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Corrections Corporation of America (NYSE:CXW)

Q4 2008 Earnings Call

February 10, 2009 11:00 AM ET

Executives

John D. Ferguson - Chairman and Chief Executive Officer

Todd Mullenger - Executive Vice President and Chief Financial Officer

Analysts

ManAv Patnaik - Barclays Capital

Kevin Campbell - Avondale Partners

Operator

Good morning everyone, and welcome to the Corrections Corporation of America's Fourth Quarter and Year End 2008 Earnings Conference Call. If you need a copy of our press release or supplemental financial data, both documents are available on the Investor page of our website at www.correctionscorp.com.

Before we begin, let me remind today's listeners that this call contains forward-looking statements pursuant to the Safe Harbor provisions of the Securities 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 the non-GAAP measures. The reconciliation of the most comparable GAAP measurement is provided in our corresponding earnings release or posted on our website. We are under no obligation to update or revise any forward-looking statements that may be made to reflect events or circumstances after the date hereof or to reflect the occurrences of unanticipated events.

Participating on today's call will be our Chairman of the Board and CEO, John Ferguson; and Chief Financial Officer, Todd Mullenger.

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

John D. Ferguson

Thank you and welcome everyone to Corrections Corporation's fourth quarter earnings call, as well as our full year earnings call. And with me today is Todd Mullenger, Bruce Scarf (ph), Dave Garfinkle, our Controller and Board member, Bill Andrews. So we will get started with some opening comments by Todd.

Todd Mullenger

Thank you, John. Good morning everyone.

Moving straight to the discussion of our financial results, in the fourth quarter of 2008, we generated $0.32 of EPS compared to EPS for last year's Q4 of $0.28, an increase in EPS of 40%. For the full year, we generated $1.20 of EPS compared to $1.06 in the prior year, an increase of 13%.

EBITDA in Q4 increased 17% to $107 million for the quarter while full year EBITDA increased 14% to $394 million. Adjusted free cash flow for the quarter increased 38% to $65 million. This brings adjusted free cash flow for the full year to $256 million or $2.03 per share, an increase of 24% over the same period last year. Part of the increase in free cash flow is due to the unusually low amount of cash taxes paid as a result of certain one-time tax benefits derived in 2008 and lower year-over-year maintenance CapEx.

Focusing on depreciation, as we mentioned in the past, unlike other industries, our depreciation expense is not reflective of the maintenance CapEx that we will incur to maintain our facilities. For example, depreciation and amortization expense totaled $91 million for 2008 versus only 35 million of facility maintenance and IT CapEx for the year.

So as we commented before, we believe adjusted free cash flow is in many ways a better measure than EPS of the return we are delivering to our shareholders.

Total revenue for this year's fourth quarter was up nearly 9% over the last year, an increase of $33.6 million. Total compensated man-days for the quarter increased 4.1%. Revenue per compensated man-day for the quarter increased 5.2% to $58.21.

For the full year, total revenues increased nearly 10%, driven by a 4.5% increase in per diems and a 5.5% increase in average daily populations.

Average compensated occupancy for the quarter declined from 98% to 92.9% which, taken by itself appears negative. However, keep in mind that compensated man-days actually increased 4.1% while the decline in occupancy percentage was the result of placing approximately 10,000 new beds into service since the end of the third quarter 2007.

With regards to the 5.2% increase in revenue per compensated man-day, results in Q4 2008 reflect the impact from certain pricing leverage we enjoy from renegotiating several contracts, the increase in populations under our state of California contract as well as routine per diem increases.

Moving next to a discussion of operating costs, operating costs per man-day for the quarter were $40.09, a 2.8% increase over the prior year. For the full year, operating costs per man-day increased 3.1%.

Our Q4 2008 operating costs per man-day reflect normal wage and other general inflationary increases, as well as operating inefficiencies associated with the ramp-up of new bed activations at facilities, such as La Palma, Tallahatchie and Davis.

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

Q4 operating expenses also reflect certain unusually large favorable expense variances, including a favorable adjustment to our self-insured workers' compensation accruals, resulting from updated actuarial studies and lower than average employee medical claims expense. These unusually large favorable items totaled approximately $3.5 million before taxes.

Operating margins per man-day for the quarter increased 11% to $18.12 with an operating margin rate of 31.1% compared to 29.5% last year. For the full year, operating margins per man-day increased 7.9% with an operating margin rate of 30.4%.

General and administrative expenses for the quarter increased 1% over the prior year and were 4.8% of revenues. GAAP income tax expenses were approximately 38% for the quarter and full year.

With regards to our share repurchase program announced in November of last year, through Friday, February 6, we have repurchased approximately 2.5 million shares at a total cost of $38 million.

We consider the share repurchase program another capital allocation alternative, with the decision to repurchase shares based upon a return on investment analysis. In other words, if repurchasing shares delivers an acceptable ROI and that ROI is higher than the other capital allocation alternatives, such as building new beds, everything else being equal, we would choose to allocate the capital towards a stock repurchase.

Obviously the share repurchase price is an important component of that ROI analysis. And it is important to note here that our decisions around the deployment of any capital will be made under the overarching objective of maintaining liquidity.

We are very pleased with our fourth quarter and full year operating results. For the full year, we delivered 13% in EPS growth and generated $256 million of adjusted free cash flow or $2.03 per share, a 24% increase over the last year, completed construction on 8,300 new beds and entered 2009 with a very solid balance sheet and liquidity. All accomplished against the backdrop of one of the worst economic and financial markets in the last 50 years.

Moving next to a discussion of our guidance for 2009, as indicated in the press release, our guidance for Q1 2009 is in the range of 24 to $0.26 and guidance for the full year is in the range of $1.10 to $1.20.

There are a number of items impacting Q1 and full year guidance. So I would like to spend sometime reviewing it. First, going back to fourth quarter EPS of $0.32. As we just discussed, there were certain unusually large favorable expense variances, positively impacting Q4 earnings, actuarial adjustment to workers' expense, below average employee medical claims expense, which combined, totaled, say, $3.5 million or almost $0.02 in EPS.

So before comparing earnings guidance for Q1 2009 to Q4 2008, we should normalize Q4 EPS by removing these unusual variances. And when we do that or we have then is an adjusted EPS for Q4 of $0.30. So we really need to think about Q4 as a $0.30 quarter normalized.

Second, you will recall from prior years that Q1 is always seasonally weaker compared to Q4 due to the payment of unemployment taxes. Employers pay unemployment taxes on the first $7000 of wages, so those taxes are always higher (ph) in the first quarter of the year. Also, the first quarter has two fewer calendar days compared to Q4.

In addition, we will see significant increases in depreciation and interest expense during 2009 beginning in Q1. Depreciation and amortization expense is increasing as a result of placing new beds into service during 2008 at an aggregate cost of nearly $600 million.

Interest expense will increase as a result of higher debt balances and a decline in capitalized interest associated with the reduced bed construction CapEx. The full year impact on 2009 EPS associated with increased depreciation and interest expense is estimated at $0.10 to $0.12 full year.

While our guidance anticipates full year EBITDA at levels comparable to 2008, the increase in interest and depreciation expense results in a decline in 2009 EPS compared to 2008.

Also keep in mind, as we mentioned earlier, depreciation expense, a non-cash accounting charge, is significantly higher than the cash we will invest for capital repairs and maintenance.

Finally, we have the uncertainty and lack of visibility associated with government budgets and future spending by our government customers, especially our state customers, as they work to cut spending the balance of budgets.

State administrations along with state legislators that have not come back in the session continue to study and debate what actions they may take to balance their budgets, including actions that could impact Corrections' budget. It is a very fluid and dynamic situation. For example, many states are hopeful that the federal fiscal stimulus bill will include funds with a system in balancing their budgets.

We have received communications from several of our state customers indicating some of the steps they may take, which could impact CCA. For example, several state customers have communicated intentions to reduce our per diems.

We are currently in discussions with those customers regarding the opportunity for CCA to reduce service levels under those contracts, so as to eliminate operating costs to offset some or all of the impact from a reduced per diem.

We can also see states take actions that negatively impact our populations, such as listening probe standards.

We have also received an expression of interest from potential new customers to use our beds as cost savings mechanisms to help balance their budgets. Needless to say, given the level of uncertainty and limited visibility, at this point in time it is extremely difficult to look out into 2009 and forecast the impact these issues will have on CCA, a risk we highlighted on the last earnings call.

However, we have done our best to factor these items into our guidance. At the end of the day, our guidance reflects our best estimate based upon the information currently available to us and we're trying to build in some considerations for the general economic uncertainty and lack of visibility, especially with regards to government budgets and future government spending.

The general economic uncertainty and lack of visibility are really in the primary risk to our guidance.

Having said all that nothing has occurred that has changed this management team's bullishness on the long-term growth opportunities for our industry and this company.

Turning next to a discussion of our liquidity, our liquidity is provided by approximately $190 million of availability under our bank credit facility plus approximately $34 million of cash on hand. This is in addition to our very strong cash flow from operations. Again for the full year 2008, we generated $256 million in adjusted free cash flow or $2.03 per share.

In addition, we ended the year with a debt to EBITDA leverage ratio of approximately three times and interest coverage of approximately six times with no pending debt maturities until May 2011.

At the end of December, we had approximately $75 million left to spend and complete all of the development projects announced to date that we're moving forward with. We believe our strong liquidity position, balance sheet and free cash flow provides us a competitive advantage, especially given the uncertainty in the financial markets.

Regarding CapEx, we are slowing the pace of investment in new beds planned for 2009 compared to 2008 until we have greater clarity around the timing of future bed absorption by our customers.

Towards that end, we have temporarily suspended construction of the 2,040-bed correctional facility planned for Trousdale County, Tennessee. While we have sufficient liquidity to complete the facility, again we're slowing the pace of new bed development until we've greater clarity around the timing of new bed procurements and bed utilization from our costumers.

We currently have approximately 11,000 beds in inventory or under development which positions us well for future growth.

With regards to our stock repurchase plan, management has been authorized by the Board to repurchase stock up to $150 million in the aggregate. As mentioned earlier, we have repurchased 2.5 million shares at a total cost of $38 million through the last Friday which leaves us with $112 million of additional capacity under the plan.

Again, the plan is not a systematic plan but rather one based on an ROI analysis with the decision to make any additional purchases to be made under the overarching objective of maintaining liquidity.

Let me close by noting, like the rest of the market, we are experiencing uncertainty caused by the current economic conditions. However, we are very optimistic about our long-term growth prospects. Current budget deficits will likely result in institution bed development by the public sector, necessary to meet their future bed needs. Our development efforts have positioned us with an inventory beds our customers will find attractive to meet those future bed needs.

This combined with our strong financial position and cash flow position us well to capitalize on the long-term growth prospects offered by a continuation of the supply and demand imbalance. That has been the primary driver of the tremendous growth CCA has experienced over the past five years.

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

John D. Ferguson

Thank you, Todd. Hope that helped many of you with the first quarter and full year guidance for 2009. I will briefly touch on our two major market areas as I typically do: first, addressing the federal market. We saw a net growth of 1,726 net new inmates and detainees for 2009. That actually was a decline of that 273 in the fourth quarter but we have had a growth of over 218 in January. So pretty much recaptured the fourth quarter growth.

We are like everyone watching the economic stimulus package, trying to get updates several times a day as to what's happening. So it's impossible to provide any clarity of what possible impact it would be to our federal customers. And I might just go ahead and mention our state customers, the one thing that as Todd alluded to. I think most states are waiting anxiously to see what the stimulus might do for them and many governors are postponing their final budgets until they have clarity around there.

So consequently, even though there have been four major solicitations by the Federal Bureau of Prisons, two of which are for up to 4,000 new beds as well as 4,000 beds for the two contracts we currently have that expire in the last quarter of 2010. We are seeing no movement, and as we have mentioned on the last several calls, it is our assessment that nothing will happen as it relates to any probable award until the Federal Bureau of Prisons has a permanent budget.

The projections that we've given historically of the difference between their demand over the three years as it against the beds that they are bringing online or have planned through acquisitions, surely is down some 6,000 short of what they need. And that's against the system that's running at 137% of their weighted capacity.

With the U.S. Marshals Service, we have talked about over the last almost a year about the implementation of Operation Streamline. We can report that here recently, we have seen some growth as the results of that. But it's still too early to assess the long-term demand changes that might bring about that there.

Also just to report that we entered into a direct contract with the Office of the Federal Detention Trustee for approximately 600 beds at our Northeast Ohio facility, Youngstown. This is... just for replaces an existing intergovernmental agreement that we had there previously.

We see status quo on detainee activity at Immigration and Customs Enforcement. And obviously, we are watching very closely what Secretary Napolitano's interest will be as she becomes more... as her tenure increases at the Department of Homeland Security.

At the state level, we still have the same procurements that we talked about last time. As we have said before, we're signing many of our costumers who are sitting on the hands until something... there is some clarity around their budget just as I described to the Federal Bureau of Prisons. Arizona had a solicitation for up to 1,200 beds to be housed out of state. They have reduced that to 750 but it is still active.

The RSI for the State of California is still out there but obviously a great deal of uncertainty they are dealing with right now where our current population is about 6,500. And it is California's plan to complete the ramp-up up to 8,132 by May.

Obviously, we all saw the announcement this morning of the outcome of the three-judged panel and their desire to see population limits put on the State of California system in state. To breach whatever that level is ultimately agreed to over a two to three year period.

Although we have seen nothing recently every indication that we heard over the last period of time is that the other state inmate populations would be over and above whatever cap was established by the three judged panel or whatever cap was settled in some negotiations so with the state and the plaintiff.

And of course the Attorney General and the Governor both said that any penal order they will appeal to the U.S. Supreme Court. And we... there is deal that we have solicitation with the state of Georgia for up to 1,500 expansion beds and another 1,000 standalone beds.

So the activity there we reported on the last time and this time is pretty similar, which is not unexpected in light of the uncertainty that our customers are dealing with their budgets.

So let me just talk a moment about what I think continues to create the bullishness that Todd related to, because we think we're in for all the turmoil and with our customers in the capital markets that we feel that CCA is in a very good position to benefit from once the state budgets become a little more clear, once they improve and be able to meet what we expect would be continued bed needs, because of continued inmate and detainee growth over the next 3 to 5 years.

We currently have some 11,000 beds in inventory or under development, most of which is now in inventory. We do have 1,072 under development to provide the beds for the U.S. Marshals Service in Southern Nevada. Of the 10,000 plus beds that we currently have available, almost 1,600 of them are designated to meet the remaining ramp-up schedule for the State of California.

So we think that, that is a pretty good inventory to have in this point in time. We also... as Todd had mentioned that we decided to postpone the completion of Trousdale. But we feel that we have made great progress to a point that we could activate the completion of that facility in a much shorter timeframe than a normal construction. So those beds could be brought online fairly quickly.

So with that availability of the beds that we have in inventory and developed, we're looking in excess of $90 million of potential EBITDA. And I think what is really attractive except for the 1072 beds in our 2009 guidance and outlook, the interest costs and the depreciation for those beds now are backed in. So at any potential EBITDA from the beds other than the Southern Nevada facility, a good portion of that would go straight to pre-tax income and then eventually to earnings per share.

So we think that, that is a good earnings potential for the company beyond this very uncertain year that we are all experiencing. And in addition to that, as Todd described and we have described in some detail over the last year or so about what our liquidity means in terms of beds that we can develop.

As we have said, we are now becoming little circumspect on what we will do. But we are in great shape that once the visibility for what we believe is significant bed needs does become a little more clear that we are on a great position to be able to need... to address what we believe is going to be needs in the future. And we also believe that once the capital market stabilizes that we are in great shape to be able to utilize them for what we believe is a strong future demand for expansion (ph) beds.

So although we know that there are folks that are concerned with the guidance that we provided for this year. But the uncertainty leads to us to try to be as realistic as we can. As you might imagine we had a great deal of struggle like many companies are today as to whether you give guidance. And we felt that we could provide some clarity around what we think the outcome of 2009 would be in light of the many unknowns and uncertainty in both our costumer base as well as the capital markets.

But our attitude about the long-term opportunities for this industry and specifically CCA as it relates to our inventory, our liquidity, our position in the marketplace, our 20 state customers, our 3 federal customers that we'll be in a great shape once this fog of uncertainty that's brought on... which may last beyond 2009, but gives us I think a great position to benefit from that.

So with that, I'll turn the... over to the moderator for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). We will take our first question from ManAv Patnaik. Please go ahead.

ManAv Patnaik - Barclays Capital

Hey guys. First question, you talked about in your discussions with several of the states with respect to them looking to maybe reduce per diems. So firstly, can you give us an idea of what sort of declines, like what sort of percentage reductions are they looking for? And with relation to that, you also mentioned that you have a lot of new customers and I guess existing ones too, looking for more bed space. Just wanted your thoughts around... obviously some states give higher per diems than maybe some of your existing states who might be looking for a pricing decrease. What are your thoughts on balancing maybe taking higher customer... I mean a higher per diem customer over an existing low per diem customer already?

Todd Mullenger

First to the first part of your question. We've received communications from about half a dozen states around actions they may be taking to balance their budgets. We would prefer not to identify them as we're in the middle of discussions and negotiations with those states on things we could do to offset any per diem reductions, for example, through the reduction of service levels to offset some or all of those costs. And that's part of the discussions we're having right now. And so that's the part of the uncertainty around estimating the impact those changes could have on our forecast for 2009.

With your question around trying to manage populations towards higher per diems, we may have that opportunity. I think as we said in the past, so we got 20 state customers, those relationships are long-term in nature, don't have 10,000 customers standing behind those... current 20 customers to take those beds, so it's a balancing act. And we're looking at the long-term growth prospects for each one of those customers. So while a current state customer might be experiencing difficulty and might be reaching out towards assistance to help them manage their budget deficits, we want to be mindful not to damage the long-term relationship but it will be a balancing act. That's not to say we won't make some decisions to provide beds currently available to an existing customer to a new or competing customer, but it is a balancing act.

ManAv Patnaik - Barclays Capital

John, I guess in another way, could you give us a breakout of what percentage of your contracts right now are take or pay versus per diem and how many of those are sort of CPI baked into the contract?

Todd Mullenger

Here we got a relatively small percentage of take-or-pay contracts. I don't have the exact percentage but it's a relatively small percentage, mostly our... those are mostly our federal contracts. And I am sorry, what was the second part of your question?

ManAv Patnaik - Barclays Capital

Just how many of your contracts sort of has CPI baked in or is it regularly you just seem to go to the legislators to request price increases?

Todd Mullenger

Yeah, it's a mixed bag. Some of the contracts specify a percentage. Some are tied loosely to CPI, some specify a specific dollar amount in next year's per diem. But they are all ultimately end of the day subject to negotiation as our customers have the ability to, in theory, cancel a contract due to a lack of appropriation of funds. So that provides some leverage in that area.

So most... the vast majority of our contracts have some form of escalator incorporated into them. The question is what situation will the states find themselves in budget wise? And will they reach out to us trying to renegotiate these per diems lower or foregoing a per diem increase or an outright reduction in per diems? And that's the uncertainty we are dealing with right now, a lack of visibility in that area.

ManAv Patnaik - Barclays Capital

Got it. And with respect to your guidance, I guess you mentioned that California has told you guys that they expect a ramp up to the 8100 beds by May. Is that... then should we assume is that baked into your assumptions or you are not going to haircut that given sort of them coming slower than expected for FY '08? And also with relation to ramp-ups what are the like states are you sort of expecting ramp ups from for at least the first half of the year?

John Ferguson

As it relates to California as you might imagine, we did hedge a little bit assuming that they might not hit their schedules perfectly. Again, as we've tried to say over and over again, we really can't time that we do our best to manage around it that. So we have prepared ourselves that the ramp up might not come quite as at the schedule they have given us, although they are working very hard to do it. As it relates to other customers that we're bringing online, I don't think that we have...

Todd Mullenger

I think we'd probably prefer not to parse the guidance at that level of detail. I have actually given the uncertainty we are dealing with in the current environment.

ManAv Patnaik - Barclays Capital

Okay. And in other way then I guess with the number of beds that you have outstanding like up to 8700 that you brought online, for example, how many of those are sort of contracted to ramp up over time?

John Ferguson

Well again, most of the beds that we are bringing online have some tact to an existing customer relationship. But we are again not going to be, I guess, trying to forecast or try to express what we think the utilization of those beds would be over time.

ManAv Patnaik - Barclays Capital

Okay, fair enough. And one last question, I will jump back. Could you just remind us firstly on, if there are any other renewals or rebids coming up in '09 and also sort of what is the restriction period in terms of you being able to go back and buyback shares?

Todd Mullenger

Well, we have the authority to repurchase up to $150 million in the aggregate through December 31, 2009.

ManAv Patnaik - Barclays Capital

I meant like, so after earnings, how many days you have to wait before you can...

Todd Mullenger

That's probably a level of detail we probably don't want to get into. We do have some windows but you can work around those windows by implementing a planned sale. So that's probably all the detail we want to give you around the share repurchase.

ManAv Patnaik - Barclays Capital

All right, fine.

Todd Mullenger

On your question on renewals?

ManAv Patnaik - Barclays Capital

Yes.

Todd Mullenger

As a reminder in our supplemental, we list out in the back of our supplemental disclosure which you can find on our website a list by facility of the major contracts, for each one of those facilities and the base term and the number of renewals and when those expire.

ManAv Patnaik - Barclays Capital

Okay, fair enough. Thank you guys.

Operator

Thank you. We'll take our next question from Kevin Campbell. Please go ahead.

Kevin Campbell - Avondale Partners

Thanks. I was hoping you guys could talk a little bit more about your guidance, help us understand a couple of assumptions. I recognize you don't want to get into any of the details on specific customers. But can you help us understand perhaps what your pricing and volumes assumptions are in general? So just to start.

Todd Mullenger

That's a pretty broad question Kevin. I am not sure how I would address that in a concise way.

Kevin Campbell - Avondale Partners

Well maybe more specifically, are you guys expecting per diems or pricing to contract year-over-year in your guidance and specifically same question on volumes?

Todd Mullenger

Yeah, well I think as we've indicated we are cautious on our outlook for 2009. The general economic uncertainty and lack of visibility around government budgets and future spending by government customers makes it difficult to forecast through 2009. And it's very difficult to assess the actions our customers may take to balance their budgets. And that makes (ph) the impact of their actions may have on our existing contracts.

There is the potential for impact from reduced per diems or our customers managing their populations lower. However, we have little clarity around the likelihood at this point in time of those changes and the magnitude of the impact for any of those changes. So again it makes it difficult to forecast revenues and EBITDA. But what I'd say is we've made our best estimates of the potential actions that may take in these areas and build that into our guidance.

Kevin Campbell - Avondale Partners

But is it fair to say that to some extent perhaps in the low end you might be assuming pricing cuts from some customer than at the high end, no cuts and same thing on volumes. Perhaps in the low end you're assuming volume pressures or removal of inmates and on the high end you're not, would it be safe to say that you'll be looking at it from that perspective?

Todd Mullenger

Well again, I think we've factored in the best we can some risk around impacts on per diems and volumes both in the high and the low end of the range.

Kevin Campbell - Avondale Partners

Okay. Looking at the fourth quarter EBITDA that you guys reported and I guess if you back out the 3.5 million or so in incremental savings on the workers' comp and the healthcare expenses you did around $104 million. Why... what should we assume that... it seems like in your guidance that obviously you can't annualize that figure because that would be sort of 416 number versus your guidance of flat EBITDA of around 390. So why should we assume that is going to deteriorate from the fourth quarter levels particularly when you saw pretty strong pricing and volume growth in the fourth quarter additionally with pretty good cost control?

Todd Mullenger

Well, let me make sure I am clear to nature of your question. Are you comparing Q4 to Q1 or just?

Kevin Campbell - Avondale Partners

For 2009 in general and I recognize Q1 has some of those issues with the taxes. But just in general it seems like there is a pressure on EBITDA. And given the results that you've seen particularly in Q4 when you saw good pricing and good volume growth and you were able to contain costs, I think to roughly 3% growth. It seems like your guidance then is assuming deterioration of EBITDA from the fourth quarter level which doesn't seem like what we have seen... doesn't seem to channel I guess with what we have seen in your action results?

Todd Mullenger

Let's talk about that for a minute. It's a good question. First, we were pretty general in our comment around EBITDA.

Kevin Campbell - Avondale Partners

Yes.

Todd Mullenger

By stating it will be comparable to 2009. So we didn't put a firm number out there in terms of guidance, all right? Next, as we just talked about, we've indicated we're cautious on our outlook for 2009, the general economic uncertainty, the general economic uncertainty, the lack of visibility around government budgets, future spending by our government customers, makes it very difficult to forecast the EBITDA.

And again very difficult to assess the actions our customers may take to balance their budgets, the potential for impact of reduced per diems and populations with little clarity around the likelihood of any changes and the magnitude of those changes again makes it difficult to forecast revenues and thereby EBITDA. So we've made our best estimates of the potential actions states may take in these areas.

Of those we mentioned on the last call and in our current press release, we're seeing some reductions in inmate population from Minnesota, Washington and Wyoming. We also have the negative impact of operating carrying costs on the beds that we've completed that remain vacant. So we got property taxes, insurance, utilities, we've got the scope from the crew at vacant facility like Adams County or recurring expenses on those vacant beds.

So for example, on our new Adams County facility, we will incur approximately, call it, $2 million of operating carrying costs on an annual basis until that facility is occupied. And then while there are a number of RFPs out in the street for new beds, you've got Arizona with an active RFPs, state of California with their RFI, Bureau of Prisons, and the state of Georgia, no one is likely to move forward on any procurement of beds until such time as their budget issues are resolved. And they know what actions may be taken that impact their individual corrections upon their budgets. And as we've already discussed it's very difficult to assess what steps may be taken and when which in turn makes it challenging to forecast new contract awards.

So in summary, I think I would say, having made the decision to provide guidance even in light of the economic uncertainty and lack of visibility, we have provided the best estimate possible based on the information available till today, while trying to factor in some consideration for the unknown.

Kevin Campbell - Avondale Partners

Okay. Looking at guidance as what I'm assuming that doesn't include... you're not assuming you are going to win any new contracts, Cara '09 in your numbers. Is that correct?

Todd Mullenger

Well, Cara, they haven't made an award yet and typically when the BOP makes an award they give a notice to proceed and that's 120 days from those to proceed before we start ramping up. So I didn't say we'd award a contract that could actually have a negative affect on earnings for 2009 if they were to delay and you start ramping up in advance of receiving inmates. Other than that I'm not sure we want to comment on the particular assumptions we made around few contract awards or bed populations in general from specific customers.

Kevin Campbell - Avondale Partners

Okay. And last question I've got is did it assume any level of share repurchases or did it assume your state level of where you are today?

Todd Mullenger

Yeah I guess I'd say around share repurchases. The potential of our repurchase shares was one of the variables we considered when developing guidance. However since our repurchase plan is not a systematic plan but rather one based on ROI analysis. And it will be executed under the overarching objective of maintaining liquidity. It's difficult to forecast exact number of shares we would repurchase between now and the end of the year. But again, it was one of the variables we considered when developing guidance.

Kevin Campbell - Avondale Partners

Okay. I will jump back in the queue. Thank you.

Operator

Thank you. We'll take our next question from Emily Shanks. Please go ahead.

Unidentified Analyst

Hi, good morning.

Todd Mullenger

Good morning.

John Ferguson

Good morning.

Unidentified Analyst

I just wanted to ask EBITDA first. Are you guys still utilizing four times as your maximum threshold for leverage for internal operating purposes?

Todd Mullenger

We haven't changed that threshold. So still maximum debt to EBITDA leverage of new beds in four times. And right now we are setting it three times with six times interest coverage. So very fortunate in that regard.

Unidentified Analyst

Yes, you are. And then also as you look at this coming year, I appreciate the visibility is quite limited. But should your CapEx levels remain per your guidance, what is your priority with free cash flow as you look at either repurchasing debt, paying down debt buying back shares and so forth, how are you looking at that?

Todd Mullenger

Let me answer that by commenting, I don't think we are over leveraged at three times debt to EBITDA. We like the current cost of capital we have in place on our existing high yield debt outstanding, so that's an average weighted cost of 7%. The revolver we are borrowing at LIBOR plus 75, so call it, at 3 month LIBOR at one in a quarter 2%. So the idea around paying down debt isn't particularly attractive given our current leverage ratios and the current cost of capital. And then on top of that one of our primary priorities would be maintaining liquidity. And then after that we've got an ROI based capital allocation process will follow, whether it's repurchasing shares or investing in new beds.

Unidentified Analyst

Great, thank you. And then if I could ask... one last one. As you look across your state customers, do you do any type of credit screening work or how do you monitor sort of their financial viability?

Todd Mullenger

Yes, we are obviously monitoring that. 12 months ago we were monitoring as closely as we are today. That said, it is very difficult to envision a scenario where the federal government would allow a state to go into bankruptcy. If they were willing to let Bear Stearns go into bankruptcy. They are probably not willing to let one of the states go into bankruptcy, but we do monitor it.

Unidentified Analyst

Okay. They did let Lehman go.

Todd Mullenger

I understand they built the firewall behind Lehman. Yes they did.

Unidentified Analyst

All right. Thanks Todd.

Operator

Thank you. We'll take our next question from Mark Paulstar (ph). Please go ahead.

Unidentified Analyst

Good morning, thanks. I was wondering if you could comment on federal populations. And just kind of remind us how the dynamics are different if they are between U.S. Marshalls, ICE and BOP, it seemed like the U.S. Marshalls was the biggest decline piece in the quarter?

John Ferguson

Well, let's take them separately. The BOP, the growth potential for CCA and the industry is going to be through procurements to meet their needs. They have continued to see a deterioration in their rated... inmate population to rated capacity and they are now at... we're seen it, I think in the last year and a half growth of 134 to 137%. They do desire to meet a fair amount of their population growth through contracts. Their limitation has been budgeting and as I mentioned in my opening comments that they are waiting on a permanent budget before they commit to these beds.

So we think we will continue to see over the next... over some horizon several years, a continued need for contract beds that will come in every year or two. They have talked that their desire would be anywhere from 1,500 to 3,000 a year. It is just the budget standing right (ph) and do that in a systematic way.

Immigration and Customs Enforcement, the funding is for 33,400 beds. It is... so that's what's going to be at most in their system at any point in time on the average. That could be above that as long as the average, so that's their funding. What we have seen in some of the growth that we had over the last several years has actually been where they are consolidating. So they don't need funds for new beds for growth but what they have found is that if they have 30 detainees and 50 different county jails, the logistics on that is very difficult. And so their desire is that they can find a location that is convenient to them, so that they can have all the inmates and detainees in one location.

Also inmate... the detainee growth in ICE will come from Davos. So lot of sources, we mentioned previously that border crossings is really a small percentage that most of the detainees that we receive in whole for ICE as they educate them for deportation or some other asylum or whatever typically coming from local jails, state jails, federal state prisons, federal prisons. So that once they have served their time, they are given to ICE, then detain them for ICE where they decide to deport them.

We also talked about the last couple of calls about the community effort is that which put in place and which Congress actually increased the funding there recently. And that is to work with local communities to try to identify illegal immigrants that have or in the country and to be able to identify them and then deport them. Many illegal immigrants commit crimes, get held for some mismanner and they are released back in their community because no one knows they're here illegally and federal government is trying to increase that so that no one is committed crime illegally as a chance to being released in the community.

And then the U.S. Marshalls we have seen not a significant growth in our population over a last year and half other than as I mentioned Operation Streamline I think is starting to kick in. And that is where everyone who crosses the border is going to be detained and charged with a mismanner and then subsequently fell on a... were up until Operation Streamline and they call a zero tolerance. You had to cross the border many times before they would detain you and charge you with a crime. And then of course we have a contract that we were awarded this past year with 1,072 beds, 750 of it guaranteed for U.S. Marshalls Service in Las Vegas. So there is no reason to believe that those populations won't just creep up over time.

Unidentified Analyst

Great, thank you. And another question, I understand the commentary about the headwind from interest expense and depreciation of facilities you brought online. But presumably you are generating revenue from that as well. Do those new facilities that associate with that, presumably come on positive EBITDA or what kind of contribution will those facilities have through '09 just with who is in those facilities now?

John Ferguson

Well, I think we answered in an earlier question. We kind of touched down that, that some of the beds that we are bringing online and we specifically mentioned our Adams County facility, we do not have a customer for it at the moment. So we started depreciating it at the end of 2008. We have the interest carry. If you back to press release above... I guess 8000 beds online in 2008. So that was... all been fully depreciated. And as I mentioned in my comments there were about little over 10,000 beds currently available and about 1,500 of them nor spoken for with the California. So the balance of them there is nothing, no majors... none of them that have spoken for. So that is going to be bringing on some of the 10 to $0.12 a share on depreciation and interest. And we'll not have at the moment... a fair amount of that will not have anticipated EBITDA.

Unidentified Analyst

Sure. I guess I understand that but the La Palma is part of the... at least expansion there is part of the increase in D&A at the very least. Is there a way to quantify that 10 to $0.12 presumably gets lower when you consider the facility EBITDA from folks that are in those beds that you have expanded now?

John Ferguson

Nothing we could speak to specifically other than to say it has been identified in the $1.10 to $1.20.

Todd Mullenger

And a couple other comments there. As we mentioned in our last call and our current press release we've seen some reductions in inmate populations in Minnesota, Washington and Wyoming. We have the negative impact of the operating carrying costs on the beds we've completed but remained vacant and may remain vacant. For example Adams County, $2 million of operating carrying cost on an annual basis until occupied.

And then we try to factor in a number of uncertainties into our guidance based on the current economic environment, lack of visibility including the potential for per diem reductions and further inmate population reductions due to cost cutting measure states may take. However if you take the information we've provided, so Q4 EPS normalized at $0.30 and annualize that you get $1.20. Then subtract the $0.10 drag on earnings from increased interest and depreciation that gives you $1.10. Everything else being equal, so to get to $1.20 there needs to be some improvement.

Unidentified Analyst

Great and the last question I'll let you go... beating the guidance horse again. Do you make the assumptions... clearly you're making some assumptions that you give some rate concessions, are you also assuming that you get to take out some of those costs or are you assuming that you get rate reductions with not necessarily that commensurate or at least a partial cost reduction by reducing programs?

Todd Mullenger

Yeah, don't want to get into specifics, primarily because of lack of visibility but as I mentioned we are in discussions with the customer to negotiate reductions in the service levels that would allow us to reduce operating cost to offset some or all of those per diem reductions.

Unidentified Analyst

Thank you.

Todd Mullenger

You're welcome.

Operator

We will take over next question from Dana Walker. Please go ahead.

Unidentified Analyst

Good morning.

Todd Mullenger

Good morning.

Unidentified Analyst

Could you talk about the effects that your customers are seeing the economy play on crime and possible flow of future inmates?

Todd Mullenger

I think the conventional wisdom is a recession and increasing unemployment, puts up more pressure on current rate. There is no definitive studies out there to support that. And it's too early into the process of our customers to draw any conclusions around what they are seeing in their own inmate populations or crime rates.

Unidentified Analyst

On the topic of per diem, it seems to me that I think all of us have heard your argument on how you want to maintain stability with your customers and that you and they are making long term commitments. And yet they view on our end is that what choice do your customers have, you've made a significant commitment to a long life capital project on which you need to earn a return. And you've committed that project and its capacity to these customers. If you break price then what's to for stall them coming back and saying well you've done that and now you've... we've agreed on what the topic is just how much we're going to bend. How do you respond to that?

John Ferguson

Well it is a balance that Todd mentioned. And I think we always have to remember that we do business with a customer who makes laws. And that they could always put themselves... put us in a very uncompetitive situation by authorizing to build its capacity just to get out of one of the relationships. So it is our desire that our customers never feel the need to build another prison bed. And that sometimes means that we cannot exert the leverage that in the short-term that we would have.

Unidentified Analyst

Final question from me relates to what you didn't say about the guidance about what... I think a lot us would like to hear you say about compensated man-days and particularly owned and managed compensated man-days with the prospect of California attains the spread or closes the spread between 6500 and 8132. Should there not be some growth in compensated man-days in '09?

John Ferguson

We don't. It would seem to me that as we have said with the original 8,000 that we are part of the solution, that we believe every inmate that we receive is in a constitutionally cared for environment. But it relates to all aspects, overcrowding, health care and that if they... the California would have a difficult time identifying where the 58,000 would come from. They can reduce the need for 58,000 to be released by letting someone else take care of them in a constitution environment. But I don't know if that's how that's going to play out.

Unidentified Analyst

Very well. Thank you.

Operator

(Operator Instructions). We'll take our next question from David Snyder. Please go ahead.

Unidentified Analyst

Hello.

Todd Mullenger

Hello.

Unidentified Analyst

Can you hear me?

Todd Mullenger

Yes.

Unidentified Analyst

Good. When you authorized the stock buyback that was in November of '08 and the stock is currently below the average price that you bought back stock. So in November, we already knew that the economy was really nasty. And so as far as specific to you, is there some change from when you decided to buyback stock till now? Because obviously, it's not fun for you to buyback stock and then see the stock below what you guys paid for?

Todd Mullenger

I don't think we've changed our approach to making the decision around repurchasing shares. Again it's an ROI based analysis. It's not a systematic plan. In other words, we're not going to purchase a fixed dollar amount of shares regardless of the price that goes the ROI analysis. And if the ROI is appropriate and it is the highest and best use of the fund that will drive our decision making around our capital allocation process.

Unidentified Analyst

Okay. So as far as the '09 guidance you are assuming no new contracts that are... or nothing that's not yet announced?

Todd Mullenger

I don't think we'd parse the guidance at that level of detail. What we said there is a number of RFPs out on the street but there is a tremendous amount of uncertainty and lack of visibility around whether or not those customers are going to move forward with those contracts and if so when. But I don't think we specifically address whether we made the assumption around any new contracts or not. And historically, I have not parsed our guidance at that level of detail.

Unidentified Analyst

Okay. I guess that's often being right now.

Todd Mullenger

Thank you.

Operator

We will take a follow-up question from Kevin Campbell. Please go ahead.

Kevin Campbell - Avondale Partners

Thank you. I was hoping you guys could comment real quickly on California and the prospects of them paying their bills or not paying them in cash and issuing IOUs, is that something in your discussions with the state that they've indicated maybe likely for you?

Todd Mullenger

That is a possibility. To date we haven't seen any significant variance in our day sales outstanding from the State of California but that could change. And again, I think one of the states that are hopeful that the federal fiscal stimulus bill will provide them some discretionary funds that allows them to meet some of their budget issues.

Kevin Campbell - Avondale Partners

And I am assuming there is no impact of that on the income statement. And really it just fell on the cash flow statement in the balance sheet?

Todd Mullenger

Yes, to the extent my accounts receivable increased significantly. I mean there is working capital drawn on the revolver, there will be some incremental interest expense. But it held plus 75, current borrowing rate at 2% but that'd be pretty significant to have a material impact.

Kevin Campbell - Avondale Partners

Okay.

John Ferguson

We are hoping that's not where we have to do use our cash for.

Kevin Campbell - Avondale Partners

Yes. You guys saw some pretty good margin improvement in your managed only segment. Sequentially that is, was that driven by the exit of the Bay County contract or was that more related to the lower healthcare expenses or workers' comp or was that on the G&A? And could you comment on that on the managed-only segment?

Todd Mullenger

Yeah, well the employee medical and the workers' comp will be spread across owned and managed only. And then the Bay jail facility was, call it, at a breakeven contract. And that was exited at the beginning of the quarter. So that would have a positive impact as well.

Kevin Campbell - Avondale Partners

Okay. Last question, any cost pressures you guys are seeing, it doesn't sound like it but trying to get confirmation?

Todd Mullenger

Yeah, not seeing any cost pressures from an inflationary standpoint. Actually, potentially just the opposite, for example, the reduction in the below average employee medical claims. For example, there is some speculation that's being driven by decision-making by employers around, managing their cash flow more tightly. So they are not running to the doctor with every cold and flu. They're avoiding physical that sort of thing and our health care plans are very consumer driven oriented, in other words, high deductible, high co-pays, high co-insurance.

There is also some early indications, it's hard to tell for sure that the increase in unemployment rate we're seeing increases in the applicant flow for jobs at our facilities, both in quantity and quality. And there is some early indications that suggest possibly we may see some benefit from that through reductions in turnover and thereby decreases in overtime. But it's really too early to tell at this point.

Kevin Campbell - Avondale Partners

Okay. All right, thank you very much.

Operator

Thank you. It appears that we have no further questions at this time.

John Ferguson

Okay, thank you. Thank you everyone for taking time to let us respond to many questions. As we said, to provide guidance this year was a tough challenge. It is very apparent that we'll not buy ourselves. Many companies are giving significantly wide guidance or no guidance at all. So we want to do our best to try to be as realistic as we could in light of very uncertain times in dealing with the customer base that is also dealing with an uncertain time. But as I've said in my comments and Todd said in his, we are really bullish as it relates to the long-term future for this company.

We know that 2009 is going to be tough, could be 2010. But we are highly confident that the inmate population growth and our customers and our prospective customers will continue. And we know that the money that our customers are spending is on things other than infrastructure for their correctional systems and that allows success that we had starting 2003 up till now, one I think attribute to a very similar circumstance with a lot of our state customers and not build on their infrastructure.

And we were asked what we're going to do with the cash, I think we are trying to position ourselves so that when things to do clear up that we are in a great position to be able to deliver a meaningful public service to our customers who will need to deal with their overcrowd and we would be there just in time for them. So thank everyone for joining us. Good day.

Operator

Thank you. This concludes today's teleconference. You may now disconnect your lines and have a wonderful day.

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Source: Corrections Corporation of America Q4 2008 Earnings Call Transcript
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