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Executives

Damon Hininger – President, Chief Executive Officer

Todd Mullenger – EVP, Chief Financial Officer

Analysts

Kevin McVeigh – Macquarie

Kevin Campbell – Avondale Partners

Tobey Sommer – SunTrust

Clint Fendley – Davenport

Corrections Corporation of America (CXW) Q4 2012 Earnings Call February 14, 2013 11:00 AM ET

Operator

Good morning, everyone, and welcome to CCA’s Fourth Quarter 2012 Earnings Conference Call. If you need a copy of our press release or supplemental financial data, both documents are available on the investor page of our website at www.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 the 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 discussions of non-GAAP measures. The reconciliation of the most comparable GAAP measurement is provided in our corresponding earnings release and included in the supplemental financial data on our website.

We are under no obligation to update 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.

Just a reminder that this today call is being recorded and joining us today 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

Thank you, Lorrie and good morning everyone and thank you for joining our call today. In addition to Todd and I being on the call we also have our Chairman, John Ferguson, our Vice President of Finance David Garfinkle and Board Member, Bill Andrews joining us on the call.

Before I turn it over to Todd, I want to give you a few highlights for both the quarter and for the year ending 2012. And the first of which is just to note that we’re very excited about our two new facilities being in the portfolio that came online last year in at our Ohio facility. And also our recently constructed Jenkins facility down in Georgia. Two new facilities on the state side of the book of business.

And also to note that we’ve had three new contracts with state partners taking advantage of existing capacity in our portfolio. And those are the states of Idaho and Oklahoma and also the Commonwealth of Puerto Rico. So these are great new contracts utilizing existing capacity within our system.

And it just, again, shows the power of existing capacity being in the right location at the right price married up with a strong operational record. And how attractive these are two partners that are growing or dealing with overcrowding. We’re also very thrilled towards the end of last year getting a new contract with the state Arizona.

So this was a former partner that we’ve had in the past, but obviously we’re very excited that they’re back in the state book of business. This award will take advantage of capacity that we’ve got out of Red Rock facility out in Arizona. And we will see any, I’ll say effective of this current track in 2013. But they’ll start ramping up in 2014 and they’ll be taking advantage of capacity that’s currently used by the state of California.

As it relates to some of the financials. We had a strong cash flow performance for the quarter with FFO being up over 8% to 64 million. And reported $0.44 in adjusted diluted EPS, which is just up over 7.3%. We also had strong cash flow performance for the year with FFO up over $237 million and reported $1.57 and adjusted diluted EPS.

Now 2012 marks the 12th consecutive year of EPS growth for the company and if you look at compounded average growth rate of AFFO over the last seven years that is up over near 11%, so great performance not only for the year, but also the last few years.

Finally, we’re extremely excited about the successful work we completed during the course of 2012 leading to our announcement last week which is the conversion to Real Estate Investment Trust in 2013.

So we’re very pleased about the quarter and the full year for 2012. As always my sincere appreciation to the CCA management team, our wardens, and really the entire team of CCA correctional professionals around the United States doing a great job for us everyday.

With that, let me now turn the call over Todd.

Todd Mullenger

Thank you Damon and good morning everyone. As Damon mentioned, in the fourth quarter of 2012 we generated $0.44 of adjusted EPS, an increase of 7.3% compared to the prior year.

Normalized FFO per share was $0.64 or 8.5% higher versus the same period in 2011. EPS and FFO per share have been adjusted to remove the REIT conversion cost and favorable impact on our Q4 tax rate resulting from a partial reduction of the deferred tax items resulting from our corporate restructuring at the end of 2012.

Fourth quarter EPS and FFO per share exceeded our expectations, primarily due to lower than anticipated operating expenses. The lower than anticipated operating expenses were partially the result of a $3 million reduction in operating expenses from a settlement of a supplier dispute. This translates into a $0.02 favorable impact on Q4 EPS that won’t be duplicated in Q1 of 2013.

So for 2013 financial modeling purposes, we really need to think about Q4 is a $0.42 quarter free pass $0.62 for FFO. More on that in a minute.

Moving next to discussion of our guidance for 2013, as indicated in the press release Q1 2013 adjusted EPS guidance is in range of $0.47 to $0.48. Adjusted EPS guidance for the full year is in the range of $2.05 to $2.15. Q1 FFO guidance $0.66 to $0.68. Full year FFO guidance $2.80 to $2.90, first quarter AFFO guidance $0.64 to $0.66, full year AFFO guidance $2.72 to $2.87.

Guidance excludes REIT conversion cost, debt refinancing cost, reversal of deferred tax items associated with the REIT conversion as well as the impact of any shares to be issued as part of E&P dividend.

For more specifics on those items related to the REIT conversion, we would refer you to the press release and investor presentation we issued on February 7th. Guidance is obviously impacted by the lower income taxes resulting from our REIT conversion. As stated last week, guidance assumes a consolidated GAAP tax rate of 8.5% to 9%.

There are number of other items to consider for purposes of financial modeling. With regards to the first quarter guidance, as mentioned earlier, Q4 included a one-time reduction of operating expenses associated with the settlement of the supplier dispute which favorably impacted Q4 EPS by $0.02 which will not be duplicated in Q1.

As you may recall from prior year’s, Q1 EPS is always weaker compared to Q4 due to our large increase in unemployment taxes. Generally speaking, we pay over two thirds of our annual unemployment taxes in Q1 because of how the taxes are calculated and when they are paid.

As result, unemployment taxes will be over $5 million higher in Q1 versus Q4 that translates into a $0.05 negative impact on Q1 EPS and FFO versus Q4. However, in Q2, unemployment taxes will decline by around $4 million versus Q1, Q3 employment taxes will decline by another $1 million versus Q2 after which unemployment taxes will stabilize for the balance of the year.

In addition, there are two fewer calendar days in Q1 versus Q4 which is important consider when forecasted EPS and FFO as we are paid by the day. The difference in days translates to a two and half cent negative impact on Q1 versus Q4.

The Q1 guidance range also assumes a slight seasonal reduction in ice populations from Q4 which we have historically experienced from time to time. Q1 and full year G&A expense is expected to approximate 5.75% of total revenues, which includes the increase associated with ongoing recompliance cost. There can be some variability in G&A expense between quarters, but again it should average 5.75% of total revenues.

Full year guidance assumes flat facility level EBITDA or net operating income year-over-year as guidance was developed using the assumption that no new contracts are awarded to CCA in 2013. We will certainly be working diligently to beat these assumptions. Guidance also reflects a slight increase in depreciation expense.

With regards to California mix, our guidance assumes all 1,500 inmates in a Red Rock facility are returned to California between July and December 2013 in order to make space available for the state of Arizona beginning in 2014, under our previously announced new contract with Arizona.

We will not be accepting any Arizona inmates into Red Rock until all California inmates have been removed. However, we will maintain the proper staffing levels through the transition periods in preparation for receiving Arizona inmates in 2014. The impact of the removal of California inmates at Red Rock is $5 million to $6 million of net operating income, with that impact occurring the second half of the 2013.

That impact is estimated under the assumption that the approximately 1,500 inmates are removed ratably from July through December. That said, we have not determined a definitive removal timeline or the process for the potential return of the inmates to the state of California. To extent California needs replacement capacity for the inmates being displaced in our Red Rock facility, we have the flexibility to offer other vacant beds within our system to California.

As we’ve mentioned previously we expect diluted shares outstanding to average between 102 million and 103 million shares excluding the impact of any shares to be issued under the E&P dividend. The full year – full guidance ranges is further impacted by a small increase in projected maintenance CapEx for real estate assets.

Full year guidance also reflects a range of impacts on interest expense related to the incurrence of additional debt to fund the REIT conversion. The ultimate impact on interest expense will be a function of the number of variables in addition to the interest rate on any new indebtedness that may be issued as part of the refinancing.

Well, we’ve given a great deal thought to our capital structure, and evaluated the various alternatives available to us. We will continue to evaluate the optimal capital structure based on changes in market conditions up through completing any refinancing, which is why we are not able to provide more specific guidance on interest expense. Other than to say, we believe our earnings guidance factors in the likely range of potential outcomes.

With regards to our potential inclusion in REIT indices, our financial advisors have researched the decision-making processes used by the various REIT indices in selecting companies for inclusion in their indexes. Based on that research, our advisors believe CCA will be a candidate for inclusion in one or more of the REIT indices.

Our advisors have also had direct conversations with representatives from the firm’s who manage the various REIT indices. Those managers are generally not willing to comment on whether a particular company will or will not be included in their index, nor comment on the specific timeframe by which they will make a decision on inclusion.

We know the indices are typically rebalanced on a quarterly basis. However, our advisors believe given the timing of when rebalancing decisions are made and communicated to index subscribers each quarter and given the timing of our private letter ruling and conversion announcement it is questionable whether CCA would be considered for inclusion in the first quarter changes to the REIT indices in 2013.

We know for example that we have not been included in the first quarter changes to the MSCI REIT Index released yesterday. However given the GO was included in the first quarter rebalancing of that index, we’re confident we will hopefully be included as well. Inclusion in the REIT indices is an important objective of the company, as such we will continue to work with our advisors, as well as directly with the index managers to ensure we are appropriately consider for inclusion at the earliest possible date.

I will now turn it back over to Damon.

Damon Hininger

All right. Thanks very much Todd. Now it’s for our market assessment and also outlook for the business. Now let me first just make a global comment, I’m reading all the same headline says you all. There is lot of mixed messages out there right now as relates to the economy and kind of the national environment.

So we continued to opt to monitor very closely and have concerns like many people about potential slowdown or other challenges to potentially lead into a recession. So we continue to be very cautious in the near term about the business and looking at this national environment.

But let me just give you a little bit of an observation both on the state side of business and also the federal side of business. And for the first of state side a few updates since we talked last November. First of which is just to restate what I said earlier, we’re very excited about our new Arizona contract.

Again, this is going to be utilized in existing capacity at our Red Rock facility that’s currently being occupied by the State of California. And one thing I will notice that, we are working through the course of the year doing some upgrades for this facility to meet all the requirements of this new Arizona contract. So this will be an ongoing priority for the company during the course of 2013.

But also let me provide a few global comments on the state side. First of which is to say that for the new fiscal year that started this past July, there has been no new meaningful new capacity being funded except for Arizona and California. And this is the third consecutive year of minimal preparations for new state capacity.

Now we’re expecting the same environment in this legislative season, which just started here in the last few weeks. And that means that we think there is going to be a very meaningful or very small amount of money being appropriated for new capacity for this upcoming fiscal year. So we think this environment where limited funds are being appropriated for new capacity is going to continue here for the near-term.

Now I can’t underscore how significant dynamic this is for the industry. The partnership corrections industry makes up about 10% of the total prison capacity in the United States with the public facilities encompassing the other 90%.

As the public sector, which again is 90% of the marketplace continues to defer cost associated with growth overcrowding or dealing with old dilapidated facilities the partnership corrections industry is well-positioned to fill that void, at the same time delivering cost savings and capital voidance to state budgets. Given CCA’s existing capacity plus our strong balance sheet, we are extremely well positioned to help states deal with their correctional challenges for many years to come.

But also one other global observation relates to the State Book of Business. We’re observing a very much enhanced appreciation to the significant operational cost savings we can provide our partners at the state level. Examples of this are recent actions taken by Ohio and Puerto Rico in their individual initiatives to you CCA to deal with their issues within their not only respective states, but also dealing with issues within respective budgets.

So I would say that states and other stakeholders are looking at more closely their actual cost of corrections and I want to give you a very specific example. This past year the variance of justice released a report with a title, The Price of Prisons. In it a report said 40 states that the variances surveyed the total taxpayer cost of prisons for those 40 states was on average 14% higher than the cost represented in their combined corrections budgets.

Now this is because of what I’ve been trying to highlight for several years, which is that State DOC budgets typically do not fully embed the cost of pensions, healthcare cost and capital outlays as it relates to the corrections departments. With all these factors, all these cost factored in which clearly has not been the case in the past, when cost comparisons are done between us and the public sector, our value proposition grows even further.

Now let me go to a couple of very specific observations for the State Book of Business and the first of which 11 of our existing state customers have grown by almost 5,000 inmates this past year and two examples of that is Idaho, which has grown by over 300 inmates this past year and as reported they did a recent procurement and contract with us to deal with that growth and are currently now using capacity that we have available in one of our Colorado facilities.

The other example is Oklahoma. Oklahoma has grown by 900 inmates this past year and has expanded our contract to allow us to house another 350 inmates for them. So again, great value of having existing capacity at the right time at the right price to deal with the states as they grow.

Now looking forward, we have 10 state customers who we provide owned and manage solutions and this is excluding California, that they’re expected to grow by 10,000 inmates over the next five years and have no capacity to deal with that growth.

I also want to note that we are pursuing six state – six new state prospects and these six states are projected to overcrowd within their respective systems over the next five years by about 8,000 inmates. Now I know there’s been some questions about California, so I’ll provide a much – more detailed report on them here in a few minutes. So, let me just make a comment as it relates to state budgets – budgets at the state level I should say. And the first of which is the state economies continue to improve. We’re all seeing some signs that state budget and revenues coming into state budgets are proving, but they’re still not above pre-recessionary revenue levels. So, we’re still seeing environment where it’s very tight at the state level.

Plus, states and this is kind of an obvious point, the states are watching very closely what’s happened that the federal level and potentially negative impact that has on state governments. But I will note of our 17 state partners, 16 of them have released budgets for the consideration within the respective legislatures for the coming fiscal year starting July 1st. And seven of those 16 states are proposing funding increases to our per day rate. So, we’re seeing a little improvement there also.

Let me now move to the federal book of business and just first make a comment about the federal budget. Both Congress and the President passed a six-month continuing resolution for the current fiscal year that takes us through the end of March. Where there’s been a few weeks away from the end of the – continue resolution, we may see some clarity on how Congress and the White House will address the fiscal year ‘13 budget and the looming sequestration cuts.

Also February is typically when the President proposes a budget for the coming fiscal year 2014. But as we understand it now, the President’s budget will not be released until early March. So, the potential sequestration scheduled for March of 2013 has created some uncertainty for the government. While many believe that Congress will find a way to stop or delay sequestration in advance of April, we will continue obviously to monitor very closely.

Let me now move to the significant penny procurements that are going on right now within the marketplace. And the first of which is New Hampshire. New Hampshire released a series of procurements last year, the primary one being for a new 1,550 bed in-state facility. Proposals are currently being reviewed by an outside consultant and we anticipated decision on how they move forward no sooner than this first quarter of 2013.

The next one to notice the Bureau of Prisons. On August 1st of last year the BoP released a procurement for a contractor owned and operated a facility for up to 1,600 beds that must be ready to accept inmates within 150 days of award or no later than September 1st this year. Proposals were due on September 18th of last year and based on their timeline, we think an award will be likely later this year.

Next of which is Harris County Texas which is Houston, they issued a request for proposal in June of last year which the county is seeking proposal for the management of the entire Harris County jail system of approximately 9,000 beds. We submitted our best and final offer on August of last year and we think that County can act on this sometime this year if they decide to move forward.

The last to highlight as Michigan. The state has recently issued an RFP for an in-state management of up to 960 inmates. Now offers can propose in privately owned in-state facility or use a regionally close state on facility. Proposals are due on April 2nd with an anticipated contract start date of July 9th of 2013.

Let me now go and give a brief update to a couple topics rolls us to California. As a reminder, the State and CDCR released a report titled the Future of California Corrections in April of last year and this is also known as the Blueprint.

The plants effectiveness and impact on CCA’s California populations continued on several key provisions. First, the state’s realignment plan secures continued decline in the state inmate population. Second the state completes in-state construction projects and finally, the most notable, the assumption that the state is successful in convincing the federal court to raise the capacity limit of their 33 facilities.

As it relates to the last part of their plan, the population cap several points to report. Through the end of 2012 and early this year, the state and the plaintiffs litigated the state’s plan request that the three-judge panel court raise the court order final population cap. Couple of other items to note here in the last few months, but first of which is in the state’s November and December status report the state acknowledge that it would fail to meet the December 2012 population reduction benchmark.

On January 7 of this year, the state responded to the court’s earlier order that it provide plans for complying with the population reduction order by June of 2013 and by December 2013. The state provided a statement listing steps it could take and legal obstacles that they would have in carrying out those steps. But, the state also moved that the court terminate the capacity order in its entirety arguing that the medical care system in California exceeds cost to sure requirements and no further population reduction is needed.

Later in January, the healthcare receiver filed a regular report indicating that he was not prepared to support the state’s assertion that Prison Health Care in California was fully constitutional citing the lack of both persuasive evidence that the appropriate results have been fully achieved.

On January 29, 2013, the court set a February 12 date, due date I should say, for the state to furnish additional filings in support of its motion to terminate the population reduction order. At the same time, the court extended the compliance deadline for the population reduction order to December 2013 six months after its original deadline.

On February 6, in one of the underlying cases in response to an earlier order, the state reported it’s plan timeline for returning to out-of-state inmates to California, which is a restatement of the state’s outline they provided in last year’s blueprint. Now this is an important point and I want to mention this specifically because there was a note that came out in the past week that mentioned this response by the state and somewhat indicated that this was a new development with the state.

The states response on this February 6 filing was a restatement of what the state had within their blueprint from last year, which was over five years they would reduce the population in the out-of-state program through 2016, so this is not any late breaking news or new information. This is basically a restatement of what the State put out there about a year ago.

On February 12, the state filed a response to the court’s January 29th order saying that the state cannot meet the population benchmark by the new deadline of December 2013 and it never represented that it could. Finally, also on February 12, the plaintiffs and the plaintiffs who represented the inmates in this case, submitted a filing with the court opposing the states motion to vacate the prison – prisoner population reduction order.

They expressed in their filing that the California prison system remains in a state of emergency and an adequate repair continues to do to overcrowded. A lot of developments here in the last 60, 90 days, so let me summarize.

The state has requested that the cap be weighed with their position being that the 33 state facilities are operating at a level higher than the constitutional requirements. The plaintiffs have briefly submitted filings refuting that position and opposing that listing of the cap. The federal and medical receiver submitted also a filing indicating that it is not prepared to support a listing of account nor that the state has reached full constitutional compliance in its healthcare system. So it is now in the hands of the three-judge panel, and the three-judge panel has not set a date by which they plan to rule on the state’s request for waiving the population cap.

Now let me talk a minute about California and the budget. As it relates to the proposed budget that was released earlier this year by the governor and as expected, the governor is proposing funding consistent with the blueprint from last year, but again the budget proposal is consistent with what they had in their blueprint from the spring of 2012.

I should also note that as a result of the tax increase that was enacted late last year, the state has estimated a balanced budget for the first time in many years. Let me also make a comment on their populations.

Inmate population reductions due to realignment have slowed in the second half of 2012. In the spring of 2012, as a further blueprint they were projecting their 2017 total inmate population being just under 124,000. Versus now they are projecting to be closer to 130,000 now this is another and very important point, so a lot of references over the last few months about the blueprint by many different stakeholders. That blueprint which again came out in the spring of 2012, estimated that the state population would be close to 124,000 in 2016, 2017. They have now revised those estimates and it’s up 6000 inmates higher at that same period to 130,000 so again another important development as it relates to the state of California.

So obviously we’ll be monitoring very closely all of these developments and stand ready to serve the state as they consider alternatives in a reaction to any likely court ruling or orders. So let me now bring it close to my comments and make these final points, the first of which new business opportunities are highlighted, we’re very excited about knowing what new development opportunities are, but also working very hard to trying to find partners to use existing capacity within our system. And the success we’ve had this past year with Puerto Rico, with – excuse me with Oklahoma and Idaho shows are a success in finding partners utilizing existing capacity.

Also in our steps to create more shareholder value, we were successful in our goal to convert to a Real Estate Investment Trust which will be a perfect new platform for us as we reach a larger group of investors but also enhance our competitive advantage in the marketplace and also our value proposition to our partners. So at this point, this concludes our prepared remarks. Thank you again for calling in today’s conference, and let me now turn it over to the operator for Q&A.

Question-and-Answer Session

Operator

(Operator Instructions) And we will go first to Manav Patnaik.

Manav Patnaik

Hey good morning, everybody. Thank you so much for the color, and you just try to find all the stuff going on in California it’s been a little confusing. But just related to that and what’s baked in your guidance I think last week you talked about the assumption was basically one that you made because either way you have to move the inmates out to vacate for Arizona, I was wondering have you notified California of your intent to do this, and have they in any way responded saying, okay, we’ll take it back or just move it to your other facility?

Damon Hininger

Good couple questions, Manav. So, let me answer that – this is Damon. So, we have made California aware all along the way as we went forward on pursuing the Arizona contract, so from day one when we submit a proposal in advance to submit a proposal I should say, we made California aware and their role were that with that type of opportunity where you had a contract potentially with Arizona for 20-year term and guarantees that would be a very attractive for us, since we had this uncertainty going on with California. So, every step of the way we’ve made them aware and they know about the Arizona contract award and they know that we would start taking inmates the first of next year.

The second point, I would say is that, they have not formally given us indication that they’re going to take all 1,500 inmates back into the state. We’ve got that in the plan just because we have to get the inmates out by the end of this year because Arizona will not let any kind of cross mixing of population, so that is in the guidance. We have to get the population off by the end of the year. We haven’t received anything formally from the State of California.

So there will be ongoing discussion as we go into the year and as they react to a likely order from the region three-judge panel and also we’re we’ll prepared to deal with what their needs are, so if they have a need for those 1,500 inmates that remain out of state, we also have capacity in our system that we can provide to them and stand ready to do that, so again will get more clarity I think as we going to the spring or into the early summer.

One other thing I would note is that, we’ve got a contract for about 9,000 beds for the State of California and we’ve been right at about 99% for quite some time, so they’ve been utilizing all of our capacity here in the near term, even as all the stuff circling with the three-judge panel in the actions by the court.

Manav Patnaik

Got it. And can you remind us on the Arizona schedule, if I remember correctly it was 1,000-bed contract, but 500 stock like Jan 1st of ‘14, and then another 500 another year later, is that what you still expect?

Damon Hininger

That’s correct.

Manav Patnaik

Okay. And then just on the sequestration stuff, you made some comments this time when you talked about it before as well, do you guys have any idea or guidance around if anything in there could directly or maybe indirectly impact sort of your customers, and may be some of your contracts just curious if there’s any way to read through that at all?

Damon Hininger

Yeah, good question. So couple of observations there, one of which is that we had as a dry run through this potential threat here late last year, so as you know sequestration was supposed to go into effect on January 1st, and in the days weeks leading up to that date before the compromise was worked out between the administration and Congress, we didn’t see any notable changes with our customers, how they were doing business, in fact we are observing and basically they were looking just kind of at a status quo.

I think one key reminder on sequestration is that the cuts have to be affected sometime during the fiscal year. It’s not necessarily the case that on March 1 all of these cuts have to be put in place. So, if there is a budget reduction that – a customer or if he has to do, they’ve got the rest of the fiscal year to do that, they don’t have to do that on day one. So that’s one I think important reminder.

And then I guess the last point, part of your question is so we’ve got two kind of – two key days you’ve got sequestration, which is due to go to and in effect on March 1st and then you got continued resolution that goes through end of March.

So there is – and I think is why they report on media, there is one group of thought that sequestration comes to pass on March 1, you have the administration and congress work through the month of March to work out a – some type of compromise both the risk and sequestration, but also a funding bill for the rest of the fiscal year and that gets worked out before the March – end of March continued resolution expiring.

So, we’re up to continue monitor it very closely, but to your first part of your question, I think we’ve got a pretty good sense of how our customers reacted with the last brass blast sequestration on January 1st.

Manav Patnaik

Okay. Got it. And one last just sort of housekeeping one for Todd. You already gave us sort of the depreciation of real estate assets is about 77 million. Can you just help us fill the gap in between your sort of total guidance is slightly increased like what the other depreciation number should be?

Todd Mullenger

So, full year 2012 was around $114 million and we’ve guided to a slight increase, so that you know, 2 to $4 million on top of that, for total depreciation.

Manav Patnaik

Okay. All right, fair enough. Thank you guys.

Damon Hininger

Thanks, Manav.

Operator

And moving on, well go next to Kevin McVeigh of Macquarie.

Kevin McVeigh – Macquarie

Great. Thanks. Could you remind us if California doesn’t put those 1500 beds back to you, what would that suggest in terms of upside to current estimates?

Damon Hininger

We haven’t given any estimate as it relates to what the impact would be and again depends on kind of the timing and exactly what they want to do and also depends on exactly what we do for them, and so let me explain that specifically. So if we utilize capacity at facilities that’s partially utilized, we’ve got some big capacity and we can increase the (inaudible) percentage that could be a little more of upside this year.

But if we have to go to a vacant facility and started up, then that would be potential a little more of a drag this year, but up to be upside for ‘14. So again depends on exactly what their need is, the timing of which is an ultimate what we propose as a solution

Kevin McVeigh – Macquarie

Got it. And then just with kind of Arizona taking over some of those California beds. Is that – would you kind of view that as a longer term strategy just given the uncertainty around California to kind to try to proactively replace those beds or is it ultimately going to depend on what – how their realignment settles?

Damon Hininger

Little bit of both. So, we have been working really hard and our partnership development folks have been working hard on. When we look at the portfolio of beds currently utilized by State of California, we’re always looking at opportunities where we could have a solution that’s a little more longer-term and lowers the risk profile. And again Arizona is a great example of that, because they’re offering a 20 year contract with the 19 guarantee.

And California stands at two, again as I mentioned earlier to Manav, we are in consequent communication with California educating them on that point. And they understand that. They understand obviously with everything circling it’s hard for them to give us a lot of certainty relative to their needs out-of-state. So, it’s a very good collaborative discussion with California and again we’re always looking at opportunities to lower that risk profile. We can now have contracts like Arizona utilizing existing capacity that California is currently in.

Kevin McVeigh – Macquarie

Got it. And then just one other – one around capital structure obviously I know we need to do the E&P and part of that is amending some of the debt. As you think about the capital structure going forward, have there been different conversations posted positive PLR as you’re thinking about be it terming out some debt or just any thoughts on cost capital structure relative to the PLR and then ultimately any sense of timing on kind of the E&P post clarity on debt.

Todd Mullenger

Sure. I’ll take that one, Kevin this is Todd.

Kevin McVeigh – Macquarie

Hey, Todd.

Todd Mullenger

Obviously, we’ve given a lot of thought to the capital structure but will continue to update our assessment of various issues such as the appropriate levels of liquidity, the outflow mix of variable-rate debt, fixed rate debt, optimal mix of bank debt versus bond debt, the amount of covenant flexibility we desire and are willing to pay for and the length of the debt maturities all of which can be influenced by potential changes in market conditions which could have an impact on interest expense. Anyways with regard to the E&P dividend we would expect to make that distribution sometime after we complete the refinancing.

Kevin McVeigh – Macquarie

Okay. Thank you very much.

Operator

And we’ll move on to Clara Evan with Avondale Partners

Kevin Campbell – Avondale Partners

This is actually Kevin. I had a question for you guys just on the index inclusion. Are there any requirements at this point that you guys haven’t met you know do you have to make your E&P distribution beforehand? Any other requirements that still need to be made that you have to check the box on?

Todd Mullenger

Kevin this is Todd. Again when we have spoken with the index managers there’s I think intentionally vague on some of the decision-making they will typically refer you to their published methodology which isn’t always clear around the issues they consider.

When making decisions around whether or not to include company and went to include that company but it is possible that one or more they want to see the distribution of the NP dividend before they pick this up for inclusion.

Kevin Campbell – Avondale Partners

Okay. And I don’t know if these indexes were even around back then but was PCN included in any of the read indexes that were around in the 90s?

Todd Mullenger

I believe they were. I can tell you which one so.

Kevin Campbell – Avondale Partners

I’m curious to sort of separately bigger picture on ICE, immigration reform obviously has been a topic that you know under the forefront here in the first part of this year so I’m curious what you’re hearing on immigration reform and how that could look and knowing that its obviously very early stages?

Damon Hininger

Good morning, Kevin. This is Damon. Let me tackle that one. I don’t have any really new information or additional insight than what’s been reported more globally in the national media. But I will say that generally, talking with ICE whose has been a partner for us for many, many years, I think they’re just general belief is that there’s always going to be a demand for beds.

Now their profile of detainees in those beds may change over time to where they focus more on what they call criminal aliens versus non-criminal aliens, so that may change over time from – from time to time I should say based on both the demand and maybe any policy value administration.

But I guess yes, my last point would be what you just said at the end, I think its too early to tell exactly what the impacts going to be, but again, generally ICE has always said that there’s going to be a demand for bed space here in the U.S. because of all the things we’re doing both within the interior, on the border, from the people that are released from state prisons that are ultimately need to be deported there’s always going to be strong demand, regardless of what’s been done at the national role of this immigration reform, but again it’s too early to tell and what to monitor closely.

Kevin Campbell – Avondale Partners

And Todd you mentioned last week that the investment grade ratings for your debt is important to you. Could you maybe tell us some of the steps that you’re taking for that and if you are achieve it what that means financially for the firm?

Damon Hininger

Second part first; think it means a lower average cost of debt capital. And I think it could also favorably impact our cost of equity capital by improving our if you see financial position. In terms of the steps we need to take, we are continuing a dialogue with the rating agency; he’s got a great group of analyst there, very accessible, very knowledgeable around the business.

And now that we’ve formally converted to a REIT we’ll continue to press our take with them, funny how we comp very well compared to the average REIT. The average REIT include, a lot of the investment grade REITs have leverage in excess of five times or three times and coverage ratio is down around three times or we’re approaching seven time, so I think we’ve got a lot of strong arguments to make that will likely take some time and they are independent as you know they got their own perspectives and methodologies, but we’ll continue to push – make those arguments and push that case forward.

Kevin Campbell – Avondale Partners

And in terms of impacting your sort of cost to borrowing, though when you need to get that done before you came to market with a new debt?

Damon Hininger

Yeah, great follow up question. We are not going to see any movement on the rating agencies before we’re going to market. That’s going to be hit, it’s probably at least 12 months before they would even consider making a change based on our REIT conversions. That will be a longer-term process decision-making process with the rating agencies.

Kevin Campbell – Avondale Partners

And then the benefit then to obviously is over the longer term your cost of borrowing.

Damon Hininger

Yeah.

Kevin Campbell – Avondale Partners

Okay, I’m curious on Michigan, RP how you feel about your ability to compete there, I didn’t – if you said this previously, I’m sorry, I missed it, but would you be submitting it as a management contract and you would partner with the state on an existing facility or would you be able to purchase one of these states – facility?

Damon Hininger

Yeah, good question, Kevin. This is Damon again. So RP just came out, so we’ll still assessing the procurement itself, and the requirements I think the two were of the existing state facilities until later this month. So as we understand it, it’s really not an opportunity to acquire facility you really just have two ways to propose a solution to this state, one of which is to propose own capacity in state and of course we don’t have the capacity in Michigan, so we wouldn’t be able to compete on that part of the proposal but the other possible proposal is to use an existing state owned facility and proposed management of that housing of about 1000 inmates, so basically we have managed only opportunity.

So again we’re still assessing it and taking a look at it, again, I think the two were our facilities that’s owned by the states a little later this month, so we’ll give updates along the way.

Kevin Campbell – Avondale Partners

Okay great. Thank you very much.

Damon Hininger

Absolutely. Thanks Kevin.

Operator

Our next question today is from Tobey Sommer at SunTrust

Tobey Sommer – SunTrust

Thank you. A lot of my questions have been answered. And I just wanted to ask at this stage of the state budget cycle with some of the healing that’s going on. How do you think about that vis-à-vis demand for your services.

Damon Hininger

Yeah, great question, so couple observations, so one of which is what I said earlier that we’re seeing a play out even though budgets are improving, we’re seeing a play out to our where states property in very little, if any money for new capacity. And we – as I mentioned earlier we are seeing states a double-digit number in our portfolio that are growing by 5,000 this past year. So I think that’s an encouraging sign, I think one of which is that we’re making good progress on showing states that we can provide a solution versus inmates in the capital investment to deal with our growth.

Todd Mullenger

The other thing I would say is that we are seeing a little bit of improvement on the budgets as it relates to going ahead and buying some the beds. And I think a good example as I think about our state portfolio is Oklahoma. This is a state that has been dealing with a little of bit overcrowding for last year’s.

But they’ve had a challenging fiscal environment. So them going out now and procuring some beds in our portfolio this past year, I think is an encouraging signs that they now feel like, okay, we’ve overcrowded for a little bit, but now we can reduce a little bit in our system and now take advantage of some beds within CCA.

And then the third point is little bit to what I mentioned earlier is that I’m a little more encouraged, again, can’t bite the ball yet, but I’m a little more encouraged that we’re seeing state budgets coming out to where we’re seeing escalators within our state contracts that are due to increase on July 1.

Again, these are initial proposals, they have to work their way through legislature. But seven of our 16 showing per day increases I think is encouraging sign. Again, we had a lot of work still to do, and they’re still not at levels they were a few years ago, but I think its going in the right direction.

Tobey Sommer – SunTrust

Thank you. That’s helpful. And if I think about the opportunities that you have sometimes that materialize direct negotiations as opposed to RFP processes. In the context of where the state budgets are how do you feel about those opportunities – in the frequency of those opportunities to increase relative to the trend of the last couple years?

Damon Hininger

I would say its slightly better again, slightly better. So Puerto Rico is a great example. Puerto Rico we had in that list of fixed prospective states that we didn’t mention my name and then got it across the finish line with the new contract last year. There’s a couple other states that I would say are kind of in that, not the same category where they’re growing and overcrowding. But also their budget environment is a tad better, so they may be feeling a little better, they could reduce the overcrowding their system, so I’d say again it’s not dramatic, but it is a slight improvement.

Tobey Sommer – SunTrust

Under a REIT structure do you feel that the sale of an existing facility by a customer is more likely or enhanced in some way by the structure or is it a neutral impact?

Damon Hininger

I would say a neutral maybe a tad better than that, but as Todd mentioned earlier as we think about our capital structure, if we get good movement on our cost to capital and see the improvement in rating agencies of again what that’s on it to do less for the management team. Then if our cost of capital is slightly better than that makes our buy proposition slightly better, but I would its generally I’d say neutral.

Tobey Sommer – SunTrust

Okay. Thank you very much.

Damon Hininger

Thanks, Tobey.

Operator

And we will move onto Clint Fendley at Davenport. Sir.

Clint Fendley – Davenport

Good morning guys. Thanks for taking my question, one question on California, I wondered if you think we’d see the demand for beds changing in California if the population caps were placed on individual prisons rather than the reporting that is currently done on a statewide average?

Damon Hininger

Yeah, that’s a great question. You may have seen in the filing by the plaintiffs a suggestion to that so for the rest of the audience the cap is for their whole system wide population which is 32 facilities. There’s been some suggestion including by the plaintiffs that that cap is for each individual facility. So that would potentially create some more challenges for the state of California.

But to answer your question assuring you I don’t know if they have their requirement they have to do that by facility versus system wide it could create some challenges for them in manifest itself into an opportunity for CCA. Again it’s one of the many different outcomes and as I said earlier we stand ready to support the state as they see fit as they do with this potential action by the court.

Clint Fendley – Davenport

Could you maybe even help us understand I’ve read some reports that have indicated that some of their individual prisons capacity is as high as 180% currently I mean, does that mean that they have shifted some of these inmates over to newer facilities, is that allowed them to maybe manage them more efficiently or how should we think about that?

Damon Hininger

It’s probably a combination of all the above it’s probably looking at classification. So they may be willing to do a little higher percentage on a lower custody population versus higher custody population. It could be to your point newer facilities versus older facilities newer facilities maybe be with a lot more technology and secure hardware and technology could allow them to a little high percentage, so it’s probably a combination of many different factors, both age of facilities, location of facility, from a staffing perspective and then also the classification of inmate.

Clint Fendley – Davenport

Okay, thanks. And one last question here, I wondered if you could remind us, do you have labor costs that are indexed to the minimum wage, and if so, do your contract provisions address that if it were to rise to $9 as has been proposed?

Damon Hininger

We do not have them indexed. Many of our federal contracts are driven by Department of Labor, so those rates are determined by Department of Labor and then we’re able to get adjustments based on any increases by Department of Labor, but not on our state side, they’re not indexed to minimum wage.

Clint Fendley – Davenport

Okay. Thank you, guys.

Damon Hininger

Thank you.

Operator

And we will go back to Kevin McVeigh, Macquarie

Kevin McVeigh – Macquarie

Hi. Can you hear me.

Damon Hininger

Yeah.

Operator

Yes, sir. Go ahead. Thanks.

Kevin McVeigh – Macquarie

Sorry about that. Damon, if you get those per diem increases on the seven to 16 state that are showing that, is that factored into the ‘13 guidance or would that be additional upside?

Damon Hininger

That will be factored in.

Kevin McVeigh – Macquarie

So it’s factored in already or would suggest additional upside if it were successful with those per diems.

Damon Hininger

We factor it in.

Kevin McVeigh – Macquarie

You did. Okay. Super. Thank you.

Operator

And that is all the time we have for questions today. Mr. Hininger, I’d like to turn the call back over to sir for any additional or concluding remarks.

Damon Hininger

All right. Thanks again, Lorrie and appreciate everyone’s participation in today’s call. We are very excited about the results we had in 2012, most notably, the accomplishment of our conversion to our Real Estate Investment Trust. Let me just also say, as always, very thankful for the investors on the call and your investment in CCA. As always, your management team here in the room and throughout the organization we’re working very hard to execute on another good quarter and another year – another good year for 2013, and we look forward to reporting progress during the course of the year.

So thanks again for your participation this morning. Goodbye.

Operator

Once again, ladies and gentlemen, that does conclude our conference for today. I would like to thank everyone for joining us.

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