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Corrections Corp. of America (NYSE:CXW)

REIT Conversion Conference Call

February 8, 2013 11:00 am ET

Executives

Damon T. Hininger – President and Chief Executive Officer

Todd J. Mullenger – Executive Vice President and Chief Financial Officer

Analysts

Manav Shiv Patnaik – Barclays Capital, Inc.

Tobey O'Brien Sommer – SunTrust Robinson Humphrey

Derek Sbrogna – Macquarie Capital (NYSE:USA), Inc.

Kevin Campbell – Avondale Partners LLC

Barry J. Klein – Macquarie Capital (USA), Inc.

Brent Greenfield – Soroban Capital Partners LLC

Operator

Please stand by. Good morning, and welcome to CCA’s 2013 REIT Conversion Conference. Today’s conference is being recorded. If you need a copy of our press release or the presentation accompanying this call, both documents are available on the Investor page of our website at www.cca.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 release and included in the presentation on our website.

We are under no obligation to update or revise any forward-looking statements that may be made to reflect events or circumstances after the date hereof or to reflect the occurrences of unanticipated events.

Participating on today’s call will be our President and CEO, Damon Hininger, and Chief Financial Officer, Todd Mullenger.

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

Damon Hininger

All right. Thank you so much Farah and welcome everyone to our call this morning. We’re obviously very excited about this announcement and very significant milestone for the company. On the call in addition to Todd, is our VP of Finance David Garfinkle, he will be joining us throughout the call this morning.

During our remarks this morning, I’m going to refer to the presentation that’s out on the website that we sent around late last night. And during our remarks, I’ll be referring to the page numbers on the bottom. So if you have that handy, there are several key points during the discussion today that I want to refer to in our presentation.

But if you look on the very first page, basically the cover sheet of the presentation, this is where we’ll get started and I wanted to point out a view of one of our facilities. This is a great evening view of our Adams County facility down in Natchez Mississippi and it’s a significant portion of our real estate portfolio and this is really a court of what we do, what we provide these type of solutions to government partners. The core function of that is our real estate, and our real estate solutions and Adams is a great example of that. This was build about four, five years ago for about $120 million in CapEx and it provides a great solution to government partners at a federal, state, and local level, who are looking for ways to deal with overcrowding or incremental growth. Corrections and new investors to the industrial find is that our corrections and correctional facilities. The needs for these type of solutions have been around for centuries and we’ve been providing a great solution over the last couple of decades as government still with growth and also overcrowding.

So let me move forward into the presentation and just talk a minute on page three and going through the agenda. We’ve really got four key items that we want to cover today, the first of which is talk about the re-conversion and the highlights of our conversion as we go through in 2013. Second is to also talk about the value creation and opportunities for growth, now that we are moving forward as a REIT company. I am going to turn the call over to Todd on number three, which is talking through some of the key conversion items that we will be working on here in the coming days and weeks. And then finally, I will wrap up the call before we go to Q&A to talk about the company background and this will be a key interest to new investors to the company and to the industry.

So let me now move to page four of our presentation and we have a management team and a Board has very focused on create shareholder value. We think we’ve got a great track record over the years, showing that we do that all the time, looking at ways to provide value to our shareholders, and that’s why we pursue the conversation, because we see an opportunity to create value for our shareholders, but also with as be in a REIT, we know that real estate is an essential core of our business.

And so as you see on this page, number four, some of the key goal is to talk a little bit about our real state portfolio. We have about $14 million in square feet within our 51 owned facilities nationwide here in United States and the lands and buildings in our real estate portfolio consists of about 90% of our total fix assets, which is just north of $3.6 billion, 90% of our operating income is generated from our own facilities and this is a percentage has been growing over the last decade, where more and more government partners want us to provide the real estate solution for their needs, and owning the real estate has been very key in winning the retaining contracts.

I’m going to talk a little more about this here in a minute, but it really it has given us excited advantage by owning the real estate. Two other quick pictures there you will see on the slide on the right Ohio, this is the new facility we just acquired from the state of Ohio about a year ago, again I will mention that here a little more in detail here in a minute on the later slide, and then on the bottom is our newest new build facility in Georgia, this is in Jenkins County Georgia, cost is about $50 million to build the facility and we activated it last year.

So let me talk a few minutes on page five about the highlights and as I said earlier, we are extremely excited for the company and really for the industry to effective conversion into a REIT and be able to do it in 2013. So some of the highlights and the obvious one is what we’ve reported last night that is the receipt of our favorable IRS ruling, and we also have unanimous Board consent an authorization for this conversion. No shareholder approval is needed for this, but we are going to get shareholder approval on some changes to our charter, upcoming Annual Meeting in May. Again we will talk about that here in a minute.

But other highlights, significant increase in shareholder value, and the great thing is we are going to be able to provide is value immediately in 2013. We’ve taken the steps to get ourselves ready for this conversion on January 1 for the value creation as immediate with this announcement today and we received the PLR from the IRS. And this is going to result in higher net income, higher dividends, significant earnings growth capacity that we got with [bacon beds] within our portfolio, but it’s also going to be able to expand our investor base, we think a meaningful amount and really attract us a new group of investors that are very attracted the company that have a significant real estate portfolio like CCA. We also see this as a great opportunity to move into a sector that has strong access to capital at very attractive rates and we are a company that has been managing our balance sheet very prudently. And right now we are estimating that our leverage rates going to be about just north of three times as we go through some of the activities in 2013.

Now also on the slide, we’ve given guidance for 2013 and it's important to note some of the key things that this guidance is calculating or does not calculate. And as you see here on page five in the parenthesis, this guidance excludes REIT conversion cost, debt refinancing cost, impact of shares issued under E&P dividend, and a reversal of certain tax deferred items. Again we’ll talk in little more detail what these items are during my section also Todd, it was important that when you look at this guidance you exclude those factors into that calculation. But you see the numbers there as it relates to EPS, FFO and AFFO and then we are expecting our annual dividend to be in a range which $2.04 to $2.16 and will be paid quarterly as other REIT’s typically do.

Now one thing, I do want do know, we have our earnings call next week, we are planning to do it next Thursday. So our typical business and market commentary that we cover will be done during that call. So what we like to do for today’s discussion is really focus on the conversion and announcement of today during our Q&A, but rest assure next week we’ll go in great detail like we always do every quarter and talk about the business market commentary, and obviously answer questions during that call too.

But I do think it’s important to make a couple of comments as it relates to guidance today. Because I think there is some confusion on what’s been inside or outside of the guidance for 2013. The first of which is and Todd will talk a little more about this later is that, we are estimating higher interest expense this year to as a result of taking on some debt to pay the cash dividend that we are expecting to pay it to shareholders later this year, as part of the E&P approach and then also some higher G&A costs. Again, Todd will talk a little more of that in detail in a minute, but those are included into our guidance this year.

The second thing I want to touch on is California. There has been a couple of articles and I know there was a analyst report overnight about California that is somewhat misleading, and maybe not given a complete picture of what’s going on in California. So I do want to take just a quick minute and talk a little bit about California and how we are thinking about that for 2013. So as it relates to our guidance, we are right now estimating that 1,500 inmates that are out in our Red Rock facility will be returned to California between the months of July and December of this year. And this is to make space available for our brand new Arizona contract that are going to affect in January 2014.

So we announced that contract award late last year, but our guidance this year does assume that we will be losing California during the last half of 2013. Now, to the extent that California does need replacement capacity somewhere in the system obviously work very well – made them well worth I should say on solution that we can provide in other beds, in our portfolio, and how that need we will make that available, but we have assumed that loss of population in the last half of 2013.

But another key thing I just want to mention on California is that we have seen a lot of activity in the court case, the California has against the three judge panel, since our November call, but the most notable which is the most recent is statements by the state to the court here in the last week about their plans for the out-of-state program. And this is one of the things that was brought up in one of the analyst report here in the last 12 hours.

Now the report that the state gave back to this courts about the out-of-state program and winding that program down through 2016, it is consistent, what the state announced last year through their blueprint, so there is no new information being shared. Their information that they shared with the court this past week is consistent to what they shared publicly about a year ago, so again no new information here and no change to that plan. But it’s important to point out that the court still has to weigh in on the state request to release as a cap, so we think that will be coming some time maybe a little later this spring, but the court will clearly weigh in on this issue. And also it's important to note that our capacity days at about 99%, so our contract capacity with the state of California is about 99%, so they have been utilized and virtually all the beds that we’ve made available to them in our system.

And the final thing is that and this is not something that’s been talked about here recently, but the state has revised their projections for their population over the next five years, and they revised this late last year in October and November. And basically the net result of that is to increase their population assumption by 6,000 inmates in 2017. So basically if you look at the blueprint last year versus this new projection at 6,000 inmates higher. So anyway, we'll talk more about that as we be in the call next week, but I did want to provide some of that clarity on California. Again no new news as it relates out-of-state program, court is going to have to weigh in on the cap and also populations are projected now to increase versus their year first estimate that they outlined to the state last year in the blueprint.

Let me now move on to page six and talk a little more about the highlights for the conversion. As you see there, we’ve got some one-time conversion items, which is first the E&P payment and we are estimating that to be about $650 million to $700 million, timing still to be determined and we are expecting that to be a split of 80% in shares and 20% in cash. We’re also estimating about $25 million in [converted] cost throughout this year 2013. And as I mentioned earlier, we are also looking to reverse certain net deferred tax liabilities and we're estimating that to be about $150 million to $135 million.

Now the CCA REIT structural reorganization is complete. And as we saw in our announcement early in January of this year, we are electing REIT status effective January 1, 2013, again we announced this. But the good news about this is that we're going to be able to enjoy a full year of tax savings for 2013 by as taking all the efforts that we did back in December, they get the reorganization completed and an effect on January 1. And then we also expect to execute certain debt transactions during the course of the year and again Todd will talk about that little more in detail during his section.

Let me flip a couple of slides to go to page eight, and highlight some of the immediate value creation for shareholders and this tax efficient REIT structure creates immediate shareholder value, as I said earlier with the Board and the management took steps late last year, so we can get ourselves prepare to enjoy full tax savings during the course of 2013. And I won’t go through all of the numbers on the slide, but obviously would highlight the tax expense going down by an estimation of $17 million plus and then also expected dividends growing from $0.80 annually to $2.10 annually, if you take the mid point in our guidance for the dividend.

Now one other key thing I want to clear up here if I could AFFO and FFO and how the per share or how that those amounts are calculated. As you saw or see hopefully in A-6 in our appendix, we show the definitions for NAREIT and how those amounts were calculated. Now that we are REIT, we're converted to that methodology, because this is very common practice for REITs.

If you go and look at their financial statement very common for them to use these definitions, but now that we are REIT, we're converted to that methodology and this will then put us on a level playing field when investors compare to other REITs within that equity universe. So again very excited obviously about some of the numbers here off the tax savings and the increases in net income, EPS, FFO, and AFFO, and obviously a significant increase into the dividend amount.

Now, let me talk a little bit on page nine about our capital allocation policy and very straightforward policy and after a lot of discussion internally and with the Board, move forward with a policy that looks a really kind of two buckets. The first bucket is having about three fourth of our AFFO go out in dividends, so about 35%. And again if we take our number that we estimate for 2013, that means a dividend in a range of about $2.04 to $2.16 for 2013. Again they are looking to pay that quarterly, but we will obviously on an annual basis or sooner if indicated revisit that policy as an appropriate and look to also increase the dividend with future growth, and again I’ll talk about that here more in a minute.

The other bucket is it takes the remaining quarter of our AFFO and reinvest that for growth for the company. And some of the options that we’ve got there is to do facility acquisitions or development to help grow earnings is at any unused amounts would be used to increase dividends or potentially to reduce the debt.

And of course if that’s not enough for future growth and we can go out to the debt markets or the capital, or raise the equity capital to help further fund new growth opportunity for the company. We have to say one quick thing on this page again for investor that new to the company, and new to the industry, we see a meaningful opportunities for growth for the company even with this new structure.

Right now, if you look at our entire industry ourselves and the competitors in the space base only about 9% of all inmates attaining further into the United States are out in private facilities and that’s compared to about 6% about a decade ago. So we see an opportunity to grow that penetration to where we are housing more and more population for federal state and local levels as they grow or deal with overcrowding.

Let me stop here a minute and turn it over to Todd and allow couple of more comments on our capital allocation policy.

Todd J. Mullenger

Thank you, Damon. I would just add that we believe our financial profile compares favorably to REIT with investment grade credit ratings. However, we are not quite there yet with our financial partners at the rating agencies. And we believe our post conversion credit profile along with its capital policy positions us well, to continue to make the case for why we should be investment grade especially in comparison to other REITs and having an investment grade credit rating is important to us.

We see value in obtaining an investment grade credit rating and we will be working towards that goal. One other point, the guidance on the dividend range excludes the impact of any shares issued as part of the E&P event.

Damon T. Hininger

Very good. Thank you, Todd. Let me now direct your attention to page 10 of our presentation and talk about significant opportunities for earnings growth and value creation. And we have a very unique situation right now to where we have a significant amount of opportunity to grow without the need to raise new capital.

As you saw on the appendix, we right now have about 13,000 beds in our portfolio that are bought and paid for. And so we’ve already got them on our balance sheet and our vacant capacity can drive some meaningful growth over the next few years, by filling that vacant capacity. So as you see there are 5% to 10% annual earnings growth potential over the next three to five years and this is – we are maintaining about three times debt leverage, again without the need to raise new capital to drive that growth.

And if you look at this appendix you’ll see that we perform it out by filling in those beds would add another dollar to EPS or FFO per share which will be about $139 in facility level of EBITDA. And this is a very attractive capacity. I want to give you a quick example here, in a past year we have had three customers in state of Oklahoma, state of Idaho, and also the Commonwealth in Puerto Rico a worst contract here in a last 12 months to take advantage of existing capacity in our portfolios. So we have a very significant competitive advantage, and we’ve been delivering on that here in a past year, as states have been growing or dealing with overcrowding.

In fact, we are estimating right now, and I shared this with investors last quarter that we have got right – right now 10 state customers that are grown in the past year by about 5,500 inmates and they have not add a capacity to deal with their growth. Again we’ve had a couple of states already signed contracts with us to use that capacity, so have this capacity available is already brought and paid for and to use very quickly by these partners if they grow it’s extremely attractive and can drive meaningful opportunities for growth.

As I mentioned earlier the remaining quarter of our free cash flow will be reinvested as appropriate for new development opportunities. And as you could see some of the boards here this could be to expand existing facilities which is a common practice and something that’s always in our play book for existing partners to expand existing facilities, also to acquire facilities. I mentioned earlier, we had opportunity this past year to acquire a facility from state of Ohio, very first transaction of its kind in the industry where a state sold an existing asset to a private provider, but also do some Greenfield development.

Now, but we also can see, as you see on the bottom of the sheets here, we have other opportunities for growth. This could be from pricing opportunities as replacement cost is considered and capacity shortages are dealt with. We see opportunities for reprising if contract was appropriate. But also raising, investing new capital and you see our returns there over the last five years a very significant return on capital, which is just about 14%. Now with our potential to lower or cost to capital, we think this could even be more meaningful on our returns on capital.

So now maybe move here from that slide to page 11, and talk a little bit about our historical cash flow growth. So we've talked about a little bit about the future and opportunities for the growth of the company. But let me also just talk about our track record. And I think the slide here demonstrates our track record very effectively. We have very, very viable assets that ever produce; as you see in this chart and very durable earnings over the last six, seven years.

As you see our AFFO from 2006 to 2012, our CAGR during that period of time was about 11%, but I’d really like to direct to your attention to 2007, 2008 and 2009, obviously, the worse economic environment of our life time, but as you see there from the numbers we are able to navigate it very well. And this is during a period of time, we are also, we're adding capacity into the portfolio. So we're able to add capacity, see growth and earnings and navigate a very tough economic environment, while maintaining a very modest leverage ratio.

So very proud of that fact, we think that’s obviously a good indication and how we manage the business and what investors can expect going forward. And I’d also just point out that we've been to enjoy good occupancies during the years typically in the range of about 90%.

So with that, let me wrap up that section and turn it over to my colleague Todd.

Todd Mullenger

Thank you, Damon. You turn to slide 13 for a review of key conversion items. One of the requirements to meet REIT qualifications is the need to distribute our historical earnings and profits accumulated up through December 31, 2012. We will accomplish this through its special dividend pay to shareholders, which is currently estimated at $650 million to $700 million or around $6.40 to $6.90 per share.

We intend to pay the E&P dividend with a combination of up to 20% cash and 80% common stock depending upon the license made by shareholders. Well, there is no minimum amount of cash we must pay based on the elections made under similar distribution by other companies; we would expect to pay out the maximum of 20% in cash.

But if an investor like to receive our stock, they will receive our stock, except for any fractional shares. A specific date for the distribution has not yet been set, but it will be made some time after we complete our plan debt transactions, more on that in a minute.

Next as mentioned previously, we expect to incur approximately $25 million in the conversion costs, relating to advisory fees and other costs. There will be no new tax liabilities created from a recapture of depreciation expense, as we have not identified any assets that need to be reclassified from personal property to real property.

Turing to slide 14, conversion to a REIT will result in a reversal of certain net deferred tax liabilities currently carried on our balance sheet, which will increase net income in 2013 by $115 million to $135 million. This is a one time, non-cash credit to the income tax line on the P&L statement.

As Damon mentioned at our May Annual Shareholder Meeting, we expect to see shareholder approval of ownership restrictions within the company’s charter to help ensure we don’t violate limitations in this area. This is standard procedure for a REIT. Other financial modeling considerations to keep in mind, we will be issuing additional debt from the conversion more that in a minute. We are estimating $2 million to $4 million of incremental ongoing G&A expense related to ongoing REIT compliance costs. And finally, we’re estimating $102 million to $103 million average diluted shares outstanding in 2013, excluding any shares issued as part of E&P dividend.

Turning to slide 15, for discussion of the expected debt transactions. We plan to refinance our $465 million senior notes due 2017. This is the only issuance the senior notes left outstanding. The notes were callable beginning June 1 of this year, as it is our intention to pay a portion of the E&P dividend in cash, we will refinance the senior notes to provide us that flexibility.

We also plan on raising addition debt to fund the cash portion of E&P dividend estimated at $130 million to $140 million. The $25 million of REIT conversion costs and the debt issuance in refinancing costs were $40 million to $50 million. With regards to the bank facilities, we may also seek an amendment to our $785 million revolving bank facility to secure greater operating flexibility under our new REIT structure.

We are very confident in our ability to execute these transactions and to do so with attractive pricing terms and conditions. This is based on discussions with our investment bankers as well as the strength of our financial position is reflected by modest leverage and coverage ratios, as well as a very strong debt capital market environment. We are targeting completion of the transactions in the second quarter, but timing can be a little sooner.

Continuing on the slide 16, this slide highlights the strong balance sheet, we will have post refinancing. The table on the left side starts with the estimated net debt at the end of 2012 adds $215 million as an estimate for the additional debt we expect to raise which results in pro forma net debt of around $1.3 billion and pro forma debt to EBITDA leverage of around three times with interest and fixed charge coverage ratios approaching seven times. This compares very favorably to the average REIT, the average REIT has leverage in excess of five times, and coverage ratios down around three times.

Several additional points unrelated to the slide, with regards to 2013 guidance. Guidance assumes generally stable EBITDA versus 2012, as generally speaking, our current guidance assumes no new contract awards in 2013. However, we will certainly be working hard to beat this assumption. Guidance includes an increase in G&A related to the ongoing REIT compliance costs of $2 million to $4 million, as well as a slight increase in depreciation expense.

Guidance also assumes an increase in interest expense related to the increase in debt necessary to fund the conversion. As Damon mentioned earlier, with regards to the California inmates, our guidance assumes all 1,500 inmates, and our Red Rock Arizona facility are returned to California custody between July and December 2013, in order to make space available for the state of Arizona beginning in 2014 under our new contract with the state of Arizona.

Also keep in mind that Q1 earnings are always seasonally weaker, due to items such as unemployment taxes which are always significantly higher in Q1 versus other quarters. This year the increase in unemployment taxes from Q4 2012 to Q1 of 2013 is estimated $5 million.

In addition, there are two fewer days in Q1 versus Q4, which is important to consider when forecasting as we charge our customers by the day. Next, we have changed our calculation of FFO and AFFO to conform more closely with the calculations used within the REIT industry. Prior to converting to a REIT, we use the calculation we had developed internally. We believe our new calculation is more consistent with NAREIT definitions and REIT industry practices. It’s important to as we see that as a REIT, our FFO calculation confirms to the NAREIT definition.

Slide A-6 in the appendix provides a thorough comparison of the old versus the new calculation. For briefly, the primary differences between the old and the new calculation. Our new calculation does not adjust for differences between GAAP income tax expense and cash taxes, the old one did. And that’s the primary driver of the difference in AFFO between the old and the new calculation. You will know for example in 2012 not making the adjustment between GAAP and cash taxes under the new calculations decreases both AFFO and FFO by about $10 million in comparison to the old calculation.

In arriving in FFO under the new calculation, we only add back real estate depreciation, whereas under the old calculation, we added back total depreciation real estate and personal property depreciation. Other non-cash items are added back at the AFFO line rather than the FFO line. Again the primary driver of the difference in AFFO between the old and new calculation is the fact we are not adjusting for the difference between GAAP income tax expense and cash taxes under the new calculation.

Now there is no NAREIT definition of AFFO, however, our research combined with the recommendations of our financial advisors indicate our AFFO calculation is consistent with many REITs that disclose AFFO. One notable comp is pro largest, a $16 million market cap REIT who like us only adds back real estate depreciation and only subtracts out real estate maintenance CapEx. The idea being that personal property CapEx should be roughly equal to personal property depreciation, which is true in our situation. I understand it’s a bit complicated so if you are feel free to contact us with any questions. Finally, in the Appendix you will find several pages summarizing the various items to consider in your financial modeling.

And with that I will turn it back over to Damon.

Damon Hininger

All right, Todd thank you very much and I'm now going to move into the company background. Very, very proud of this company and I'm very proud to talk about what we do, and also recognized many employees who got throughout the portfolio providing great solutions to our government partners allover the U.S. Let me give you a little bit of history lesson for the folks that maybe are new to the company and new to the industry. So if you go to page 18, talks a little bit who we are?

We are the clear leader in partnership corrections here in the United States. And we are established 30 years ago, in fact we just celebrated on January 28 our 30th anniversary, where we own and operate medium, low and high security facilities allover the United States. Now we love to seeing with all 50 states and the Federal Bureau of Prison we are the fifth largest correctional system in the United States. And we're larger as I said earlier about 47 state systems, we're also larger than immigration and customer enforcement, their entire system and we're also larger than the United States Marshals Service their entire system combined. And we are like in the largest within the private sector.

Now we provide space and services to about 80,000 inmates on any given day and 67 facilities located in 20 states and also the District of Columbia. And our market share right now is 44% of all the private partnership beds that are here in the United States.

Let me switch over to page 19, and talk about the investment characteristics of our company. As I mentioned earlier, only about 10% of all the population in the U.S. that are House and Federal state, and local facilities are in private facilities like CCA's. So we see there is great opportunity to grow that penetration, and as I mentioned earlier, about a decade ago, that number was closer to 6%. So we see meaningful growth over the last decade in enhancing that penetration.

But, we also provide a very difficult to replace real estate, and it’s a very resilient, as I showed earlier with our calculations in our performance over the last year, last few years with all the cash flow, but there is also a very high barrier to entry. To build a facility typically is anywhere from $50 million to $100 million, so it’s very capital extensive, very much high barrier to entry for potentially new participants into this type of solution. We have a facility profiled through here the U.S that is very diverse and here in a minute you’ll see a map of where our footprint here in the United States. And we also have a significant portion of our contribution, financially come from our own assets and that creates a much more resilient rather to value creation.

Many of our contracts provide for auctioning guarantees and we’re paid on a per day basis and where we invoice our customers on monthly invoice. But we also see the opportunity for future growth, because we’re seeing significant best shortages within the industry. Again to investors are building the company for a few years. They know this fact, but it’s important one to restate. That over the last two fiscal years at the state level, we have seen very, very little dollars appropriated by state government for new Prism capacity to either deal with growth or overcrowding.

In fact, we see the amount being funded for capacity over the last two years being unprecedented that if we go back to last two, three decades, we have never seen such minimal appropriations being given to Corrections department for new capacity and for states dealing with overcrowding. And this is significant, so again if we see partners, they are dealing with these issues having their capacity in our system, where we can provide just in time solutions is very, very attractive, but we are also seeing some opportunities to grow in different ways. And as I mentioned earlier, we are seeing customer interest in selling facilities that they currently own and taken it from their balance sheet and putting it to on to ours.

Again, we had a very significant milestone this past year with State of Ohio, so the facilities that was about 13 years old to CCA and an amount of about $70 million. We bought that facilities now. Our balance sheet, we have a 20-year contract now with the state of housing made to that facility, a great solution we think it’s a solution that other states will be attracted to in the coming years.

As it relates to our industry and our position within the industry, we have been the market leader for many, many years. You see some of the highlights there relative to our position with the industry, but a couple of things of note. One is that, we have shied away from the risky business of running juvenile facilities. This has been part of our business a couple of decades ago, but really in the last decade, we’ve made a strategic decision to shy away from that business. But we also have a high percentage of owned facilities versus our marketplace. So you’ll see the chart here a minute it shows that we have about 60% of all the owned beds within our market that we own that’s in our balance sheet.

Now going to page 20, talk a little bit about the real estate and how difficult it is to replace. So I talked a little about these numbers earlier, but we have about 51 facilities that are owned and controlled in our portfolio which is about 68,000 beds and about $14 million in square footage. And from that real estate portfolio, we see about 90% of our net operating income generated from those owned facilities and again that percentage has been growing. We are seeing more and more states and the federal government looking for us to provide the real estate solution over the last decade.

This is a significant increase again, where states have been limited our appropriate dollars for new capacity. Typically, our facility has economic life of 75 plus years, and we have a very young portfolio with about 16 years average age on our facilities within our real estate portfolio, and all of our fixed assets, I should say are fully unencumbered.

Now I’ll talk a little bit about the difficult to replace. We have had very sticky contracts over the years. You see here we’ve got a 90% contract renewal rate on owned facilities, but it’s very difficult to replace these solutions. Once we’ve got a contract, very difficult to not only have the high barriers to entry with the capital outlay, but also defining an appropriate community it is all we’ve done and also have the unique understanding of the service component, but also how to design a correctional facility, so very difficult industry to go into for a new provider.

As I mentioned earlier also, we are seeing increasing customer interest in selling facilities, and we again, think this is a great part of the play, but going forward as states figure out ways to maybe bridge, very challenging fiscal environment, and very difficult budget years where they can be and fill a gap for them by selling an assets to CCA, and still provide that capacity to them through a contract, but we also have great ways to hedge on inflation. And you see some of the bullets there, but I would note that last one, which is many of our contracts that we’ve negotiated with our customer partners include CPI escalators to help deal with increases in cost.

Now page 21 gives you a good visual of our position within industry, as I mentioned earlier about 44% of the marketplace is controlled by CCA, but if you look at the red bars, which are significant, those show the beds own within the industry and as I mentioned earlier, we own about 60%. So we have a dominant position within the marketplace on the owned capacity here within the United States.

Switching now to page 22, this is another great visual that gives you a sense of our footprint here in the United States. I mentioned earlier about 51 owned facilities throughout the U.S., and you see the [doc] there, where it shows the owned and control versus the managed only.

Let me now move on to page 23 and talk about our customer base. We have a very diverse, the high quality customer base. So we have about 90 agreements negotiated with federal, state, and local agencies that have investment grade ratings for them and that providing services to them I should say.

As CCA has multiple contracts with individual our customers with staggered expiration date. So it’s important to note that we have, for example, our largest customers, which is United States Marshal Service, we have many different contracts for the Marshal Service that makes up that 19% it’s not one big master contract, it’s many separate contracts with different expiration date.

Within a most notable with that is that on those individual contracts of the Marshal Service had a facility level will have individual Marshals that you see here on the last bullet, well then open to Marshals that are used capacity with that facility under their contract. So for example, our typical Marshal facility that has one contract, we may have three to five, six, seven, eight Marshals separately use bed under that agreement, so very diverse from a contract perspective, but also from a customer perspective.

I’m going to wrap up our prepared remarks on page 24, and this is we think a very good indicator again on how we manage the business both on our debt leverage and then also our fixed charge coverage. And I very proud of this fact, we think we’ve compared a very favorably as we start to migrate into the REIT universe and start drawing comparable with other REIT within that net equity universe, we think our leverage and our fixed charge coverage you’re going to care very favorably to other REITs.

So we are looking forward to obviously this conversion and looking forward to working with the new set of investors and again excited to talk about what we do, but also what our performance has been and what it is going forward. So let me wrap up the call with a couple of comments before we go to Q&A. The first of which is, we are going to have a call next week, as I mentioned earlier, to talk about fourth quarter earnings and also full year 2012.

And again we’ll provide a lot more discussion on our market and kind of business views for 2013. So looking forward to answering questions during that call on those topics, but I also wanted to point out that for new investors on the call give you the name of our Investor Relations individual and that is Karin Demler, she is here in the office in Nashville, Tennessee 615-263-3000 is our number, you can call in and be happy to educate you in the coming days and weeks enroll at the CCA if you’re a new investor. But we are also going to be hitting the road and be leaving Nashville, and so in the coming days and weeks we will be thinking about our schedule for 2013 to go out and meet a lot of you in person and also participate in upcoming conferences as appropriate.

So with that let me just wrap up with a couple of thank you’s and then give it back over to Farah for Q&A. And I want to thank several people if you indulge me that’s been working so hard in this project. The first of which is our external advisors and that’s the JPMorgan folks, Ernst & Young, Bass, Berry which has been a great part of the team from our local counsel here in Nashville, but also Latham & Watkins and most notably Michael Brody, they have been a great team to work with over the last year and half on this project and has been [same device] and obviously help us deliver the ultimate goal with this announcement today.

I also want to thank our board, our board has gone through a very long journey with the management team and very helpful supportive giving a lot of advice and counsel on the way, but very appreciative of our board working very hard with us on this conversion, And then finally want to note the work of the management team it’s been a lot of work as many of you know over the last year and a half, but this management team has done a great job again with the goal of trying to deliver additional value to our shareholders, and I most notably want to recognize our CFO, who is across from me right now Todd Mullenger, who has been a great leader in this project and work tirelessly to help us to get to this day.

So, with that let me wrap up the prepared remarks, now I hand it over to [operator] for Q&A.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) And we’ll hear first from Manav Patnaik of Barclays.

Manav Shiv Patnaik – Barclays Capital, Inc.

Thank you, good afternoon everybody and congratulations firstly.

Todd Mullenger

Thank you, Manav.

Manav Shiv Patnaik – Barclays Capital, Inc.

I just want to start off itself on the, I think Todd you had mentioned that 13% assumes flat EBITDA, and also just wanted to clarify so firstly in the fourth quarter you guys raised guidance and it seems like it was something fundamental going on there, so what was that and what was that impact? and then also it seems like the – the assumption of the Red Rock facility, the 1600 beds, that you guys assume will be vacant by the end of the year was something that I think most of us were not, so, can you maybe help to quantify what that 1600 bed impact is on an answerable basis?

Todd Mullenger

I’d say we rather judge that question next week on the fourth quarter earnings call, but we have factored in the reduction in California populations in our guidance, assuming that begin of being return back to California custody in July completed by December. Maybe generally speaking on a full year basis, I think that’s around, I am sorry, on half year basis, I want to say, it’s around $5 million to $6 million in EBITDA.

Manav Shiv Patnaik – Barclays Capital, Inc.

Okay, all right and then, go ahead.

Unidentified Company Representative

Go ahead.

Manav Shiv Patnaik – Barclays Capital, Inc.

Okay, I guess – okay that’s fine and then the interest expense on the $215 million that you planned to raise, any color on what the assumption there is?

Unidentified Company Representative

Yeah, I’d say, well based on to the strength of the credit market we would expect any new notes will be issued at a coupon lower then the 7.75% coupon as to 2017, credit market is very strong right now, but the ultimate pricing will be depended upon market conditions to time when you execute the transactions. So not in a position to provide a guidance on the interest rate for the new…

Manav Shiv Patnaik – Barclays Capital, Inc.

What next?

Unidentified Company Representative

That will be issued but Joy, you need to keep in mind, we will be issuing additional debt to fund conversion, which will offset interest expense reduction achieved from potentially lower coupon rates versus current coupon rate on our outstanding senior notes.

Manav Shiv Patnaik – Barclays Capital, Inc.

So jut to confirm that, so in the 2013 guidance, the interest expense, the incremental interest expense that is baked in is whatever the interest rate is going to beyond the incremental $215 million of new debt that you are going to raise to fund the E&P and those kind of things.

Unidentified Company Representative

(inaudible)

Manav Shiv Patnaik – Barclays Capital, Inc.

But you have not Incorporated in there the potential cost rate or interest expense savings you get when you refinance the $475 million at whatever the lower rate would be, is that correct?.

Damon T. Hininger

I’d say that the guidance range assumes the range of potential outcomes based on ultimate pricing. So, even if we achieve a lower coupon rate recognizing the 465, we could still own about higher net interest expense as a result of the additional debt we issued to fund the conversion. It’s all going to be dependent upon ultimate pricing, which is going to be driven by then in current market conditions.

Manav Shiv Patnaik – Barclays Capital, Inc.

Okay. So, but all the moving parts is in your ranges basically?

Damon T. Hininger

Yes.

Manav Shiv Patnaik – Barclays Capital, Inc.

Okay, all right. And then just some color maybe around timing like when to out of the finance that is, you said the notes recallable is June, is that a factor like, I mean, I guess given I could say how good the credit markets are. Are you suspecting and if you decide you can get this thing done in three or four days? But I was just curious what the thoughts around timing there?

Damon T. Hininger

Yeah. So timing, a number of variables there, so our investment bankers advise as we need to issue the 10-K before we can go to market. I guess our public numbers got sales there in a few days, last QA issuance back in November. So we need to have it for us, public filing or financial statements. And so, that’s the 10-K that will be likely published in late February and that will be a function of timing around market conditions. I want to be a little nimble around any noise created by an event in Europe or something that, but we’re targeting completion sometime in second quarter, but it could be a low sooner.

Manav Shiv Patnaik – Barclays Capital, Inc.

Okay. And then last one. Yeah, go ahead.

Damon T. Hininger

Yes. And with regard to the fall, I’ll also consider, given the strength of the credit markets evaluate a potential early tender of the notes.

Manav Shiv Patnaik – Barclays Capital, Inc.

Okay.

Damon T. Hininger

…asking as well versus ratings on the first call.

Manav Shiv Patnaik – Barclays Capital, Inc.

All right, got it. And last one from me and then I’ll hop off, you mentioned addressing the slide eight, whatever that you looked at other comps and you cited ProLarge as the one who did the FFO adjustment as you did. But I guess there are several others that what would be more closely aligned to your old method. And I was just wondering, if there were other examples outside of Prologis that you can provide us and maybe you can go and look at and why did you pick one over the other? Is it just, did you feel, this is the more conservative route? Is that the side you want to take or just maybe some part around, because I've seen both sides out there, so just curious why you pick one over the other?

Unidentified Company Representative

Yeah, great question. Let me make one clarifying point here, and try to make it in my prepared remarks. So if we chose that about total depreciation.

Manav Shiv Patnaik – Barclays Capital, Inc.

Yeah.

Unidentified Company Representative

Similar to the old calculation, we would also have to subtract our total maintenance CapEx. On to the new calculation, we are just adding back depreciation on real estate, so real estate depreciation and we are only subtracting out real estate maintenance CapEx. If we go back to the old calculation, my depreciation expense as that would increase, but my maintenance CapEx subtraction would increase by amount, then our personal property maintenance CapEx is roughly equal to personal property depreciation.

So the net of this going to back to the old calculation on that item, it have very little impact on our net AFFO, does that make sense?

Manav Shiv Patnaik – Barclays Capital, Inc.

Yeah, okay. All right, fine. Thank you, guys.

Unidentified Company Representative

Thanks, Manav.

Operator

Our next question comes from Tobey Sommer from SunTrust.

Unidentified Company Representative

Good morning, Tobey

Tobey O'Brien Sommer – SunTrust Robinson Humphrey

Thank you, good morning. I have a question for you on A-6 again, you discussed I should say the difference in the left-hand side and right-hand side and the deprecation side. Is there a change relative to amortization from financing as well, could you use just speak to that? Thanks.

Todd Mullenger

No there is not. No change on amortization or depreciation on the methodology and the calculation of those numbers.

Tobey O'Brien Sommer – SunTrust Robinson Humphrey

Okay. And then thank you. The leverage ratio, three times it’s something you referred to multiple times, could you speak to why you think that’s the right threshold, and what the advantage is to you and shareholders of pursuing investment grade. Thanks.

Damon Hininger

Yeah, let me speak to that a little bit, this is Damon, so we really just trying to give an estimate of what this year look like, once we get under the side of some of these significant conversion items, but we’ve conveyed and continue to be very comfortable going up to four times, and obviously we’ll be watching very closely at the market comps, within the REIT universe, and then again a greater awareness of, what the equity and capital markets look like for us going forward as a REIT. But three times is kind of what we’re estimating today, once we get through the some of the transaction, we got for later this year, but we we’re very comfortable going to four times is appropriate, to help with the any items the company may need most notably help fund new growth.

Todd Mullenger

And I would say just follow-on to that comment, so we’ve got the billing up four times and we’re comfortable going up four times in a situation where we’ve got numerous, compelling investment opportunities, they present themselves all at the same time, I’d say we’ve got closer to four times, we’d be working get it back down closer to three times, and when we’ve seen based on recent past history with the economic down, those companies including those REITs that were heavily levered, paid a significant price, meaning those REITs had to go to market in the equity market and issue equity, buy down the market to show up the liquidity. And that dynamic wasn’t lost on us and then our board and the management team have historically had a more prudent perspective around what the appropriate capital structure look likes with regard to the leverage.

Tobey O'Brien Sommer – SunTrust Robinson Humphrey

Thank you very much.

Damon Hininger

Thank you.

Operator

Moving on, we will hear from Kevin McVeigh of Macquarie.

Derek Sbrogna - Macquarie Capital (USA), Inc.

Hi, good morning guys. This is Derek on for Kevin. First of all, congratulations, on getting this done, well done.

Damon Hininger

Thank you Derek.

Derek Sbrogna - Macquarie Capital (USA), Inc.

Yeah, you are welcome. I was just wondering maybe you guys can talk about a little bit about kind of how you are thinking about the dividend and the payout ratio relative to your AFFO and what is kind of give me the levers you’re going to influence that and then maybe more specifically if you could provide what you think kind of the range could be for that level of it’s kind of under AFFO, well now if you have 75% how high can we anticipate that potentially going?

Damon Hininger

Yeah, absolutely so what we are looking at as our policy is to basically look at 75% on payout for dividends for AFFO, and then a quarter being used to help fund new growth and the new growth could be for either new facilities, expansions, acquisitions et cetera. So that’s what we’re setting as our policy 75% for funding of the dividend, 25% for a new growth. Our thoughts are probably on annual basis, but could be sooner. I will revisit that based on the business and the marketplace, and then looking to also grow as we grow AFFO. So that’s what we are thinking is our policy, again we will revisit on an annual basis, but we think that’s a good number, the great value back to our shareholders on a regular basis, but also gives us lot of good drive power for new growth.

Derek Sbrogna - Macquarie Capital (USA), Inc.

Okay, great and just one more, I know you’d kind of talked about there is a lot of moving parts with debt transaction, and kind of the timing of the E&P distribution. But, can you guys give any kind of goal post for us, as to when you’d anticipate that E&P distribution being made?

Damon Hininger

Sometime after we complete the debt transactions, and so we’re targeting having those transactions completed in the second quarter so, sometime after we’ve completed the debt transactions, we sit down with the board, and set a record and communicate that to the investment community.

Derek Sbrogna - Macquarie Capital (USA), Inc.

Okay. Thanks very much guys. Congratulations.

Damon Hininger

Thank you very much.

Operator

(Operator Instructions). We’ll take our next question from Kevin Campbell with Avondale Partners.

Kevin Campbell – Avondale Partners LLC

Hi, good morning. Thanks for taking my questions and congratulations as well.

Damon Hininger

Thanks, Kevin.

Kevin Campbell – Avondale Partners LLC

You’re welcome. I wanted to ask if you guys, what your thoughts on potential inclusion in the REIT indices and whether or not you’ve talked to any of them and potential timing of that happening. Is that, on your radar screen?

Todd Mullenger

Yes, so our financial advisors has informed us, they believe, we will qualify for inclusion and one or more of REIT indices. Timing is a little difficult to predict, it varies from industry to industry, as I understands there can be a little bit of judgment in terms of the timing of the inclusion, but our financial advisors have indicated it, we should be picking up in one or more of the REIT indices.

Kevin Campbell – Avondale Partners LLC

And is that some time that you guys are going to be pressing yourselves to go and talk to the indexes or?

Damon Hininger

Absolutely.

Kevin Campbell – Avondale Partners LLC

Okay, Okay, Great. And, on the debt side in replacing the old senior notes. Is it possible that you could replace all of that into the 215 with bank debt or do you think you’ll have to go to the market with other senior notes?

Unidentified Company Representative

We’re going to go to the market for the majority of that in senior notes significantly increasing the size of our bank dividends, probably not something we choose, they consider that be a very large doing all of that, replacing the 465 and 215 by upsizing our bank still it will be very large bank facility for company of our size and it probably requires significant increase in pricing and that require pledge of fixed assets right now, all of our fixed assets are encumbered, some of that additional capacity, we’ve probably have to come from institutional term loans, which are in as cheap as probably to bank debt. So, I think the majority of the refinancing and the increase in the debt issuance will come from the senior notes market.

Kevin Campbell – Avondale Partners LLC

Okay. Last question, you guys have historically talked about your targeted ROI for a minimum 13% to 15%. Does any of that change here post conversion?

Damon Hininger

At least not, this is Damon, Kevin, at least on the near-term, I mean as we go through the conversion and, see what the markets have liked for us, all that to capital and equity and cost of capital, which we’re looking to enjoy now as a REIT and compared to other REITs, we think a very good balance sheet cash flows that we should enjoy, not only favorable access, but lower cost. So that’s something we regretted along the way, but here in the near-term notes, we’re changing that.

Kevin Campbell – Avondale Partners LLC

Okay, great. Thank you very much.

Damon Hininger

Thanks Kevin.

Operator

And our next question today comes from Barry Klein with Macquarie.

Barry J. Klein – Macquarie Capital (USA), Inc.

Hi, guys. Just a question on the dividend growth, you mentioned you referenced 5% to 7% EPS guidance. I was just wondering if we could expect the dividend to grow at approximately the same pace?

Unidentified Company Representative

Yes. Our goal is that as we grow the total amount AFFO that we keep that policy of 35% for the dividend and 25% for new growth, so yeah, that would be going up and like a (inaudible).

Barry J. Klein – Macquarie Capital (USA), Inc.

Okay, so we could expect just to be clear, do we need to expect AFFO guidance, should be approximately the same to that EPS guidance of 5% to 7%.

Todd J. Mullenger

Well, yeah what we are saying is the policy, the policy would be 35% for dividend, 25% for new growth either for new capacity or expansion capacity. And so as we grow our AFFO, which that you saw on the slide looking based on our vacant capacity. You can grow in that range of 5% to 7%, as that grows, what we’re anticipating is that we keep that same policy with that with that ratio.

Barry J. Klein – Macquarie Capital (USA), Inc.

Okay, and the 5% to 7% that is, that I am clear on that right that’s the guidance that you’re putting out there is potential.

Todd J. Mullenger

No, that’s potential, that’s growth opportunity over the next three to five years.

Barry J. Klein – Macquarie Capital (USA), Inc.

Okay, got you. Okay, thank you very much.

Damon Hininger

Thank you.

Operator

And moving on, we’ll hear from Gaurav Kapadia of Soroban Capital.

Brent Greenfield – Soroban Capital Partners LLC

Hi, good morning. Thanks so much for the call, this is a Brent for Gaurav, few questions, first off, if I look at your historical AFFO calculation for 2012 compared to the new calculation. You mentioned that you’re excluding amortization associated with items other than REO property and the associated maintenance CapEx. If I just look at the calculation, it looks like you’ve taken about $35million out of amortization and only about $30 million out of your maintenance CapEx calculation for 2012, so it seems like a there was a positive $5 million cash flow benefit is excluded, is that capture somewhere else in the new calculation.

Todd J. Mullenger

No, it just reflects on the fact that maintenance CapEx guidance for next year is little bit higher than 2012 as it relates to the 2012 number just a difference in the range I believe.

Brent Greenfield – Soroban Capital Partners LLC

Okay. So maintenance, your actual expectations for maintenance CapEx are going up relative to 2012?

Unidentified Company Representative

Yes, I think it’s around $5 million if memory serves me right in 2013 versus 2012?

Brent Greenfield – Soroban Capital Partners LLC

All right, thanks. And on the assumption regarding the 1500 California inmates being returned in the third quarter timeframe, have you actually got any request from the state to return those inmates are you just making that assumption, because you need to create room for the Arizona contract and if there is no such request at that time you have the capacity within the system to reallocate those inmates to spare a capacity?

Damon Hininger

Yeah, great question. So this is Damon, let me walk you through that. So we have not got notice from California they intend to return those 1500, but we put that as into our guidance for this year, but we do have to remove those I should say from the Red Rock facility, because the Arizona is going to start using capacity of that facility sometime after January 1 of 2014. And it’s a unique requirement under that contract with the State of Arizona, because they said on day one they don’t want any other system or either they use some beds there. So we have to completely vacate all the beds there at Red Rock by December 31.

So, it’s kind of a unique requirement. So a lot of agencies, lot of us to maybe have the populations in the facility at the same time, but the requirement by Arizona is that we’re vacant out of Red Rock by December 31. Now a lot of different things I mentioned earlier as it relates to California what’s going on right now and most significant milestone we see in a near-term is the core acting on their request to not be held accountable to a cap within their 33 public facilities. So we’ll all wait to see to the court’s ruling on that. But as I mentioned earlier, right now, we’re sitting at 99% of our contract capacity within our system. And as the court come back and let’s say, it does need those beds, we do, the second part of your question, we do have capacity within our system, a very, very attractive rates, but also capacity to meet their needs for equipment.

Brent Greenfield – Soroban Capital Partners LLC

Okay. So would it be possible to reallocate them to spare capacity within the system at high rates is what you’re saying?

Damon T. Hininger

That’s correct, yeah.

Brent Greenfield – Soroban Capital Partners LLC

Okay, great. And then if I could just have one more follow-up on some of the earlier discussion, just to be perfectly clear, you have made an assumption about the rate at which you’re able to refinance the current senior notes.

Damon T. Hininger

Yeah.

Brent Greenfield – Soroban Capital Partners LLC

The forward interest rate assumption for ‘13?

Damon T. Hininger

Yes. We’ve made a range of assumptions, yeah.

Brent Greenfield – Soroban Capital Partners LLC

All right. Just because you’ve already given us a range of AFFO in that incremental, would it be possible to just sort of book and what that range would be, so we have a sense for how conservative even?

Damon T. Hininger

Yeah. I’m not really comfortable doing there right now, subject to market conditions in my crystal balls and particularly, any better than anyone else, so before not to understand the question, but before not to provide the bookings.

Brent Greenfield – Soroban Capital Partners LLC

Okay, thank you very much.

Damon T. Hininger

You’re Welcome.

Operator

And that will conclude our question-and-answer section. Mr. Hininger, I’ll turn the conference back to you.

Damon T. Hininger

All right. Farah, thank you very much and thank you very much for all the participants on today’s call. As a reminder, we do have our call next week, we’ll be talking about earnings for the fourth quarter and also 2012, and as always, we’ll provide a market commentary and also updates on some business significant business issues. So looking forward to talking with you all next week. As I mentioned earlier also feel free for new investors to reach out to our Head of Investor Relations Karin Demler and like then a coming days and weeks we’ll be going out on the road and talking more about CCA and also our exciting new development of converting to a REIT.

So thank you for your time this morning and look forward to talk to you soon. Good-bye.

Operator

Ladies and gentlemen, again that does conclude today’s conference. We thank you all for joining us.

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