CoreCivic Inc (CXW) 2006 Q3 法說會逐字稿

Good afternoon, ladies and gentlemen, and thank you for standing by. Welcome to the Corrections Corporation of America 2006 third quarter financial results conference call.

Before we begin, let me remind you today's listeners that this conference call contains statements that are forward-looking as defined within the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from the statements made. Factors that could cause operating and financial results to differ are described in the company's form 10-K as well as in other documents filed with the Securities, factors that could cause operating and financial results to differ are described in the Company's form 10-K as well as in other documents filed with the Securities and Exchange Commission and these factors include, but are not limited to changes in the private corrections and detention industry, the Company's ability to obtain and maintain facility management contracts in general economic market conditions.

This call may include the discussion of non-GAAP measures, for which the reconciliation to the most comparable GAAP measurements is provided in the Company's corresponding earnings release. The Company does not undertake any obligation to publicly release the results of any revisions to the forward-looking statements that may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.

Participating on today's call will be the Company's Chairman of the Board, William Andrews, President and Chief Executive Officer, John Ferguson, and its Chief Financial Officer Irving Lingo. And now I would like to turn the conference over to Mr. Andrews, please go ahead, sir.

Well, good afternoon, everyone and welcome to our third quarter earnings release. I hope you'll be pleased with today's and this quarter's results, and I'll turn it over to Irv to have him give you a review of our financial results.

Thank you, Bill. Third quarter results for 2006 came in at $0.42 a share, and that's compared to EPS for last year's Q3 of $0.34 a share, that's an increase of-- in earnings of about 23.5%. For the nine months just ended, net income per diluted share after special items amounted to $1.20, and that's compared to $0.81 per share as adjusted to exclude refinancing charges for the comparable period last year. This represents an increase in EPS of approximately 48.1% for the first nine months. Earnings for the quarter were positively impacted by an increase in population to the number of our facilities including northeast Ohio, where a large contract with the Federal Bureau of Prisons essentially commenced in the second half of last year, as well as a improved operations at a number of other facilities, those would include T. Don Hutto, Eloy, Prairie, North Fork, and Crowley.

Adjusted EBITDA was up 16% to 74.1 million for the quarter. Which means that over the last 12 months, we've generated over $275 million of adjusted EBITDA. Same-store facility EBITDA for the third quarter increased approximately 16% over the prior year. Operating income for the quarter was 56.2 million and that represents an increase of 7.5 million or 15% over the third quarter of 2005.

Adjusted free cash flow increased to 44.6 million, that compares to 43.6 million [inaudible] in the same period last year. This represents the fifth consecutive quarter we've exceeded 40 million in adjusted free cash flow, so we're clearly generating significant amounts of cash, which will become increasingly important as we continue to pursue the [builder] program laid out in the press release.

Turning to operations, total revenue for this year's third quarter was up 11.5% over last year's third quarter and that amounted to 339.3 million. Compensated man days increased 7% to 6.3 million from 5.9 million in the previous year. Revenue per man day increased 3.9% to $52.81 and that's from $50.82 last year. Compensated occupancy for the third quarter increased to 94.5% from 92.7% last year. The mix of federal and state revenues for the quarter remain relatively constant from last year with our federal business now representing 39.6% of total revenues and our state and local business representing -- and our state business, I guess, representing roughly 48.5% of total revenues. Since there was little change in customer mix, the 3.9% increase in revenue per man day is substantially due to increases in pricing power brought about by the tight supply of prison beds.

Our press release does a pretty good job of detailing changes in fixed and variable costs so I'll add just a few global comments here. Operating costs per man day for the quarter actually increased to $38.53 from $37.44 in last year's third quarter. As can be see in the press release, fixed expenses per man day were up only 1.6%, approximately 85% of fixed costs are salaries and benefits. Salary increases we gave during the year were in the range of 3 to 3.5% and they were muted by the ongoing leveraging of our fixed costs over ever larger numbers of compensated man days.

Variable expenses were up 6.8% for the quarter, that's an increase of $0.63 per compensated man day. The increase in variable expenses substantially resulted from an increase in our reserve for legal settlements. Essentially, we had a very good comp quarter last year with respect to legal and this particular quarter Q3 of '06 was more or less a reversion to the norm. The end result was that operating margins per man day increased $0.90 per man day at $14.28 from $13.38 last year and our margin percentage increased to 27% from 26.3%.

It should be noted that the margins for Q3 were negatively impacted by the opening and ramp-up of our Stewart and Red Rock facilities, as well as the transfer of over 900 Alaskan inmates from Florence to Red Rock. Over the near term, we expect to backfill Florence with California and Federal inmates to fill Red Rock with a combination of inmates from Alaska and Hawaii and to fill Stewart with detainees provided under our agreement with ICE. Should this occur, and we expect that it will, will be a strong driver of earnings growth in the coming year.

General and Administrative expense for Q3 was roughly $2 million higher than in the previous year, included in G&A was an additional $600,000 in stock-based compensation over the previous year. As I've said in many earnings calls, we target G&A to be under 5% of total revenues in this quarter, we came in at about 4.8%.

Income taxes were computed based upon a 37% rate, which at this time is the rate we're anticipating for the full-year 2006. With respect to payment of cash taxes, our expectation is that we will be required to pay approximately 8 million over the balance of 2006, as we have substantially utilized our operating loss carry forwards. Going forward, because our Federal NOLs have been substantially utilized, our cash taxes paid will increase more in accordance with what would normally be paid based upon our effective rate.

So in summary, Q3 was a very strong quarter coming on the heels of a strong Q2. Revenues per mand day increased almost 4%, while the increase in operating cost per man day was muted, both due to control of costs but also due to the ongoing leveraging of our fixed costs over an ever larger number of inmates. The end result was a 6.7% improvement in margins, despite the negative impact of a Stewart and Red Rock ramp-up expenses.

Occupancy continues to improve throughout our portfolio. We currently stand at almost 95% occupancy. And most importantly, we continue to generate significant adjusted free cash flow which amounted to over 170 million over the last four quarters.

I'm going to comment briefly on development activity. As I said in last quarter's earnings call, in light of the ongoing constraint supply of prison beds nationwide, our ability to deliver new inventory is an increasingly important part of our story. I want to briefly review where we currently stand with respect to existing inventory, development currently underway and our expectations for new development activity over the course of the next year.

At October 31, the Company has approximately 4100 beds in its existing inventory, the largest blocks to this inventory are located on our North Fork facility with 900 beds, and I'm rounding here a little bit, our Red Rock facility with about 500 beds, our Diamondback facility 200 beds, Florence with 500, and Stewart with about 1100 beds. And then, throughout the remainder of our portfolio, more or less on a one-off basis we have an additional 900 basis. Most of these beds are committed to customers and represent potential future profits to the Company.

Because we've seen for some time now that our existing inventory would be rapidly depleted, we began the development activities that you see reflected in the press release. We're currently underway or have signed development agreements for over 3800 expansion beds, most of which will be delivered during 2007. Roughly 2500 of these beds are being developed for specific customers, however none have a guarantee of occupancy. The 960 development beds at North Fork and the 360 beds that we're developing at Tallahatchie represent speculative development, however, based on the demand that we're seeing, particularly for beds at North Fork, we're quite comfortable that any risk represented by this development is minimal.

With respect to new development, we continue making progress on our 1900 bed [inaudible] facility, and currently expect that facility to be completed in mid-2007. Upon completion, Hawaiian inmates relocated from Diamondback and Tallahatchie will fill [Carraroe] and we'll begin working to back fill the vacated Diamondback and Tallahatchie beds. Here again, particularly with respect to Diamondback, we're optimistic with respect to such back fill.

Over and above these activities, we've been actively working on identifying and permitting sites for new prison development. Based upon our progress to date, we believe we should be underway at some point during 2007 with an additional 4,000 the 6,000 beds. Again, that is 4,000 to 6,000 beds over and above what we currently have under development.

So, adding all of this up, we have 4100 beds in our existing inventory, roughly 6,000 beds under development currently, counting both expansions and Carraroe, and believe that e can have another 4,000 to 6,000 beds underway during 2007 for delivery in 2008 or 2009. This adds up to a potential of between 14,000 and 16,000 beds to meet existing and future demand and to drive the Company's earnings growth beyond 2007.

No I'll wrap up with a quick review of our outlook for the balance of the year. Our guidance for Q4 is in the range of $0.42 to $0.45 resulting in full-year guidance for 2006 of $1.62 to $1.65, that excludes $0.01 per share incurred during Q1 for refinancing costs net of taxes. The guidance includes $0.05 of stock compensation expense, which for the full year 2006 exceeds stock compensation amounts from last year by $0.03 a share. The guidance for CapEx is included in the press release and is slightly less than we forecast in last quarter's call primarily due to timing of expenditures.

The guidance incorporates an estimated effective tax rate for the year of 37% and includes the ongoing estimated affects of the opening and ramp-up of Red Rock, the negative affect on our Florence facility, due to the relocation of Alaskan inmates from Florence to Red Rock, the affect of the ongoing ramp-up of our North Fork facility, and the impact of the ramp-up and initial receipt of detainees at our Stewart, Georgia, facility. It also reflects our best efforts to estimate the overall inventory absorption we expect to experience in Q4, which would include the timing of the backfilling of our Florence facility.

As I said at our recent analyst day, we are optimistic regarding the prospects for our business. We believe that the activity we have witnessed thus far in 2006 provides strong emphasis to earnings growth and earnings visibility as we enter-- as we prepare to enter 2007. Specifically, our agreements with ICE at T. Don Hutto and Stewart and the opening of North Fork all took place at varying times during 2006 and we expect to get a substantially higher benefit from these contracts during our full-year 2007.

That said, as we have seen in Q3 and is reflected in our guidance for Q4, the opening and ramp-up of new facilities does have a short-term negative impact on our results in the quarter in which these event occur. For example, although there are many positive drivers we see for 2007, the opening of our new Carraroe facility and the relocation of inmates from Diamondback and Tallahatchie to Carraroe will have a short-term negative impact on operations over Q2 and Q3 of next year. The bottom line is we still believe we can generate solid, double digit earnings growth in 2007. However, as I like to do, we caution investors and analysts from becoming too [abulling].

I'll now turn it over to John to get into the specifics of our business prospects.

Thanks, Irv. Let me try to bring into perspective some of the things Irv was talking about on the developmental activity and also some of our longer range forecasts.

As we've said now for the last several conference calls that the visibility couldn't be any better for the Company. But to put it in perspective, the developmental activity over the last 22 months, or since the January 1, 2005, the Company has added roughly 8500 inmates with our 19 state customers and our 3 Federal agencies. As Irv pointed out, we have some 4100 beds in inventory, mostly of contractually committed to existing customers. We are nine months away from completing 1896 beds at Carraroe, at which time we will be freeing up some 1600 beds in Diamondback and Tallahatchie as well as adding additional capacity for the state of Hawaii, and then in addition to Carraroe, we have some 3800 plus beds under development.

So over the next 22 or so months, between now and the third quarter of 2008, we have roughly 10,000 beds that would be available that we feel very optimistic that we will have some customers that will use -- or future prospects that will utilize this bed. Obviously, we have no guarantee that that would happen. But, again, with the visibility we've seen, and I'm going to talk about that in just a second, we feel very good that we can deliver some 10,000 beds to our customer base between now and the end of 2008.

And then as Irv described, we are actively pursuing locations to site some 4 to 6,000 future beds. Why do we feel so strongly about the utilization of this roughly 10,000 beds? And why do we feel so good about to speculate in another 4 to 6,000 beds starting in 2007? So let me go again, the customer base that we are dealing with and what we think we're seeing that leads us to that, and again, these are things that, of course, we've been observing for the last half of a decade. But if we take the 19 State customers that we currently do business with, plus California now makes 20, so we're very proud of that as of Friday afternoon, we received our first 80 inmates into our west Tennessee facility and all seems to be going well and the feedback we're getting is the California inmates feel very good about where they are right now.

But, if we look at the 19 states we currently do business with and look at their forecast between now and 2008, they see a bed need of some 40,000 beds, and if we take the horizon out to 2010, I think we can easily see a bed need of some 60,000 beds by these 19 State customer that is we currently do business with. Obviously all those beds will not be needed by to be delivered by the private sector, but again, if you just take some small percentage of that growth with customers who currently utilize us, we feel that we have a pretty good ability to see demand coming from those. And as we've previously said, we bring down our forecast internally state by state and we see not only some of these 19 states needing additional bed space, but we see some states that we currently don't do business with. And then, if you just look at the state of California, they're forecasting a bed need over and above where they are now, which, of course, is a very overcrowding situation of some 20,000 plus beds over that period of time. And of course we're very cautiously optimistic that we'll continue to see the utilization of CCA beds by the state of California.

And as we look at our three Federal customer, pretty much the same story we've been telling over the last several quarters. The Bureau of Prisons continues to be an overcrowded situation at some 134% of their rated capacity. Again, if you look at what they're forecasting, and that is that they will need or will have something like 20,000 -- I'm sorry, 220,000 inmates in their system. That's up from 195,000 today. And you look at the beds they're bringing online, it's some 25,000 potential bed shortfall that they need. And as we have expressed, we think that the Bureau now sees how the private sector can help them deal with their situation specifically, handling a lot of their low and minimum security inmates, thereby freeing up beds for their greatest need, which is minimum security beds.

The U.S. Marshal Service has grown at a compounded rate of growth over the last five years at 7.2%. That equates to roughly 4 ,000 new detainee bed needs by the U.S. Marshal Service. And as we've mentioned previously, the Secure Border Initiative not only affects detention bed needs for immigration custom enforcement, but also generates detention needs for those criminal aliens who are charged with a Federal offense. We see that continue to grow. And as we pointed out, there was $110 million of new money put into the Marshal's budget for the fiscal year ending 2006, which of course just ended. And of course, we're watching very closely the 2007 budget.

And then we turn to immigration custom enforcement. We've talked on several conference calls about the Secure Border Initiative. Secure Border Initiative 1 and 2. I think we're starting to see some activity. The Secure Border Initiative 2 is where they're looking at the interior, trying to find folks who have been here for some time, but who are still here illegally. And so, we're very optimistic, and as we disclosed in the last quarter, the 2007 budget was passed, and as you compare it to the beginning of the 2006 budget year, it's adding some 6700 beds or funding for 6700 beds or 27,500.

I pointed out that there was a study done about a couple professors at Stanford University, asking them if there was a complete elimination of catch and release, what would the bed needs be and they said that they see upwards of 35,000 beds, so we think we'll continue to see an increase need by Immigration Custom Enforcement as they deal with their border initiatives. And then we pointed out, something called Operation Reservation Guarantees in which ICE has now set up a centralized location to make sure that if an inmate is detained in one part of the country that has no beds, that they can identify where to send these detainees in another part of the country. We're working very closely with them to let them know beds that we have available.

So we've identified tens of thousands of bed needs being generated by our current state customers, of just identified tens of thousands of potential needs by our three federal agencies. Don't know how much of that will turn into, and ultimately need for beds in our facility, but we think it's very significant, and, again, put everything back in perspective, we currently have a little over 72,000 beds. So we think that we see some meaningful growth, opportunities by the Company over the next several years.

And if you just took the roughly 10,000 beds that Irv described and I just described to -- that will be coming available over the next two years and our current margin rates, we're looking somewhere in the mid-$60 million range of increased EBITDA just with the utilization of those beds, and put that into perspective, that [inaudible] amounts $74 million in EBITDA for the third quarter. So we feel very good about the needs for our existing inventory. We feel very good about the need for the future development and our ability to continue to deliver a meaningful public service to our government customers so that we can meet security needs, we can meet needs to alleviate overcrowding, and we can do it at a time in which we save taxpayers hundreds of millions of dollars. So we feel very good about that.

One last thing, comments to make before we turn it over to questions, we do have an election tomorrow. I'm sure there is some interest in how we see things. Obviously we're not trying to call any races, but we thought we would give a little bit of a color of what we see at each of our customer base. First of all, at the national level, remember that our customers are executive branch customers, and unless there was a significant public policy shift, we see that the needs and desires of the Federal Bureau of Prisons to continue use of the private sector shouldn't change. We feel the same way about the U.S. Marshal Service, as well as Immigration Custom Enforcement. Obviously we know that there will be a lot of debate on how to secure the border and we, I think, have analyzed that almost any outcome does not eliminate the need for detention beds to help secure the border.

As we look at our state customers, we have four states that we do business with who will have new governors, and that is Alaska, Colorado, Florida, and Indiana -- Idaho. We see nothing that would lead us to believe, again, that there would be a significant policy shift. Actually, in each of those states, I think, based on the bed needs and capacity that we are helping them deliver that we will make it very comfortable for whoever the new governor is, so they won't have to deal with correction issues for several years, which is the one area governors don't enjoy dealing with. We can't say for sure, but we don't see any significant threat to each of those.

And then, of course, there could be a governor change in Minnesota, and kind of the same thing, we don't think there would be a significant policy change. Of course, we don't see any major changes in the legislative makeup, which is as important in some cases as who the chief executive is. And in Minnesota, in fact, if things should change, we would -- the Prairie facility has been a very attractive facility for us for out of state inmates, so we don't see that as a threat. So, that's kind of a quick lay of the land of those things -- those states that we might have some change.

So with that, I would turn it back over to the moderator for questions.

Operator, we're prepared to take questions now. Coretta?

[OPERATOR INSTRUCTIONS] Our first question is coming from Emily Shanks of Lehman Brothers.

Hi. Thank you for taking the question. Very nice quarter. I've got a quick question really around CapEx. First, can you give me what CapEx spend was for 3Q?

Yes, I can. Hold on. Did you say Q3?

Yes, please.

Okay. 15.1? 13.1 million.

Okay, great. And then, as we look at the two expansion projects in Colorado next year, should that 44 million for each facility be fairly well spread out over next year? Or how should we think about the timing of that spend? Hello?

[TECHNICAL DIFFICULTIES] Our next question is from Jeff Kessler of Lehman Brothers.

You there, Jeff?

Hey, can you hear me? [CONFIRMING CONVERSATIONS]

Hi, you're on the call.

Okay. I feel guilty cutting off Emily here.

It's okay. We cut off Emily. We apologize to everybody on the call.

I apologize to Emily. Emily and I can e-mail each other back and forth. I guess one of the things I should ask you, what expansion capabilities do you have in your existing facilities beyond Colorado at this point, beyond the 4 to 6,000 beds --

Jeff, go ahead, I'm sorry [inaudible]. Was that your question?

Yes. From existing facilities, what do you think you still have left in the hopper, so to speak?

Jeff, that question gets asked a lot, and the way I answer it is, we really don't total up everything that's expandable, because there would be some facilities that there might not be an expansion for five years and it wouldn't totally be relevant. I would tell you that many, many, many of our facilities, the young facilities have additional land. One of the benefits of what we do is that we're buying land in places where the land is very cheap, so banking some additional land is not that difficult to do. A significant number of our facilities do have expansion potential and to the extent that a customer need manifests itself for that geography, we can typically accommodate it, but we've never really added up how many could be expanded by how many beds, because it could almost be misleading if there was no customer there.

Okay. Can you give some idea of the operating and -- opening and moving costs that you're going to be faced with, particularly as they peak in the second and third quarters of next year?

I don't have that number with me right now. Typically, when we open up a facility it runs between 1 and $1.5 million, I want to say, in ramp-up expenses. And again, that's bringing the guards in, the corrections officers in, excuse me, ahead of the inmates as we always do, and other added costs like that. That's typically what it runs. What I'm referring to is that many of these openings now are resulting in the transfer of inmates from an existing facility. And, as you know, the first 100 inmates into a facility, we lose money, and the last 100 inmates into a facility we make a lot of money. So, to the extent that we do transfer inmates from a substantially full facility as we did in Florence this quarter, that is a bigger issue sometimes than the actual ramp-up costs.

Okay. The federal demands, does it appear to you that even with the possibility of 3 to 4,000 new state beds over the next five or six years that are possibly being planned and all the capacity that could come on in the private industry, is the combination of this even close to where federal and state demand could actually be? It seems there's still going to be a disconnect between the private and what public can produce given what the federal and what the states seem to be needing.

I'll let John comment on this too. I think that's true. I think even with the capacity that we're planning to bring online, if you look at the demand over the next few years, there will still be needs in excess of that supply. And you look at what the customers are bringing on, I think we have a statistic out there saying within the next three years, there are roughly 2800 beds being on the states that we operate. I think that's probably a true statement, would you?

I would say that's true. The one thing, the states are going to do everything in their power to try to avoid new beds until they can, so it isn't like every bed needed will return to the private sector, but it would appear that there is going to probably be demand that would exceed this supply for the next several years.

Okay. One final question. That is, with regard to the state of California, this seems to be -- I'm not going to call it a cat and mouse game, but it's certainly going back and forth as to somebody attempts to -- somebody attempts to halt the moving of the prisoners out of state and then the court basically comes down and says we're not going to make a judgement on this and we get one step closer to the final move out. What steps currently are still needed for what we might call an unrestricted movement of prisoners out of California to relieve the space issues there?

Well, I think the obvious one would be these two hearings that have been scheduled for the, I think it's November 21st, and 22nd. One issue has to do whether what's being done is unconstitutional. The executive branch feels very strongly that they're within their constitutional rights to do what they're doing and they were somewhat prepared for the correctional officer's association to make that challenge and they feel that's comfortable, but there has been a subsequent hearing.

The other one has to deal with the -- those inmates who have some mental health issues to make sure that everything has been done properly so that they are -- their needs are addressed and we think, and we're getting some experience just this past weekend in doing that and we think we can make everyone feel comfortable, but it does appear we have to go through another couple of court hearings before things will start moving on a smooth basis. And then, of course, we're watching to see how many inmates volunteer, because that would be the desire that they can meet all the needs that California feels they need prior to state inmates with inmates who volunteer.

Okay. Final question, that is, what the ebbs and flows and you bringing prisoners on -- you bringing inmates on and the new capacity you're bringing on, do you have some idea of where your occupancy rates should vary from some type of general range? Are we expecting to see 93 to 98% over the next two years?

Don't know that with the capacity and the timing of the capacity exactly where the occupancy will fall out, Jeff. I do expect that we're going to see higher and higher numbers. What we try to do is point people more to compensated man days as opposed to the overall occupancy rate because our denominator is going to change. I want to say this quarter for several hundred thousand more compensated man days than last year and as an average margin in our own facility starting to approach $20 now, that's meaningful. We don't have any target ranges of occupancy.

What we're trying to do is to continue to grab -- to accommodate, I guess, as many customers, as many inmates as we possibly can, drive higher the number of compensated man days and stay out there a little ahead of the curve with inventory. Because, as we've said many times, we think the number one criteria for success in our business will be to have the inventory available when the customers need it. No targets, and we'll try to make things as smooth as we can, but really, [inaudible] one of the customers will give us the inmates and we'll try to have the capacity for them.

The assumption is, as you move towards more and more compensated man days, mix shift towards more owned facilities, as you put them up, your compensated man day margin should have upward pressure on it?

Absolutely, yes. And in the existing facility base, again, given the tight supply situation, I would expect that our existing base that is not subject to the openings and transfers, that those populations would go higher and with the fixed cost leverage, that would also enhance margins.

Okay. Thank you very much.

Sure.

Our next question is coming from Barry Stouffer of BB&T Capital Markets.

Good afternoon.

Hi, Barry.

Is $1 million in start-up costs that's mentioned in the press release, is that just for Stewart?

Yes, it was just Stewart.

And do you have any estimate of the inefficiencies that surrounded Red Rock?

I would say that it's seven figures easily hit at Florence for that.

Okay. And the depreciation expense in the quarter, was there anything unusual, or is that a good quarterly run rate going forward?

It's the run rate -- it's the rate right now and I looked at openings, it's just going to depend on the openings. What happened this quarter was we had Red Rock, which opened, we had the Stewart Detention Facility, and for more than it was last year, and then as we continue to put -- when you open a new facility, you put in FF&E, we do have IT initiatives and things like that going forward, that depreciation is obviously the faster rate than over a prison. Right now, Barry, I would use that. We're just going to have to update our guidance quarter to quarter based upon when we think these facilities will actually come online.

But there was nothing unusual like a large write-off in that number?

No, no.

That's all I had, thank you.

Thanks, Barry.

Our next question is coming from Anton Hie of Jefferies & Company.

Thanks. You guys, obviously, did a pretty good job holding the line on the G&A spend despite some additional spending expectations there with some hires and stock option expensing. Just trying to get a feel for where the fourth quarter might be. Have you already done the hiring that you need, or should you expect a further sequential uptick in the G&A? Thanks.

I think you're going to always see -- well, not always. I would tell you that there would be some uptick, and then what I would do if I were you is kind of target to that, that we're nudging up at that 5% level. That's what we're going to try to stay at. I don't see it dropping back to 4.5. We're going to try to keep it in that 5% range and so that's what I would do.

Okay, thank you.

Okay.

Our next question is coming from Jim MacDonald of First Analysis.

Good quarter, guys.

Hi, Jim, thank you.

You say you're going to try to stay ahead of the curve, although it looks like, maybe -- What happens if you don't stay ahead of the curve in demand?

I don't know. [LAUGHTER]

Jim, we're trying -- it's Bill Andrews. We're trying to look out where we have some relative confidence of the demand level to build these prisons on spec. And we certainly don't want to get into the situation we got into in the late 90s where we built prisons on spec and really didn't have a firmer demand kind of confidence level. We can build these prisons that we're talking about within our current capital structure. If there's a further demand that we're relatively sure of, we're going to build more prisons. And we can certainly do other things, raise equity, whatever we have to do to build these prisons, but we're trying to stay within that zone of meeting demand that we're relatively sure of and not getting out there so that we're hanging with excess capacity with a demand that may fall off. That's where we are.

Jim, what I would say is, we're talking about right now, I think, 4 to 6 ,000 beds we're talking about for next year, and then we have 6,000 beds under development today. We've got $100,000 on the balance sheet, to kind of echo what Bill said. Our leverage level is starting to drop close to three times debt to EBITDA,, as Bill has said, maybe perhaps four times would be a better level. So, we have significant borrowing capacity, we have over 100 million, I think we're down to about $120 million of cash on the balance sheet. You see the amount of adjusted free cash. I think that's right. We can add a significant number of beds. At least the number of beds we're talking about in the press release, without having to tap the equity market and keeping ourselves at a leverage level that we're comfortable with.

Now, what happens if we're not approaching -- I think your specific question was, what happens if we're not providing enough supply? Again, that's what I was saying. I think that what happens is the price of beds might be affected by that, the level of occupancy within our core facilities could be affected by that, right now the only players, there really haven't been any new players coming to the game, and so, and I don't see enough activity being generated now on the part of our customers that any meaningful delivery could take place over the near term. So, it's an interesting environment, it's a good environment for our business, we don't expect that kind of environment is going to go away, and I don't -- all we can do is try to add the beds that we can add.

I know it happens with some facilities, but what are the odds your customers would use your facilities at above capacity?

Well, that happens in a number of cases, and I guess that's going to be on a case by case basis depending on that customer. I mean, they have to make decisions, I guess, as to what they're going to do if they keep incarcerating people.

Okay. And in the past you've talked about announcing a 1500 bed facility by the end of the year, is that now sort of subsumed by the 4 to 6,000?

Yes. What that particular facility, which to be named later, is still something that we think is viable. I don't know if it will happen between now and the end of the year. I guess, I'll learn this now, I learned this about customers, they don't always decide what they're going to do exactly when you want them to, and there are certain issues with that facility that might not be resolved by the end of the year. That facility and a number of other possibilities are still very much in the hopper for next year. What did happen this particular quarter, is that, an ambition to bent now that we set our implementation for another 700 plus beds at Kit Carson, so that's half of what we were going to announce anyway, at least the additional 700 beds. So, yes, that one is still there. I would not look for that necessarily between now and the end of the year, but that particular project is still one we're working on.

In addition to that, as we said in the press release, we have been actively trying to identify additional development sites. Going back to what Bill said, in places where we think that there is demand for what we might build. And so, in other words, speculative, yes, we would undertake in the most technical sense of the world speculative development, but we would do it. I think this environment is very much unique and different from anything I think the industry will experienced. I think we would be confident about what we would be undertaking.

Could we talk a couple seconds about the California contract? And just to confirm some of the issues there, the three-year contract. What happens if they kind of change their mind or if the courts change their mind for them related to your contract?

What do you mean, if they decide not to go further?

Yes, if they decide that it gets struck down, or if they decide they don't have the budget for it? I mean, what kind of outs are there?

I think right now the exposure would be that, on them they have 80 inmates that if the court told them bring them back I guess they would have to give them back. We're fairly optimistic, based on this much intelligence, we can get that's probably not going to happen. But I guess if it did, it really -- I'm not sure it changes the environment a great deal. It might be a few thousand beds of demand, at least [inaudible]. But, overall, when we look at things like in North Fork, there are multiple customers for something like a North Fork, and so.

I was trying to just figure out how fixed the multi-year contract is with California?

The one that we have is pretty fixed for three years.

Okay. And just one quick other question, Transcorp was up a bit, is that sustainable or does that relate to some moving of Hawaiian inmates around?

The way I would envision Transcorp, is our goal for Transcorp is an adjunct to our business and it's a break even entity.

And the revenue is going to be about the same, or?

Well, the revenues are in the revenue line, Jim, and what happens, again, is that the cost gets buried into our operating costs and they're consolidated. What you see are the third party revenues, I guess, right, from Transcorp, not the inner company. So to the extent that they're doing work for us, that revenue or whatever might be recognized a different way.

Okay. So what you reported this quarter was totally third party?

What you see there is totally third party. And, again, the way to think of Transcorp is it's not -- it's something that we are trying to break even and support our business, I think, as much as possible.

Okay. Thank you.

Our next question is coming from Todd Van Fleet of First Analysis.

Thanks, usually I let Jim ask but I want to duplicate his efforts. Just thinking about California again, the 4 to 6,000 beds you talked about here over the longer term, 2008 and beyond, just was curious, is there anything that has transpired, I guess, in the California opportunities that you would characterize as different this quarter relative to last quarter? That is, are you more or less optimistic about the prospects of doing business with the state than you were a quarter ago, or is it about the same? Thanks.

Are you saying specifically California?

That is correct.

Yes, we're much more optimistic. I guess a quarter ago, it had not really -- we saw it, we knew of discussion, we knew what they were trying to do, but we in no way would we have been able to even internally forecast it to just because it was such a unique state. I think our forecaster, a little bit clearer, but we're not trying to get too ahead of it. In fact, I think the 4 to 6,000 beds that we have been discussing internally actually began before California even was on the horizon.

Thanks.

Our next question is coming from Emily Shanks of Lehman Brothers.

Hi. Sorry about that earlier.

Don't you apologize. We promise not to touch the phone again.

I just had one quick follow-up. All of my questions have been answered. I don't know if this came out before, but I was just interested on the timing around the spend on the two expansions in Colorado, the $44 million each?

Substantially, it will start next year and will run probably the majority of it next year and then we'll finish it up in mid-2008.

Okay, perfect. Thank you.

Our next question is coming from Patrick Swindle of Avondale.

Good afternoon. Solid quarter.

Thank you.

First question. The managed only fixed cost per man day was up sequentially year-over-year. Was there anything unusual in that statistic, or should we extend that on a going forward basis as to run rate?

No, don't extend it on the run rate. We just had some benefit-type costs [inaudible] around Workers' Comp in the last quarter that impacted those costs and impacted the margins for the managed-only business, and I wouldn't at this point -- no, I wouldn't make a run rate off that.

Okay. That's helpful. And it looks like the cost per bed on the two expansions in Colorado is just over $61,000. Should we view that as the proxy right now for new build and expansion activity, or would new build be ahead of that?

Every situation is unique based on the geography and the customer requirements. Right now our new build, I'll continue to assess this, but I would say 55 to 60,000 on a new build, maybe a little bit less on an expansion, to the extent that, for some reason, that it is higher, than either the operating costs or the per diem needs to change for us to get where we're going, and so we're comfortable that we will get the return that we are seeking on Colorado. I wouldn't look at it as a proxy right now for where we're going, but I would tell you that somewhere between 55 and $60,000 generically is a cost of [inaudible], I would have said a flat to $55,000 before.

Okay. And to clarify Mr. Andrew's comment earlier, all of the new build activity that you're talking about initiating the 4 to 6,000 beds can be funded on top of your current expansions and builds with free cash flow and with debt with no equity issuance?

Right now, I think we can do that, Patrick, yes.

Okay. Last question. It looked like -- I guess my sense is given the immediacy of demand from both California and ICE and your other customers that obviously demand as far as stripping supply should give you some pricing leverage. You indicated that most of the year-over-year increase in per diem this quarter came as a result of, at least somewhat as a result of that leverage. From an order magnitude standpoint, can you quantify at all how much that could add on top of the normal CPI increases in mix shift you might see over the next few years? And is it conceivable that you could do another 100 to 200 basis points purely from price because of the supply demand environment?

Can't qualify it. It's just something we need to stay tuned to it. There are clearly some per diems in our portfolio that we need to think about. Every customer is going to be different. [AUDIO DIFFICULTIES ***This quarter we had the benefit of some price increases. Where we had price increases that we weren't getting from certain customers in the past, we are now starting to get those.***] We do continue to get our CPI increases and in some cases we are indeed seeing the pricing leverage that I talked about. It's going to be on a case by case basis, but, it's just the laws of supply and demand are such that as supply gets tighter and tighter and tighter, one would expect that we would see some increases. We don't have any targets, but I just think it's one of those general, put in the back of your mind things that might be beneficial to our business going forward.

All right. Last question. When you pulled the expansion down in Texas, you indicated your expectation the U.S. Marshal Service would likely make an award for the Laredo Bell [inaudible], is that still a likely time horizon?

Yes. As we know it, yes, it is. Nothing to be determined that it's going to be delayed any further.

Only comment I would add to that is, [multiple speakers] Everybody's been late before, everybody's been late before, so.

I understand that. I just want to make sure that, at least as far as right now it appears to be back on track.

That's what we hear.

Thank you very much.

Our next question is coming from Bill [Gillcrest] of [Hemco].

Thanks for taking my question. Irv or John, if you could just answer this big picture question, talking about 60,000 beds for the states over the next four to five years, and you made the comment that certain percentage of them, obviously, will go to the states and some will go to the private sector, but, I guess, from my understanding, 2800 beds are going to be state prisons. How should I -- how should we all think about not almost all of those beds going to the private sector, those 60,000 beds? What can the states do to take 50% of those given their overcrowded situation?

First of all, tell you how we kind of develop it. We go to every State's website, and they usually are putting their forecasts out there, so it's a little bit of a Kentucky windage to as what they think it's going to be based on certain growth and they also try to factor in laws. There's less than a handful of States who don't project out that far, and what we do is go back and say, okay, what has been their rate of compounded growth to then and then extrapolate out and try to do that. Whether there'll be that many, it remains to be seen. But it is 19 states currently using the private sector, currently do business with CCA that have that. And my guess is, as I said earlier, they'll do their best to try to avoid doing anything for as long as they can. So, somehow they may squeeze them into where they had, they may try to change the parole mechanisms so they sometimes can let people out and they add typically and so forth, but I would say that based on where we are that some percentage, it doesn't take a very big percentage for it to be meaningful to the continued relationship we have with them, they will probably look to us, and it's our challenge to try to be just in time based upon those needs.

Again, we've given you a global number. We really go state by state and state, and so, this state, if it has this kind of growth, it would be a good prospect for us and their continued growth. This state is going to take a while and so forth. So it's hard to say what percentage of that would be. It just gives you, I think, a pretty high level of need that's developing out there. And our challenge, again, is to have the beds just in time for when those needs develop.

Okay.

We do know that, we in almost every case can be there before they can be there if they do decide that their going to acquire new beds somehow.

Okay, great. Also, on the California decision hearing, you probably have to go through a couple more hearings to decide the ultimate how fast this happens or how many inmates come. Why would a U.S. district court judge, who's, I guess, residing over the medical side of California's prison system, why would they -- what are they looking at in terms of deciding for the private sector versus the unions? What kind of arguments are the unions using to persuade them? It seems like if they're already saying, I'm -- you guys are doing a poor job and it's overcrowded and there's medical issues, I find it hard to believe that they would side on favor of the union, but I want to see what the argument --

You've got two issues. The union's lawsuit is about the fact that the that they're not using civil service employees to manage the inmate population, so therefore, they say it's unconstitutional. We think that everybody is going to see that that's a stretch, so that's the issue in the union's lawsuit. The other lawsuit, which is the inmate advocacies, they are just interested in making sure that the care that they get out of state is adequate, and I think it seems to be focused a lot on mental illness, and to make sure that if an inmate who maybe has some mental illness that could be a suicide risk, that that risk is identified and dealt with timely and appropriately. And so, their issue is just to make sure-- in fact, I think they have now recognized because they have visited our facility as has the receiver. I think they see the quality of the facilities that these inmates are going to, this is about making sure that the health care issues are all being addressed appropriately.

Last question. On the pricing, obviously there is a lot of talk about California's per diem rates being higher than what other states are paying, how are your customers in negotiations, conversations with them, how are they approaching this? Are they cognizant that, geez, I'm up for rebid here in six months and I'm going to have to be paying more? What is their thinking like right now with California kind of upping the ante?

It goes state by state, and we have very few situations in which it is eminent that we have to deal with that, but our customers are becoming aware that beds are becoming scarce and that what the per diem rate is going to be going forward, and then it will just be a discussion we'll have with each one of them in order for us continue to deliver them the quality of services that we have compared to what some other customers would be. So it's not a wholesale answer on that yet. We may have one in about six months, but right now it's customer by customer.

Great. Well, congratulations. Thanks a lot.

Thank you.

Our next question is coming from Dana Walker of Kalmar Investments.

Good afternoon. Could you talk about how your commitment to build as many as 10 to 14 to 16,000 additional beds offsets some of the fear that your state and federal customers feel on the pricing pressure front with California entering the equation?

I don't know that they think about it that way. I think I understand your question, Dana, it's just by virtue of the fact that if we're adding 14,000 beds, does that take the pressure off the steam kettle, I guess, with respect to pricing, I think is what you're asking.

That is, yes.

And some of these would be earmarked for specific customers in geographic areas. For example, if we were to build in Arizona or Texas along the border, that would probably be for a federal customer. And then, if we were to build in another location, it might be to deal with some of the state demand [inaudible] for single or multiple customers. I don't know, when you look at the numbers that are out there that what we're adding would take enough [inaudible] and with the construction prices increasing, I think that there's just going to be a lot of serious discussions about [inaudible].

A lot of pricing pressure brought on by demand is one issue. But if you look at what's happening [inaudible], we're not really getting far ahead of what they would be experiencing if they went out and built their own prison and had to [inaudible], some of the costs that's being driven by capital costs.

We understand their capital costs in trying to get someone who understands the operating and capital side of it. I think that [inaudible] what it would cost them, it's still a compelling value.

Some customers are probably, because of the benefit over the last couple of years because the equation hasn't be quite lake it is of getting per diems that really aren't realistic when they look at what it would cost to really [inaudible].

This is not going to be the tail that wags your dog, but as one looks at your managed only business where the operation -- operating margin per compensated man day has fallen below 5%, even if it was for a one timer, in the environments that we are increasingly witnessing, can you see that margin creeping back up into the 5.5 to $6 a day range?

Are you talking about on the managed side?

Yes.

Again. There are a couple things going on there. We had a rebid in one case, and as I've said on many occasions, it's a very competitive business. We don't control the real estate. The second thing was, again, that we did have some unusual events around Workers' Comp. I hope that it goes back over that and we'll just have to communicate over time what that is.

On the topic of California, you have a second chapter built into your original agreement, which suggests that if they need incremental space starting in the middle -- in the middle part of next year, then you seemingly agree to some terms. Can you frame how that might play out? How should we think about that arrangement?

You mean over and above the initial 1,000?

Yes.

Yes. We said we would have capacity being freed up in the second half at Diamondback and Tallahatchie. The number that California thinks they're going to need is still a little bit of a moving target, but I think we have heard somewhere in the magnitude of 5,000 is what they think that would help allow them for the growth that they see coming, so these 5,000 inmates would be their pressure [inaudible] them some beds in their system in which their inmate growth can go to 5,000 is the number, then they need another 2800 or so, and BCA was just able to show them with future bed capacity that we would be bringing online through the opening of Carraroe, and some other things that we would deliver and they elected to go ahead and through those facilities acknowledge that they might need and we might [inaudible] time. But nothing new. Neither side has committed to today.

You touched upon --

A contract that could deal wit at the appropriate time.

Finally, you touched upon this, partly in your opening statement, but could you once again summarize or perhaps more than summarize what customer sources would be your primary incremental inmate sources over the next couple of quarters? Some of those are obvious, but maybe just go through that, if you would?

I think the 4100 would be easy to go to those facilities that Irv listed. We have contractual commitments on a lot of those already. And so we just see that we believe the customers who've contracted for those beds will utilize that, the biggest one would be ICE at our Stuart facility. We have, of course, identified that California is looking at using [inaudible]400 beds in Florence continue to see needs by the U.S. Marshals and ICE in central Arizona. We believe, once we said that [inaudible] is open we will transfer 1600 beds from Tallahatchie in North Fork into Carraroe, and then at the same time we see bed growth for the remaining beds at Red Rock, and the current North Fork beds, we believe that shortly we will have a customer who will want to utilize those beds.

Does Colorado have incremental need before those two building projects are done in '08?

There have been stories -- in fact, I think it was published that the Department of Corrections went back to the legislature and asked for a supplemental appropriation, which was given to them, in order to contract for beds in the interim if they needed to do that.

Thank you very much.

Thank you, Dana.

Our final question is coming from T.C. Robillard of Banc of America.

Thank you. Just two quick questions. Taking a look -- Irv, based on the commentary you put in the press release with respect to some inflation on the fixed cost side. And I'm particularly looking at the owned facilities. Just trying to reconcile that plus the ramp-up costs at Stuart with the fixed OpEx per man day going down 2% year on year. I just want to make sure that's a function of the leverage and the model as the utilization went up significantly year on year, or if there was some costs that were are artificially higher in the September '05 quarter?

First of all, let me say congratulations to you.

Thank you.

I heard you had some good news, you'll be paying tuition in about 18 years.

Exactly.

Congratulations. On the fixed cost side, I think what we are saying there is, we are seeing the ongoing leveraging of our fixed costs and the increase in fixed costs is obviously -- what I was trying to say, the increase in fixed cost is less than just the pure wage inflation that we would have had. So, what's happening there, and, then again, you do have the ramp-up expenses. So, I think that that does point dramatically to what we've been talking about all along, is that we are getting some fixed cost leverage at a number of these facilities as they start to all move up in this environment. So, we're excited about that.

I agree. I think it really underscores that. I just wanted to make sure there wasn't any kind of one-off items in there. And then, I guess, lastly, John, can you kind of talk to -- I think it was last week, it might have been two weeks ago, with the U.S. Marshal's operation Falcon, I think they called it, where they had something along the line of 10 or 11,000 arrests over the course of a week. Do you guys get any benefit from that? Are you associated with any of those programs, or is that something they're doing procuring beds locally or with the Bureau of Prisons?

We would see some of that just based on maybe the contract beds we had, andwe've heard just a little, not what I'd call significant. But the Marshal Service utilizes the local county jails to a greater volume than they utilize us. So they would -- everybody would have experienced that, but I don't think I heard where we saw any great increase in the Marshals, but we have a facility in which we house Marshal needs for the City of Memphis and the City of Nashville, and that might have seen a few inmates based on what they did there, for example.

Great. That's all I had. Congratulations on a great quarter.

Thank you.

We have a follow-up question coming from Jeff Kessler of Lehman Brothers.

Jeff?

Mr. Kessler?

I guess we don't.

There appear to be no further questions in the queue, sir.

All right. Let me try to sum this up, because there's been a lot of speculation and questions about the future.

Just briefly, to go back over the results in summary. Our net income was up 23.5% for three months. It was up 48.1% for nine months. Our EBITDA was up 16.1% for three months. Our operating income was up 15% for three months. Our revenue was up 11.5% for three months. And our occupancy rates have gone from 92.7 to 94.5 comparing a relative three months. The increases were due to northeast Ohio, T. Don Hutto, Eloy, Prairie, North Fork, and Crowley, and our operating margins are now running 27% up from 26.3%, and that's including some start-up costs at Red Rock and Stewart and some shifting costs from Florence and Diamondback to Red Rock.

Now, talking about the future, John has gone through, kind of a look to the global future of a need for maybe 120,000 beds over the next three to five years from our various customers. And, I kind of rejuggled the numbers here to look at what we're currently doing, and we currently have 41 bed -- 4100 beds in inventory, which we are under contract for, but not guaranteed occupancy. We have another 5,735 beds that should be completed in 2007, and of those, 2,500 of those are under contract but not guaranteed. So it means that we've got 6,500 beds, which are currently under contract, and which will be filled sometime, but not guaranteed full occupancy, during 2007, which leaves another 3,300 beds which will come onstream in 2007, which are not under contract, and in addition to that we've said we'll start 4,000 to 6,000 more beds in 2007.

So it's great to be in this strong demand position and we'll continue to operate and monitor our opportunities closely and adjust accordingly. And because so many of you asked about what kind of demand is going to really be out there, what are the states going do? If we see further demand, which we can be relatively sure of, we'll build more and we will price accordingly without affecting our long-term relationships with our customers. And we're looking at this both from an opportunistic basis, but from a conservative basis without trying to get out ahead of a demand factor. And we will continue to monitor this and report back to you on these quarterly meetings.

So, with that, thank you for your attendance today and we look forward to talking to you again at the end of the year.

This ends today's conference call. You may now disconnect.