CoreCivic Inc (CXW) 2018 Q2 法說會逐字稿

Good day, and welcome to the CoreCivic's Second Quarter 2018 Earnings Conference Call. Today's conference is being recorded.

At this time, I would like to turn the call over to Cameron Hopewell. Sir, please go ahead.

Thanks, Travis. Good morning, ladies and gentlemen, and thank you for joining our call. Participating on the call are Damon Hininger, President and Chief Executive Officer; and David Garfinkle, Chief Financial Officer.

During today's call, our remarks, including our answers to your questions, will include forward-looking statements pursuant to the safe harbor provisions of the Private Securities and Litigation Reform Act. Our actual results or trends may differ materially as a result of a variety of factors, including those identified in our second quarter 2018 earnings release from yesterday and in our Securities and Exchange Commission filings, including forms 10-K, 10-Q and 8-K reports. You are also cautioned that any forward-looking statements reflect management's current views only and that the company undertakes no obligations to revise or update such statements in the future.

On this call, we will also discuss certain non-GAAP measures. A reconciliation of the most comparable GAAP measurement is provided in our corresponding earnings release and included in the supplemental financial data on the Investors page of our website, corecivic.com.

With that, it's my pleasure to turn the call over to our President and CEO, Damon Hininger.

Thank you, Cameron, and good morning, and thank you to everyone for joining our second quarter 2018 conference call today. We are also joined here in the room by our Vice President of Finance, Brian Hammonds.

CoreCivic is a diversified real estate investment trust, specialized in delivering government real estate solutions to serve the public good. We are the country's largest owner of government-leased real estate assets with nearly 100 facilities totaling over 17 million square foot of real estate and a 35-year history of delivering a broad range of solutions to help solve tough government challenges in flexible, cost-effective ways.

Our assets generate a consistent cash flow stream underwritten by investment-grade government tenants. We have 3 primary business segments that focus on corrections and detention facility ownership and management, a growing network of residential reentry centers that help address the America’s recidivism crisis and ownership of mission-critical government-leased real estate.

Our Safety segment includes 51 correctional and detention facilities with a design capacity of 72,833 beds. Our Community segment includes 26 residential reentry facilities with a design capacity of 5,214 beds. And our Property segment, taking into account recent acquisitions, includes 25 facilities representing over 1.5 million square feet of real estate.

Over all of our segments, we have active agreements with over 125 government agencies, which provides meaningful diversification, not only in assets we own but also significant diversification in our customer base.

To briefly summarize our second quarter financial performance, we exceeded the high end of our guidance with normalized FFO of $0.57 per share.

Our adjusted EBITDA in the second quarter of $97.5 million significantly exceeded the high end of our second quarter guidance of $93.4 million and grew from the $92.1 million in the first quarter of 2018, despite a sequential decline in the average daily California inmate population by over 900.

Our second quarter results outperformed our expectations, principally due to increasing utilization trends across our portfolio for the United States Marshals Service, startup-related expenses at our Lee Adjustment Center for a new contract with Kentucky coming in line with our expectations and the timing of California's exit from our Tallahatchie County Correctional Facility being consistent with our forecast, supported by stability in the balance of our portfolio. Dave will provide a more detailed summary of our second quarter financial performance at the conclusion of my remarks.

Also included in yesterday's earnings release was our updated full year 2018 financial guidance, representing increases across all of our per share earnings metrics. We currently expect to generate normalized FFO per share of $2.29 to $2.33 and AFFO per share of $2.21 to $2.25. Dave will cover in detail the primary drivers of our guidance. However, it is important to note, our 2018 guidance does not include the potential impact of new contracts or acquisitions aside from the 2 new federal contracts we announced in June and July that will have a modest impact this year and a larger financial impact next year.

We continued to see a large amount of opportunities for new business in the market, and we are actively pursuing attractive acquisition targets, all of which can contribute to future growth and diversification.

We are pleased to carry the second quarter earnings fee through to increase our full year 2018 guidance and believe recent business developments have positioned us well to continue to generate earnings growth next year.

In the last 18 months, we have been awarded 5 new state contracts to utilize existing capacity, representing incremental utilization of approximately 2,200 beds, and 1 new state contract to construct a 2,432-bed correctional facility that will be leased to the State of Kansas under a 20-year lease agreement.

The largest 2 new contracts for existing capacity completed their ramp up during the second quarter. We completed the activation of our 816-bed Lee Adjustment Center Kentucky and reached normalized occupancy levels. We also completed the ramp-up of our new 996-bed contract with the State of Ohio at our 2,016-bed Northeast Ohio Correctional Center.

We are very pleased with the performance of our facility operations teams throughout the ramp-up of both facilities, and we expect these new contracts to contribute to earnings growth in the second half of this year.

During the second quarter, we continued site work for our new facility development project in Lansing, Kansas, following the development and 20-year lease agreement we were awarded in January. The $155 million to $165 million project to replace the state's existing 150-year-old-plus prison is proceeding on schedule with its first quarter 2020 completion date, and we are pleased with the progress of our team and our construction partners.

During the second quarter, we closed on the private placement of $159.5 million in nonrecourse senior secured notes that will be used to fund the project. Especially in an environment of rising interest rates, we were extremely pleased to finance this project with 20-year bonds at a yield to maturity of 4.43%.

In the last 60 days, we have also been awarded 2 new federal contracts that are scheduled to ramp-up in the second half of this year and are expected to contribute meaningfully to earnings growth in 2019. In June, we are awarded a new contract with United States Marshals Service at our Tallahatchie County Correctional Facility in Mississippi that house 1,315 -- 1,350 prisoners with the option of housing additional population should additional capacity be available.

The new contract is governed by an intergovernment agreement between the Tallahatchie County Correctional Authority and the United States Marshals Service and has an initial period of 2 years with unlimited 2-year extension options. Both the Federal Bureau of Prisons and Immigration and Customs Enforcement are authorized to utilize this contract should they have needs arise. In fact, ICE is currently housing over 500 detainees at the facility under this contract.

In July, we were awarded a new contract with the federal government to utilize a portion of our 3,060-bed La Palma Correctional Center in Arizona. Under the agreement, ICE currently expects to house up to 1,000 adult detainees at the La Palma facility as bed capacity becomes available. The facility is currently occupied by approximately 2,300 offenders from the State of California, but the state has indicated it intends to exit the facility by January of 2019, due to projected population reduction in the state system. We started the ramp with ICE in the last 10 days, and we currently care for over 100 ICE detainees at the La Palma facility.

La Palma facility is the fifth and final company-owned facility that has provided capacity to populations for the State of California out-of-state, which, at its peak, had it caring for nearly 11,000 inmates from California. With this new contract with the federal government, we have now secured new contracts with multiple state and federal partners for all 5 of these facilities, substantially removing what has been an earnings headwind for the last 3 years as well as further diversifying our sources of revenue. Despite these headwinds, California has been a meaningful partner to us, and we stand ready to serve their needs should they continue.

Across the 7 new federal and state contracts, we expect to utilize approximately 4,500 beds in our CoreCivic Safety portfolio, which is clearly one of the strongest business development performances we've had in a number of years. However, there are still a large number of new market opportunities available in the near term, and we still have a significant amount of available capacity to meet those needs. We believe these opportunities could lead to meaningful increases in our long-term cash flows because of our approximately 10,000 beds available in idle facilities and more than 3,000 beds in partially utilized facilities that could effectively provide solutions for these opportunities without the need for additional capital deployment.

I'll first discuss state-level opportunities. Earlier this year, the Commonwealth of Puerto Rico issued an RFP to move up to 3,200 inmates off the island in order to reduce the annual budget for the Department of Corrections and Rehabilitation. This budget reduction initiative is part of a larger effort by the Commonwealth's Governor to address the territory's debt crisis, which is impacting essentially all of the government agencies and their operations. The RFP calls for an initial phase of 1,300 inmates to be housed off the island beginning this year. Upon full implementation of the RFP, the Department of Corrections estimate annual budget savings of approximately $50 million. We have responded to the RFP and believe our response is compelling, not just for the cost savings for the Commonwealth but also to provide a more humane and more robust programmatic environment. We believe an award to be announced in relatively short order, and we believe we are uniquely positioned to meet this urgent need.

Earlier this year, the Vermont Department of Corrections issued an RFP to house up to 350 inmates due to overcrowding in the state's correctional system. The inmate population is currently housed under a separate contract between Vermont and the State of Pennsylvania that is scheduled to expire this fall. We have responded to the RFP with available capacity in our facilities and are awaiting a final decision.

With the successful ramp of our 816-bed Lee Adjustment Center completed and the Commonwealth of Kentucky having an additional need for capacity in their system due to overcrowding, we have the opportunity to market our 2 remaining out facilities that are located within the state. The Marion Adjustment Center and Southeast Kentucky Correctional Facility have a combined capacity of approximately 1,500 beds, and Kentucky's need for additional capacity far exceeds this capacity.

We are also in active discussions with a number of other states that have correctional capacity needs that could materialize over the next 12 months. In terms of estimating the magnitude of these needs, we've had discussions with multiple other states looking for between 1,000 and 2,000 beds individually. We are also in the process responding to a new RFP for a 1,931-bed managed-only opportunity in Delaware County, Pennsylvania. Although we have exited a number of managed-only contracts in recent years, we carefully evaluate each opportunity that comes to market and consider submitting a proposal on a case-by-case basis. The facility is currently operated by another private provider under a contract expiring at the end of the year, so we expect an award announcement to be issued later this year.

Looking next at opportunities for CoreCivic Safety at the federal level, our recent contract wins with United States Marshals Service and Immigration and Customs Enforcement clearly indicate both agencies have experienced increased capacity needs recently and are projecting their needs will continue to grow.

United States Marshals Service average -- daily prison population average, I should say, has grown substantially in 2018 from 52,000 at the beginning of the year to approximately 57,000 as of June 30. Multiple CoreCivic facilities with Marshals' contracts already in place have experienced an increase in Marshals' populations and have capacity available to accommodate additional populations growth. And our new contract with the Marshals at Tallahatchie expected -- is expected to ramp up in the second half of the year. Should the agency have additional capacity needs, we have multiple facilities that could accommodate this growth.

ICE gradually increased its utilization of our detention capacity in the first half of 2018 and with the new contract for 1,000 beds at our La Palma facility, we expect their utilization will continue to increase in the second half of the year. We are in the time of the year, during the hottest summer months, where the rate of activity along the south of Florida typically experiences modest declines. This summer has seen above average temperatures in the Southwest. So it is likely we will see the seasonality again this year. This short period of seasonality aside, ICE is actively pursuing additional capacity as ICE is projecting continued growth in their detention capacity needs.

Finally, with the Federal Bureau of Prisons, there are 2 outstanding procurements. CAR XVIII is a rebid of the managed-only 2,355-bed Taft facility in California, which is currently operated by MTC. Responses were due to the BOP last year and follow-up discussion notices with the Bureau have been ongoing. CAR XIX is a procurement that was issued in 2017 and is intended to provide additional bed capacity from the private sector to alleviate overcrowded conditions at BOP-operated facilities and to increase utilization of the Bureau's most cost-effective beds. We believe an award announcement for both of these opportunities will come in the first half of the federal fiscal year.

As a reminder, today, we only have 2 contracts with the BOP for correctional capacity, representing 5.6% of our total revenue.

Clearly, there is a lot of positive activity ongoing in our CoreCivic Safety segment, but we also have a number of attractive opportunities in our other 2 business segments, CoreCivic Properties and CoreCivic Community.

In CoreCivic Properties, we're specialized in the development, construction and maintenance of mission-critical real estate leased to federal, state and local government agencies. There are at least 6 other states publicly discussing a public-private partnership approach as a possible solution to replace their aging prison infrastructure, a solution similar to the ongoing prison development project we have in Kansas.

We've made great progress in marketing this solution to jurisdictions, given that until January of this year, no transaction of this kind had ever been done or been achieved. The runway for opportunities in this market strictly looking at the replacement of out-of-date criminal justice infrastructure is substantial. Collectively, we estimate $15 billion to $20 billion of required investments are desperately needed for these type of facilities to make them safer for staff and inmates alike, more efficient and provided the kind of reentry programming space we know can help people better prepare to rejoin their communities.

We believe public-private partnerships, similar to what we accomplished with Kansas, are the key to solving this national infrastructure challenge. In addition, we have existing idle correctional facilities in Colorado, Oklahoma and Minnesota, where we continue to pursue opportunities to lease this capacity to these respective state departments of corrections, as all 3 have a need for additional correctional capacity in their system due to overcrowding and/or aged infrastructure.

And we aren't simply limiting the growth of potential -- growth potential of CoreCivic Properties to the criminal justice sector. We are also pursuing growth of this business segment through the acquisition of other government-leased assets with a bias towards those that are mission-critical. Growth in this area will allow us to leverage our extensive real estate management and maintenance capabilities as well as our 35-year history of developing real estate solutions for government agencies. So far this year, we have acquired 13 properties leased to federal and state government agencies, representing over 367,000 square feet. These leases provide predictable stream of cash flows through the long-term lease agreements with investment-grade government tenants, resulting in an attractive risk-adjusted returns to our shareholders.

We are aggressively pursuing additional opportunities to grow this portion of the business. Between the real estate assets leased by the federal government through GSA and similar real estate leased by states and local government agencies, the addressable market for potential acquisitions are substantial, and we are actively pursuing multiple investment opportunities.

In CoreCivic Community, we were quiet on the acquisition front in the second quarter, but we continued the integration of Rocky Mountain Offender Management Systems, a provider of nonresidential, community-based correctional alternatives, which we acquired in January. This process has gone quite well, and we've had positive discussions with our existing partners about this new service capability and how they could potentially utilize the services. We are continuing to pursue acquisitions of additional community correction facilities and providers of alternative detention and incarceration services in order to expand the footprint of the CoreCivic Community segment and the solutions we can provide.

As you can see, we have experienced very positive developments across all 3 business segments through new contract awards, increased utilization and accretive M&A transactions. Coupled with the fact that the utilization of our existing contracts have been mostly stable, we believe these positive developments have put us on a trajectory of cash flow growth over the next year.

Another positive development has been the health of the overall economy, improving the fiscal conditions of our government partners' operating budgets. The strong labor markets and increasing state budgets have provided the best environment in many years for contractual inflators being appropriated for contracts. The contractual inflators and state contracts typically go in effect at the start of the states' fiscal year, which is typically July 1. This is a trend we have been seeing over several years, but the trend appears to have accelerated this year as growth in the overall economy has accelerated and the nation's unemployment rate has declined.

Now like many corporations, of course, this has also created labor challenges for us in certain locations, requiring us to make market adjustments when necessary, something we expect will continue continuously, and we will continuously monitor and take closer look at this going forward.

At this time, I'll turn the call over to our CFO, Dave Garfinkle, to provide an overview of our second quarter results and our updated full year 2018 financial guidance. Dave?

Thank you, Damon, and good morning, everyone.

In the second quarter, we generated $0.36 of adjusted EPS compared to our guidance range of $0.33 to $0.35 and $0.02 ahead of the First Call consensus estimate. Normalized FFO totaled $0.57 per share compared to our guidance range of $0.53 to $0.55 and $0.02 ahead of First Call consensus estimates.

AFFO totaled $0.55 per share compared to our guidance range of $0.50 to $0.52. Adjusted EBITDA was $5.1 million higher than the midpoint of our guidance for the second quarter, reflecting strong operating performance. Q2 2018 adjusted amounts exclude charges of $1 million associated with the amendment and extension of our credit facility executed in April, $800,000 of M&A expenses and $1.6 million of asset impairments, while Q2 2017 adjusted amounts exclude $300,000 of M&A expenses.

Our financial performance exceeded forecast, largely due to higher federal populations in our CoreCivic Safety portfolio. Notably, our per share results exceeded expectations, even though we retained staff at our 2,672-bed Tallahatchie County Correctional Facility in Mississippi longer than previously anticipated, as our prior guidance contemplated the complete phaseout by California at this facility by June 30. While California did in fact transfer all 1,300 inmates out of this facility, we retained staff throughout the quarter, while we negotiated with a number of potential new customers to ensure a smooth transition with experienced staff, if we were able to secure one or more new contracts. On June 14, 2018, we announced a new contract with the U.S. Marshals Service to care for up to 1,350 offenders at this facility, essentially replacing the vacancy of California populations with the ability to utilize additional beds subject to availability.

At June 30, 2018, we also cared for 200 additional offenders at the Tallahatchie facility under new contracts utilized by the states of South Carolina and Wyoming as well as the U.S. Virgin Islands, and are in discussions with additional state customers with needs that can potentially result in utilization of the remaining capacity.

When compared with the prior year quarter, earnings were positively impacted by higher U.S. Marshals populations across the portfolio and a new contract with the State of Ohio for up to 996 offenders at our Northeast Ohio Correctional Center that commenced during the third quarter of 2017. The positive impact of these population increases was offset by startup activities in the current quarter at the Lee Adjustment Center pursuant to a new management contract with Commonwealth of Kentucky, the transition from California populations to new federal and state populations at our Tallahatchie facility, the termination of a contract with the Bureau of Prisons at our Eden Detention Center effective April 30, 2017 and higher interest expense. The increase in interest expense primarily resulted from the repayment in October 2017 of variable-rate short-term borrowings under our revolving credit facility with net proceeds from the issuance of $250 million, 10-year unsecured notes at a fixed interest rate of 4.75%.

Financial results also included 6 M&A transactions since the end of the second quarter of 2017 through the end of the second quarter of 2018, with an investment totaling $88.6 million for 5 residential reentry centers, 4 government-leased properties and a company that provides nonresidential correctional alternatives, including electronic monitoring and case management services. Of these 9 properties, 4 are residential reentry centers that we own and operate under our CoreCivic Community portfolio and 5 are properties operated by third-party tenants under our CoreCivic Properties portfolio.

Our CoreCivic Community portfolio generated 6.1% of our adjusted EBITDA during the second quarter of 2018, which as of June 30 comprised of 26 residential reentry centers we owned and managed with a total design capacity of 5,214 beds in 6 states and the aforementioned nonresidential correctional alternative subsidiary, providing electronic monitoring and case management services.

Our CoreCivic Properties portfolio generated 9.1% of our adjusted EBITDA during the second quarter of 2018. Subsequent to quarter end, we acquired a portfolio of properties for $12 million, a 100% lease to the U.S. federal government through the GSA on behalf of the Social Security Administration, the Department of Homeland Security and Immigration and Customs Enforcement. We expect this 12-property portfolio acquisition to achieve a cap rate in excess of 10%, well above our target return for GSA-leased assets.

Following this acquisition, our CoreCivic Properties portfolio comprised 25 properties leased to third parties totaling 1.5 million square feet in 10 states. The CoreCivic Properties portfolio was 99.5% leased during the second quarter of 2018 with very stable cash flows under leases with fixed monthly rents.

At June 30, we had $71 million of cash on hand and nearly $700 million of availability on our revolving credit facility and no debt maturities until 2020.

We have a strong balance sheet with leverage of 3.7x and fixed charge coverage of 5.2x using the trailing 12 months. We are in excellent position to grow our cash flows through the utilization of idle bed capacity in an environment with increasing demand and have the flexibility to take advantage of M&A and other growth opportunities that require capital deployment.

We continue to build a pipeline of government-leased property acquisitions, which generate cap rates in the market generally from 5% to 8% depending on property characteristics, enabling us to achieve levered returns that exceed our weighted average cost of capital utilizing nonrecourse secured debt.

We also have an active pipeline of investments that fit in our CoreCivic Community portfolio that we would expect to finance with our corporate balance sheet.

Our capital expenditure forecast, which is included in the press release, includes approximately $50 million of capital expenditures for the remainder of 2018 for construction of the new Lansing Correctional Facility in Kansas, which is progressing on budget and on schedule to be complete in the first quarter of 2020. This project has a total estimated cost of $155 million to $165 million, $12 million of which has been incurred through June 30 under a guaranteed maximum price contract with the developer. The project will be 100% financed with the previously disclosed private placement, which closed in the second quarter of 2018 and will be drawn in quarterly installments to align with construction expenditures.

Moving next to a further discussion of our earnings guidance. As indicated in the press release, adjusted EPS for the third quarter of 2018 is a range of $0.37 to $0.39. Normalized FFO per share guidance for the third quarter is $0.57 to $0.59, and AFFO per share guidance for the third quarter is $0.55 to $0.57.

For the full year, adjusted EPS guidance is a range of $1.47 to $1.51, an increase from our May guidance of $1.42 to $1.48. Full year normalized FFO per share guidance is a range of $2.29 to $2.33, up from our May guidance range of $2.24 to $2.30. And full year AFFO per share guidance is $2.21 to $2.25, up from our May guidance range of $2.17 to $2.23.

Our updated full year guidance reflects the $0.03 beat in Q2 carried through to the full year, an additional increase of $0.02 to $0.04 for the new contract with U.S. Marshals Service at our Tallahatchie facility, partially offset by $0.02 for a faster ramp down of California populations forecasted at our La Palma Correctional Center and the transition to a new federal contract at this facility as it ramps up populations during the second half of the year.

Our updated full year guidance reflects an increase in adjusted EBITDA by $8.3 million at the midpoint compared with our May guidance.

Elaborating further on California, as we discussed on our last earnings call, because of projected lower inmate populations in California's correctional system, our previous forecast reflected a reduction in California inmate populations at our 3,060-bed La Palma Correctional Center to 1,500 inmates by December 31, 2018, which was based on the proposed fiscal 2019 budget issued by the Governor of California in January calling for the phaseout of the La Palma facility by fall 2019. Governor Brown signed the state's fiscal 2019 budget in June, which calls for the removal of the California populations at our La Palma facility by January 2019. Our guidance generally conforms with the state's final budget and now reflects a reduction to about 450 inmates by December 31, 2018, a faster reduction at La Palma than our previous forecast.

However, on July 24, 2018, we announced that we entered into a new contract with the federal government to utilize a portion of the beds expected to be vacated by California at the La Palma facility. Our forecast reflects the ramp-up of federal populations close to 1,000 offenders by December 31, 2018. This faster reduction in populations from the state of California and carrying costs while we ramp up federal populations during the third and fourth quarters resulted in a $0.02 per share reduction from our May guidance.

Obviously, we stand ready to assist California with their needs, and if California does not ramp down as quickly as we have forecasted, there could be upside to our guidance. As of yesterday, we cared for 2,300 California inmates at the La Palma facility, down from 3,000 as of the beginning of the year. Revenue from California's out-of-state program is expected to generate 3.6% of our revenue in 2008 -- 2018 and about 1.5% of our revenue in the fourth quarter of 2018.

As Damon further described, we continue active discussions with potential customers at both the federal and state level to utilize our idle facilities and available capacity. However, our guidance does not include any new contracts beyond those previously announced because the timing of government actions on new contracts is always difficult to predict.

Depending on the location, new contract awards could also come with start-up costs that are not included in our guidance. In addition, although we continue to pursue a number of attractive investment opportunities that are accretive to FFO per share using our long-term weighted average cost of capital, our guidance does not include any new M&A activity beyond those already announced.

The adjusted EBITDA guidance in our press release enables you to calculate our estimated effective income tax rate of 4% to 5% and provides you with our estimate of total depreciation and interest expense for the third quarter and full year 2018. We expect G&A expenses to be approximately 5.5% to 6% of total revenue.

I will now turn the call back to Damon for closing comments before opening up the lines for questions.

Thank you, Dave. Now before I open the call up for Q&A, I would like to take this opportunity to discuss recent coverage of federal immigration policies in order to clarify the valued, but limited role, CoreCivic plays in the country's immigration system.

While we know this is a highly charged, emotional issue for many people, much of the information about our company being shared by special interest groups is outright wrong and politically motivated, resulting in many reaching misguided conclusions about what we do.

To be clear, none of our facilities provide housing for children who aren't in the supervision -- under the supervision of a parent. The only facility of ours that houses children is our South Texas Family Residential Center, a facility that was built in 2014 with a family residential mission at the request of President Barack Obama's administration to help the country address a humanitarian crisis along the Southwest border, which is intended to maintain family unity, while federal authorities conduct the initial steps of the asylum determination process. At no point in time do we house minor children in absence of the child's parent. Additionally, CoreCivic does not advocate for or against legislation or policies that determine the basis for or duration of an individual's detention. We do not enforce immigration laws or policies or have any say whatsoever in the individual's deportation or release. CoreCivic does not know the circumstances of individuals when they are placed in the facility and our responsibility is to care for each person respectfully and humanely, while they receive the legal due process they are entitled to.

Our ICE facilities are under consistent operational oversight and held accountable to Federal Performance-Based National Detention Standards, and in the case of our South Texas Family Residential Center, we are also held accountable to Federal Family Residential Standards. Each and every one of our ICE facilities are required to undergo regular review and audit procedures, and we are proud of our operational performance.

The fact is, our sole job is to help the government solve problems in ways it could not do alone, to help manage unprecedented humanitarian crisis, dramatically improve the standard of care for vulnerable people and meet other critical needs efficiently and innovatively. We have done the same mission for more than 35 years, working with both Democrat and Republican administrations, to operate the facilities for ICE and its predecessor, Immigrations and Naturalization Service, an agency that was founded in 1933.

CoreCivic's first -- very first contract was with INS at our Houston Processing Center, a contract we still have to this day because of the quality service we have provided to the federal government for more than 3 decades.

Having set the record straight on this often misrepresented topic, I'll turn the call over to our operator to open the lines for questions.

(Operator Instructions) Our first question comes from Tobey Sommer, SunTrust.

With respect to occupancy, first topic I'd like to ask a question about, it sounds like you think you can hold the gains year-over-year. And I'm curious that, Damon, what do you think occupancy can be in maybe not just 12 months, but 24 months?

Absolutely, Tobey. Thank you so much for your question. So as you know, we've got about 10,000 beds in kind of round numbers for idle facilities, about 3,000 beds in facilities that are partially utilized. And I think, if we think about kind of the line of sight that we've got with existing facilities that are partially utilized, which we talked about before, Puerto Rico from kind of active opportunities plus the couple that are off market and then also kind of mid- to near-term with BOP and CAR XIX and some other activity we see the federal level, we think there is a path to north -- be north of 90% occupancy within the CoreCivic Safety portfolio. We've got 2 or 3 facilities, kind of look at it a different way, 2 or 3 facilities that probably near-term don't have any marketing opportunities, notably with Minnesota, with our Prairie facility, our Kit Carson facility in Colorado and our Torrance facility. All 3 of them are being marketed. Could be opportunities, I don't see anything probably in the next probably 6 to 12 months. But if you back out those 3 facilities, occupancy potentially could be in the CoreCivic Safety kind of in the 90% to 95% range. So hopefully that gives you kind of at least a kind of indication of what potentially opportunity could be over the next 24 months.

It does. And as a follow-up, with respect to changes in occupancy, what's a good rule of thumb for what each points in occupancy can mean for profitability metrics, whether it's EBITDA or FFO per share? And I know there's some variabilities as to contract per diem who the customer is, the location, et cetera, but any kind of ranges that you can give us there?

Yes, Tobey, this is Dave. That you raised kind of the multiple variables that go into that calculation, whether the facility is going to be an owned and managed facility, whether it's going to be leased facility, generate -- generally generate lower EBITDA. And I would use probably EBITDA is probably the easiest calculation, but, well, a 1% increase in our occupancy, we've got about 78,000 beds, so that would be about 780 offenders. If you apply the average margin in Q2, which we posted on our supplemental disclosure report on our website. So Q2, the average margin was $20.18. So if you apply that $20.18 to 780 offenders, that would be about $5 million to $6 million of additional EBITDA. Obviously, the number would be lower, if you're activating a facility and it's underutilized because you'll have lower margins as opposed to a higher facility when utilization is maximized. So if the 1% is coming from a facility already in operation, let's just say that, the number could be up to twice as much of that, $10 million to $12 million.

And wanted to kind of switch topics and talk about per diems, which were up. Could you talk about the trends that are allowing that to happen? And whether or not you see momentum there continuing?

Absolutely, Tobey. This is Damon, so I'll tackle that one. And I'll give you 2 observations. The first one is, just generally, we're seeing state budgets improve throughout this country and notably with our partner agreements that we have with about a dozen various states. And so with that, the discussions that we've had during the spring have been very, very encouraging and good support there to not only give us increases but with that saying that we're going to raise salaries as appropriate because of the trend we're seeing in the labor market. So that would be my second point. The labor market, being in a business where we work with customers who do this themselves, they're obviously feeling pressures like we are with the labor market. And so we are somewhat aligned -- very aligned, I should say, with our state partners, Department of Corrections leadership, when we go to the legislature and others, talk about funding increases because increases that we have in our contracts that help deal with some of those pressure on the labor side. They're looking also for increases on the safe side just to deal with public employees that are feeling the same type of labor prices within those respective jurisdictions. And one thing I'll say -- Tobey, I'll say one more thing is that we went back, I didn't say this on my script, but we went back, it's probably been -- probably 5, 6, maybe 7 years, where we've had this type of kind of positive movement on escalators on our state contracts.

Okay. And do you think that is there -- I guess, if the economy holds up, do you think there would be an opportunity for kind of an above recent average increase next budget cycle?

I would say it's probably going to be -- see if David agrees -- pretty close in line with CPI. So I think, yes, you probably got some jurisdictions, if you've got a little more tightness and maybe more activity on the labor market than others, then you may be a little above average. But I'd say generally, if I think about the whole portfolio, it's probably in line with CPI.

Yes. And most state budget years begin July 1. So we've already seen those in Q3. We haven't, obviously, reported those. But -- and as Damon mentioned, it was as good a year we've seen it as in many years for appropriations getting funded for CPI increases.

Okay. I was wondering if you could comment on the M&A pipeline, the amount of activity you're seeing, are the property or deal sizes changing?

Absolutely. So this is Damon, again. So I would say it continues to increase. The amount of activity that our folks internally are bringing us relative to deal opportunities, I'd say, it is generally continuing to increase during the course of the year. And so just kind of give you a sense of size, we've looked at portfolios where we got multiple properties, of course, as large as 15. So up to 15 properties in a portfolio. And we've looked at kind of transaction size kind of in the range of $10 million to $20 million, kind of on the low end to -- up to $0.5 billion. In fact, kind of near-term, we're looking at some opportunities that are in the range of kind of $50 million to $250 million. So it's a very active market. And as you know, we've gotten some opportunities at the federal level, but also at the state level. And we think that there's obviously a few players at the federal level looking at these assets, but at the state and local level, we don't think there's much competition. So we think there's good opportunity, kind of mine for value for some of these opportunities and bring a lot of expertise to the table as owners.

Dave, I think you mentioned something about potential incremental 2019 impact from recent contract wins and the ramping of those. What is the knowable kind of incremental impact from those for next year in terms of FFO?

Well, the notable ones are the U.S. Marshals Service at Tallahatchie. That was a $0.06 to $0.10 FFO per share increase for a full year basis. Then we've got the new contract at Saguaro -- at La Palma that's going to be offset by the decline at La Palma. So those populations and that's for what we estimate to be 1,000 inmates or detainees at La Palma from the federal government, that would be replacing at the beginning of this year 3,000 California inmates. So that's probably a net negative unless we are able to enter into new contracts, and Damon talked about some of those opportunities that we're very optimistic of getting that could be incremental to La Palma. Obviously, Ohio and Lee Adjustment Center, 2 contracts really stabilized occupancy, capped out on those contracted capacities in the second quarter. So those will be a full year impact in 2019. I think those are probably the most notables.

Okay. Shifting gears to Puerto Rico. You talked about the savings. There've been some media reports that you are a front-runner for the initial phase. I was wondering if you could speak to that? And what the likelihood is for Puerto Rico to execute kind of the full scope of the contract, as they have articulated, it's a bigger number than the initial kind of tranche?

Very good, Tobey. Damon, again. Thank you for this question. Yes, so Puerto Rico, let me answer maybe the last half first. We think that there is a real, real need for the solution. Puerto Rico has had some fits and starts in the past as they thought about solutions off the island. But we think the time line they've laid out from the first part of the year to the issuance of the procurement, some of the public statements made by the Governor and other leadership within the Commonwealth and the time line they followed, I should say, also with the procurement, with the due date, with the tour of facilities, they have kept pretty close to that timetable. So kind of back to the first point, we think this is a real opportunity and a real need, and a really great way we can provide a great solution for them. As you all know -- as you know, I should say, Tobey, I mean, it's just been really challenging for the Commonwealth, not only for their fiscal situation but also with these recent hurricanes and how it's really put a lot of stress on their infrastructure. So we are in active discussions with Puerto Rico. We think we are well positioned for really 2 key reasons. One is, we know Puerto Rico really well. We've been working with them off and on over the last 20-plus years, both on the island and off the island. And so we think we'd bring a lot of expertise to the table. And then the second thing is that since they do want to move fairly quickly, we think capacity that we've got available today, where we could ramp up immediately, puts us in a great competitive advantage. So we're hopeful. Again, the discussion has been very positive. We think that the urgency and the need is really there. And we also know that they're looking at our other jurisdictions where we do work. These last 18 months where we've gotten these 5 new state contracts, those haven't happened by accident. It's because we provided really good, high-quality great programmatic solutions to the government partners. And so when you get 5 new agreements, people like Puerto Rico and Vermont, they're talking to those folks as to how has the experience been. And so we think that also has been working to our advantage with this momentum we've had on the state side. So stay tuned. We're, I'd say, in active discussions, and hopeful that they move forward here before the end of the year.

Okay. Two last questions from me. One on the replacement bed opportunity. Should -- are there any characteristics of the Kansas arrangement that might change or be different in the replacement conversations that you're having now. And principally, I kind of have one in mind. Is it possible that the company, CoreCivic, could retain long-term ownership? And then, my last question is, with respect to BOP inmate populations, do you think they're going to increase over the next couple of years?

Absolutely, Tobey. So let me -- this is Damon, again. Let me -- I'll tackle both of those. So the first one, to your question on other jurisdictions looking at kind of Kansas like solutions? Yes, everyone is going to be very different. One thing we've learned in our travels around the country and marketing the solution to places like Alabama, Vermont, Wyoming and Wisconsin, some of the jurisdictions that we talked publicly about a need for this replacement capacity. Every jurisdiction is different, and some of the pressures and challenges and constraints they have, not only on the project itself but also the lease and how they lease those facilities, we think are going to be very different. So our view is, let's get in front of these jurisdictions, let's introduce ourselves, let's talk about our experience in providing mission-critical real estate solutions over the last 35 years and then just listen, understand kind of what their constraints are and some of the sensitivities they have, not only with -- again, the actual physical plant and the facility but also the actual lease and some of the maybe constraints they have on their system relative to balance sheet, bonding capacity levels, et cetera. To your second question, on BOP, so we're actually at the BOP, we just met with them here over the weekend at the American Correctional Association Conference up in Minneapolis. They're always good to meet with the industry during these conferences. And so we got a really kind of new view from them or updated view, I should say, not new, but updated view from them over the weekend on kind of populations. And what they're saying, going into next fiscal year, which, as you know, starts on October 1 at the federal level, they're saying they probably will see -- still see some declines for the first part of the year, but the populations will reverse, bottom out and then start to increase during the course of the fiscal year. So I think their view is '19, a little bit decline at first, bottoms out, start to increase, but potentially just kind of flat for the fiscal year. And they're going into 2020 and beyond seeing increases. And they noted, as you and I talk about, Tobey, kind of the leading indicator, the Marshals Service population. So with the Marshals Service increasing by about, gosh, 8,000-9,000 prisoners over the last 12 months, they're clearly watching that closely and seeing as a lead indicator for their additional capacity utilization. So not part of your question, but a common question we ask about CAR XIX is, with 9,500 beds in that procurement, is the need still there? And I think with them seeing 8,000 to 9,000 population increase to Marshals Service, that the need is still going to be there with the Bureau going into '19 and 2020.

(Operator Instructions) Our next question comes from Kevin McClure, Wells Fargo Securities.

Want to talk about just usage of capital over the next 12, 24 months. When you think about how you allocate gross capital, how would you bucket between office acquisitions versus residential reentry or growing your correction detention business, are there any new development or expansions?

Thanks, Kevin. I will take that one. I would say the pipeline both -- pipeline for both CoreCivic Community, which is residential reentry center business, is active, probably not as active, as I said, as CoreCivic Properties. Our pipeline would be, there is just more opportunities in the GSA and government-leased property type than there are in the residential reentry center market. The residential reentry center market, you're typically going to be seeing relatively small transactions, anywhere in the $5 million to $50 million transactions, where, as Damon pointed out, if you're looking at CoreCivic Properties and the government-leased asset class, they can be significantly varying sizes. So we're looking at deals anywhere from $10 million to $50 million for individual properties and then portfolios that reach $250 million or higher. So I would say, as we look at the capital allocation, it's probably going to be more skewed on a dollar basis toward CoreCivic Properties than it would in CoreCivic Community just because there is more opportunities in that space. When it comes to the CoreCivic Safety space, we've got 10,000 available beds, so don't see any new construction on the horizon. I guess I wouldn't be too shocked if we had a small expansion in a particular market that has unique demands or acute demands with limited alternative bed capacity. But really shouldn't see too much deployment of capital in the CoreCivic Safety business.

Okay. And you mentioned that expansion, would that be Otay Mesa? And if so, would that expansion include family beds?

This is Damon. So yes, the Otay facility is one that we are considering. It would just be for adults.

Just for adults. Okay. And then looking at your office portfolio, you mentioned, Dave, $250 million portfolio transaction or larger. How would you plan to fund that in terms of debt versus equity?

It would be with secured debt in the government-lease nonrecourse market.

All nonrecourse?

All nonrecourse, yes. CMBS financing, mortgage, something like that. It's similar to what we financed Capital Commerce Center at the beginning of the year, that acquisition was financed with about 50%, 55% loan to value with an attractive 4.5% fixed fully amortizing mortgage over a 15-year term. So it would look very similar to that.

Got it. And then as you think about leverage going forward. I know you -- as you grow out the property side of the business, that can support a little bit higher leverage point. And in the past, you said that blended leverage would be a little bit about 4x. So as you're thinking about your credit rating and your, I guess, the ending leverage point, what's kind of the sweet spot for you guys?

Yes, that's a great question, Kevin. You're right. I look at it as we've always said 3x to 4x on the CoreCivic Safety and CoreCivic Community business. Government-leased assets can handle a higher leverage level investment-grade REITs out there in that asset class, 5, 6, maybe even 7x leverage. We have no aspirations to carry our leverage that high. On that part of the business, we'd be comfortable 5x or 6x leverage. So on a blended basis, it does come out a little bit north of 4x. Did that answer your question?

Yes, that's helpful. I appreciate that. And then, can you just maybe give us some visibility into how populations at South Texas trended throughout the quarter given all the influx and arrivals and the attention around family separation?

Yes, this is Damon. So I can give a little color there. So we saw some fluctuation during the summer months. I looked at it this morning and I think we were kind of 1,500-1,600, I think, beds there that would be in occupied. So probably, historically, that's probably pretty close to the average. We've been as high recently as 2,000 and then sub-1,000. So I'd say right now, today, it's pretty close to probably the historical average. And then I know some numbers just came out, more generally, not just with South Texas, more generally about kind of family activity on the Southwest border and I've looked at that over the last few days, and it appears that family kind of apprehensions on the Southwest border are maybe a little higher than historical, still below the notable level in 2014, which was a huge crisis on the Southwest border and called us into action with Obama administration. But I'd say the kind of current activity is a little -- maybe a little higher than historical norms during the summer months.

Got it. And then final one for me, housekeeping item. The Lansing CapEx, the $60 million-or-so that you plan to spend in 2018, that's all running through the cash flow statement, correct? Because in other words, year-to-date, you've only incurred, from my estimates, $44 million of CapEx versus the $130 million guide. So I just want to make sure I'm comparing apples to apples.

You are. Yes, absolutely. Those cash expenditures go to the investing section of our cash flow statement.

And at this time, I would like to turn the call back over to our speakers for closing remarks.

Thank you, Travis. Before we conclude the call, I want to take a moment to recognize our employees, who are chaplains, nurses, mothers, veterans and many others. These are really, really good people, doing great work for our government partners and the individuals entrusted in our care. So to them directly, I'm sincerely honored to serve alongside you all. I really appreciate everyone joining us on the call today, and we look forward to reporting to you in November on our progress through the third quarter of this year. Everybody, have a great rest of your day.

Thank you, ladies and gentlemen. This concludes today's teleconference. You may now disconnect.