CoreCivic Inc (CXW) 2007 Q2 法說會逐字稿

Good morning, ladies and gentleman, and thank you for standing by. Welcome to Corrections Corporation of America's second-quarter 2007 earnings call.

Before we begin, let me remind today's listeners that this call contains statements that are forward-looking as defined within the Private Securities 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 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 and general economic market conditions.

This call may include the discussion of non-GAAP measures for which the reconciliation to the most comparable GAAP measurement is provided in the company's corresponding earnings release or posted on the Company's website. The Company does not undertake any obligation to publicly release the results or any revisions to the forward-looking statements that may be made to reflect events or circumstances after the date hereof or to reflect the occurrences 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 as Chief Financial Officer, Todd Mullenger. I would now like to turn the call over to Mr. Andrews. Please go ahead, sir.

Good morning, everyone, and thank you for joining us to announce our second-quarter 2007 financial results. And John and Todd will take you to financial -- through the financial and operating results, and obviously we're here to answer any questions you may have. David Garfinkle, our Controller and Vice President is also here. So we'll begin with John -- I'm sorry, Todd with the financial results.

Thank you, Bill. Good morning, everyone. Well, we are very pleased with our second-quarter operating results so let's move straight to a summary of those results.

Second-quarter results for 2007 we generated $0.26 per diluted share compared to EPS for last year's Q2 of $0.21 per diluted share, representing an increase EPS of 24%. Earnings for the quarter were positively impacted by increased populations at a number of facilities including -- Stewart, Red Rock, T. Don Hutto and North Fork.

Adjusted EBITDA increased over 18% to $84.8 million for the quarter. Same facility EBITDA for the second quarter of 2007 increased approximately 12% over the prior year, while operating income for the second quarter of 2007 was $65.8 million, representing an increase of 19% over the second quarter of 2006.

Adjusted free cash flow for the quarter decreased 3.6% to $42.4 million as a result of increased cash tax payments. While pre-tax income increased $11.5 million or 28%, cash income tax payments increased $18 million due to the payment of $21 million income taxes for the first half of 2007 made in April and June of the second quarter. This increase is primarily a result of having utilized all of our federal met operating loss carry-forwards, and we are currently estimating quarter cash taxes in the range of $10 to $12 million each for Q3 and Q4.

Cash flow from operating activities for our cash flow statement for Q2 is approximately $60.7 million with expenditures for facility development and expansions of $47.8 million, and expenditures for other capital improvements, maintenance and IT CapEx of $10.6 million. We are currently estimating maintenance and IT CapEx for the full year will total approximately $54 million.

Total revenue for this year's second quarter was up 11.7% over the last year, an increase of $37.9 million. Total compensated man days increased 8.6%; that's $6.6 million from $6.1 million man days in the previous year. Revenue per compensated man day increased 2.9% to $54.08 from $52.55.

Average compensated occupancy for the second quarter increased to 99% from 94.9% last year. This increase in occupancy percentage was especially significant in light of the fact that our average available beds increased from 70,574 in Q2 2006 to 73,450 in Q2 2007.

With regards to the 2.9% increase in revenue per (inaudible) a couple of comments. Results through Q2 2007 did not reflect any meaningful impact from pricing leverage on our per diems for existing contracts as a result of the current supply and demand imbalance. The improved pricing we've already negotiated on certain existing contracts was not effective until July 1, 2007.

As we have said previously, our goal would be to benefit from additional pricing leverage will come over time as the contracts come up for re-bid. Corrections is not like the hospitality industry, and we're not going to be increase pricing based on changes in supply and demand. In addition, [mix] is another item that impacts increases in our average per diem calculated over the entire system. As populations increase under contracts with per diems below the average, it can dilute the increase in average per diems year over year.

For example, if we were to add a large number of new inmates at a per diem well below the average but with attractive margins, while my EBITDA would increase nicely, it would dilute the average company-wide per diem increase. We saw some of this impact in Q2 2007 versus Q2 2006 as we saw a nice population increases and EBITDA increases at existing facilities under contract with per diems below the company-wide average. This will likely continue for the next several quarters as our customers utilize all available capacity under existing contracts, and as we work to squeeze out additional capacity under these contracts at existing facilities to meet their needs.

Finally, as we've indicated before, competition in the managed-only segment will also impact our ability to obtain per diem increases on these contracts.

Our press release does a good job of outlining the changes and fixed and variable costs so I will add just a few general comments here.

Operating costs per man day for the quarter increased less than 1% to $38.35 from $38.06 in last year's Q2. Fixed expenses per man day decreased slightly primarily because we spread these costs over roughly 522,000 additional man days versus the prior year. As a reminder, approximately 85% of our fixed costs are personnel related, and once a facility reaches a certain occupancy level of 80 to 85% we have substantially all of our fixed costs in place. At that point, our business model improves dramatically as we leverage these costs over larger numbers of inmates.

Variable expenses per man day increased 3.4% to $10.25 per compensated man day. Operating costs in Q2 2007 included $1.9 million in startup costs related to the opening of our Saguaro facility as compared to $300,000 in startup costs for Red Rock in Q2 2006. The end result was that operating margins per man day increased $1.24 to $15.73 from $14.49 in the prior year, and our margin percentage increased to 29.1% from 27.6%.

GAAP income tax expense for the quarter was computed based on the rate of approximately 38%, and we currently anticipate our rate of approximately 38% for the balance of 2007.

So, in summary, we're very pleased with our second-quarter operating results. The positive supply and demand environment resulted in higher prison populations providing additional leveraging of fixed costs, and as a result, higher operating margins.

I will finish with an update of our guidance for 2007. As indicated in the press release, our guidance for Q3 is in the range of $0.23 to $0.25, and for Q4 is in the range of $0.26 to $0.28. And guidance for the full year is in the range of $1.01 to $1.05.

As discussed in our previous earnings call, there will be a number of significant transitions taking place during the third and fourth quarter this year. Some of these transitions involve the receipt of additional inmate populations into our system. Some of these transitions involve the relocation and replacement of existing inmate populations to make room for the new inmate populations. The relocation and replacement of existing inmates will negatively impact EBITDA in margin rates in Q3 and Q4 as a result of increased transportation costs and a disruption of EBITDA streams at certain facilities.

For example, we are transferring existing State of Hawaii inmates currently housed at our Diamondback and Tallahatchie facilities into our Saguaro facility, which will free up beds at Diamondback and Tallahatchie. We are replacing existing State of Arizona inmates currently housed at Diamondback with different State of Arizona inmates in order to simplify certain operational issues at Diamondback.

These movements will result in significant transportation costs and a disruption of the EBITDA streams at Diamondback and Tallahatchie as even under the best of circumstances there will be a delay between the transfer out of the Hawaiian inmates and the transfer in of replacement inmates to Diamondback and Tallahatchie. This, in turn, will negatively impact EBITDA in margin rates in Q3 and Q4.

For example, occupancy at our Tallahatchie facility is currently at approximately 40% of capacity as we've begun transferring Hawaiian inmates to Saguaro. This is down from nearly full capacity a number of weeks ago. And Saguaro is currently only at 24% of capacity. These low occupancy rates will impact EBITDA and margin rates in Q3 and Q4 as I have essentially 3,000 beds online with 900 inmates in them.

Relatively speaking, Q3 should see higher transportation costs and a larger disruptive of EBITDA streams than Q4. As in Q4, we would expect to see the transitions to begin to stabilize a little.

The good news is these movements will free up bed capacity and allow us to transfer in additional State of Arizona inmates into Diamondback, replacing the State of Hawaii inmates transferred to Saguaro. The transfers also free up capacity at Tallahatchie for additional State of California inmates. And the guidance we provided does assume a gradual increase in our State of California inmate population.

I think it's important to keep in mind that as we continue to bring new beds online we will likely see similar transition costs such as startup costs, transportation costs and potentially a disruption of EBITDA streams at other facilities. It is important to note that between now and Q4 2008 we expect the complete destruction of nearly 8,000 beds with nearly 5,700 beds to be completed during 2008.

In addition to these announced projects, CCA continues to evaluate additional development opportunities. The activation of the announced projects and any new projects will likely result in short-term operating disruptions as the capacity is brought online.

Another item I'd like to point out now that we have begun developing a large number of beds through construction this will obviously result in increasing depreciation expense as the beds are brought online. A good rule of thumb to use in estimating the increase in GAAP depreciation expense is to take the total investment cost in the project and divide by 37 years. This 37 represents the blended-average depreciable lives of buildings and equipment for new development.

As far as funding this new development, we believe that cash and investments on hand, free cash flow from operations, capacity available [under our revolver] will allow us to fund all development projects announced today. And (inaudible) any more than $400 million left to spend between now and Q4 2008 on development projects that we have announced today.

Our guidance also reflects annual merit increases effective July 1 for the majority of our roughly 16,000 employees. One of the primary risks to our guidance as always is timing around the receipt of inmates. This is particularly true with the State of California which is a new customer and one that is receiving a great deal of scrutiny around transferring inmates out of state. It is important that the ramp-up of all new inmates occurs as smoothly as possible. As such, we may slow down the ramp-up of one or more of these populations from what we currently expect if we feel it is necessary to avoid any issues that could negatively impact our long-term relationship with the customer.

John will talk more specifically about the demand. Overall, the outlook for our business remains quite favorable. The combined beds of CCA and our private competitors are not sufficient to deal with the demand for prison beds that exist today. I'll now turn it over to John for specifics on our new business prospects and bed development.

Let me begin by reaffirming the demand that we have on the last several calls pointed out. In our two major markets, that'd be on our state on one hand and our federal customers on the other. On the state side let me start off by saying that I'm happy to report that in the last call I mentioned that we had a few threats that were around some RFPs for some current contract we had. That was for two facilities in the State of Florida and one in Tennessee. I'm very happy to report that those threats have now been removed and that we will continue to manage the populations for Florida and Tennessee.

I pointed out last week the results of some research done funded by Pew Foundation where they forecast 162,000 new state inmates that they expected between now and 2011, and of those 162,000 CCA's 20 current state customers would represent two-thirds or 98,000 new beds of new inmates of those -- in that 162,000.

Of course, we announced last time that we signed a new contract with the State of Arizona, and hopefully by the end of the year we should see over 2,000 Arizona inmates in our Diamondback facility.

We have pointed out that the legislature in California passed legislation signed by the governor that authorized the transfer of inmates out of state, and that it had been the expression of the governor that he intended to utilize at least 8,000 beds.

Currently, we have right at 600 California inmates. The last 120 we received last night in Mississippi. But California has asked us to allow the Department of Corrections Rehabilitation to transfer around 300 to 400 per month. Now, if they meet that schedule that would mean that approximately 4,500 California inmates would be in 68 facilities by June 30 of 2008.

We, as everyone else, are watching some of the public policy issues in California. There has been a three-judge panel that has been authorized by the federal district courts in California; however, we really don't know how that will play out. They'll obviously have to deliberate before issuing any orders, and some experts have indicated to us that that panel could take testimony and look at actions for at least a year. And then before any action is taken, we do know that Schwarzenegger administration would then appeal whatever action they elected to take. And then we've seen no indication that the court is considering stopping the transfer of inmates out of state.

So in addition to Arizona and California, if you look at the other 18 states that we currently have relationships with we see, based on the Pew report, an anticipated growth of 70,000 new prisoners between now and 2011. So again, this is just to reaffirm what we've been saying for the last several quarters that we continue to see a substantial need by our state customers as well as some state prospects, and not a great deal of capacity being brought online by these states.

Moving on to our federal customer base, the Federal Bureau of Prisons -- in their last report is showing they have 199,000 plus inmates, and they continue to be 34% over their rated bed capacity. They're expecting growth between now and 2011 of some 30,000 net -- new prisoners, and they are bringing online capacity equal to approximately 14,000 beds. So that's leaving a 16,000 bed shortfall.

The present fiscal year and '08 budget does request additional funding for the BOP, and request some of those funds be used to expand contract beds, which is the term of utilization of the private sector, but to increase the expansion contract beds by more than 1,100. We -- as we pointed out last quarter, the fiscal '08 budget does request additional funding for the US Marshal Service, that we saw year-over-year growth in the last reporting period of 5%, and that we have seen a 15% growth in our US Marshal population over the last six quarters.

Immigration and custom enforcement, the latest published populations of detainees shows that right now ICE is detaining 32,000 inmates. Of course, we had pointed out previously that their current funding is for 27,500. And we have seen the House move to appropriate funding to increase the 27,500 to just 28,450, but we've just recently seen the Senate appropriate in their budget a piece of the funding for 31,500. And then on top of that, emergency funding to fund up to 45,000 detention beds over the next two years.

So again, we continue to watch public policy around immigration and custom enforcement. We continue to see the need for our detainee beds to grow as the policy of catch and release has been replaced by the policy of catch and return. So we continue to be bullish with both our state customers as well as our federal customers.

So let me move to what I think is the story that -- and the -- in our earnings release this quarter, and that is that we have highlighted that over the last several quarters that we have announced the development of close to 8,000 net new beds under our system. In addition to that, we have almost 3,600 beds in inventory, so that gives us a total of 11,600 beds to provide to meet this growing demand.

Of our inventory, which is up a little bit from last quarter, 2,500 of those beds are at Saguaro, Tallahatchie and North Fork, and all those beds have pretty good visibility with the -- our customers. The customer of Hawaii going into Saguaro; the customer of California going into Tallahatchie; and then California and various others going -- utilizing the beds at North Fork.

To reinforce a comment that Todd made about the availability in liquidity, if we were to stop construction today and just finish the 8,000 beds we have under construction, which again, gives us 11,600 or so of available beds, that if we just replicated the free cash flow over the next 18 months that we've had over the last 12 months, plus the cash and investments that we had on hand at July 1, we would be able to fund all of that bed expansion and have no need for increased debt beyond that. If you were to take the 11,600 beds and just apply the operating margin per compensated man day at both -- for the last quarter for both our own facilities and our managed facilities, these beds would generate somewhere in the range of $84 million of additional EBITDA with the -- with no additional debt needs defined by the company.

One of the things as you look at the press release, I think you can see that we talked about what we believe is pretty good visibility. And obviously, we can't guarantee any of the -- that these beds would be used, but we feel very strongly that based on our customer base and the demand that we're seeing that the utilization of these beds looks pretty good. In fact, just to put it in perspective that by the second quarter of 2008, we could see all 1,800 beds at Saguaro being utilized; over 2,500 beds at our Tallahatchie facility once it's completely expanded, which the last expansion is due to be completed in the second quarter of '08; 2,400 beds being utilized at our North Fork facility. And we feel very confident that Florida is going to utilize the expansion beds that are being brought online this quarter.

So we feel pretty good about our ability to continue to meet the demand that's out there with the development decisions we've made to date. I made the statement that if we stop today, but we don't plan to do that. We feel that we continue to believe that we can identify where much of the demand is going to come from, and as we've stated previously, we believe that with the right assessment of that and delivering beds just in time for this demand will bring on continued utilization of capacity that we would bring online.

We have, on numerous occasions, made presentations to investors, and this presentation we put online. But just to highlight what we think our capabilities are going forward if we were to continue to generate adjusted free cash flow that would be consistent with what we've done over the last 12 months, and utilizing a leverage of no more than 4 to 1 against our last 12 months of EBITDA.

The company has, in addition to the development decisions that have already been made which are highlighted in the press release, we feel we have the capability of another 8,000 beds to meet what we believe is a demand that is out there and see no reason why it would change dramatically over the next several years.

Before I open the call up for questions and answers, I want to just speak to the announcement we made about the retirement of Ken Bouldin as our Chief Development Officer. As I have stated previously, Ken is someone that I have known for decades, and I've had a prior business relationship, and I have a great deal of confidence in him. So I'm going to miss Ken, but as Ken will be 65 next month, and as we pointed out in the press release, Ken is going to stay available to advise and counsel the company for the next year.

But what is great is that Ken has developed an organization that puts the company, once again, in the position to promote within. Damon Hininger is a 15-year employee of CCA. In fact, I had the honor of asking him to become an officer in the Company back in December of 2000. And Damon assumed his responsibilities of handling our federal book of business in the summer of 2002. So Damon has many years experience in dealing with our customer base of federal customers.

Tony joined the Company in February of 2003. Actually, Tony is someone I knew previously. He had been the Commissioner of Economic Continued Development at the State of Tennessee. I saw him work with very high-level individuals within some companies, specifically Nissan. Tony was instrumental in beginning discussions with Nissan about moving their headquarters to Nashville, which they subsequently did. So Tony has been handling our state book of business since February of 2003, so he will continue to do that.

So we have two individuals who will continue to handle the very important responsibility we've had and have responsibility for the growth that we've seen in both our state and federal customers. They will just add to their responsibility in advising the direction of the company in addition to that, so we are very pleased with their promotions. And Ken put in place a very strong business development structure, a lot of support we didn't have previously and that support will continue to aid Tony and Damon as they carry out their job.

So with that, I'll open the phones for questions and answers.

Thank you, sir. (OPERATOR INSTRUCTIONS) We'll take our first question from TC Robillard from Bank of America Securities.

Great, thank you. Good morning, everyone. I just want to get a little bit of clarification around a couple things. First, John or Todd, can you give a little more clarification around California in your guidance in terms of what you guys are modeling with the rate of transfers? I know that the state is looking to do 300 to 400 a month. How have you guys looked at that based on what you've seen to date and what your conversations have been with the state?

TC, this is John. We have modeled it for a little bit slower ramp-up than the 300 to 400. We are working very diligently to get ourselves in position so that this transfer becomes easy, but the transfer last night is the -- will bring the Tallahatchie population to 200. We're still moving out Hawaii inmates, which will take a period of time because we want to transfer and ramp-up Saguaro without any problems. So we're trying to be very cautious and -- so we're -- our guidance is less than the 300 to 400.

I guess in some ways we are real excited about this relationship that we have with the State of California in what it's going to look like when we take a snapshot a year from now. But in some ways the beginning of the relationship is really a drag on the operating performance of the company. But that's something that is a good thing that it's taken place. It's just one that we're having a tough time forecasting, and so we elected to be a little more conservative in the ramp up in our guidance.

That's a great call. I think that's definitely very prudent on your part. In terms of transportation costs with California, can you give us some sense as to how we should be looking at that? Is there anything different in terms of the relationship you have with California relative to a normal new customer relationship? Obviously, the distance between California and Mississippi is significant. Does that have any bearing on greater than normal transportation costs? Is there anything unique in the relationship that you can kind of point to that's obviously going to be a little bit of a near term headwind for you guys as you clearly have mentioned in your prepared remarks?

Yeah, I can brighten -- maybe a little bit more color around that, TC. It's not just California, as I mentioned in my opening comment. It's the Hawaiian inmates we're transferring, existing Hawaiian inmates; and then there are existing state of Arizona inmates currently in our facilities in the first half of the year that we're transferring back to the State of Arizona and replacing them in with the new Arizona populations.

So to kind of put that in perspective, during the second half of the year, we would expect to transfer about 3,500 inmates, some of them new, some of them existing inmates. So that's a pretty significant number of moves that are going to impact us on the transportation cost side.

And how -- can you remind us how transportation costs are handled from your standpoint? Is that a service where you guys generally try to be -- break even or is that a situation now giving some of the unique natures? Obviously you guys have been very forward-looking to the street on the Hawaii side. But as far as Arizona, that sounds like kind of a unique situation where they're taking back inmates and then sending you a whole new group of them.

Are we in a situation now where this ends up becoming just an incremental near-term expense for you or should we still be modeling this to be a break-even event on the transportation line?

Well, for the -- we're going to be picking up most of that transportation. The movement of the state of Arizona inmates is to allow us to take a larger number of inmates solely as to have a homogenous population there and avoid some operational issues that we had with mixed populations.

Hawaii, we're moving again to our benefit, to free up capacity at the other facilities. We're picking up the cost for Hawaii. And then California, is kind of a mix. We're picking up some of the cost; they're picking up some of the cost.

Okay.

On Arizona, once we get all the populations settled down there will be some transportation where they swap inmates out on a recurring basis, but that's been pretty much done historically and it's not anywhere the volume that we're dealing with today.

Okay. Perfect. And is it fair to assume that the Arizona population, kind of the swap if you will, that you should see a pretty substantial or healthy -- I guess is probably a better way to say it -- a healthy increase in the per diems with respect to your new contract for these new prisoners you're getting versus the existing contract of the existing prisoners?

I think we will see some improvements in our contracts.

Okay. And then, Todd, can you give a little bit more clarity? I just want to go back to the per diem comments that you had made in your opening remarks, particularly around the mix issue. I mean, I clearly understand getting the better profit dollars and filling up beds and getting some leverage there. The question that I want to ask around that is given the demand environment why would you look to price those beds at the highest rate available given how strong demand is? Can you give us a little bit of flavor around what's going specifically with those mixes? Maybe I'm just misunderstanding something.

Yeah, no, I think I can. We have existing contracts with an existing per diem outlined under that contract that we're obligated to provide inmates at that per diem. And we have a fair number of contracts where the per diems are substantially below our average blended per diem. So it's not like the airline industry.

We've got 50 customers; it's a relatively small base of customers. We need to maintain long-term relationships with these customers. We have existing obligations under existing contracts that would be difficult for us to go in and break that contract and negotiate a higher per diem overnight. We're going to obligate those contracts long term.

Where the opportunity comes in is where they come to us and want to make a change in the contract. They want an initial level of service or the contract comes up for re-bid. That's where we're primarily going to have the opportunity to negotiate the per diems higher. And so as our customers continue to have bed needs, they're going to use all available needs under our contracts at the current per diems we have, and again, some of those per diems are significantly below the average. And so as those populations on those contracts increase you're going to see a mix issue that impacts our average per diem increase year over year.

Okay. And then so is it -- would it be fair to say that the ability for per diem rates to increase over the long term is not done, this wasn't a situation where you were running per diems in that 4% range only for a couple of quarters? I mean, it seems to me that this will be kind of a stair-step function over the next several years with per diems. Is that a fair way to think about it?

Yeah, that's probably a fair way. Again, you're going to be frustrated when you look at our average per diem increases year over year because of the mix issue, especially for the next several quarters until all of our available capacity on those existing contracts is taken off.

And that's why I use the analogy for a stair-step where you might see somewhere it's a little bit slower, and then obviously as a function, like you said, that's mixed. Then you should see that per -- that average per diem look like it'd take a bigger step up for a near-term, and then back to leveling off and then another step up. Is that a fair way to think about it?

Yeah, it could be. That's probably a fair way to look at it. There's a lot of issues in place, and we've got 65 facilities with multiple contracts. The mix has a significant impact. That's just hard to model out simply without doing it on a detailed basis like we've done.

Okay. I'll jump back in the queue. Thanks, guys.

We'll move on to our next question from Emily Shanks with Lehman Brothers.

Hi. Good morning. Very nice quarter. I have just a couple of follow up questions. In terms of the Greenfield facilities do you have many more in your pipeline coming up?

We have several that we're working on. I think the only one that we have mentioned by name that we are giving some consideration is a facility here in Middle, Tennessee. Beyond that, I don't think we've mentioned but it is something we continue to work on.

Great. That's helpful. And then as I look at the G&A margins for the quarter, it looks like were slightly above what collections goal was of around 5 percent, and I just want to know if there's anything particularly driving this or is this a better run rate in the second half of the year?

Yeah, well, on the -- if you're looking quarter over quarter --

Yeah.

If you look at Q2 there are a number of items there impacting the increase there. One, we have an increase in non-cash stock comp expense. As you know, we're required to expense stock options. We accelerated the expensing of our options in 2005 with a one-time charge, and so you saw the first normal impact on G&A beginning in 2006. And each year that stock option expense will increase up through 2008 as we have a three-year vesting period on our stock options. It's going to take three years for that expense to normalize out.

Also, in Q2, we had additional expenses associated with the expansion of our real estate department as we have added resources to assist in the development of new beds. And then we also had a number of employee training conferences during Q2.

Great. Thank you. And then just one last question. One of your competitors released results this morning as well and indicated that an ICE contract was pulling out of the New Mexico location that they had. I'm not sure if you saw it or not, but I wanted to ask and see if you had any -- if you could provide any indications of if you're seeing a change from ICE and or is there any implications to corrects on this announcement?

We did see it. We have known about it for a few days because it became evident that ICE was looking for replacement beds last week, and they placed them around a lot of places. We can't speak to the issues there. I know we're very sensitive to making sure our customers would never come to our facilities and find the quality not meeting our standards. So I would hope it's isolated for [Point L]. I would believe that it is.

But we as an industry have an hurtle, right, on quality and security, and that's something that for all these conference calls every quarter and we talk about operating expenses and so forth, still the Number One priority of CCA is to deliver and hopefully exceed the quality that's expected by our customers.

Great. Thank you very much.

We'll take our next question from Jeffrey Kessler with Lehman Brothers.

Thank you, and good quarter. And I want to comment -- just make a quick comment on congratulating you guys on letting us know for the prior six months of the cost factors that are going to be involved in both transporting and putting in infrastructure for these prisoners. If the stock market -- if people are surprised by it this time it's because they haven't been listening to you folks for the last six months, not because it should be a surprise. Clearly, these numbers are in line and they're good, and your prognostication for the rest of the year for these higher costs should have been known already because you've said it enough. So I just want to congratulate you guys on at least putting us on alert way in advance.

Thank you. That's always our objective.

With that in mind, can we talk a little bit about your variable cost per compensated man day lines which has been bumping around 9 or 10; it came down a little bit in the first quarter. Now, what we're seeing obviously is with some of these extra expenses that you've taken on, that number is going to be moving up. But is there a -- is there a comfort zone that you have with that number either on an absolute or on a percentage basis that you think it will settle out at once you get through all of the -- with all the moving over the next two or three quarters?

I can provide color on that. (Technical difficulty) working hard to minimize the increase of the cost. Two, you -- I think looking forward, we haven't seen any indication that our -- will see increases above kind of what I call general inflationary increases, 2 to 3%.

Now, what happens in the variable cost line, and is a source of frustration for me, is forecasting (technical difficulty) predictability. There's a couple of cost categories that are all up in the variable cost. One is our inmate medical cost including the full-risk contract we have on medical, which can generate what we refer to as catastrophic medical (technical difficulty) made as a heart attack or as severely ill. And we're responsible for the first 48 hours, or in some cases, all the medical care.

And the problem with that is we haven't found a way to smooth out those costs like you would like to see from a forecasting standpoint. So we have to recognize those expenses as they're incurred.

Same is true on the inmate litigation expenses. You'd like to see those costs incurred smoothly over the year, but the reality is you have to recognize those expenses as they're incurred. And both those expenses can be rather chopped, and we saw a little bit of that in Q2 of 2007. So I don't know if that answers your question?

Yes, it does. With respect to California, one of the criticisms of the court was that even with a policy of sending prisoners out of state California, that was going to end up with something like in three or five years just 200 prisoners more -- less than what they have already in the system because of new prisoners coming in. And so I guess, John, this is directed to you. Short of turning out prisoners early and reaping the world of what we'll call newspaper headlines; short of sentencing -- complete change in sentencing policy or building or somehow getting together $15 to $20 billion, what alternative is there to private, and what's going to happen if both the private and the public function cannot handle the number of new prisoners that are going to be needed, because that appears to be what the situation is turning into?

Well, the governor feels that he has put forth a plan that will start to alleviate some of their immediate crisis. The most -- the quick fix for him is to transfer 5,000 inmates out of state, allowing them to take away what they refer to as bad beds, and those are beds that are in program space gymnasiums. And so they feel like that's a pretty quick fix.

And then the long-term fix is to continue to develop new mental health beds, to expand some of their existing facilities so that they can do the same thing. And then eventually they want to do another -- I guess if his goal is in fact 8,000, then do another 3,000 after the original 5,000.

But I guess it has -- the real long-term solution for California is going to be how well this Assembly Bill 900 plays out as it develops beds. But it would appear to me that they've got to continue to add capacity as they go forward, but it also appears to me that they're going to need the utilization of the private sector and out-of-state beds probably for sometime. But of course, we -- at the moment we know that they could end this on June 30, 2011. But the reality of the situation is that they've got a crisis situation, and how it's going to play out I couldn't say.

Okay. With regard to your occupancy rate, you've previously been running -- obviously occupancy rates come up over time over the last few years, but you've been running 92, 93, 94, 95%; and you always had a specific or at least a fairly substantial cushion in terms of beds versus design capacity. You're now running at 99%. You enumerated how much you're going to be bringing on. Can you give us some idea of over the next two years of what type cushion you are most comfortable running with?

You know, I'm not sure that I can tell you for sure. I think that one of things that we have now put in place is the 8,000 beds, that most of which will be available during 2008. We do have one Greenfield that looks like it will be close to the end in 2008. We did open up the Saguaro facility in June the 26th, so the 99% occupancy average -- comp state occupancy only considered a few days of that facility. Had that facility been there the entire quarter it probably would have brought that number down. '

So in addition to the 8,000 that's in our underdevelopment list you could add to that the 1,800 that we brought online at the very end of June. But I would say that we probably feel that we should have north of 5,000 beds and any point and time that future inventory.

What counts in getting there is the demand we're saying.

Yeah.

The other challenge is our balance sheet. We like to keep our balance sheet in proper ratios, and all this growth we're talking about at the present time is within the ratios of our balance sheet without adding additional debt. We certainly have a huge demand factor out there that went beyond this. We have other recourses, the equity, more debt; but at this point we're trying to balance demand and our balance sheet, okay.

Well, that was actually my next question. Given the fact that it wouldn't be a bad thing if you started going beyond the need, for say, 11,000 new beds, and the need went to 15,000 over the next two years or so, the equity markets would be an alternative and it wouldn't be necessarily a negative alternative for you folks.

Well, that's true. And just make sure to qualify what Bill is saying. He was talking about keeping our debt within the 4 to 1 ratio, which we count -- right now we're at about 2.9 or so, so we do have some capacity there. As our EBITDA grows then that really gives us even more capacity if you figure that we stay within the 4 to 1 that we have there.

Your covenant is at what?

Our covenant it's in excess -- well, right now it's in excess of five.

So we're in pretty good shape.

We have credit ratings we have to think about also, so we're trying to balance all these things and demand is one of the factors, but credit ratings and barring capacity and balance sheet are other factors.

All right. So we've got a self-imposed limit right now of 4 to 1 on debt to EBITDA.

Okay.

And if we stay within that we feel we have the capability for an additional 8,000 beds over the next couple years. But we are very sensitive to what's happening in the debt market today as well, so we're very circumspect as we add capacity that should require us to utilize some debt.

One final question and it revolves around prospects for 2008. Both the challenges you have as well as the possible RFPs that are out there, Number One, the challenge side you had a couple of competes for 2007, and it looks like you've come through them pretty well. What do you -- what is on the -- what actually is out there that might be competed for, management contracts that you may have ending in 2008?

And on the other side of it, are there the prospects for federal contracts or state contracts that we may not being knowing about right now that you may have some feel for coming in 2008?

Well there is a solicitation out there right now by the U.S. Marshal Service for 1,000 beds in within a certain mileage distance from Las Vegas. We expect that one to play out over the balance of the year. In fact the proposals are due the 15th of August and it will take a little while. So that's one that's out there.

We expect sometime in the next year or year plus, that the Federal Bureau of Prisons will probably be out for another criminal alien requirement. And as I pointed out in my comments there is funding for at least 1,100 new beds in the present fiscal year '08 budget. Traditionally they've gone out probably in the 1,500 bed range, so we would expect the VOP to be trying to meet their shortfall that I've described.

Beyond that, of course, there was originally a solicitation by the State of Idaho for some out-of-state beds, and we're going to be delivering some of those beds for them. I think that's the solicitations that we know about right now.

As you, again, go back and look at our development list we feel that most of those beds that have been brought online or to meet existing and growing customer demands that we have under existing relationships.

Did I miss anything Todd that you can think of?

Well, in terms of contracts that are coming up for potential re-bid we have a schedule in our supplemental disclosure that outlines the expiration of the base term and any remaining renewal options, and I refer to that. And you can assume that there's a remaining renewal option -- that's a pretty safe assumption they'll exercise it so those contracts aren't at risk.

And then right now it's kind of early. We don't have anything left in 2007 that's at potential risk. So 2008, and you can see the one's on that schedule of the supplemental disclosure says it's 2008. Right now it's early but we don't have any current concerns over our ability -- regarding our ability to renew those contracts but, again it's early.

Okay. And thank you very much, guys. Once again thank you very much for preparing at least some of us for the cost structure changes that you're going to have over the course of the next year. Thank you.

Happy to do it.

We'll move on to our next question from Kevin Campbell from Avondale Partners.

Thank you. Good morning. I wanted to ask real quickly back on the Cornell Regional Correctional Center, I didn't hear whether or not you guys actually had said whether you've actually received any detainees from that facility or not, or whether or not you can comment on that?

I think right now probably not a -- prefer not to comment.

Okay. Could you talk a little bit about the increase in medical expenses? I know you touched on that briefly, but was that -- were there any things that you expect to be sort of one time (inaudible) or is it just going to be choppier this quarter compared to others? Was it spread across a number of facilities or is it limited to one specific facility?

It was a handful of facilities, primarily it was a result of offsite medical costs on contracts we have greater medical exposure. And as I mentioned earlier, you will see some choppiness in those costs as well as in our inmate legal settlement costs as well from quarter to quarter. There is just some variabilities and volatilities there. I don't like it, but it's a reality you have to deal with.

And you mentioned -- and I missed the number on the actual California inmates that were transferred last night; how many new inmates were sent into Tallahatchie last night?

One hundred and twenty.

Okay.

At least that was the plan. I have not heard a report, but as I understand they were in the air yesterday.

Great. And then last I wanted to ask a question about just general demand from ICE. We had seen a report out of customs and border protection about arrests being down 24% or so year over year in the southern border. It doesn't look like you guys are having any problems with ICE in the number of detentions that you have, but if you could comment on that, that would be great.

Well, one of the things -- even though the arrests might be down the arrests are turning more into detainees than they have previously because in prior periods a fair amount of the arrests were just released. And with the removal -- the changing of the policy to catch and return a lot of detainees are now being held. And of course, what happens is that when they're detained in their various issues, such as seeking asylum, which they may have not previously -- if you were caught and released you didn't have to seek asylum. You kind of got it.

Now that they seek asylum then that means that they -- they're given the latitude to deal with that, and that sometimes that means some of the detainees are staying longer. And then we do hear from time to time increase in the interior enforcement that wouldn't be a border arrest. It would be somebody who's been here that their now detaining. It may be down, but I mean, based on what we're seeing the need for beds continues grow.

And the average stay, has that changed at all for the detentions? Are they going from -- was the average stay two weeks before and maybe now it's four weeks? Have there been any change there?

You know, that's a good question. I don't know the answer to that at the moment.

Okay. Thank you very much for taking my questions.

We'll move on to our next question from Barry Stouffer from BB&T Capitol Market.

Morning, gentlemen. I have two questions. I want to revisit the G&A question. The expense level we saw in the second quarter, is that representative of a run rate going forward?

It'd be a reasonable estimate, yes.

Okay. And just curious if you have any concerns about competition in general; have you seen any behavior out there that troubles you?

Anything in the competitive that troubles us? No. I feel pretty good. I mean, obviously it would be wonderful being in the chocolate business and Hershey's on strike. But I think as we've mentioned, I think what our business model is to try to anticipate the demand that's out there and try to have the beds available when they are needed. And although we have seen some of our competitors starting to do a little bit of that, I think they do have some balancing constraints that we don't have.

And as we've mentioned, right now it'd be our assessment that the demand in the marketplace at the state and federal level is such that we're all put together probably not going to meet the total demand.

Okay, thank you.

Our next question comes from [Eduardo Arbush] from Millennium.

Hi. Thank you. My question has already been asked.

We'll take our next question from [Eric Anderson] from Ivory Capitol.

Morning, guys. As we think about pricing going forward you gave some positives and some negatives. Obviously, a positive being a lot of your re-pricing being effective July 1, as you mentioned; but the negative being that mix is going to continue to be a headwind. Adding up these puts and takes is it reasonable to assume that owned facility per diems in the second half of 2007 are below the 2.8% you guys saw in Q2?

I'm sorry, can you say that one more time?

Is it reasonable to assume that owned facility per diems in the second half of 2007 are below the 2.8% year-over-year increase based on Q2 '07? You guys noted that we'd probably be disappointed with second half of '07 pricing so I'm hoping you can give a little additional color on that.

Well, yeah, again to the mix it's not so much a negative as how it impacts the average. For example, my average per diem is $54.00, all right. I've got a fair number of contracts substantially below that. So let's pick a number. Let's say I receive additional inmates in at $45.00 under an existing contract. So $45.00 is substantially below the $54.00. But if there's a lapse under inmates in to the facility they come in very, very attractive margins, right. So I can get in a $25.00, $30.00, $35.00 margin on a $45.00 per diem if there's a lapse coming into the facility.

So you'll see in the margin a nice pick-up in EBITDA at an attractive margin rate, but you won't see that transfer over into the blended per diem increase because they're coming in at $45.00. Does that make sense?

It does make sense, and I guess I was just kind of --earlier you mentioned 65 facilities and how this blends together, and I just didn't know if there's additional color you could give? If -- for -- and I was just trying to put it in context of the 2.8% in Q2. I mean, should we expect even weaker than the 2.8% year over year just as we think of the average itself?

Yeah, we typically haven't been giving guidance at that level of detail. In terms of what our average per diem increase is going to be in Q3 or Q4, whether it's going to be above 2.8 or below 2.8, we typically haven't been given that level of guidance. I know you'd like to have it. We just haven't typically parched it out at that level of detail.

Okay.

We'll move on to our next question from Ben Joseph from Rice Voelker.

Thank you, guys. Most of my questions have all been answered though.

We'll take our next question from Todd Van Fleet. Mr. Van Fleet, your line is open, sir.

He's probably made it down to the Cornell call.

We'll go ahead to our next question from TC Robillard. He has a follow-up question with Bank of America Securities.

Actually, John, can you give us a sense obviously a little bit more on the new bed construction than even what you were talking about last quarter? What -- aside from California, what else is out there that you guys are seeing that's giving you increased visibility, increased confidence on the demand front? Is there anything that you can point to or give us some additional color on?

Well, on the federal side we believe that we'll continue to see a percentage growth by the Marshals. We believe that in the end there's got to be additional funding for ICE beds. As I said, they're now at -- fund is for 27,500; they're running at 32,000. So that gives us some comfort that somewhere -- we don't know what the compromise is going to be and can't speak to that, but the emergency funding for up to 45,000 is maybe not where it's going to be. But anyway, we just have a feel that we are just going to have state funding for additional ICE.

And then the Bureau of Prisons continues to be -- pin-up demand. They're an agency that -- it just has to go about it in a much more methodical way. They do not use intergovernmental grievance; therefore, that gives them the speed sometimes to move with what they have. And then they can -- so their appropriations are much more specific. But as I said, they're 34% over capacity. They're 16,000 beds shortfall between their forecast and what they're bringing online. So we feel -- so at the federal level we just see all those.

But at the state level, we mentioned Arizona and California that we see a good more than half than of the states -- remaining state customers we have are experiencing situations that are going to require needed beds. So we're quite bullish as it relates to fulfilling the needs of our customers. Of course, some of that's shown in some of the expansions that we have today.

Okay. Great. Thanks for the color.

(OPERATOR INSTRUCTIONS) We'll take our next question from Eduardo Arbush from Millennium.

Yes, hi. More of an opportunistic question here. I'm looking at the stock down 13%. I'm wondering -- I mean, you've discussed this in past calls, does it ever become trade-off in terms of buying back your own stock and growth -- I mean, for growth sake? I mean, how do you guys think about that in terms of balancing returns to shareholders?

I think a probably great opportunity to ask the question but it's probably getting ahead of what we would be considering based on the options we look. Right now, we feel that it is pretty bullish for our shareholders that if we can add 8,000 new beds as well as the ones we brought online the last 24 hours, and at the end of 2008 have the same bed structure. And then also have the leverage that we have on our balance sheet to expand, that that's where I believe our shareholders will be rewarded the most.

But your question is one that I think any board of directors is going to have to give consideration as they weigh the options for advance in the value of the shareholder.

Okay. Well, thank you very much.

And at this time, gentleman, there are no further questions. Thank you.

Well, thank you all. I'm going to try to summarize, and then there were a couple of questions that came up that I think I may add some more color to also.

Todd reported that our sales were up 10% for the three months and 11.5% for the six months; earnings per share up 24%; our EBITDA is up 18%. Our free cash flow is $42.4 million for the quarter, a little bit down from 2 '06 but we had a considerably higher tax payment. Our occupancy at 99% compared to 94.9% in 2006, and that's with the addition of 3,000 more beds this quarter.

Somebody raised the question about the compensation per man day. Todd answered it that you can't just look at that, that many times we get people in where we get these higher occupancies and we get a full flow through of all the revenue because all our fixed costs are covered. So I think you got to look at our operating margins, and we're up to 29.1% compared to 27.6% in 2006.

Another issue that occurred in the first quarter were the $1.9 million of operating costs for opening Saguaro. Todd has forecasted or we're forecasting $0.23 or $0.25 for the third quarter, $0.26 to $0.28 for the fourth quarter and $1.01 to $1.05 for the full year. And Todd has said and John has said, and I've heard some of the people on the call say that these earnings per share are affected because of the margins being affected because of our relocations, receiving new inmates and trying to balance them out in the various facilities with additional transportation costs, disruption costs and startup costs. In addition, as we add these new beds, we get increased depreciation.

John gave a great report on our future demand, and the Pew Report, which is the best guidance we have for the future, says they need 162,000 new beds in the states in 2011, and 98,000 of those beds occur in the 20 states where we do business. And a good example is California now expects to give us 4,500 inmates through 2008.

John mentioned the Bureau of Prisons. They're well-over capacity and have been. They're 199,000 beds and 33% over capacity. They're going to need 30,000 by 2011. They're only funded for 14,000 to build in that period of time. So either they have to get more funding or go outside for the other 16,000-bed shortfall.

The Marshal Service is growing at 5%, and we actually have been growing at higher rates than that with the Marshal Service.

ICE is an issue regarding funding at the present time. They've got 32,000 people in their beds and they only have funding for 27,500. It looks like they're going to need 45,000 beds in the next two years, so they need more funding and we believe some of these will be private beds.

The whole discussion came up -- one gentleman asked about buying back stock. Well, I think if you look at what we're trying to do because of this demand factor we think the best utilization of our cash and our born capacity is build new beds, which generate the best value for our shareholders. As John has indicated, we've got 11,600 beds available through 2008. That's 8,000 new beds, and the 3,600 that we have that are still within the system. And I think he indicated that would be generating $84 million of EBITDA, and that's with no additional borrowings.

And the other area that we discussed was that we still have another $400,000 available from future cash flows and borrowings to build another 8,000 beds for future growth in 2009.

And one of the things we don't talk about too much in these calls because we're namely talking about earnings and projections, but the question came up about quality and security. And these are two of our fundamental operating principles, but they obviously have a cost. And over the long term, even though we're spending money for these, we believe it benefits us through better relations with our customers, which ultimately generates more business for us.

So as you think about all these earnings projections and where we're going, we're doing this with the highest quality and security in the industry.

So I thank you for your attention today, and we look forward to our next earnings call. Goodbye.

And that does conclude today's presentation. We thank you for joining. Have a wonderful day.