CoreCivic Inc (CXW) 2010 Q2 法說會逐字稿

Good morning, everyone, and welcome to CCA's second quarter 2010 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 and 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 and included in the supplemental financial data on our website. We are under no obligation to update 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, John Ferguson; President and CEO, Damon Hininger; Chief Financial Officer, Todd Mullenger. I would now like to turn the call over to Mr. Ferguson. Please go ahead, sir.

Thank you, and welcome everyone to our second quarter 2010 earning call. In addition to the individuals that the operator identified, we have in the room with us today David Garfinkle, our VP of Finance and Controller, and Brian Collins, our Chief Human Resources Officer. So with that I will turn it over to Todd to talk about our financials.

Thank you, John. And good morning, everyone.

Moving straight to a discussion of our financial results, in the second quarter of 2010 we generated $0.34 of adjusted EPS, compared to $0.30 of adjusted EPS in Q2, 2009. The $0.34 in Q2 2010 is adjusted to exclude goodwill charges, while the $0.30 in Q2 2009 is adjusted to exclude refinancing expenses.

Our better than expected EPS performance is primarily the result of two general items. First, US Marshal populations in the Southwest were higher than anticipated when we provided earnings guidance back in May. Second, we experienced better than expected operating performance at those facilities where we were ramping down or ramping up populations.

For example, we began accepting inmates at both the Coffee and Wheeler expansions sooner than expected and were able to do so while managing the ramp up costs very efficiently. In addition, while the level of California inmate intake at our North Fork facility was in line with expectations, facility staff did an excellent job managing the ramp up costs below forecasted levels. Also during Q2, we were ramping down Arizona inmates in our Diamondback facility where the facility management also did an excellent matching the ramp down of inmates with the ramp down of operating expenses. As such EBITDA at these facilities exceeded expectations in the quarter.

And then finally, our earnings guidance in May assumed no additional share repurchases, which in fact was not the case as we will discuss later. Total revenue for the second quarter was up 1.6% over last year, reflecting a 2% increase in average daily compensated populations.

The primary drivers of our year over year revenue and earnings growth include increased compensated mandates under our BOP contract at Adams County, increases in US Marshal populations, and increases in the state of California and Georgia populations.

These increases were offset by declines in populations from the states of Arizona, Alaska, Minnesota, and Washington. Revenues per compensated man day in Q2 2010 were down slightly against last year, reflecting a decrease in per diem related to the placement of family detainees at our T. Don Hutto facility with an all-female adult population. Excluding this impact, per diems increased by approximately 1% year-over-year in the quarter.

Average compensated occupancy for the quarter was 90% compared to 90.5% last year. Operating expenses per man day declined to $40.29 compared to $40.42 a year ago. The net result was that margin rates were essentially flat against last year, with Q2 2010 at 30.6% versus 30.7% last year.

Adjusted funds from operations for the quarter totaled $55.4 million, or $0.49 per share, compared to $34.6 million or $0.30 per share in the prior year. The primary drivers of the increase in AFFO were an increase in net income, and a significant decline in income taxes paid due to a $14 million refund of an overpayment in estimated taxes from 2009.

For those investors new to CCA, unlike other industries, our depreciation expense is not reflective of the ongoing maintenance CapEx that we will incur to maintain our facilities. For example, depreciation, and amortization expense totaled $101 million in 2009, versus maintenance CapEx for 2009 less than half of that amount at only $49 million. Therefore, we believe adjusted funds from operations per share, which adds back depreciation, and amortization, and subtracts out maintenance CapEx is in many ways a better measure than EPS of the returns we are delivering to our shareholders.

With regards to our share repurchase program announced in February of this year, we have repurchased 1.6 million shares during Q1, 2.8 million shares during the second quarter, and have repurchased an additional 1.6 million shares in the month of July. So the number of shares repurchased through July 30 totals approximately 6 million, at a total cost of $119.5 million, with the average cost per share at $19.90. As of July 30, absolute shares outstanding, and that would be basic shares, totaled approximately $110.5 million.

Moving next to a discussion of our guidance, as indicated in the press release, we have raised full-year EPS guidance to a range of $1.26 to $1.30, excluding goodwill charges. Guidance for Q3 is in the range of $0.31 to $0.33 and Q4 is also in a range of $0.31 to $0.33. Adjusted funds from operations per share guidance for the full year has been increased to a range of $2.01 to $2.11.

Guidance was developed under the assumption that no additional share repurchases are made during the balance of the year. Our guidance is impacted by a number of key factors, which I will spend a few minutes outlining. First we have announced the loss of the BOP contract at California City, where we expect removal of all inmates to be completed by the end of September of this year. Our [Gaston] contract will terminate effective August 1, while our Hernando Jail contract will terminate at the end of August. Next to our guidance, it also includes increases in inmate populations under our State of California contract. Our California pops averaged 8,600 for Q2 2010 and was approximately 8,900 at the end of June. The ramp-up of additional inmates assumed for the balance of the year for California is as follows -- 600 during Q3, and 500 for Q4 for a total population of around 10,000 by year end. Damon will address this in more detail, but we continue to be optimistic around the long-term bed demand from the State of California.

Regarding the State of Georgia, demand for beds from the State of Georgia remains strong. We expect ramp-ups of the 1,500 beds of expansions under the State of Georgia contracts at Coffee and Wheeler that began in Q2 to be completed in September. Next we expect to activate our new 1,072 beds in the Nevada southern facility for the US Marshals, during Q4 2010, with a gradual ramp up beginning in October. However, for the year, we expect the facility to generate a net loss as a result of start-up costs. Nevada Southern is expected to incur around $3 million of start-up costs in Q3.

So trying to understand the sequential decline from $0.34 of adjusted EPS in Q2, to a range of $0.31 to $0.33 in Q3, it can largely be explained by several items. First the incurrence of approximately $3 million worth of start-up costs as we activate the Nevada Southern facility without the benefit of revenues until Q4. We will also have a full quarter impact in Q3 from the loss of Arizona inmates at Diamondback that occurred mid-second quarter. In addition, we will lose Gaston in early August, but not begin management of Graceville until the end of September.

Some of these losses will be offset by increased inmates from the State of California and continued ramps of Coffee and Wheeler. The flat EPS guidance from Q3 to Q4 can largely be explained by the increased intake of California inmates, ramp-up of Nevada Southern, Moore Haven and Graceville, offset by the loss of Cal City and some declines in US Marshal populations at existing CCA facilities, as some number are transferred to our new Nevada Southern facility when it begins accepting inmates in Q4.

With regards to AFFO, cash taxes paid are expected to approximate 30% in 2010, which was used in developing the AFFO guidance, versus a 38% GAAP tax rate reflected in EPS guidance for 2010. For purposes of preparing long-term financial projections, we would recommend assuming cash tax and GAAP tax rates of approximately 39%. Turning next to a discussion of our liquidity, as of June 30, 2010, our liquidity is provided by approximately $199 million of availability under our bank credit facility, plus approximately $23 million of cash on hand. Our total debt leverage ratio is 2.8 times, with interest and fixed charge coverage ratios at around 5.8 times.

So even after repurchasing 6 million shares of our stock, our liquidity and balance sheet remain very strong. Uncertainty remains related to the general economy and around government budget deficits. This is the primary uncertainty and risk we face for the balance of 2010. In developing our guidance, we have incorporated our best estimate of the range of potential outcomes related to the risks and opportunities associated with those government budget uncertainties, including the risks of population declines and the potential for pricing pressure, as well as the opportunities to secure new contracts.

However, we believe the long-term prospects for filling our vacant beds and growing EPS and AFFO per share remain attractive, as our customers are not building new bed capacity sufficient to meet their future needs. I will now turn it over to Damon for specifics on our new business prospects and bed development.

Thank you, Todd. And thank you so much callers for participating in our conference today. We are pleased with our second quarter results and I very much appreciate the efforts of our 17,000 employees nationwide. This morning I would like to break my comments into two topics.

First, is to share an update on our short-and long-term focus for the business, and second, market observations and opportunities. So as it relates to our short-term focus, our priorities are as follows. As always one of our main focal points remains on filling excess vacant capacity. We think we have had a good amount of success this past quarter, so let me give you the highlights. During this last quarter, California continued a steady ramp of 679 inmates into our facilities. As of August 1, California's total population in our system was 9,178.

Second, we have seen good increases incrementally throughout the system with our United States Marshal Service populations. We have seen a growth of over 682 prisoners since January 1 this year into our system, and 1,657 prisoners since January 1, 2009. With our facilities and expansion well underway in Georgia, our system-wide count with the state has grown by 1,451 inmates since January 1st.

Finally, we finalized the ramp of BOP inmates into our Adams County facility during the second quarter of this year. In a minute I will give an update on potential near-term opportunities for our remaining available capacity. Second item to mention that is high on our short-term priority list is the continued emphasis on controlling operating cost. I think our results show another good quarter on keeping the lid on cost, and as Todd reported, we continued to see some encouraging signs from our company-wide initiative.

Let me also say that our team will continue to recalibrate our expense bin as quickly as possible based on changes in customer demand and/or need for narrowed services. Now for our long-term focus, one of our key business strategies continues to be carrying beds and inventory to meet future demand. With over 9,000 in new incremental bed demand in the marketplace today targeting existing capacity, we continue to think this strategy is a sound one. But with that, we continue to hold off on new bricks and mortar construction of speculative beds.

As mentioned in the press release, we had approximately 12,500 unoccupied beds, including the beds expected to be come vacant at our California City facility later this year, and nearly 1,072 additional beds under development at our Nevada facility. So we will continue to monitor closely the needs and timing of new bed development, but clearly, we would like to continue to see some more meaningful utilization of remaining capacity and better visibility from our customers before we add additional capacity.

Additionally, as announced in February, we have a new share repurchase program. We continue to think that based on the current level of inventory in our system, it is appropriate to repurchase shares at prices that would equal or exceed the ROI available from investing in new beds. As we reported, we have had great success so far with the new program, and think it is the best alternative in deploying capital during this tough economic environment.

Finally, we will also continue to pursue build-to-suit opportunities, and as demonstrated over the last two years, we've had a good amount of success with these type of procurements. However, with the continued short-term uncertainty in the marketplace, and limited visibility from our customers as it relates to their budgets, the Company's ROI hurdle on new construction will persist to be higher.

Now for market and industry observations and opportunities. And first a couple of comments on state budgets. As Todd mentioned, our state customers are not out of the woods yet. Except for California, our other 14 state customers have passed their 2011 budgets, which would have begun this last July, but as the past 24 months have shown, their ability to forecast accurate projections has been extremely difficult at the state level, so budget revisions are possible as we go into the new fiscal year.

The National Council of State Legislatures, or NCSL, released an update on state budgets just this past week. They reported that state finances are not expected to recover for at least another two years, but in the summary of the report, they gave some encouraging commentary around the fact that states feel that they have finally hit the bottom. The report also reaffirms what we said in May, which is that 42 states project that their fiscal year 2011 revenues will match or grow above 2010 levels.

And for the first time since the recession, all of CCA's customers are projecting either a modest increase in revenues over 2010 levels, or equalling the amount they achieved this last fiscal year. So although there is still continued uncertainty as it relates to state budgets, let me point to a couple of positive things that we see with the states. With all of the states except California now having budgets in place, none of CCA's 15 state customers are funding or have proposed funding for new prison capacity.

Additionally, our research indicates that none of the 50 states are funding or have proposed funding for new prison capacity. Four states have authorized funding in previous fiscal years, but no one has proposed or authorized funding for this upcoming fiscal year 2011. This, we think, is very significant, because as states deal with incremental growth and/or overcrowding, they clearly are not ability to appropriate dollars in this fiscal environment to add capacity, but it also shows the acceptance of the value and the level of service we have demonstrated to provide our customers.

I mentioned in May, the report by the Pew Center on the States that was titled "the Trillion Dollar Gap". This report continues to get more traction in media as the key points of this report indicate that state retirement systems are underfunded by over a trillion dollars. When comparing our price to the cost it requires a state to operate a facility, this ongoing pension cost is getting more scrutiny as it could add, on a cost-per-day basis, up to $30.

And obviously, every new employee that a state hires to operate a prison adds to the long-term legacy retirement and medical cost to that state. So not only can we give value to our customers in the cost of construction, or complete capital avoidance and lower operating costs, but also this is how we can save states money long-term by lowering their pension liability and growing legacy cost.

Finally, is to mention again, that we have people on the ground in half a dozen states that currently are not doing business with CCA . We estimate that these states are approximately 12,000 inmates over capacity today, and by 2014 will be over capacity by over 28,000. Think we could see several state use a private sector after this recession that don't have the capacity to deal with their overcrowding, and/or growth.

Now a couple of comments on significant pending procurements. There is a good amount of activity both on the State and the Federal side. The first of which is Arizona. The RFP for up to 5,000 in state beds has been released, and responses were due May 28. Statutorily, the state was supposed to award on July 1 of this year, but obviously that hasn't happened yet. We think it may be awarded as early as this quarter or in the fourth quarter.

Now to California. California issued an RFI for more beds out of state in December. Due date for responses was on December 28. We submitted a proposal and obviously think we have viable solutions for their increased needs. Our understanding is that the evaluation of proposals is well under way and that the state is looking to secure 5,000 more beds. Timing of awards could be as early as this quarter or in the fourth quarter, and ramp-up would likely begin in 2011.

Now to CAR 12. This procurement, as a reminder, is the rebid of our BOP contract at our McRae, Georgia, facility which expires in December of 2012. The BOP anticipates this requirement be fulfilled through a single award. A proposed facility may be an existing facility, a newly constructed facility, or an existing facility with expansion and/or renovation. The procurement has been released and proposals have been submitted. We expect the award to be before the beginning of the Federal 2012 fiscal year.

Now to the ICE procurement for beds in the Northeast. ICE intends to issue a solicitation for our contractor owned and operated detention facility capable of housing and managing approximately 2,500 detainees in the New Jersey/New York area. The RFP should be released later this year.

Now to the BOP procurement for 3,000 beds. This opportunity is for our contractor owned and operated facility for the housing of up to 3,000 short-term-sentence inmates. The procurement only allows existing facilities to be proposed and be able to begin accepting inmates within 120 days of award. Also the procurement only allows facilities to be proposed within the states of Arizona, New Mexico, Oklahoma, and Texas. The due date for this procurement was last Friday, and we expect the award to be in the first quarter of 2011.

I also want to comment on another BOP procurement for 1,200 beds. The BOP plans to release this week another procurement for our contractor owned and operated facility for the housing up of 1,200 low-security inmates. This procurement also is allowing only existing facilities to be proposed and the successful offer must be able to accept inmates within 120 days of award. It is also worthy to note that there is no restriction on location for this procurement. Proposals are due on September 14, and we anticipate the award to be on either the first or second quarter of 2011.

Finally a comment about Indiana. The State of Indiana has invoked an RFP for the management of a state-owned prison housing up to 1,500 male inmates. Proposals are due August 24, and we expect award to be in October. So even with a tough fiscal environment, a very meaningful amount of activity within the industry for new beds. If you pull out the beds currently managed by the industry that are up for rebid, you have over 18,000 new beds coming out for bid this year.

Let me now make some specific comments on our four largest individual customers. And actually let me first say that in February I provided detail on the proposed budgets for our three Federal customers these budge proposals are still making -- ( loss of audio

(Operator Instructions.) And you are now back live, Mr. Ferguson.

Okay. Thank you. All right. This is Damon Hininger, I will apologize for the disconnection there. But I'll resume my prepared remarks, and then we'll go into Q&A here in a minute.

So I was about go make some comments about our four largest individual customers. Let me first just say that in February I provided some detail on the proposed budgets for our three Federal customers. These budget proposals are still making their way through Congress and our sense is that none of our Federal customers will have a proposed budget passed by Congress and in place by October 1. With that, we expect our Federal customers to operate under a continued resolution at the start of their fiscal year.

But also, one late-breaking item to report, as we understand it from last night, Congress is on a path to pass a $26 billion funding bill to help the states with Medicaid and indication costs. This is the package that the States have been hoping for all summer to help further shore up their budgets this coming fiscal year.

Let me now talk about the US Marshal Service, and just a comment really about our facility in Nevada. As Todd mentioned, we are well underway through activation and looking to start taking prisoners late this quarter into fourth quarter.

Now for ICE and one item of note. As mentioned in February, we have seen a softening of their demand systemwide, as we understand that ICE is still dealing with fiscal constraints during the fiscal year. ICE was targeting a systemwide funded population of 33,400 this fiscal year, but with their fiscal limitations we understood earlier this year, that they are running 2,000 to 3,000 short of that target. While ICE's fiscal challenges continue, we now understand that their systemwide population has increased to 33,000, and we have seen a modest rise in our system since February.

Now for the Federal Bureau of Prisons, which is the largest prison system in the United States, and let me give you an update on their population projections. We reported last year that the BOP was at 137% of their capacity. Based on their funding of activation of new beds and their projected growth through 2011, we are estimating their systemwide occupancy could creep up to almost 140% and have an unmet bed demand of nearly 4,000.

But the BOP has also recently reported new population and capacity projections through 2016. This past week, the BOP reported their systemwide population being at just over 211,000. With their new projections, they are now estimating their system to grow to 245,000 by 2016, a growth of 34,000 inmates. As of right now, the BOP is only projecting 19,000 new beds past 2010. And that projection assumes that the BOP still operates at 140% in 2016.

So with this projected increase of populations, and significant unmet bed demand on top of a very overcrowded system, and two pending procurements for 4,000 new incremental beds, we continue to believe the BOP will be a meaningful opportunity for the industry.

Now I'll comment on California and let me first mention that we are well underway as mentioned earlier with the ramp of our new contract signed last November.

As of August 1st, we had 9,178 inmates in our system from the state of California. That compares to 7,970 inmates on January 1. As it relates to the three-judge panel, there isn't any meaningful update to provide beyond what I shared earlier this year. And as reported earlier this year, the Supreme Court has agreed to hear the state's appeal. Our best guess is the decision on the appeal would be issued by July 1, 2011. And as mentioned earlier the state appears to be taking steps on increasing their placement of inmates out of state.

So let me bring to a close my comments and make these final points. We are obviously very pleased with our second quarter earnings. We achieved positive EPS, revenue, adjusted funds from operations and EBITDA growth with EPS growing at 13.3%. Additionally we have been successful in bringing back in over 12% of our stock with our two share repurchase programs. We think accomplishing all of this is very significant in today's challenging economic environment. Our competitive advantages continue to be a strong balance sheet, good liquidity to fund new capacity development and execute on a share repurchase program, limited manage-only operations and focused operations in a largely unpenetrated US marketplace.

We believe the supply/demand imbalance will continue long term, and insufficient public sector capital investment ensure the shortage of beds with both existing and potential new customers. We are seeing very healthy activity in the market for new bed opportunities with over 18,000 new incremental beds coming up for bid this year, but also a half a dozen states considering using CCA to deal with their overcrowding and/or growth. As mentioned earlier, the combined total of the overcrowding by these states is over 12,000 inmates.

And like the last recession in the early part of the last decade, we feel having inventory as we come out of the recession is going to be extremely attractive, and give us a significant competitive advantage for this new business,. But just as important, we think we have taken the appropriate steps in the short-term in managing our liquidity and balance sheet to well position ourselves for future build-to-suit opportunities.

And just to reinforce, how valuable our inventory is right now, you have the two largest correction systems in the US looking for 9,000 in new incremental bed at existing facilities, with CCA being the sole provider to the State of California, and the largest provider to the BOP, we think our proposals and existing capacity will be extremely attractive to these customers.

And finally if we are successful in filling the nearly 12,000 beds I mentioned early that we have in our system, and with our beds under development in Nevada, that would translate to nearly $93 million in incremental EBITDA, and $0.49 in EPS. That concludes my prepared comments. Thank you again for calling in to today's conference. And let me now turn it over to the operator for Q&A.

Yes, thank you. (Operator instructions.) And our first question today comes from Kevin Campbell with Avondale Partners.

Good morning, thanks for taking my questions. I wanted to ask real quickly about your Nevada Southern detention center, does that require additional appropriations or new funding from the Federal budget? So it is somewhat contingent upon them passing the budget, or is the funding for that already coming from existing sources?

Good morning, Kevin, this is Damon, and it's the latter. So it is coming from existing funding sources. In all of our discussions with the Marshal Service and the trustee's office, the pockets of population that will go in this facility are currently being housed in other facilities, so they are anticipating some incremental growth for this facility, but the vast majority of the population should be populations currently in the system.

Okay. And then Todd, I wanted to follow up with you on your comments about Q3 to Q4 being flat. I wanted to make sure I heard everything that was happening. So maybe if you could just repeat your comments from your prepared remarks?

Sure. So that flat EPS from Q3 to Q4 can largely be explained by the increased inmate intakes of California inmates, ramp-up of Nevada Southern, Moore Haven, and Graceville, offset by the loss of Cal City and then some potential declines in our US Marshal populations at our existing facilities, as we believe some number of these existing populations at CCA facilities could be transferred to Nevada Southern when it opens in Q4.

Thanks, I had missed one of those. So that's helpful. Your BOP contract at Cal City, do you have occupancy guarantees that really protect you from the drawdown in inmates through the end of your contract, or will that affect your financial results?

No, that's -- it is correct that we have a guarantee in place, and that would go through the end of the contract term, which would be end of September.

Okay. So even though you might see a draw down in actual populations, the financial impact won't be as significant, other than, say, the transportation costs? Are you guys responsible for the transportation costs, or does that fall on the BOP?

We have some responsibility in transportation costs, but I don't expect it to be anything more than what we have done over the last ten years.

When we look at changes from your average daily population, from Q2 to Q3, theoretically you guys provide data that is based on compensated occupancy, so we should assume no change in population from Q2 to Q3 of what you report for that reason? Is that safe to assume as well?

Yes, that would be correct.

Okay. That's helpful. Also, I wanted to talk a little bit more about Georgia. Obviously, you know, you increased the size of that contract. It is ramping ahead of expectations. Could you maybe talk about how that came about, was it related to negotiations on prices? Did you give some concessions on price to get incremental inmates, or was it more a function of they needed the beds because Cornell had made that capacity available to the BOP?

Yes, it's really the latter, I mean the displacement of capacity that they felt with the Cornell beds obviously created a challenge for them, because they are obviously overcrowded today, and then also seeing significant growth, really, short-term and long term. So I think being displaced and seeing the incremental growth created an opportunity for us.

Is your pricing then consistent with the revised contract from -- that you signed last year? I think it was roughly a $47 per diem?

I think we had some discussion on the price and I couldn't give you an exact number, Kevin, but I would say it's consistent with previous contract amounts.

Okay. I'll save some questions for some for some other folks. Thank you very much. Great quarter.

Thank you.

We'll go next to T.C. Robillard with Signal Hill Capital Group.

Thank you, good morning, everyone. I just wanted to get a sense -- Damon or Todd, the ramp-up of Nevada Southern in terms of taking existing Marshal populations, will all of those come from existing CXW facilities, or only a portion of those?

Yes, no, this is Damon. Our sense is that a large part of that population will come from other, facilities outside of the CCA system. So our sense is probably some county facilities that are currently housing that population. That population will be pulled out of those facilities.

Okay. And then Todd, can you give us just some sense -- I mean, obviously fantastic job on managing the cost side both on a facility basis, and just on the G&A line. I just want to get a sense as to how we should be thinking about these cost levels. I mean, is there anything in there that was kind of a deferred cost on the G&A side, or are these some levels that we can expect through the back half of the year? Understanding that those costs would ramp once you guys actually see a pickup in filling beds, but if everything stays the same now, from a broad environment standpoint, how should we be modeling the G&A line?

I would model it is a little bit below 5%. It will be a little higher than the 4.7% we achieved this quarter, and then there's some variability quarter-to-quarter, seasonality around election cycles, and other disbursements, but -- so maybe just a tad under 5%.

Okay. That's helpful. So a little bit of a move up, but not significant?

Yes.

And then how should we -- not necessarily how should we, but can you give us any insights into pricing now that we're in the new fiscal year, just on an apples-to-apples basis, not necessarily as a customer, but if you think of a specific customer in your head, can you give us a magnitude of pricing when you are talking apples-to-apples, either contract renewal or extension.

Let me first say that, as you know, almost all of our State contracts are actually tied to the fiscal year, so we had a lot of new state contracts start July 1, and as I think I mentioned in May, we were well underway and in May and in June kind of finalizing negotiations of those new contracts, either new contracts or renewal contracts. And so we went through that process. Some of it was a little bit give and take on maybe changes of services, and then you had some states that had automatic escalators in the contract. So as it relates to rest of the year, our State contracts are right now negotiated at the rates that were in place on July 1. I don't know if that completely answers your question. But it's a little different obviously this quarter than it was in May, whereas we've got our contracts now negotiated in place and the new rates at the levels that were negotiated starting July 1.

So nothing material -- I mean flattish, kind of a good term to use?

Yes, as we mentioned on previous calls, kind of expect flattish per diems, and our goal is to kind of hold the line on margins, and minimize any impact on margin rates, which to date we have been largely successful in doing, and that's partly a reflection of the cost containment efforts as well as a modest inflationary environment.

And Todd, do you think you can maintain now that we're in the new fiscal year? Can you maintain that? I know you have talked or there has been questions in the past with respect to customers, where over the last year or so, you have gone through the service reductions, and you have been able to offset some of the per diem pressure on the margin line. Obviously the second iteration of that gets harder. Is that something you guys still have a high degree of confidence in, in terms of being able to maintain current margin levels?

It certainly gets more challenging with each passing iteration in terms of requests from the state customers, and so I would say that would be largely a function of how well the states have forecasted their revenues, and whether that have to come back to us, if they miss their revenues, whether they come back to us looking for additional assistance in managing their budgets tighter. As Damon just reported it looks like the Federal government is going to provide some additional assistance in the form of funding to the states, which should be helpful, but then it is going to be a function of what happens with the general economy, and how that drives sales tax revenues and income tax revenues. And it's really hard to project.

Yes, T.C., I would just add that we feel really good on what we have been able to accomplish over the last two fiscal years, on working through those issues, and to reinforce, like I said, going into this year. Right now, and this is obviously subject to change, but right now NCSL is sensing that hopefully most all states have hit the bottom and seen a little modest rise going into this fiscal year, so I think on -- with that on top of the fact that it looks like the Federal government is going to give them a little relief on Medicaid and education costs, which allows them to maybe plug some other caps in their budgets, that's an encouraging sign, but it's -- like the last 24 months, we're just going to have to wait and see and just see if those forecasts change or not.

Got you, that's helpful color. Thanks, guys. I'll jump back in the queue.

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

Good morning, guys. Nice quarter.

Good morning, Todd.

Todd, you mentioned in your remarks something about a 1% increase year-over-year, excluding certain items, what was that again?

I believe that was on the per diems.

Right, so the aggregate --

In aggregate, yes, so when you exclude the impact of the decline in per diems on the T. Don Hutto facilities as we migrated from family detainees to adult females, which required a much lower per diem.

Yes.

The year over year increase in per diems was around 1%.

Okay. So you said the state per diems in aggregate are kind of flattish looking into the back half of the year. The Federals are a bit more positive movement, I guess, from the Fed customers in general?

Yes. The Federal customers, as we talked about previously, aren't under the same magnitude of pressure that the states are around their budget.

Right. So overall this calendar year, you are looking at overall positive movement on per diem across your portfolio, excluding the impact of mix issues with respect to the likes of T. Don Hutto.

Yes, and keep in mind that a number of our per diem increases in the contract are tied to CPI.

Right.

So to the extent that CPI is lower, our per diem increases will be lower. And CPI the last 12 months is around 1%. But that also impacts us favorably on the expense side.

Right.

So lower inflation, it means hopefully lower increases in operating expenses as well, and to date we have been able to achieve pretty significant operating cost efficiencies.

Right. Okay. Let me ask about the moving parts here in the back half of the year, just to recap in Q2. So Arizona when they were pulling out Oklahoma, you had no population guarantees there; is that right?

That's correct.

Okay. So would you say overall that facility -- I think it was Diamondback -- was that operating at kind of a substandard margin during that -- while Arizona was vacating that facility?

Yes.

Okay.

But it was still positive in the quarter.

Sure. Sure. And then on Nevada, the new Marshal Service business, do you have a population guarantee there while you're ramping up?

We do, that will have a -- I believe it's a 75% guarantee on that contract of 1,000 beds.

So Damon, it's 75% on the entire -- so from day one, you start taking in the inmate day one, you get 75%, and then as you get over 75%, then it's kind of man for man then, I guess up to 90% or is that generally how it's structured or --

Yes. Basically once you get over 75% it's a man for -- per man day rate about that level.

Okay. Thinking about Nevada then, so if we exclude the impact of the three -- I think it's still $3 million of startup costs for that facility, right?

Correct.

So if we exclude the impact of that $3 million, that facility probably should be pretty profitable for you in -- during the ramp-up phase in Q3?

Well, we won't start taking inmates until Q4.

All right. Okay.

All right?

Okay.

So we'll start generating revenue in Q4, and we're occurring the ramp-up costs in preparation in Q3.

Okay.

And then the profitability in Q4 will be dependent on how much of a staffing we continue to ramp up in anticipation of a higher population above the 750.

Right.

And how accurate we are in making that call.

Okay. But overall Q4 sounds like it should be a pretty good quarter for the margin on that facility --

It should be profitable, yes.

Okay. Then the other -- in Q3 -- so you are exiting a couple of management-only contracts, you're bringing on a couple of management-only contracts. Help me understand how the profitability of those contracts is impacted while you are leaving -- while you are exiting the contract, versus entering a new management-only contract. It seems like it should be more cut and dried that day one you should get relatively the same margin that you are going to get day 120, but how do you guys think about that?

That is generally correct. You will have a little bit of startup costs, if you will, because we're responsible for replenishing the inventory of supplies, we don't get to keep the supplies that were there under the previous operator, so we have to -- there's a little bit of up-front cost in investing in the inventory of medical supplies, clothing, janitorial, but it's not nearly the magnitude of startup cost you would have in an owned facility we're ramping up from zero.

A little bit of training cost too, just with new staff coming in from CCA, and facing unique HR requirements and training requirement business. Pretty minimal.

Okay. So as I think about the sequential movement then for the Company overall marginwise, moving from Q2 to Q3, you are going to have a piece of business that was Arizona and Oklahoma that was kind of operating substandard. That will be out of the picture in Q3 where it was in the picture in Q2, right?

Right. Yes, that's correct. And we'll have the cash operating carrying cost of the vacant beds.

That's right. That's right. And then you'll have -- in the Q -- I guess in Q3, you'll have the two management-only contracts coming on, and the two coming off, right?

That's correct, yes.

And then you'll have the $3 million of startup costs related to Nevada?

Correct, yes.

And is that the totality of it in terms of activity happening during Q3? And I understand that Cal City is going to be winding down, but you still should be doing pretty well there from a margin perspective during that rampdown period.

That's the majority of it, yes.

Okay. So I guess I'm wondering would we necessarily see any margin deterioration going from Q2 to Q given the transitions that we're aware of. You'll have more California business coming on at higher incremental margin. It sounds like the margin should hold up pretty well in Q3 relative to Q2?

Yes, we do have the startup costs --

Ex the startup costs, yes.

So ex the startup costs, that could be true.

Okay. All right. Very good, thank you guys.

Thanks, Todd.

And we'll go next to Manav Patnaik with Barclays Capital.

Hi, good morning guys. Congratulations on the quarter.

Good morning.

First question on the demand picture you were painting, in the long term focus section, Damon, I think you said that there were about 9,000 new incremental demand targeting existing beds. I was just wondering if -- or existing capacity is I think is what you said. I was wondering, were you referring to add that existing capacity to your current inventory? And then sort of the second question was just, you mentioned a number of additional states, I missed the number that were currently 12,000 capacity and potentially 28,000 by 20104. Is there any overlap in those two or just a little more clarity in how to think about that

Absolutely, so let me go to the 9,000, and that was referencing, really, two customers -- California, and the Bureau of Prisons. California as you know is looking for 5,000 new beds out of state, and then the Bureau of Prisons, both with the 3,000 procurement and then this newly advertised 1,200 bed procurement. Basically those two customers with those three requirements, about 9,000 in incremental demand, targeting existing capacity. That was that answer to that question. As it relates to the question about states having a need that we're currently not doing business with. That would be a completely separate need. So the six states that I mentioned, currently not doing business with CCA, right now the combined total of those six states' respective systems are overcrowded by 12,000 inmates. So that's in addition to, not part of the 9,000.

Okay. And with respect to California and the Bureau of Prisons targeting those inmates can you give a little color -- clearly, obviously the Bureau of Prisons, the STS bid has restrictions in where the facility should be, I'm not sure if California has that, but is there clearly going to be some overlap in the bids that have been submitted in terms of the facilities? And would you be or required to sort of move around some of the inmates to accommodate both customers?

Well, I think there is probably high likelihood to your first part of your question that both customers -- both agencies will get proposals for the same facility or facilities.

Okay.

So I think that's probably likely. As it relates to moving of populations, as we understand it right now, California is looking to award either this quarter or fourth quarter, and the timing on the Bureau procurements is really first quarter, second quarter. So I think there is, at least as we understand it today, there is a chance that California may act on their needs and their requirement before the BOP acts and awards on their requirements.

Got it. So I guess, as you think -- since California potentially comes out first, if they take a facility that obviously would fall under the BOP restrictions, is that -- how do you look at the opportunity? Do you just take what comes first? Or what is the strategic thinking around which customer to pick?

Yes, that's a good question, and it's definitely part of our analysis as we think about proposals for both vendors. Understand kind of their long-term needs, what they are trying to accomplish in these requirements, so that is something we definitely put in our decision-making process, we think about which ones do we want to submit proposals on and what is really the best proposal and potentially the best contract for the Company long term.

And just a final question, I noticed in the facility list that the Oklahoma facilities and the Larado facility still had a June, 2010 expiry, is that just sort of pending negotiation, or is there an update to that?

Yes, I believe the Oklahoma agreements have been finalized or are being finalized, and then the Larado agreement has been for many years under an IGA, so that's a pretty straightforward process, to extensions there. So I think both of those agreements either have been negotiated or are being finalized as we speak.

All right. Great. Thanks a lot, guys.

You bet.

Our next question comes from Toby Summer with SunTrust.

Thank you. Our outlook section says you are building in some expectations for potential risk on managing volumes in potentially per diem pricing pressure. I was just curious, do you anticipate those pressures -- which I presume are principally among state customers as increasing or consistent with what you experienced in the first quarter, second quarter? Thanks.

Well, I would say -- I think if you compare the last half of this year, versus the last half of the last two years, I would say it's probably pretty consistent, and I don't see an increased or a decreased level of potential risk there, but as I think it relates to the last half of this year, versus the first two quarters of this year, it is a little different, because obviously we have a lot of our state contracts coming up for renewal July 1. So a lot of the discussions relative to not only potentially pricing pressure, but also obviously renewing our contracts happened, really, during the first and second quarter of the year. So I think where we are today, versus where we were really the last two years for this time of year, it feels about the same.

Thank you. And are you, just curious if you are noticing any impact of any some the consolidation that has been going on in the industry, whether that's either increased some opportunities for you, or whether there has been any change there? Thanks.

Yes, don't have a -- no sense on the consolidation having any impact on the short to midterm relative to operations. I mentioned earlier, obviously, not really relative to the consolidation, but more in just an action taken by Cornell that we have seen some positive improvement on populations and contracts in Georgia, but nothing more than that.

And just curious on some of the -- on California with the procurement that is expected, do you expect to maintain your exclusivity there, or do you anticipate at some point, California wanting to diversify its providers?

Well, I can't say for California. I guess I would point to a couple of things. They -- they being the CDCR -- you probably read this in the early part of this year when the legislature was in session, there was some discussion and some dialogue that obviously was captured in media about the CDCR need to diversify a little bit and not have all of their eggs in one basket, so I think that -- I'm sure that is on their mind as they think about this upcoming procurement and how will want to award that, some of the feedback they got from the legislature. And then I guess I would also look at other states, other states that obviously have taken the step of diversifying a little bit, and not having all of their populations with one single provider. So I'm sure that's on California's mind as they think about these awards.

Thanks, Damon. Last question. Do you have any evolution in your thoughts about creating an operating company, and then having a REIT, or is your thinking consistent in the last time we heard you address it on a conference call?

I would say our thinking is consistent, has been consistent, since, I think both February and May. I think what this management team and this Board has done for a long time, going back the last ten plus years is always looking at strategic alternatives as it relates to M&A, to a new service line, to a restructuring, and determining what is the best course of action for the Company's long-term ability to grow and obviously the best value for shareholders. So I think we have had a good record on acting on those. I think the share repurchase is a great example that we put in place over the last 24 months where that was a great tool in the toolbox to pull out, take advantage of some excess liquidity, and buy some shares back. So it is a constant conversation that management and the Board have on looking at those alternatives and determining what is the best course of action short-term and long-term to create value for shareholders.

Thank you for the update, the level of detail is very helpful.

We'll go next to Jamie Sullivan with RBC Capital Markets.

Hi, good morning.

Good morning.

Quick question, Todd I guess, on the startup cost. I think just throughout the quarters it was $1 million in Q1, and $3 million in Q3. Is that right? Or are there any others?

That's right.

Okay. Thanks. The question on the Georgia contract, the 90% occupancy guarantee there. Is that on the 4,500 or 4,800 total beds that you have built there. Is it on the new level of capacity that is discussed -- that you signed on with for Georgia?

It would be a 90% guarantee on the total contract amount, which would be 2,600 to 2,800.

Okay. And then for each facility, right?

For each facility; that's correct.

But you can go above that level? Is that -- the 2,600 to 2,800? Okay. So that's on the max occupancy. Okay.

Correct.

And then it looks like that is about 115% or 116% of capacity. Just wondering, are you doing anything with the design of the facilities or is that the stretch level the states look at near that kind of Federal long-term target? Just your thoughts there?

You are asking specifically about our BOP contracts?

Both, with the Georgia contract, they expanded it up to 115% or 116% of capacity there, if my math is right?

Yes, we have had good success, I mean, Georgia is just one example, but one of the things we challenge ourselves internally, and sit down with our customers, especially in this tough fiscal environment, it they need increased capacity is looking at the existing capacity, and see if there's a way to either retro fit or renovate or move some service areas around where we can increase capacity. So I think what we were to accomplish in Georgia is consistent with what we will be able to in other states, which is to look at the existing facility and maximize our capacity and occupancy.

Right. Okay. And is that -- are there some states that are doing that in their own facilities? Is that kind of a trend with the overcrowding that we've seen, that they're finding new ways to get more people into the existing facilities?

Yes. I wouldn't say it's a new trend. I think all states probably for many years have looked at ways to maximize their capacity. So I wouldn't say it is a new trend, I think it's something that all states take a look at. And all states have a different level of threshold of how aggressive they want to be. It's clear that it's on everybody's mind on what is going on in California, if you get too aggressive on going over capacity, then obviously you'll potentially have the Federal courts intervene and you have to do some drastic action to reduce your population. So it's somewhat of a delicate balance, but something that states I think look at on a typical -- or on a regular basis.

Thanks. And one last one. On the six new states that you mentioned. Do any of those currently use private operators or would that be a completely new arrangement for them? And then just your thoughts on how close you think any of them are to issuing RFPs or making a move on outsourcing?

Yes, of the six states, I think there's only one of those that are currently using some beds with another provider. I think the other five are not. And wouldn't want to speculate on timing of a requirement.

Okay. But is it more of a long-term, by 2014, when they have those needs, or is it something that could be closer to where we are today?

Yes, no, I think it could be closer. I mean, we have different levels of discussion with these states, so I think some could be much sooner than 2014.

Okay. Thanks a lot.

Thank you.

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

Thanks, just a couple of quick follow-up questions. I wanted to ask real quickly, when do you lock that T. Don Hutto comp? Is that starting in the fourth quarter of this year or?

On the T. Don Hutto comp?

Yes, for pricing.

It's third or fourth quarter.

What was the question again, Kevin --

The question is when does the --

Yes, when do you have that pricing headwind go away.

On T. Don Hutto. When did the per diem drop last year? I think it's fourth quarter.

Fourth quarter we think, Kevin.

That makes sense when you look at the year over year comps from the last couple of quarters. And what about an update on the rebid of your California beds? Do you think those will get put out to bid, do you think they will just negotiate that directly with the CDCR? Any comment there?

Probably wouldn't be appropriate for me to comment. I think California would say that they feel like in their appeal to the Supreme Court they have made good progress on reducing the overcrowding within their system with the out-of-state program. So I think they have got a little bit of a mind to make sure that obviously they don't do anything to disrupt the progress that they have made. But probably wouldn't be appropriate to speculate more than that.

Is there any move in California legislatively to remove the sunset provision that expires June of next year?

Yes, I think it has been reported -- as I mentioned earlier, California is the only state that does not have a budget, but I think it has been reported, some discussion about either removing or extending significantly the sunset.

But it hasn't formally been done yet.(Overlapping speakers.)

It has not formally been done yet.

Do you think that will be part of the budget or done separately?

I think probably done with the budget, but it could be done separately, so that would be a guess on my part.

And then two quick questions about your occupancy guarantees at Cal City and Nevada. So at Cal City, it s it a 90% guaranteed level? Is that typically what a BOP contract is, or is it different there?

No, that's correct, Kevin.

Okay. And then Nevada, just to confirm, you have got the 75% from day one. You don't have to reach a certain inmate threshold before that kicks in?

Yes, that's correct. Yes, it's 750 inmates day one. But it's -- that is probably what's different on this contract versus BOP, because as you know on BOP contracts they do have a tier, I think they go up to 50% typically then the 90%.

And does your press release say -- I'm sure it probably does -- but when you expect to start the Nevada Southern? Early in the fourth quarter?

Yes, October 1 or shortly thereafter.

Great. Thank you very much.

Thanks Kevin.

We'll take our last question from Todd Van Fleet with First Analysis.

Wanted to ask you about what is your thinking about potential competition from state-owned facilities that are idle? Obviously states are looking for additional revenue anywhere they can get it, they're looking for employment opportunities anywhere they can get them. So as states are thinking about looking -- I'll use Pennsylvania as an example, right, so they are sending inmates out of state, decide to contract with another state provider. How do you guys think about the competition out there from these idle state facilities that might throw a wrench in the works to some degree looking at some of the new procurement opportunities you might be looking at the state level anyway?

Yes, good question, Todd. Let me first say that we incorporate into our pricing analysis, our kind of strategic analysis on how aggressive we want to be on the business opportunity, we look at what capacity is out there in the country, both public and private. So that's a part of our analysis, and we're try and understand how big of risk those various facilities may be on a specific requirement. But our sense is, even though Pennsylvania is using some beds in Michigan and Virginia, their attraction to those beds was in large part just because of the location, being so close to Pennsylvania versus capacity somewhere else in the country. But the one thing we have heard and I think this is what is consistent with California, is that states going out of state like California, one, obviously the peace of mind that their inmates will be in a safe and secure facility and the needs can be met, and specifically if they have got some high standards like California, with medical requirement, they want to make sure that the provider can meet those needs.

So I think when California has gone out most recently looking at available capacity in other states, those were not only concerns about those standards, but also the cost. The other things that states have said in thinking about working with another state is the commitment of how long that capacity will be available to that state. So if a -- State of California works with another state, the state providing the proposal may only be able to make a commitment for six to 12 months. And that's obviously troubling for a state of California because they want a long-term commitment that they have got that capacity.

But the last thing I would point to is just the age and the quality of those facilities that some of these states are proposing. A lot of times -- more times than not, I should say the facilities they are closing and then making available to some other states are some of their oldest and most inefficient, and they have limited space for different service requirements. So I feel really good that when we are proposing at least on that issue with other states, our facilities are a lot more modern, a lot more up to date standards, can be a lot more efficient from a staffing perspective, and in a way we can provide a lot more value to the state.

Yes. Damon, when you were looking at the Pennsylvania business, you were offering up Minnesota; isn't that right?

We were -- I don't know if we have disclosed that, but, yes, we were obviously proposing capacity in Prairie and other places.

How comfortable are you that the responses, I guess, to Pennsylvania were kind of on an apples-to-apples basis, so that Michigan and Virginia, they were responding apples-to-apples with your proposal, that is the healthcare costs were included and such? I mean, do you guys have good insight when you are responding to certain RFPs that your bids are actually kind of on an apples-to-apples basis with some of these states that might be competing?

We do. And that's probably something that -- that's both intelligence but also expertise we have gained over the years in contract negotiations, to really be sure that we can ask those questions, understand exactly what the state is trying to accomplish, and then making sure that we're scoping our agreement as appropriate, and pricing it accordingly, so, yes, I feel very good that we have had good success on being able to assess that appropriately.

Let me ask one more then, switching gears. On the 1,200 beds RFP, the 1,200 bed RFP that came out from the BOP, I think it was anywhere from 900 to 1,200 beds, is the mission the same for those inmates that the BOP is looking for? Or is it the same as what you have seen in the past or is a little bit different? Are they focused more on kind of the rehabilitation/reentry aspect of it?

Yes, I would say this procurement as we understand it, it is not on the street yet, but our assessment is that it should be very similar to our other BOP contracts we currently have in place. So the other procurement for 3,000 is a very different requirement. But I would say this most recent advertisement for these 1,200 beds is very similar to contracts we've got in place today.

What's the likelihood you think that gets upsized? 900 to 1200 beds is pretty small by BOP standards. Any likelihood that that gets upsized by the end of the day.

Yes, I think that's always a chance. I think if you look at the BOP's procurements over the last ten years there's a couple times where they've done that, especially if it's a good location and it's good value. So I think there's always that chance.

All right, thanks, guys.

Thanks, Todd.

We'll go next to Barry Klein with Macquarie.

How's it going guys?

Good. Good morning.

Good morning. You talked a little bit about cost containment, can you provide a little bit more color on what types of costs are being scaled back on? And are you contractually obligated to share any of these savings with any of your customers?

Yes, it's not so much that we're scaling back on costs or the service level as it is we are leveraging the favorable pricing environment in the market today. By that I mean we've got a number of vendors who have seen significant declines in their sales volumes in other industry segments, and they are working hard to hold on to the sales volumes they have with CCA. Likewise you've got vendors who have seen similar declines from other industry segments that would love to do business with CCA, and we have been very successful in leveraging that desire to hold on to the volumes or win new business with CCA in the pricing.

Okay. Got you. And then also with regard to your beds, what -- I know you talk about contract to contract, how much are guaranteed, 75%, 90%, whatever it may be. What percent of your total beds are guaranteed? And what is the average remaining contract life on the commitments you currently have and the contracts you currently have?

I couldn't give you a definitive answer on that, probably the best way to do that is go through our supplemental in our filing. And then we've got by facility the contract terms. That's probably the best way to do it. I would just say generally, our Federal contracts -- I would say the majority of them have some type of occupancy guarantee, but probably less than that on the state side.

All right. Thanks a lot.

We have no more questions at this time, so I would like to turn the call back to Mr. John Ferguson.

Thank you, operator, and once again we appreciate everybody's participation, and hopefully we have been able to answer some of your questions, and thank you, and everyone have a good day.

This concludes today's call. We thank you for your participation.