directors, is responsible for determining the exercise
price and vesting terms for the granted options. The 1996 Plan and 2000 Plan
option exercise prices can be no less than the market price of the Company's
common stock on the date of grant.

-59-

In conjunction with the issuance of the Subordinated Notes in July
2000, the Company issued warrants to purchase 290,370 shares of the common stock
at an exercise price of $6.70. The Company recognized the fair value of these
warrants of $1.1 million as additional paid-in capital. The warrants may only be
exercised by payment of the exercise price in cash to the Company, by
cancellation of an amount of warrants equal to the fair market value of the
exercise price, or by the cancellation of Company indebtedness owed to the
warrant holder. During 2001, 168,292 shares of Common Stock were issued in
conjunction with the exercise and cancellation of 217,778 warrants.

The following is a summary of the status of the Company's 2000 Plan,
1996 Plan and other options at December 31, 2001, 2000 and 1999, and changes
during the years then ended:

The following table summarizes information about stock options
outstanding at December 31, 2001:

-60-

Had compensation cost for the stock option grants under the 2000 Plan,
the 1996 Plan and other stock options been determined under SFAS No. 123, the
Company's net income and diluted net earnings per share would have been the
following (in thousands, except per share amounts):

Under SFAS No. 123, the fair value of each option grant was estimated
on the date of grant using the minimum value calculation prior to the Company's
initial public offering ("IPO") and the Black-Scholes option pricing model
subsequent to the IPO. The following weighted average assumptions were used for
grants in 2001, 2000 and 1999, respectively: risk-free interest rates of 5.0%,
5.4% and 6.6%; dividend rates of $0, $0 and $0; expected lives of 10.0, 6.6 and
10.0 years; expected volatility of 53.35%, 52.76% and 65.74%.

The Black-Scholes option pricing model and other existing models were
developed for use in estimating the fair value of traded options that have no
vesting restrictions and are fully transferrable. In addition, option valuation
models require the input of, and are highly sensitive to, subjective assumptions
including the expected stock price volatility. The Company's employee stock
options have characteristics significantly different from those of traded
options, and changes in the subjective input assumptions can materially affect
the fair value estimate.

NOTES FROM SHAREHOLDERS

On July 8, 1996, the prior Chief Executive Officer and the current
Chief Executive Officer of the Company exercised options to purchase an
aggregate 137,110 and 82,750 shares of Class A Common Stock and Class B Common
Stock at an aggregate price of $274,220 and $180,638, respectively. In
connection with the exercise, each officer entered into a promissory note with
the Company for the respective aggregate exercise amounts. The promissory notes,
as amended in July 2000, bear interest at an annual rate of 6.63%, mature in
June 2004, are full recourse and are collateralized by shares of the Company's
common stock.

TREASURY STOCK

During the years ended December 31, 2001 and 2000, the Company
repurchased 90,900 and 258,400 shares, respectively, of common stock for cash on
the open market under a share repurchase program at an aggregate cost of $1.1
million and $1.9 million, respectively.

EMPLOYEE STOCK PURCHASE PLAN

Effective as of January 1, 2000, the Company has an employee stock
purchase plan whereby employees can make contributions to purchase the Company's
common stock. Purchases of common stock are made annually at the lower of the
beginning or end of year market value, less a 15% discount. For the years ended
December 31, 2001 and 2000, contributions of approximately $214,000 and $97,000
were used to purchase 46,767 and 13,585 shares of the Company's common stock,
respectively.

-61-

DEFERRED BONUS PLAN

In the fourth quarter of 2001, the Company established a deferred bonus
plan for certain employees. Pursuant to the plan, $4,675,000 was deposited on
behalf of individual participants into a rabbi trust account, which included
$3,587,500 in cash and $1,087,500 in Company treasury stock. The treasury stock
portion of the rabbi trust is to remain as treasury stock, while the
participants may give investment directions to the trustee as to the cash
portion, subject to certain limitations. The investments of the rabbi trust
represent assets of the Company and are included in the accompanying
consolidated balance sheet based on the nature of the assets held. Amounts held
in the rabbi trust are generally distributable upon vesting.

The plan generally vests 100% upon the achievement of an aggregate
amount of monthly credits (based on a fixed monthly earnings milestone) expected
to occur at the end of five years beginning October 1, 2001. Vesting will
accelerate to 60% at the end of three years if certain earnings targets are
achieved. Based on the expected earnings period, compensation expense and the
related compensation liability for the aggregate plan value are being recognized
over five years. To the extent the vesting is extended or accelerated based on
the achievement of the financial milestones, recognition of compensation expense
will be adjusted on a prospective basis. Through December 31, 2001, the Company
expensed approximately $225,000 under the deferred bonus plan.

While periodic gains on the value of each participant's investments
held in the rabbi trust are recorded currently in income, an equal amount of
compensation expense and related compensation liability is recorded, since
participants are fully vested in such gains. Periodic losses incurred by
participants in their invested balances are recorded as incurred. Such losses in
excess of a participant's recorded compensation expense are guaranteed by the
participants with a full-recourse obligation to the Company. These guarantees
function to offset the loss on investments to the extent the obligations are not
reserved for collectibility by the Company.

Amounts held in treasury stock have been recorded at cost. An equal
amount has been established as deferred compensation and additional paid-in
capital in the accompanying statement of stockholders' equity. The balance in
deferred compensation is amortized to compensation expense over the expected
vesting period of five years.

11. DERIVATIVE FINANCIAL INSTRUMENTS

DEBT SERVICE RESERVE FUND AND DEBT SERVICE FUND

In August 2001, MCF completed a bond offering to finance the 2001 Sale
and Leaseback Transaction. In connection with the bond offering, two reserve
fund accounts were established by MCF pursuant to the terms of the indenture.
MCF's Debt Service Reserve Fund, aggregating $23.8 million, was established to
make payments on MCF's outstanding bonds in the event the Company (as lessee)
fails to make scheduled rental payments to MCF. MCF's Debt Service Fund, which
aggregated $9.5 million at December 31, 2001, is used to accumulate monthly
lease payments MCF receives from the Company until such funds are used to pay
MCF's semi-annual bond payments. Both reserve fund accounts are subject to
agreements with the MCF Equity Investor whereby guaranteed rates of return of 3%
and 5.08%, respectively, are provided for the balance in the Debt Service
Reserve Fund and the Debt Service Fund. The guaranteed rates of return are
characterized as non-hedge derivative instruments. The derivatives have an
aggregate fair value of $4.0 million, which has been recorded as a decrease to
the equity investment in MCF made by the MCF Equity Investor (MCF Minority
Interest) and as deferred income (a liability account) in the accompanying
consolidated balance sheet. Changes in the derivative instruments will be
recorded as an adjustment to deferred income.

-62-

Also in connection with MCF's bond offering, the MCF Equity Investor
provided a guarantee of the Debt Service Reserve Fund if a bankruptcy of the
Company were to occur and a trustee for the estate of the Company were to obtain
jurisdiction of the Debt Service Reserve Fund for the Company's estate. This
guarantee is characterized as a non-hedge derivative instrument. The derivative
has an estimated fair value $2.5 million, which has been recorded as an increase
to MCF Minority Interest and as a deferred asset. Changes in the derivative
instrument will be recorded as an adjustment to the deferred asset.

12. SEGMENT DISCLOSURE

The Company's three operating divisions are its reportable segments.
The adult secure institutional segment consists of the operation of secure adult
incarceration facilities. The juvenile segment consists of providing residential
treatment and educational programs and non-residential community-based programs
to juveniles between the ages of 10 and 17 who either have been adjudicated or
suffer from behavioral problems. The pre-release segment consists of providing
pre-release and halfway house programs for adult offenders who are either on
probation or serving the last three to six months of their sentences on parole
and preparing for re-entry into society at large. The accounting policies of the
Company's segments are the same as those described in the summary of significant
accounting policies in Note 3. Intangible assets are not included in each
segment's reportable assets, and the amortization of intangible assets is not
included in the determination of a segment's operating income or loss. The
Company evaluates performance based on income or loss from operations before
general and administrative expenses, incentive bonuses, amortization of
intangibles, interest and income taxes. Corporate and other assets are comprised
primarily of cash, accounts receivable, deposits, deferred costs and deferred
taxes.

-63-

The only significant noncash item reported in the respective segments'
income or loss from operations is depreciation and amortization (excluding
intangibles).

13. SUBSEQUENT EVENTS

On February 6, 2002, the Company announced that a Special Committee
of the Audit Committee of the Board of Directors had been formed to review
the accounting treatment for the 2001 Sale and Leaseback Transaction. The
Company entered into a retainer agreement with an investment bank dated
September 2001, which, as amended, provides that (1) the Company pay the
investment bank a non-refundable retainer fee of $3.65 million to provide
financial

-64-

advisory services concerning separate future financing vehicles and the
strategic development of the Company's business and (2) the retainer will be
applied on a mutually agreed upon basis toward future contingent fees associated
with investment banking services that may be provided to the Company. The review
focused on whether the retainer agreement and the payment of the fee affected
the previously reported accounting treatment for the 2001 Sale and Leaseback
Transaction.

The Special Committee, which was composed solely of independent
directors, retained independent counsel, who retained an accounting advisor,
to assist the Special Committee in its review. The Special Committee was
formed and conducted its review in response to correspondence dated January
31, 2002 and February 1, 2002 from the Company's independent auditors to its
Audit Committee regarding the 2001 Sale and Leaseback Transaction. In the
course of its review and pursuant to a third letter from the Company's
independent auditors addressed to the Company's Chairman dated February 21,
2002, the Special Committee also reviewed the accounting treatment for the
Company's 2000 synthetic lease transaction. The review of the synthetic lease
transaction focused on whether a fee was paid pursuant to an engagement
letter between the Company and two financial institutions participating in
the transaction and the impact of the fee on the previously reported
accounting treatment.

At the conclusion of its review, among other things, the Special
Committee recommended to the Board of Directors that:

o based on various considerations, the Company's financial statements for
2000 and the first three quarters of 2001 should be restated to reflect
the consolidation of the 2001 Sale and Leaseback Transaction and the
2000 synthetic lease transaction; and

o actions should be taken to strengthen further the Company's internal
controls.

Following discussions with its independent auditors and its advisors
regarding the accounting treatment of the 2001 Sale and Leaseback Transaction
and the 2000 synthetic least transaction, and in view of anticipated changes
in accounting rules, the market and regulatory environment currently existing
and a desire to reach a final resolution of these matters as quickly as
possible, the Company decided to consolidate both transactions for financial
accounting purposes for past and future periods. As a result, the Company has
restated its financial statements for 2000 and the first three quarters of
2001 to reflect the consolidation of the 2001 Sale and Leaseback Transaction
and the 2000 synthetic lease transaction.

These restatements are reflected in the selected unaudited quarterly
financial data set forth in Note 14.

On April 16, 2002, the Board of Directors amended the Company's
Bylaws. Among other things, the amendments establish an executive chairman
position, clarify specific levels of authority for members of senior
management and identify appropriate limits on such authority. Pursuant to
board action, Harry J. Phillips, Jr., the Company's Chairman, will serve as
the Executive Chairman of the Company, Steven W. Logan will serve as
President, Thomas R. Jenkins will continue to serve as the Chief Operating
Officer of the Company, and John L. Hendrix will continue to serve as the
Chief Financial Officer of the Company. The Board of Directors is considering
additional actions to strengthen further the Company's internal controls.

As a result of the Company's Special Committee review of certain
Company transactions, the restatement of the Company's 2000 and 2001 financial
statements and related matters, management expects to recognize a non-recurring
pre-tax charge of approximately $1.6 million for legal, accounting and other
professional fees for the quarter ended March 31, 2002. See Note 2.

-65-

Additionally, certain waivers and amendments to the Company's credit
agreements were obtained by the Company in connection with the restatement of
its financial statements during the first quarter of 2002. As a result of these
waivers and amendments, the Company will recognize a pre-tax charge to interest
expense of approximately $800,000 for the quarter ended March 31, 2002 for
lenders' fees and related professional fees.

-66-

14. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)

Reference is made to Notes 2 and 13 for a discussion of the Company's restated
quarterly financial data.

(1) The Company early retired $50.0 million and $39.4 million outstanding
of its Senior Secured Notes and Subordinated Notes in the third quarter
and fourth quarter of 2001, respectively, and recorded net-of-tax
charges of $479,000 in the third quarter and $2.5 million in the fourth
quarter due to the write-off of unamortized deferred debt issuance
costs related to the credit facilities. See Note 8 to the Consolidated
Financial Statements.
(2) The Company changed its method of accounting for supplies effective
January 1, 2002 and recorded a net-of-tax charge of approximately
$770,000 for the cumulative effect of a change in accounting principle.
See Note 3 to the Consolidated Financial Statements.
(3) The Company adopted SOP 98-5 in January 1999 and recorded a net-of-tax
charge of approximately $3.0 million for the cumulative effect of a
change in accounting principle.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE

None.

-67-

PART III

Items 10, 11, 12 and 13 of Part III have been omitted from this report
because the Company will file with the Securities and Exchange Commission, not
later than 120 days after the close of its fiscal year, a definitive proxy
statement or a 10-K/A. The information required by Items 10, 11, 12 and 13 of
this report, which will appear in the 10-K/A and/or the definitive proxy
statement, is incorporated by reference into Part III of this report.

-68-

PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K

(a) FINANCIAL STATEMENTS, SCHEDULES AND EXHIBITS

1. Financial statements and reports of Arthur Andersen LLP
Report of Independent Public Accountants
Consolidated Balance Sheets - December 31, 2001 and
2000
Consolidated Statements of Operations for the years
ended December 31, 2001, 2000 and 1999
Consolidated Statements of Stockholders' Equity for
the years ended December 31, 2001, 2000 and 1999
Consolidated Statements of Cash Flows for the years
ended December 31, 2001, 2000 and 1999 Notes to
Consolidated Financial Statements

2. Financial statement schedules
All schedules are omitted because they are not
applicable or because the required information is
included in the financial statements or notes
thereto.

3. Exhibits

(b) REPORTS ON FORM 8-K

The Company filed a Current Report on Form 8-K on November 30, 2001
regarding the Company's offering of 3,450,000 shares of its common
stock.

-72-

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, Registrant has duly caused this annual report to be signed
on its behalf by the undersigned, thereunto duly authorized.

CORNELL COMPANIES, INC.

Dated: April 16, 2002 By: /S/ HARRY J. PHILLIPS, JR.
--------------------------------
Harry J. Phillips, Jr.
Executive Chairman, Chairman of
the Board and Director

SIGNATURE TITLE DATE
- --------- ----- ----

/S/ HARRY J. PHILLIPS, JR. Executive Chairman, Chairman of April 16, 2002
- ----------------------------------
Harry J. Phillips, Jr. the Board and Director
(Principal Executive Officer)

/S/ JOHN L. HENDRIX Senior Vice President and April 16, 2002
- ------------------------------------
John L. Hendrix Chief Financial Officer
(Principal Financial Officer and
Principal Accounting Officer)

/S/ ANTHONY R. CHASE Director April 16, 2002
- ---------------------------------
Anthony R. Chase

/S/ JAMES H.S. COOPER Director April 16, 2002
- -----------------------------------
James H.S. Cooper

/S/ DAVID M. CORNELL Director April 16, 2002
- ----------------------------------
David M. Cornell

/S/ PETER A. LEIDEL Director April 16, 2002
- --------------------------------------
Peter A. Leidel

/S/ ARLENE R. LISSNER Director April 16, 2002
- ----------------------------------
Arlene R. Lissner

/S/ STEVEN W. LOGAN President and Director April 16, 2002
- ----------------------------------
Steven W. Logan

/S/ TUCKER TAYLOR Director April 16, 2002
- -----------------------------------
Tucker Taylor

/S/ MARCUS A. WATTS Director April 16, 2002
- ---------------------------------
Marcus A. Watts

-73-