CoreCivic Inc (CXW) 2008 Q2 法說會逐字稿

Good day, everyone, and welcome to Corrections Corporation of America's second quarter 2008 earnings conference call. If you need a copy of our press release or supplemental financial data, both documents are available on the Investor page of our website at www.correctionscorp.com.

Before we begin, let me remind today's listeners that this call contains forward-looking statements pursuant to the Safe Harbor Provisions of the Securities & Litigation Reform Act. These statements are subject to risks and uncertainties that could cause actual results to differ materially from statements made today.

Factors that could cause operating and financial results to differ are described in the press release, as well as our Form 10-K, and other documents filed with the SEC. This call may include discussion of non-GAAP measures. The reconciliation of the most comparable GAAP measurement is provided in our corresponding earnings release or are posted on our website.

We are under no obligation to update or revise any 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 our Chairman of the Board and CEO, Mr. John Ferguson, and Chief Financial Officer, Mr. Todd Mullenger.

I'd now like to turn the call over to Mr. Ferguson. Please go ahead, sir.

Thank you, and I also welcome everyone to CCA's 2008 second quarter conference call. In the room with Todd and me is Dave Garfinkle, our Vice President of Finance, and then also attending is Damon Hininger, recently appointed President and Chief Operating Officer.

So we will begin with Todd and the opening comments about our second quarter results.

Thank you, John. And good morning, everyone. We are very pleased with our second quarter operating results, so let's move straight to a summary of those results.

In the second quarter of 2008 we generated $0.30 per diluted share, compared to EPS for last year's Q2 of $0.26 per diluted share, representing an increase in EPS of over 15%.

EBITDA increased 14% to $96.7 million for the quarter. Adjusted free cash flow for the quarter increased 33% to $56.4 million. The growth in adjusted free cash flow is significantly higher than EPS growth due primarily to changes in depreciation expense and maintenance CapEx. Depreciation expense increased 17% over 2007, while maintenance CapEx decreased 34%.

The increase in depreciation expense obviously has a negative impact on EPS, however, depreciation expense is added back in arriving at adjusted free cash flow, while maintenance CapEx is deducted. As we've discussed on prior occasions, unlike other industries, our depreciation expense is not reflective of the maintenance CapEx that we will incur to maintain our facilities.

For example, depreciation and amortization expense totaled $22 million for Q2 2008 versus just $7 million of facility maintenance and IT CapEx in Q2. So as we have commented before, we believe adjusted free cash flow is in many ways a better measure than EPS of the return we are delivering to our shareholders.

Total revenue for this year's second quarter was up 10.2% over last year, an increase of $36.8 million. Total compensated man days in Q2 increased 5.8% compared to the previous year. And revenue per compensated man day in Q2 increased 4.8% to $56.69. Now, while compensated man day's increased 5.8%, average compensated occupancy for the second quarter actually declined from 99% to 97% as a result of placing approximately 7,200 new beds into service since the first quarter of 2007. 2,600 of these beds were placed into service during the first half of 2008.

With regards to the 5.8% increase in revenue per compensated man day, results in Q2 2008 reflect the impact from certain pricing leverage we enjoyed from renegotiating several contracts, the increase in populations under our State of California contract which pays an above average per diem, as well as routine per diem increases.

Moving next to a discussion of operating costs, operating costs per man day for Q2 2008 were $39.46, a 2.9% increase over Q2 2007. Our Q2 2008 operating costs per man day reflect normal wage and other general inflationary increases, as well as operating inefficiencies associated with the ramp-up of new bed activations at facilities, such as Tallahatchie, [North Fork], [Cape Carson], [Bent County], and Leavenworth.

As we have discussed previously, the operating cost per man day on newly activated beds start off higher as we are ramping up fixed costs, particularly staffing cost, and then decline as we increase occupancy which allows us to leverage those fixed costs lower on a per compensated man day basis.

Operating margins per man day in Q2 2008 increased 9.5% to $17.23, with an operating margin percentage of 30.4%. As a result of the operating cost inefficiencies we just discussed, margins on inmates placed in newly developed beds will be depressed during the facility ramp-up period. However, the margins per compensated man day on new beds will improve over time as we approach full occupancy on those new beds. And we experienced some of this improvement in Q2 as we filled additional beds at facilities, such as Tallahatchie and North Fork.

General and administrative expenses for the quarter were 5% of revenues. The increase in G&A compared to Q2 2007 was due primarily to the expansion of our real estate department, as we added resources to assist in the development of new beds, increased focus at the corporate level on quality and efficiency at facility operations, and an increase in noncash stock based compensation expense related to the change in accounting rules. Our goal is to keep G&A at approximately 5% of revenues going forward.

GAAP income tax expense for the quarter was computed based upon a rate of approximately 38%, and we currently anticipate a rate of 38% for full year 2008.

So, in summary, we are very pleased with our second quarter operating results and with the progress we've made developing and activating new capacity to meet the demand for prison beds.

I will finish with a discussion of our guidance for 2008. As indicated in the press release, we have updated full year guidance to a range of $1.21 to $1.24 compared to previous guidance of $1.21 to $1.28. The guidance for Q3 is in a range of $0.29 to $0.31, in Q4 in a range of $0.33 to $0.35.

We have revised guidance primarily as a result of delays we have experienced in the intake of inmates under our contract with the State of California. These delays have been necessary to ensure that we're in compliance with certain medical requirements as set forth by the Federal medical receiver appointed to oversee healthcare delivery to State of California inmates.

Unfortunately, these delays have caused us to revise our occupancy and revenue forecast for the balance of 2008. However, it's important to note that our relationship with the customer remains strong and the State of California continues to express its intention to fully utilize all of the 8,132 beds available to it under our contract.

As previously mentioned, margins on new inmates placed in new beds will be depressed during the facility ramp-up period, but will improve as the facility approaches full occupancy. Given the anticipated timing of these new bed activations we expect to see accelerating year-over-year growth in margins, EBITDA and EPS, especially in Q4 of this year.

One of the primary risks to our guidance continues to be timing around the receipt of inmates. This continues to be a risk with the State of California contract. It is important that the ramp-up of all new inmates occurs as smoothly as possible. As such, the ramp-up of California or other inmates may be slowed from what we currently expect. However, should there be a shortfall in our expectations, we are still optimistic that demand from customers will ultimately fill our beds, albeit it over a longer period of time.

As discussed on prior calls, now that we've begun developing a large number of beds through construction, this will obviously result in increased depreciation expense as the beds are brought online. A good rule of thumb to use in estimating the annualized increase in GAAP depreciation expense is to take the total investment cost in a project and divide by 37 years.

As far as funding this new development, we believe that cash on hand, free cash flow from operations, and capacity available under our revolver will allow us to fund all development projects announced to date.

Overall, the outlook for our business remains quite favorable. The projected demand for additional prison beds, combined with our new beds under development, and our ability to fund further development provide CCA with significant opportunities for growth.

I'll now turn it over to John for specifics on our new business prospects and bed development.

Thank you, Todd.

I thought I would deviate a little bit from what we've done previously. I guess it's obvious that some investors have interpreted our new guidance as negative, as demonstrated I think in some of the transactions already this morning. So I wanted to, I guess, remind everyone of the business case for Corrections Corp., what we do, and what we think is still an outstanding environment, and that we're strongly positioned to benefit from the environment.

Globally, we are still seeing some 40,000 to 60,000 net new inmates coming into the National Corrections Systems every year. We're seeing government spending money on things other than prisons, and as I think many of you have heard us express, don't know what changes that could come about that would change the dynamics of a continued need for new prison beds and the desire of government to spend their money on things other than prisons.

As you have heard us express in the past, as you look at the 20 state customers that we currently do business with, we see that those 20 states are growing at an above average percent compared to the remaining states.

Since the January 1 of 2005 we've received over 16,000 new inmates into our system, and as we look at this demand we continue to see that the only hindrance to our ability to continue to grow the Company is to make sure the beds are available when our current customers and some prospective customers need the beds.

As we look at the 20 state customers and the 80,000 new inmates that are forecasted to be needed, new inmate beds to be needed between the end of 2007 and the end of 2011, we can only identify about 8,200 beds, general, what we would call general population beds, coming online but and funded between now and 2011.

Specifically, there are a couple of solicitations out there. Florida has a solicitation for 2,000 new beds. They have a solicitation for about 500 [work count] beds. The State of Arizona recently reissued a 600-bed out-of-state solicitation, and have within the last week or so have increased that to 1,200. Of course, the State of Texas is rebidding some of their current bed needs, contracts. And the State of Hawaii has an active solicitation for female beds, which would -- we are offering the continuation of the beds that we provide them at our [Otter Creek] facility in Kentucky.

We see the forecast for the Federal Bureau of Prisons to be consistent with what we have been saying previously. You have a system that's running at 37% over its rate of capacity. Has identified, some 15,000 inmate bed needs between now and 2011, and the additional capacity today of secured is only 8,500.

And then, of course, we refer to the recent solicitation by the Federal Bureau of Prisons for up to 4,000 new beds in their [Car 8] and [Car 9] solicitation. And, of course, we've responded to both of those solicitations to be able to provide all of the 4,000 bed capacity should they look to CCA.

And, of course, we continue to see the U.S. Marshalls' growth in the number of detainees under their responsibility, by some 7% each year over the last five years. And, of course, we announced last quarter that we had been awarded a contract for 1,072 beds for the Las Vegas District.

And then we've announced that and we've said that the ICE needs are really limited to the funding, and we see that some, from 1,000 to 1,400 new beds to be funded in the '09, the difference being the Senate and the House.

So, again, we continue to see the same demand that the United States has experienced over the last five years continue, and so we believe that the opportunities for CCA to benefit from this continued need by our government customers and deliver what we would feel is a meaningful public service is brought on by the fact that we, today, have some 14,500 beds either in our inventory or being developed through an expansion or a Greenfield or new facility.

And as I look at the visibility on those 14,500, I see that almost 6,000 are under contract, specifically, for those beds. We have another 3,800 or so in which we are building beds in a system in which we already have a customer relationship and the opportunity for them to be able to meet their inmate growth by the expansion of existing relationships in existing facilities.

And then, as I mentioned, we have bid -- our Adams County Facility of some 2,232 beds into Car 8. Don't have any assurances that we would be the prevailing provider, but we feel pretty good about where that facility is and how it fits into the requirements of the Federal Bureau of Prisons.

So that leaves just about 2,500 beds that really have no strong visibility, that of course we internally feel we have the visibility. And, of course, of that 2,500, 2,000 of it is our Trousdale, Tennessee Facility, that we announced about six months ago, that will not be completed and available until the beginning of 2010.

So, again, strong demand we see continue, and the position that we find CCA in with its national platform of customers, both state and federal, and pretty good visibility to utilize the beds that we are bringing online.

In fact, if those beds were to be completely utilized over some period of time, we estimate that if we just maintain the same margins that both owned and managed that we did in the second quarter of 2008, that would generate some $118 million of net additional facility EBITDA and, of course, that compares to the $97 million of EBITDA that we just announced in the second quarter performance.

I have stated on many occasions that this 14,500 beds, a good portion of it is future expansions and new development to be brought online in the next 18 to 24 months, but that if we were to decide that we were not going to develop another bed, that we could fund that growth out of our cash on hand, our free cash flow from future earnings or potential future earnings, if it would just match what the last 12 months were, that about mid 2009 we would finish the construction and would have been able to take our revolver back down to zero, except for the [lows] of credits that are managed there.

But, as we have demonstrated so many times, that what are the opportunities for this Company to continue to meet the demand in 2010, 2011, and beyond, and that if we were to leverage the balance sheet up to 4, which we feel is in a comfortable leverage, and with the potential for adjusted free cash flow that would just match our last 12 months, that we could develop some 12,500, 12,400 additional beds to meet what we believe is going to be continued demand by our state and federal customers.

So we feel pretty good about the macro environment for what we do. We see nothing that changes there, but as we've expressed we're in a business that we can't control the timing of receiving our inmates, that sometimes it's not if, it's about when, and we do our best to try to understand the expectations. But I think we've mentioned on many occasions that this is not a quarter-to-quarter business, but one that should be looked upon as long term.

Now, before I finish up my comments, I want to add a little bit to what Todd mentioned on the State of California. It is a meaningful relationship that we begin developing in the end of 2006. By the last half of 2007 we were able to expand our relationship with them because we had the beds available, we could respond to their needs, of trying to find beds for 8,132 of their inmates to eliminate what they referred to as "bad beds." So we're pleased that the State of California has developed this relationship with us, this partnership. But when we entered into it I think we knew that there were some issues around the fact that their healthcare system was under receivership.

But, so let me just wrap-up my comments by saying that we, as of the end of July we had 4,609 California inmates in our care. And this is in six different facilities, so it's not like one, it's in six. And since the first of 2008 we've averaged 365 inmates into the system per year. And as Todd mentioned, we believe our relationship with the California Department of Corrections and Rehabilitation remains strong, and they continue to express their intent to utilize all the contract beds that we have with them.

But, however, the activation of the final expansion phase of our Tallahatchie Facility has been suspended while we work with CDCR and the Office of the Federal Receiver to ensure that the healthcare delivered at this facility is consistent with the standards that have been set by the Office of the Federal Receiver.

When we entered into this new relationship with the California, we were aware of the oversight and guidance of what is the California Prison and Healthcare Receivership Corporation, which manages the medical care operations in the California Prison System as a result of a class action lawsuit, [Plata] is the name there, which is crucial to the operation of all of the facilities housing California inmates, in State, as well as inmates housed out of State in the California system.

Therefore, we recognize that a key aspect to our continued success as a partner to the State of California is our ability to function within the regulatory and legal environment, which is unique to the California Prison System. While the delayed intake at Tallahatchie Facility has caused us to revise our ramp-up schedule for the remainder of the year, we believe that the work currently being done to develop a healthcare delivery system which is in keeping with the Plata standards will ultimately be beneficial to all CCA Facilities housing California inmates.

And is a necessary step in the development of our overall management strategy for California population, and we, of course, appreciate the support and efforts on behalf of our partners, the CDCR, as well as the Office of the Receiver, as we continue to pursue the safe and secure activation of beds under our contract.

The next thing I want to do is, one, make a comment or two about Bill Andrews. Obviously, we announced some changes in the leadership of CCA, and I can't say enough about the leadership of Bill Andrews as the Chairman of the Board since August of 2000. He's been an outstanding mentor to me, and been very helpful in developing what I consider is a very strong, independent Board, which has led us to being in the top 100 companies as identified by the Corporate Responsibility [Act] Officer Magazine, so we think that's quite a statement about the governance of this Company. Of course, Bill is going to stay on as a Director and continue to assist me when I need.

But I'm also proud to be able to acknowledge a new role within CCA. It's President and Chief Operating Officer, and proud to be able to recommend to the Nominating Committee and, subsequently, then to the Board, this new position for Damon.

Damon has been with CCA for 16 years. Uniquely, beginning his career as a Correctional Officer in our Leavenworth Facility, spent about half his career in operations, and then the other half of his career primarily in the business development area. So Damon has been around on almost all major decisions that have been made since I've been here, since August of 2000.

So just thought that we would introduce Damon, and maybe let him make a few comments. And then, with that, we'll open it up for questions and answers.

Thank you, John. And good morning, everyone. Let me first say that I am honored and humbled by this opportunity. Being with CCA for over 16 years, the opportunity that has been afforded to me to be a leader of this Company is truly the capstone of my career.

As many of you have read, I started with the Company about five months after graduating from Kansas State University. The Company has afforded me many opportunities over the years, and I obviously believe strongly in our mission and vision.

With that long term, I don't want to be anywhere else. As long as I'm providing value to the Company, our shareholders, and our customers, I plan to stay with the Company and raise my family here in Nashville for as long as you'll have me.

Finally, I seek to take the baton and continue on CCA's current management path. John has gone about the business of selecting and placing an extremely talented and passionate Management Team, that has executed against our long-term plan.

One final comment, if I can. Obviously, my initial priorities are to complete seamless handoffs with our federal and local customers with our new leadership within business development, which is ongoing right now. Additionally, I'm working closely with our operations, business development, and real estate leadership in the coming days and weeks to better understand their important contributions to our Company, and how they can further contribute to safe, secure, and just in time solutions to our government partners, and to increase the value to our shareholders by driving growth.

So, with that, let me turn it back over to John.

Okay. Operator, we are ready for questions.

(OPERATOR INSTRUCTIONS.)

And we'll take our first question from Todd Van Fleet of First Analysis.

Good morning, guys. I want to pursue a line of questioning on the issue of the morning, which is California. And you had mentioned that the Tallahatchie Facility is, I guess you singled out Tallahatchie as being a facility that pertains to this issue. Is it just Tallahatchie? Is it that we should expect a slowdown of inmates into facilities beyond Tallahatchie? If you could address that first?

Well, we can't promise what that's going to be. We continue to receive inmates. We do not believe that it would go beyond Tallahatchie on any suspension. In fact, we're doing some movement around and maybe even increase the availability in some of the others. That hasn't been completely worked out.

We will say that one of the things that is going to be an outcome of this effort in dealing with the expectations and the standards of the receiver is that it will probably drive some actions in some of our other facilities, once we work through the issues at Tallahatchie. There appears to be some desire by the receiver to like modify the medical staffing, so that we have more RNs than LPNs, and there are some processes that they feel are important.

So I'd say that we don't see at the moment that there would be any suspension of any of the other five facilities, but we do believe that we're going to probably be developing a little bit of a roadmap of some of the requirements that we may have.

And, again, we knew when we went into this transaction that it was going to be a unique relationship, because the California was, had -- their healthcare system had been taken over by the Federal Courts, and then we had to deal with it. But I guess to answer your specific question, at the moment we don't see the suspension of any of our other facilities.

Okay. So California has sent officials to Tallahatchie to review the healthcare environment there, and they have indicated that they would like to see a change in the personnel, or is there PP&E that needs modifying here, too, with respect to Tallahatchie?

PP&E being?

Property, plant, and equipment. No modifications on bricks and mortar, no.

Okay. So it's just the personnel that are available to the facility to provide care for the inmates?

Correct. And the policies and procedures and all those kinds of things ...

Okay.

... that certain expectations that we will be making modifications to meet.

Okay. And Tallahatchie is -- have California officials visited the other facilities, so [Florence], North Fork, and the others? Do you anticipate that this issue -- I know you had said that you're making plans to make sure that these issues don't affect the other facilities, and you don't foresee them affecting the other facilities, but I'm just wondering, California's due diligence and their exercise, have they visited these other facilities?

Yes, in fact, we -- California cannot transfer any inmates to us without the approval of the receiver, so that's been a process that's been in place since the very beginning. And we do know that, I personally can't say that they went to every facility. I believe that each of the facilities was reviewed by the receiver before we began the ramping up of any of them, but whether they did it to every single one of the six, I can't say that for sure, but I believe that I'm correct there.

Okay. So, and if I look at Tallahatchie then the capacity of that facility after the final expansions are put on, I think is about 2,700 or so. It appears today that they have about 1,600, 1,700 in that facility. So it appears that maybe a thousand is kind of what the exposure here is. In terms of if you expected 6,000 by the end of this year, maybe going back a quarter or two quarters ago, is that number now 5,500, is it 5,000? Can you help us calibrate that?

I'm sorry, I was looking for my numbers on Tallahatchie. Ask the question again?

So just to recap, the capacity following the expansion, I think it's the second expansion or so, gets you to about 2,700 in that facility. And California has about 1,600, 1,700 inmates in that facility today. And so that would seem to be we're going to put a hold on about 1,000 of these inmates?

Let me -- it would be, it's 848, we have 720-bed expansion that came online close to the end of the second quarter, and then we had 128 beds, which you can see in the press release, that come online here in the next month or two. So that was the beds available. The facility is 2,544, but I believe we -- if this is correct -- we continue to hold 80 beds for the Tallahatchie County Jail.

Okay.

So ...

So I'm just trying to calibrate, John, going back ...

... about 800 is what the suspension means currently.

Yes, but going back, it seemed at the beginning of this year, you had expected maybe 6,000 inmates to sent out of state by the end of this year, and I think that was the CDCR's expectation, as well.

Somewhere in that range, yes.

Right. So at this point, given what you know today and given that it's just Tallahatchie that appears to be impacted by this issue at this point, is that number -- it wouldn't seem as though they're going to put a hold on the entire 1,000 for the rest of this year. Presumably, because it's a personnel issue, it should be fairly quickly rectified, I would imagine, before you can get back on track, maybe no more than a month delay.

Again, I'm just trying -- I'm just, you know, thinking out loud here about the types of delays that we're going to see and try to calibrate the magnitude. So is it now you're expecting maybe 5,500, 5,800 for the full year versus the 6,000 that you had expected previously?

You know, you caught me -- part of our growth is going to come from the expansion of La Palma, and we have now received the first 400 or so, I believe, inmates since that was activated, and we are opening up housing units every period of time. We believe that that -- we should be able to have if things go like they should, and we anticipate a couple thousand of the beds utilized within La Palma, so that's another I guess 1,600 or so we have there.

So I would say that -- I hate to lead you to a number, but that we do think that there's a chance that we will be able to begin to utilize some of the Tallahatchie beds in the last part of the year. Again, as an expectation that it's going to be tied to some work by us, so.

So at this point you don't want to stick to your 6,000?

I mean, you know, we -- this -- if you go back and probably look at the first ramp-up schedule we did when we had a 5,000 bed contract, and then it was expanded to 7,800 and something, and then we added the 360 at Red Rock, and each time we've done it we've -- it probably has been modified in some way.

And we also have done some things within some of our other facilities so that we can stage the inmates, in other words, receive them before they go into their final designation. So I guess without -- I'd be reluctant to try to give you an exact number.

But if I could add to that, Todd, a little more color around that, we have accelerated intakes at a couple of our other facilities, such as La Palma. The challenge is at La Palma we have to add additional staff for those initial intakes. At Tallahatchie, as we sit today, we have essentially that facility fully staffed.

So all of our fixed costs are essentially in place at Tallahatchie, which means that incremental margins per man day on additional inmates at Tallahatchie are very, very, very high, and so the additional inmates at Tallahatchie I incur additional variable costs.

So call it an average variable cost, $10, $12 a day, which means you can take that revenue per day on those inmates, subtract out the variable cost, that's my average margin per man day at Tallahatchie. And then I've got the drain, since I've got the facility fully staffed, I've got the drain on my P&L of those staff sitting there without any inmates to supervise.

Right. Okay. That's very helpful. I'm sorry to take up so much time, but if I could just ask a big picture question on California then? They've got the three judge panel trial starting in November. You've got the State still, legislative body fighting with, amongst one another, still can't get a budget out.

Do you expect -- what do you hear out of California? Is it your expectation that they might continue to try to move further ahead of this meeting in November, this trial commencing in November, to help alleviate what is presumably a growing problem with respect to their overcapacity situation?

It'd be hard for us to make that call. I think that if you go back to [AB 900] the -- which was the authorization of allowing some out of state inmates, as well as, I think it started out with 32,000 beds, I think it could grow to 53 and so forth, the only piece of that that's working is the piece that we're participating in. So if California is almost a year-and-a-half away from authorizing new beds, and they really to our knowledge have not really started on anything, it would seem to me that's not a bad solution, but I don't know how to call that.

Thanks.

We will go next to Kevin Campbell of Avondale Partners.

Great. Just a couple quick questions on California, before we move on to something else, when was -- when did you guys receive word from the State that they were going to suspend sending inmates to Tallahatchie?

You know that, there was a lot of that activity over a fair amount of time. I guess we begin to realize what the expectations were in a visit that we had out in the first part of July. And then, at that time, I guess we were then beginning to say, "Okay, what is the affect that we would have on our guidance?" And I'd say we probably began to have a real appreciation for what were the expectations as we began to plan for this call, and once we closed our books on June 30th and began to do other things, so.

Okay. And looking at California, you had previously talked about some expectations of having the transfers complete by March or April of '09, do you have any idea whether or not that's still their expectation? Do you think that's reasonable, something that you could achieve, or given these delays at Tallahatchie, maybe it's more likely to be second quarter, third quarter '09 type of a finish?

Well, say, Tallahatchie, we believe that the commitment to utilize all the other beds in the timeframe that we previously discussed has not really changed. And so the only thing that I think probably could affect that would be if for some reason we didn't bring online the last beds in March of 2009.

Okay. So in looking at Tallahatchie, you guys did just complete a 720-bed expansion, you said, in the second quarter, and there's another 128 that's still to come in the third quarter?

Yes.

Okay. And you haven't stopped construction of that 128 or anything like that?

No, no.

Okay. Okay. Could you talk a little bit, too, looking at the ...

Remember that the ...

Go ahead?

... that there was one other expansion before the one that was -- we had 720, they were online in the fourth quarter of 2007, so.

Right.

But this is ...

Yes, I think that caused at least a little confusion from our part, because I know there were -- I thought there was two 720s.

That's correct.

I think, and regardless. Could you talk about state budgets? Obviously, we're seeing a couple of budgetary issues at various states. What do you guys expect to see on a consolidated basis in terms of the rate increases for this next fiscal year for state budgets? And then perhaps federal budgets, as well?

Well, most of the action that's going to take place at the state for the funding for the fiscal year beginning July 1, 2008 has taken place. We still have California that's out there, that has not done their budget. I would say that the answer, without going into [parsing] too much, is that we did get an increase with the majority of our state customers, and those increases range from 2% to 5%. So it was not a real bad year, but we did have a few states that did not give us an increase. But the majority of them we did get increases.

So on a consolidated basis, even taking into account those where you didn't get an increase, a typical sort of 3% wouldn't be unusual?

Well, you know, I hadn't tried to average what it is. I just gave you the range.

Yes, okay.

I know that we got, the 4.25%, which we've talked about on several occasions, at Colorado and some others, so I don't know what the average would be, because we couldn't just average the percentage there, we'd have to take each of the dollar amounts and average that, so.

Okay. Could you talk a little bit about what you're seeing on the cost side of the equation? Any inflationary pressures for food and utilities, healthcare costs, labor?

We can -- I can address that, try to address that. Looking at wages, general inflation continuing at its current level for an extended period of time, right, so inflation is up nationwide, if that continues for an extended period of time, that could put upward pressure on our wages nationwide for all employers. However, a recession could also provide some relief as the unemployment rate increases, so it's really too early to tell on wages. We just gave merit increases to our 16,000 employees effective July 1st and it was, call it in kind of the 3.5% range.

And then we're going to have some markets, just like we do every year, where the labor market is a little tighter and we have to adjust wages north of that on a handful of facilities. But that's really been no different than it's been in past years.

Food service, I think as I mentioned on the last call, all of our food service is outsourced under a contract through December of 2009, and that contract is scheduled for its annual escalator in Q4 of 2008, which will be the same percentage as we have seen over the last three years. It's a fixed escalator we set three years ago.

Could you tell us what that escalator is?

We have agreed with the vendor not to disclose that.

Okay.

And then fuel, another area we've seen some significant increases in fuel, obviously. However, excluding [Trans Corp.], gasoline, pure fuel is less than 1% of our operating expenses.

Okay. I'll jump back into queue. Thank you very much.

We'll go next to Barry Stouffer of BB&T Capital Markets.

Good morning, gentlemen.

Good morning.

Wanted to revisit California. I apologize, but I'm not sure I understand, one, why it'll take so long to be able to take inmates at Tallahatchie and then, two, why the issues there don't apply to the other facilities where you have California inmates?

Well, as I said, we know eventually the things that we end up developing, the processes and policies around what the expectations of the receiver, could impact what we have to do in some modifications to the -- to some of the other facilities.

I think we used the word "roadmap," but right now we have not seen any concern about suspending, any of the other facilities. Could it happen? I guess maybe it could, but at the moment the focus seems to be on sorting through the issues at Tallahatchie which then will lead us to what we need to do at the other facilities.

And why will it take so long before you can -- if it's not a facilities' issue, it's a processes, procedures, why will it take so long to work through that before you can take inmates there?

Well, I don't know. It is -- it's going to happen when it happens. We have made significant progress in some of the things that we know that they would like to see us have done already. There will be a review process on their part, and that we'll have some time, I guess that we will be expecting a -- our government partners and the receiver's office to be coming to Tallahatchie to review what we've done. That's the thing that we can't time very well. We can time the progress that we make and the things that we're committed to do to make sure that we have met the standards that we believe they've laid out.

And just to clarify, they're not suspending the intake of inmates at other facilities, just Tallahatchie?

That's correct.

Does that -- this just doesn't seem to make sense, but I guess government doesn't make sense often.

Can you comment on business trends with the ICE inmates during the quarter? Any meaningful changes in inmate numbers there?

We did have an increase. I guess since the first of the year we've increased about a thousand, as such. What do you attribute that to?

Okay. That's all I had. Thank you.

I was asking Damon.

Yes, we had a little bit of increase in ICE, and I would say probably a big part of that is some of the growth that we've had in our facility in the southeast for [Stewart County].

And we'll go next to Todd Van Fleet of first Analysis.

I didn't expect to be back so quick. Just a couple of maybe nitpick items on the financials, Todd. If I look at the supplemental, I see $2.9 million in other expense in the quarter. Can you tell us what that is?

That's going to be La Palma ramp-up cost.

Okay. All right. So that's ramp-up I guess, i.e. startup, so should we think of startup expenses in the quarter as being about the $2.9 million?

Yes.

Okay.

We're going to begin staffing that facility probably in March, to get ready for the July receipt of California inmates.

Okay. Any comments on Arizona at this point. They've kind of gone back and forth here with their RFP. What's your take on what they're thinking with respect to their future needs?

Well, it -- we're not really sure exactly why they withdrew the other one, but I guess now they've come back out and doubled it. I'm happy they did that. They have, I think they're -- that some of the capacity that they were bringing online in state I don't believe is quite materialized, and their system just continues to grow. And I think they have some real needs. I won't try to forecast that for them.

I think we, internally, have tried to evaluate that, but we believe that they've recognized that they've got to do something, their system is once again getting in a little bit of a very overcrowded situation. Of course, you remember they brought back about a little under 600 I believe, or right at 600 from Indiana, so I think they may be saying can we get by without doing anything, and then I think they quickly realized that, no, they can't, in fact, they've got to do more.

So we're happy that they are looking to the private sector to help them deal with their overcrowding and, obviously, we have availability of space, that we think that they could use.

Okay. And just jumping around here a bit, on La Palma, I'm just looking at the bed count that you guys are looking to bring on for Q3 and then for Q4, and the magnitude of the jump I guess in kind of the average bed count going from Q3 to Q4. In Q4 you're bringing on Adams County in Mississippi. You've got an expansion, another expansion I think coming online, and then you've got some more California beds, or at least La Palma probably coming online. What -- how many beds are you expecting La Palma to be able to accommodate or inmates by the end of this year?

Our expectation is up to 2,000.

Up to 2,000?

Right.

Okay.

And we currently have about 400 there today.

All right. And that's a 3,000 bed facility in total, and so you would still expect perhaps to have that last phase complete by perhaps the end of the first quarter next year?

That's the plan right now is to -- those last thousand beds would come on in the first quarter.

Okay. I think that's it. Thanks.

Thanks, Todd.

We'll go next to Kevin Campbell of Avondale Partners.

Thanks. I had a couple more questions. Getting back to California, can you talk a little bit about, and I'm sorry if I missed this earlier, what some of the differences are that you guys might have to have at your Tallahatchie compared to where you are now, how they differ, what potential impact there could be on cost, is the State going to reimburse you more for -- I know you talked about improving the nursing staffing, just is the compensation that you're going to be paid increased for that, or are you going to be eating the cost there? So if you could talk a little bit about that, that would be helpful?

I can't answer that yet. There could be some cost differentials from the existing staffing pattern that we agreed to under our contract. I think those are discussions the State of California is expecting us to get in with them, but to be able to forecast it right now I think it would be hard to do. I think there's real justification that there should be some understanding on that. So, yes, there are some staffing costs that could go up.

In addition to that, there's just some processes that need to be put in place that they, that the receiver feels are important. And then, also in addition to that, there's some reporting mechanism that the receiver wants to have in place to be able to review activity that's a little bit beyond what we would have expected.

I don't know what real cost that would be, as we put it in place, but it could be some. So I don't know how to answer what the -- or try to quantify what that'd be, nor can I give you an anticipation of the outcome that w will have with California about those additional modifications.

Okay. You did say, though, that it might -- you feel like that it could spread over to the other facilities inasmuch as if you are required perhaps to have new processes in place or reporting mechanisms, or staffing for nursing at Tallahatchie, and that could then translate into the other four or five facilities where you have California inmates, as well?

There is a possibility, yes.

Okay. Got a couple other questions. Could you talk a little bit about immigration and any concerns you guys might have about a potential change in administration, be it Obama versus McCain?

When it comes to the two candidates, I'm not sure that there'd be a great deal of difference. Then go back to, because if you remember back in April a year ago when there was an attempt to try to have some kind of comprehensive plan, the plan that was structured and was being considered was, in fact, supported by Bush. So I think Congress is probably going to have more to do with driving the public policy than whoever is the new president. And, as I remember, I think McCain was supportive of the compromise in some way, and so and I don't know about Obama, but I'm sure he is supportive of some comprehensive approach.

The thing that we tried to evaluate when, then, was what affect would it have, and one of the interesting things was that that compromise was going to benefit those who had not entered the United States illegally after January 1, 2007. So if you had entered the country illegally from January 1, 2007, going forward, then you would not benefit from the compromise. And so one of the first things we did was to check and see how many of the 6,000 give or take of ICE inmates did we have that had done that, and I think we identified 750, would have benefitted from the legislation.

So what happens is that I assume we'll continue to have the attempt to secure the borders, which means that there will still be folks trying to enter the country illegally after whatever compromise is passed, and those will need to be detained.

And then if you remember we talked about that there are lots of different sources of illegals that would be dealt with. There would be the requirement of maybe returning to Mexico or their country. If that happened that then would make, could make criminals, the folks that are here in different way than just being here illegally, based on that there was -- there are also numerous folks that are here with criminal records.

A lot of the inmates that we receive in our Arizona facilities, for example, I guess all of our facilities, are people who are being released from either the state, federal, or local correctional systems. And so they're being released because they have committed a crime, in some cases beyond just being here illegally, and they're sentenced to -- let's say the inmates that we housed at any of our Car facilities, once they serve their time then they're not released in the United States, they're turned over to ICE. ICE then detains them, and then ICE, then they go through their deportation hearing, and they get deported.

So a fair amount of the ICE detainees that we have responsibility for on any day are people who have been released from serving, from being incarcerated or even being detained in a jail before they leave. So there's still just lots of folks.

And, like I said, you've got -- if it's 12 million, 20 million, whatever the number, there's still going to be folks that are going to be defined as needing to be detained, whatever the compromise is. And then you will also continue to have folks who will still try to enter the United States, and they will not be getting any benefits from the new legislation.

So I -- it is hard to forecast other than I would say that 32,000 or 33,000, or 33,400, whatever the funding ends up being, is still not funding for a lot of beds when you look at the needs of the -- of ICE and the border patrol.

Okay. I do want to comment on one thing you guys had said, on Hawaii you mentioned there was an RFP out of Hawaii. Is that just a rebid of essentially your existing relationship with them, or is that potentially incremental to the FEMA prisoners you house currently?

It is a rebid, but I don't know the quantity, so if it's been expanded I don't -- I can't answer that, but the quick answer would be, yes, it is a rebid of the existing relationship.

Okay. And then a modeling question. I think perhaps we had heard from you previously about Adams County and some potential tax benefits associated with building the facility down there, and I seem to recall that perhaps it was going to be, the D&A was going to be accelerated a little bit more quickly. Is that correct?

Tax basis depreciation and amortization, not book basis.

Okay.

And you're seeing that in our cash taxes, that we're paying on a quarterly basis.

Okay. So we should still then on the income statement still assume 37 years for that?

Yes.

Okay. And then, lastly, could you talk a little bit more about Bay County and your decision to exit there? I'm assuming it was driven by lack of profitability, but I'd certainly like to hear you comment on it, as well?

Well, that has a lot to do with it. We, of course, that's a 20 plus year relationship, one that I guess we hated not to continue, but we rebid that, or at least the County rebid it back in 2005, I guess, or '06, it was awhile back. And the bid was to construct a new facility, and then they will tear down the one that we'd been in, which has really not been fun. It's a 30 plus year old building that's had all kinds of problems. And obviously they've been reluctant to spend some of the money, and we've had some things that have been very costly to us, based on the condition of the facility.

And, as you know, we indemnify our government customers, and so as we began to review some of the requirements for the existing facility, as well as some of the requirements for -- to go into a new facility, two things were happening.

One we realized that we actually did not adequately staff it in our bid, and that we needed additional staffing. And we also began to experience some salary increases because of the salaries that are in the Florida system, and part of that, again, is our Bay correctional facility and some of the salaries that we have there.

And so we began -- we realized that this was not going to be a comfortable financial, and we approached them about maybe some change. They were reluctant to do that, and so when we did this new agreement back in '05, we specifically put in the contract that we would have the right to give notice in addition to. As you know, many of our contracts are unilateral on the government side, and so we decided that this was just an uncomfortable situation and decided not to continue it after the 1st of October, I guess October 9th is actually the 150-day notice time.

And you guys have experienced, I think prior to this quarter, some compression of your margins on the managed only side. Should we expect that to pick-up with Bay County now being removed for some of it, or in October?

Well, yes, it's been losing money all year long, but not a meaningful amount.

Okay. Thank you.

We'll go next to Bill [Gilcrest] at Westfield Capital.

Hi, thanks for taking my questions. One question, Todd, could you give us the driver why maintenance CapEx was down year-over-year so much?

It's just a function of what the facilities request to maintain the facilities year-over-year, and some years it'll go up, so some years maybe you need a new roof for the facility, which is a big CapEx item, and other years it's routine replacements, so you'll see some volatility.

And then some of it is also timing. They'll budget the amounts and spread the budget evenly throughout the year, and then they struggle to spend it all in equal increments quarterly. So you can see that go up later in the year, but we would expect it to be probably a little bit lower than it was last year.

So on a go-forward basis, I mean it's going to be (inaudible) on the up side and down side for that total amount, but is $350 per bed per year roughly about what number we should be thinking about for maintenance CapEx?

Yes, that's probably not a bad estimate. Again, you're going to see some volatility from year to year.

Yes.

But that's a reasonable estimate looking at it on a per bed basis.

And clarification, is 3.5% merit wage increase for how many employees?

For most of the 16,000, not all of them, some of them operate under federal contracts which are governed by a different process, but the vast majority of those roughly 16,000 employees received merit increases effective July 1st.

Okay. Okay. And, John, a question for you, in the -- or anybody there -- renegotiations with these customers, I mean can you just give us a general sense of when you're talking to these states and the federal customers what their viewpoint of over the long-term of the relationship with the private industry is, i.e., are they saying, "Jeez, budgets are tight. We understand that, but we're going to need you even more so over the next few years," or any other comments about how the renegotiation fees and when it would be helpful?

Well, many of the increases that we talked about were in the contracts. We do have some in which we have to negotiate and so as far as the contracts that were in place on June 30th, we would continue. It really was a little bit of a back and forth on those areas that we had to negotiate. In addition to it, a lot has to do with what their net need is, and I think we tried to express that our ability to affect the pricing really comes about when a customer all of a sudden says, "I need additional beds, well, can you help me?" And that's when we have the opportunity to say that some of the historical numbers are not what we can use.

Also, what we always try to continue to do is to make sure our customers understand what their next thousand beds would cost them, not what their historical costs have been. Because what we're -- our growth is pretty much going to, not pretty much, but it's almost always is going to come from growth, their growth. We're not going to go in and take over an existing system. We're going to meet their demand just in time, it'll be their need to add beds, and we're helping them not to have to build a presence.

So it really is all (inaudible) and it, a lot of the new is about availability, and when it's about availability that's when we have the opportunity to I think find what we would consider a good and fair relationship.

The 8,200 beds that you talked about at the 20 state customers you have that are funded or maybe some of these states hope they're funded, how secure are those?

When you say ...

Meaning how secure is the funding for those things?

Oh, by the state?

Yes.

We would put it on the list if we felt that they had actually funded it. Now, whether it could fall through, sometimes you do have that, but I would say that we've listed it when we feel that there's pretty good possibility that they're going to do it.

Now, 4,000 of those beds are in the State of Arizona, which I think we've found that they might be running a little bit behind schedule on that, which is driving some of their needs. But I would say that right now that we feel fairly, in most cases fairly certain that those beds will be developed.

And, in general, how many beds are being considered to be built?

Well, if you take California out, which is a big number.

Yes.

That hasn't even gotten started, it would not be a whole lot different than that.

Okay.

It just, when you have tough budget years you just hardly even talk about it, unless you're just dead set on not utilizing what we have, and you know you've got to do it, but there's a lot of deferment on those discussions. And one of the things that we tried to point out when we look at the macro issues here is that we saw a similar situations back in 2001, 2002 in which the states are going through tough budgets, and infrastructure of prisons was one of the last things they wanted to spend money on. And so that's where we're benefitting from that lack of infrastructure expansion, and we think we'll continue to benefit from that. If we have the beds available when they need them.

Great. Thanks a lot.

One point of clarification on the maintenance CapEx, the $350 per bed for maintenance CapEx, that's a good number for facility maintenance CapEx, but then you also have to include IT CapEx, so call IT CapEx $150 to $200 a bed, and facility maintenance CapEx $350 to $400 a bed. Just as a point of clarification.

We'll go next to Todd Van Fleet of First Analysis.

Yes, thanks. I just wanted to follow-up, trying to calibrate again this healthcare cost, potentially related to this California issue. I think healthcare is maybe 10% of the total operating expenses? Is that right, Todd?

Well, yes, 10% of let's say revenue is probably a better number.

10% of revenue, and then the people cost, unless I guess what we're hearing today is that this is really kind of a personnel related issue as opposed to requiring additional investments in the facilities. The personnel costs associated with that healthcare component, I would imagine is the small minority of that 10%?

No, actually, personnel including contract employees is going to be a significant component of that 10%.

I would have thought that the actual cost of, or I guess I'm thinking of -- okay, I guess I'll have to recalibrate my thinking on that, I was putting it in different buckets. Let me ask a couple of, just circling back, Todd, the $2.9 million of startup for La Palma, can you help us understand what we might expect next quarter?

Well, moving forward what you're going to see is we've really reached a phase where we're going to have continued ramp-up activity. I mean when you compare kind of on a year-over-year basis, I think last year we were activating 4,000 to 5,000 beds, this year we're activating 4,000 to 5,000 beds, so from a year-over-year basis you're going to start to normalize a little bit.

And really the major impact is going to be on our fixed costs per day and our margin per day due to the operating inefficiencies. And the challenge we have, we've talked about this before, the challenge we have in identifying what startup costs are, the way we define startup costs is they're generally those costs you incur in advance of receiving any inmates.

Once you start to receive inmates and start to operate the facility with inmates in the facility, it's hard to isolate what costs are associated with operating inefficiencies due to the ramp-up versus normal operating costs. So it's really hard to, once, now that we've got Tallahatchie in operation with inmates, the expansion is there, and La Palma, it's really hard to isolate what those pure "startup costs" are gong to be. I know that's not the answer you're looking for.

It never is.

I'm glad you're used to it.

Yes. Interest expense, it was I guess amortized in the period, what was that?

Oh, the capitalized?

Or capitalized rather?

Interest ...

For the quarter, $4.1 million.

$4.1 million.

$4.1 million. Presumably that will come down moving forward then?

Well, it depends on the timing and the level of capital expenditures.

Yes. Thank you.

You're welcome.

We'll go next to Kevin Campbell of Avondale Partners.

My questions have been answered. Thank you.

You're welcome.

And, at this time, I'll turn the conference back to Management for any additional remarks.

Okay. Thank you everyone. I hope we were able to shed some light on a few things. Happy to be able to introduce Damon, and, as always, if anyone has any further questions we would be happy to try to make ourselves available. But thank you, and good day.

And that does conclude today's conference call. We thank you for your participation. You may disconnect at this time.