Corrections Corporation of America's CEO Discusses Q2 2011 Results - Earnings Call Transcript

Aug. 4.11 | About: Corrections Corporation (CXW)

Corrections Corporation of America (NYSE:CXW)

Q2 2011 Earnings Call

August 4, 2011 11:00 AM ET

Executives

Damon Hininger – President and CEO

Todd Mullenger – CFO

David Garfinkle – VP, Finance

Analysts

Todd Van Fleet – First Analysis

Tobey Summer – SunTrust

Kevin McVeigh – Macquarie

Kevin Campbell – Avondale Partners

Scott Grossman – Magnetar Capital

Operator

Good morning, everyone, and welcome to CCA’s Second Quarter 2011 Earnings Conference Call. Today’s call is being recorded. If you need a copy of our press release or supplemental financial data, those documents are available on the Investor page of our website at www.cca.com.

Before we begin, let me remind today’s listeners that this call contains forward-looking statements pursuant to the Safe Harbor provisions of the Securities and Litigation Reform Act. These statements are subject to risks and uncertainties that could cause actual results to differ materially from statements made today. Factors that could cause operating and financial results to differ are described in the press release, as well as our Form 10-K and other documents filed with the SEC.

This call may include discussion of non-GAAP financial 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.

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

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

Damon Hininger

Thank you, Jessica and good morning and thank you for joining our call today. With me today is our Chairman, John Ferguson, and also board member Bill Andrews along with our CFO, Todd Mullenger. Also joining us is our VP of Finance, David Garfinkle. In a few minutes, Todd will take you through the numbers for the quarter, then I’ll discuss market opportunities, after which we look forward to taking your questions.

First, though, I would like to make some comments on the past quarter. Let me start by saying that I am very pleased with the second quarter results both operationally and financially. Our core business which is providing adult secure correctional and detention management services to our federal state and local partners remains very strong.

As for the business going forward we think this is the most favorable new development environment the industry has even seen. The macro environment has never been more favorable. For the second consecutive year not one of the 50 states is appropriating money for new prisons which is going to further exacerbate the supply demand imbalance. Additionally, we’re actively pursuing nearly 40,000 new beds and new incremental opportunity that could be decided in the next 6 to 12 months. We estimate these new opportunities to be nearly 700 million in revenues.

Let me now say a few words about our focus on managing costs. As you know we implemented a company-wide initiative in 2009 aimed at driving greater efficiency and we continue to make significant progress. We believe we had another good quarter on managing our costs. However, we did give merit increases this last month, and this is the first merit increase we’ve given our employees since 2008 and we know this cost will obviously naively impact our margin rate for the third quarter.

Overall, I was very pleased with our performance in the second quarter. I would especially like to thank all of our fellow CCA colleagues for the distinguished performance that they have been able to achieve for our company this year.

Now I would like to hand the call over to Todd to discuss the detailed financials, and after which I’ll discuss how we see the market and our opportunities going forward. Todd?

Todd Mullenger

Thank you, Damon, and good morning, everyone. We are very pleased with our second quarter operating results. In the second quarter of 2011 we generated $0.39 of adjusted EPS compared to $0.34 of adjusted EPS in Q2 2010, a 14.7% increase. The second quarter financial performance exceeded our forecast due primarily to favorable operating costs performance driven by lower than average employee medical expenses and lower than average legal settlement expenses. You may recall from past quarters that these are two expense line items that can experience material variation from one quarter to the next.

Revenue per compensated man-day in Q2 was up slightly against last year at $58.40 reflecting increases in per diem rates from certain federal and state partners, offset by change in mix with more managed-only populations that carry a lower per diem. Although average daily populations 5.4%, average compensated occupancy for the quarter was 89% compared to 90.1% last year, a decrease that reflects the addition of new capacity for the activation of our Nevada Southern facility in 2Quarter 2010.

Operating expenses per man-day declined 1.4% compared to a year ago which reflects the lower than average employee benefits and legal expenses, our efforts to improve operating efficiencies, the low inflationary environment and increases in compensated man-days. The net result was that margin per man-day rates increased against last year with Q2 2011 at 32% versus 30.9% last year.

Regarding our current share repurchase program announced in February 2010 and expanded in May 2011, which authorizes up to $350 million in repurchases, we have repurchased 10 million shares to July 31, 2011. Including the shares repurchased under our first share repurchase program announced in November 2008, we have repurchased a total of 20.7 million shares at an average cost per share of $16.45. This represents over 16% of the shares outstanding at the beginning of November 2008.

As of July 31, 2011, we had approximately $134 million remaining under the share repurchase program. Our debt agreements restrict certain types of payments including share repurchases to an aggregate amount or basket that is recomputed each quarter. As of June 30, 2011, the total amount of basket available for restricted payments totaled to $173 million. Generally speaking this restrictive payment basket will change each quarter by an amount roughly equal to 50% of net income less repurchases made in the quarter.

Moving next to discussion of our guidance, as indicated in the press release, full-year EPS guidance is in the range of $1.47 to $1.49. Guidance for Q3 is in the range of $0.35 to $0.36 and Q4 is in the range of $0.36 to $0.37. Our guidance is impacted by a couple of key assumptions which I would like to outline. First, the sequential decline in EPS from $0.39 in Q2 to $0.35 to $0.36 in Q3 is largely explained by wage increases implemented effective July this year as well as increases in employee benefits and legal settlement expenses as we expect those line items to be more in line with their historical averages.

Next the guidance assumes no material changes for the balance of the year in the State of California inmate populations which currently approximate 9,400. The forecast also assumes generally stable populations elsewhere as we await decisions outstanding RPA’s from the State of Arizona, the State of Ohio, and the State of Florida, which Damon will address in more detail shortly.

Finally with regards to our liquidity as of June 30, 2011, we had very ample liquidity provided by approximately $295 million of availability under our bank credit facility, plus approximately $55 million of cash on hand. Our leverage is around 2.4 times debt-to-EBITDA and we believe our strong liquidity and balance sheet are competitive advantages to position us well to capitalize on future growth opportunities.

I will now turn it back to Damon.

Damon Hininger

Thank you very much, Todd. Now looking forward, as we move through 2011 as mentioned earlier, I’m very optimistic about the business. In terms of our long-term strategic priorities, our focus is to go and continue to be carrying beds and inventory to meet future demands.

With a meaningful amount of mew incremental bed demand in the marketplace today targeting existing capacity, we continue to think this strategy is very appropriate for the company. With a nearly 5.5% increase in compensated man-days, we’ve made good progress here, but we are focused on achieving a higher occupancy rate before building more spec capacity.

Finally, we will also continue aggressively pursue build-to-suit opportunities as demonstrated with our new Jenkins facility; we’ve had good success with these types of procurements.

Now for the market industry observations and opportunities. As Todd has described, our financial guidance is based on our prospects as we see them right now. Of course, we’re optimistic that, just like last year and this past quarter, we’ll be able to see additional opportunities that will deliver additional growth. Let me take you through how we’re looking at the market and also where we see the main opportunities for the coming year.

First, a couple of comments on state budgets. The physical situation at the state level looks and feels more encouraging than it has been in the last two years. Many states including California are reporting revenues coming in higher than the forecast. However, there is plenty of doubt and uncertainty out there right now, but we remain reluctant to pronounce that states are in the clear.

Furthermore state revenues are still significant below their highs of 2006 and 2007. As for our states, all of our state partners have enacted budgeted effective July 1st and none of our states implemented and or negotiated a per diem cut. We view this as a very favorable development because over the last two budget cycles, we have encountered per diem reduction requests from roughly half a dozen of our state partners in each of those years, which we were able to largely offset with service reductions. And in a few minutes I will provide a detailed update on California and their enacted budget.

Let me provide a couple of additional comments that we see of the states. CCA’s current state customers are projecting a growth of 12,000 inmates over the next five years. This is, of course, without California. This is on top of the half a dozen states we have mentioned recently that are currently not doing business with CCA. We estimate that these states are approximately 13,000 inmates over capacity today, and by 2015 are projected to be over capacity by 19,000. We think we could see several states use a private sector that don’t have capacity to deal with their overcrowding and/or incremental growth.

You have heard me report earlier that for the second consecutive year not one state is funding new prisons. But you’ve also heard me report for many quarters the chronic problem states face in funding their pensions. As you know, the recent legislative season has put this issue front and center for governors and legislative leadership, and as they think about ways to slow the rate of growth regarding this issue, our long-term value proposition is resonating more and more.

We think that this is key catalyst for many states like Ohio and Florida that are providing these unprecedented opportunities we are seeing right now. And we think additional states are watching these procurements closely as they consider doing similar actions.

As another side of approval within the state business, let me also mention two states that we were watching closely over last two years. Colorado and Tennessee are two states that were taking steps to cut funding and to or reduce population within our facilities, and we discussed this risk frequently on these calls over that period of time.

As many of you know our Whiteville facility here in Tennessee was fully funded this current fiscal year. And in Colorado the state has cut funding to their Huerfano facility this fiscal year which was one of their oldest and highest cost facilities within the state. We have been positively impacted by this action as we’ve seen our count go up in Colorado, since the beginning of this new fiscal year.

Now, this is a point where I typically give updates on pending procurements, but before I do that let me make a previous comment on the federal budget for 2012 in wake of this week’s debt limit deal. We’ve been analyzing the details of this deal as they have emerged this week, and we do not believe that our federal partners will be significantly impacted in the near term.

It is our understanding that the vast majority of discretionary spending cuts in the deal will not occur until or after fiscal year 2013, and that the fundamental day-to-day operations of the Federal Government will be tilted downward only slightly during the next two fiscal years.

We expect that appropriation process for fiscal year 2012 will not change significantly although as in previous years there is a very good chance that it will not be completed before the start of the fiscal year, which is on October 1.

Lastly, we continue to believe that OMB, Department of Justice and DHS understand relatively inflexible nature of best pay for government federal prisoners and detainees and we expect they’ll continue to ensure all federal partners have sufficient funding to meet their requirements.

So now to significant pending procurements we believe the large amount of opportunities that we’ve seen at one time as an industry. The first of which is Arizona and the requirements of 5,000 new beds owned and operated in state. This procurement reminder was canceled last year but was rereleased in January and bids were due February 24. We expect the reward to be in the third quarter of this year.

Just as a reminder this procurement is looking at two dates for the ramp of these 5,000 beds. The first 2,000 inmates would ramp no later than April of 2013, and the next 3,000 inmates would ramp no later than April of 2015.

Now to Ohio, State of Ohio is listed in RFP for the purchase and operation of five state facilities which totals approximately 6,500 beds. Responses were due July 1, and we think the award could be this quarter or in the fourth quarter and as anticipated that the successful offers will start performance in the first quarter of 2012.

In Florida, a procurement was issued this past week for the management and operation of the South Florida region or region four. This will include 29 facilities housing over 16,000 inmates. Bids are due September 23 and the reward to one vendor is anticipated in November of this year. CCA is extremely well positioned to compete since we have a largest market share in doing business in Florida, DOC and DMF. We also have a strong history operating in Florida which includes management of the largest private female facility and the only private youthful offender facility.

We are aggressively pursuing this opportunity, the state. We are also aggressively pursuing opportunity of the states undertaking to optimize the operation of existing private sources to release by to 1,200 inmates, which we think could be decided later this year.

Harris County, Texas, which is a county that surrounds Houston, issued a request for proposal on June 10, 2011, and which the county is seeking proposals for the management of the entire Harrison County jail system of under 10,000 beds. We’re actively looking at this opportunity. But more importantly, I think it just shows how meaningful the opportunities are, not only at the federal and state level, but potentially at the local level.

As for renewals, as mentioned in the press release, we’re very excited about renewing through recent competitive procurements with the states of Hawaii and Vermont for their housing of their population out of state. And finally to court 12, this procurement is the rebid of our BOP contract going to Georgia facility, which expires in December of 2012. The BOP anticipates this require will be fulfilled through a single award and we expect the award to be in the third or fourth quarter of this year.

As mentioned earlier, the most meaningful amount of activity ever within in the industry with 40,000 new beds out for bid. Now, before I make my final comments, let me give a brief update on a couple of topics relative to California. We have seen over the last 60-plus days, two very significant wins in the state of California. The first of which is, California enacted their budget on June 30th and fully funds all of CCA’s contract beds. The budget also includes language that protect CCA from losing this population to any other provider.

Now, as part of the budget the governor was able to approve and fund his realignment plan. The plan will move parole violators and non-violent, non-effective offender serving one to three years to county government facilities. The plan is set to begin on October 1, 2011. Realignment would apply perspectively and not apply to any existing populations. And this would be funded through a temporary tax swap with California officials still seeking a ballot initiative for permanent funding, which we believe will be sometime in 2012. The impact on the state’s inmate population is not known at this time and probably will not be clear until some time has passed once the plan is in place. One thing to point out is that CCA does not have this type of lower custody offender within our facilities.

The second significant event that happened earlier this summer is the ruling by the Supreme Court in which the state lost its appeal. Most observers were not surprised to learn that the state lost the appeal, but most of those were surprised that the Court upheld the lower Court’s ruling, which applied reductions that must be achieved within two years. The state has approximately 143,500 inmates as of June, and they have to reduce the population within their 33 adult facilities by 33,500 inmates by May of 2013.

It is important to note, in all the public comments today by both, the state and CDCR they have set forth target reductions that comply with the ruling that do not include the approximately 9,600 inmates currently housed out of state.

Now tying these two events together, the hope on the state’s part is that the realignment plan will effect a reduction within state facilities that helps them achieve the required reductions set forth in the federal case. Again, it will be a while before the state will know if realignment will help them be successful in complying completely with the federal court case. And of course, we stand ready to help further if appropriate, both the state but also the counties.

Finally, as it relates to our award with the state for 3200 new beds. The state has not withdrawn the intent to award. We believe their action will be taken on this until the state finalize its reduction plan and also until they see the impact of realignment.

So let me bring to close my comments and make these final points. We continue to believe that we’re very well-positioned in the market that despite the economic pressures faced by our customers has provided healthy financial performance.

Indeed, it is because of these pressures which lead to severe capital constraints and a need to avoid increasing their pension liabilities that we believe our value proposition to customers is getting stronger. Actions underway in Florida and Ohio approved us. We don’t see change to the current position that we are able to meet their needs in existing capacity or our ability to construct facilities faster and at a much lower cost.

We believe the supply and balance will develop further long-term and in sufficient public sector capital investment has opened up significant possibilities for potential new customers.

Financially, our business is very sound. We have a strong balance sheet, good liquidity to fund new capacity development and focus operations in a largely unpenetrated U.S. market.

In summary, the business is performing well and we’ve taken action in both the short and long-term to make sure it continues to do so. As mentioned earlier, I’m very optimistic about the business. We have been very deliberate in how we manage expenses and capital in order to deliver healthy financial performance, but also positioned our company for long-term growth and we will continue with the strategy well into the future.

That concludes my prepared remarks. Thank you again for calling today’s conference, and let me now turn it back over to Jessica for Q&A.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) We’ll take our first question from Todd Van Fleet from First Analysis.

Todd Van Fleet – First Analysis

Hi, good morning, guys, nice quarter. I wanted to ask you about the pricing environment. You said that the fiscal situation at this stage is more encouraging than it has been in the past couple of years. What does that mean in terms of kind of pricing at the state level and my guess at the federal level and then I guess an aggregate?

Damon Hininger

Good morning, Todd this is Damon. A couple of answers there. Relative to existing contracts and our annual rates renegotiates from year-to-year. Again, we didn’t see any pressure to reduce those rates. Going forward, let say new term in going forward I think build it to increase price is going to be slow. I think, partly because we’ve some vacant capacity within the industry, so we get some tightening of some of that capacity or tightening of the market and I think we tender with the low movement on pricing, but I would say right now it’s any meaningful movement on pricing is probably going to be take some time.

Todd Van Fleet – First Analysis

Okay. So would that be at the state level or federal level, Damon.

Damon Hininger

Well, I would say probably at the state level. The federal level will be a little different is because if we’ve got federal opportunities that are very focused on certain geographical locations that potentially has positive impact on pricing. So I would say my comments are more focused on the state side.

Todd Van Fleet – First Analysis

Okay. So but mid-year is when you typically get your price escalators, is that right?

Damon Hininger

That’s right, yes.

Todd Van Fleet – First Analysis

Okay. So you should see probably some of that, is that across the board, or is it mainly for at the State or Federal level?

Damon Hininger

Our state contracts are typically tied to their fiscal year which will be July 1, so we get most of the increases on July 1 and then on our Federal contracts I would say majority of them are tied to their fiscal year which is usually October 1st.

Todd Van Fleet – First Analysis

Okay.

Damon Hininger

Which is October 1st I should say.

Todd Van Fleet – First Analysis

Right okay very good. Todd, a lot of, well there is a lot of uncertainty out there in the markets in general right now, and you guys have?

Todd Mullenger

We noticed that.

Todd Van Fleet – First Analysis

You guys have potentially a lot of ways to spend money, I guess, looking forward over the next couple two to three years. And I’m wondering about how you’re thinking of the kind of tired debt structure that you have in place. It’s now the time to start thinking about going back to the market and looking at what is possible and the way of debt issues?

Todd Mullenger

Well, we do have the 2013’s that we’re callable upon now and matures first quarter of 2013. We’ve also got a bank credit facility that turns current first of next year. So we’re monitoring credit markets, a lot of volatility in the credit markets right now. You’ve seen a significant decline in treasuries, but still lot of uncertainty in the credit market around, situation in Europe and general economic conditions.

And so but it’s something we continue to monitor. We’re thinking about more options for refinancing both the bank credit facilities into 2013 and we would like to see some additional stability in the credit markets before we did anything, so we’ve got a little bit of runway in front of us before we have to do anything.

Todd Van Fleet – First Analysis

Right. How much runway do you think you have?

Todd Mullenger

We don’t have any particular problem going current on either one of those. Either the credit markets have always been open to us with maybe the exception of when they melted down a couple of years ago. The credit markets like our paper, bonds are trading very well right now. Lot of interest from the bank community around, replacement revolving for us and we don’t have any concerns, even given some of the uncertainty in the credit markets and our ability to refinance our debt at attractive terms and conditions. So I think we can afford to be a little opportunistic in trying to do that.

Todd Van Fleet – First Analysis

Okay all right. Let me just ask one more before I jump off and on the, at the federal level, and I apologize if I missed some comments in your prepared remarks, but the situation with ICE and I know you’re looking at an opportunity in the Southeast, could you just kind of talk about what developments you see happening within ICE and then perhaps U.S. Marshals Service over the past quarter, in terms of their increased appetite for continuing the consolidation, play well I guess both agencies are kind of undergoing here nationally over the past couple of quarters?

Todd Mullenger

Absolutely. So let me talk about ICE first. We’ve been monitoring some activity with ICE on consolidations that they’re trying to accomplish in different parts of the country. They’ve been pretty well reported with an industry that they’re looking at Florida, Illinois, and Northern California. We’ve been monitoring and participating in those opportunities appropriate. It’s been reported about our selection on the proposal we’ve given on location we’ve got in South Florida for the opportunity there, and so we’re participating as appropriate. We have been selected to sit down with them and negotiate a contract, so we think over the coming days and week we’ll get more clarity on that opportunity, and then also announced as appropriate if we get successful resolution on new contract. And as you know, that activity is been good. We think from our prospective for ICE to undertake, because this, you know, Todd, we’ve had some pretty good success stories in our current systems specifically our facility in Georgia where we’ve done a similar thing, where we consolidated, putting the population in one location and creating efficiency both from transportation and but also from a staffing perspective. So we’re monitoring and participating those opportunities as appropriate, again, think we’ve got a good track record and goodbye proposition to lever to ICE.

On the Marshal side, it’s been us a very interesting 12 months. We saw a dramatic increase as you know third quarter of last year was our Marshal populations. And we’re seeing population going up because it was a backlog of people building up in our facilities and other facilities around the country that needed to go over to the BOP. I think the market is very aware that that has – we are pretty dramatic over the last, probably six to eight months to where, I think almost 7,000 prisoners from Marshal’s have moved over to the BOP during that period of time. So they’ve really moved a lot of folks from Marshal over to the BOP. But we actually have been pretty stable in our populations. I reported, I think in May that we got close to 11,000 prisoners system-wide and where we’ve been kind of net range really over the last three, four months. We’ve been kind of that 10.8 to 11.2 range during that period of time. So, we’re marching very close to BOP now that 142, I think 143% of capacity. But the question will be is that – will that be sustainable to have that many prisoners going from the Marshal Services to the BOP. So it’s a little bit, but wait and see. It’s been a real challenge as we talk upon this for the last 12 months projecting Marshal populations, but again, we’ve been stable in the near-term and tend to monitor going forward.

Todd Van Fleet – First Analysis

Thanks, guys.

Todd Mullenger

Thank you, Todd.

Operator

Our next question comes from Tobey Summer from SunTrust.

Tobey Summer – SunTrust

Thanks. I wanted to ask you question about two significant opportunities on the marketplace that’s maybe hint at potential for a whole new ballgame for market share gains. The Florida and Ohio initiatives to take existing beds and convert them to private partnership; in general do you think that the RFPs from both are well thought out enough and address most of your concerns, so that we won’t have to go through kind of a start install type process where they need to come out with another iteration of the RFPs and somehow draw it out?

Todd Mullenger

Yeah. That’s a good question. And let me talk about both states individually. So Florida, Todd, just came out. We’re still going through the details. I think that pre-bid conference was yesterday, so I don’t have a full report on that, and I know we’re going through a Q&A process. So we’ve got a lot of questions still to be answered, and it’s not due till end of September. But I would say, Florida they’ve got a meaningful amount of beds already managed by the private sector. It’s been our experience that they have refined that process over the year. They’ve been doing propositions since the early 90s. So my sense is that it’s a pretty well thought out plan. We may have a couple of reiterations, where we’ll try to find little bit on just make sure that we are clear from the contract terms and make sure there’s lot of opportunity. But I would say overall Florida has been through this many times in the past, and I think they have a pretty well thought out procurement on the street.

Ohio is very unique perspective from the perspective. Well, this is your first time doing something this large, but also first time that really anyone is looking to sell that facility owned by the state. So one day, we got a pretty good sense of though is when the procurement came out up until when I was doing July 1st is that they were very open to a lot of questions from potential vendors on getting clarity on some of the key terms and have them think about maybe some of the key contract terms and also some of the length of terms of contracts. I think the initial procurement when it came out they were looking at a two-year term of contract for the management contract we bought the facility and talking through kind of risk and obviously make assure that we’re there for the long term. They excrete them out for the pure process up to 20 years. So they’ve been pretty open and pretty flexible on some of the key issues that we pointed out to them that either was pretty concerns for us from a risk perspective and also making viable the opportunity. So when I would say that was probably little behind Florida from that perspective since it is a very new opportunity from prospective of selling a piece of real estate or say to the private sector. But again, they appeared to be move forward on and trying to find out a solution that have been open to comments and it appears they’re leaning pretty far forward and trying to make this work and execute a transaction.

Tobey Summer – SunTrust

Thank you. Just ask one follow-up and I’ll get back in queue. For both of those opportunities, could you comment on the number of competitors that you might expect to buy for those given that there are little bit different one larger in scope, but the other requires capital. Thanks.

Todd Mullenger

It’s too early to tell in Florida since not due until the end of September, but I think the media has reported, I take it as what the media is reporting on the 13 verified fact, I think there has been three vendors proposed in Ohio, (inaudible).

Tobey Summer – SunTrust

Thank you very much.

Todd Mullenger

Thank you.

Operator

We’ll now go to Kevin McVeigh with Macquarie.

Kevin McVeigh – Macquarie

Great. Thank you. I wonder if you could talk about – and nice job with the guidance. As we think about recovering the wage increases does that come vis-à-vis productivity and just thoughts on ultimately there hadn’t been one in a while, is that just more confident in the near term outlook that drove you to do that. Thanks.

Damon Hininger

Yeah, this is Damon. Lot of different factors, one of which is obviously monitoring labor market. We’ve had good tailwind and we still can enjoy little bit of tailwind here in the near term are also labor market and unemployment. But take that into account, taking into account our turnover metrics, retention metrics, taking into account that we haven’t done one for three years, but also taking account what the organizational needs are going to be here in the next 12, 24, 36 months a lot of meaningful opportunity. Also we want to have a good workforce is well prepared, well-motivated to expand and be prepared for some of the potential promotion opportunities with these opportunities. So taking all these different factors in account lead to that decision. The other thing – I guess first part of your question, it is a merit increase, and we do tie it to individual performance.

Kevin McVeigh – Macquarie

Super. And then just as you think about obviously a lot of opportunity out there, how should we think about that relative to the uncertainty that California constantly just brings to the equation, and what I mean by that is, do you position some other states to try to take some uncertainty away from California, or should we think about that?

Todd Mullenger

Yeah. Great question. It is something we think about all the time. We think about optimization, we think about our capacity availability, but we also think about demand of either current and existing partners. The probably the best example I could point you to on, when we talk about those types of issues and it leads to the decision on the company’s part was decision we did late last year on not renewing California at our Florence, Arizona facility. That is in the central part of the state. It was partially utilized by the Marshal Service and ICE. And we thought opportunity to divest a little bit with California that location, because we saw increasing demand from the Marshal Service. In fact, the Marshal Service has basically fully utilized the beds that California vacated here about last 60 days. So, that is part of the playbook all the time, is that we are thinking about those risks, thinking about those opportunities and think about potential growth opportunities existing over new partners and make some of those decisions along the way.

Kevin McVeigh – Macquarie

That’s helpful. And then I know California facility that the 3,200 beds or so, it’s not in the guidance. Any thoughts on just approach around that, or you’re in a holding pattern until – any benchmarks that we could focus on from a market perspective?

Todd Mullenger

Yeah. We really think it’s going to be a couple events. It’s going to be for implementation of realignment, and then also how that is successful relative to the targeted reductions they’ve got to achieve at the federal case. And the challenge will be that that will be clear for quite some time. The plans then will – talked to over first and they have to achieve these reductions with the federal case within two years. So, I think it’s going to be – and we’ll continue to give updates on these calls. It will be months, probably a couple of quarters until we get clarity on the timing of all that, how that shakes out and how close are they? Does the realignment get close to the reductions they need to achieve for the federal case, or is there a Delta? And if there is Delta, how can they close that relative to either using space in states or out of state.

Kevin McVeigh – Macquarie

Great. Thank you.

Todd Mullenger

You bet.

Operator

And we’ll now go to Kevin Campbell with Avondale Partners.

Kevin Campbell – Avondale Partners

Thanks for taking my questions. Damon, perhaps. – Good morning. Good morning. Thanks for, again, for taking my questions. Perhaps you could talk about the opportunities, besides the opportunities you mentioned in Harris County, Texas, what’s sort of the revenue opportunity there? And then, Damon, you mentioned Northern California and ICE. I think we all knew about them looking in South California and awarding beds. So, is this Northern California with a new opportunity and maybe the potential magnitude of that either in terms of the number of beds and potential residents?

Todd Mullenger

Yeah. So, on Harris County, Kevin, too early to tell. The procurement just was out recently. We’ve asked for a lot of information relative to the current costs, and so that we’re still in the due diligence period, but I’d say with rates in taxes in the 40 to 50 range, maybe low or little higher depending on area that maybe a good ballpark but it’s too early to tell or kind of give a precise number.

Kevin Campbell – Avondale Partners

Okay.

Todd Mullenger

As it relates to California. I would say that’s not a new opportunity. That’s just an opportunity that’s been out there, and I said Northern California, I thought it could be Central California or near Southern California. It’s not a new opportunity, it’s just the one that has been there quite some time.

Kevin Campbell – Avondale Partners

Okay. Do you think there is more of an opportunity beyond the beds that were recently awarded to GEO?

Todd Mullenger

I’m sorry, the opportunity for the GEO got it (inaudible)

Kevin Campbell – Avondale Partners

Yeah, that’s right.

Todd Mullenger

I’m sorry.

Kevin Campbell – Avondale Partners

Yes, do you think ICE has more demand beyond those 1300.

Todd Mullenger

Yes, it’s a possibility. I would say it’s – our sense is that as they prioritize those solutions, Florida and Illinois are a little higher on the list than California. It may be the case where they’re taking a little bit of wait and see with the beds they’ve got from GEO, also warehousing and populations both in San Diego and also our Cal city facility. So we think that opportunity is still there but I’d say it’s a little lower and probably that’s relative to Illinois and Florida.

Kevin Campbell – Avondale Partners

Okay. And Arizona procurement, I think you talked before about part of the opportunity would be to potentially move some existing customers that are out of state customers to other facilities and then still existing capacity with Arizona. Is that still a possibility? And have those customers agreed to that or would you still have to get their approval regardless?

Todd Mullenger

Yes, that’s still a possibility and yeah, that’s just part of our plan. When we’re looking at those opportunities we’re in constant communication with the existing customer partner and customer base. We’ll talk about what those opportunities are and then also provide any alternate solutions for them. So that’s very similar to what we did last year with California moving out of Florence. So those were discussions both in California marshal service during that period of time that led to that decision. So that’s just part of the playbook, just to make sure that we’re communicating with the customer and then providing alternative solutions.

Kevin Campbell – Avondale Partners

But you haven’t necessarily at this point gotten approval from any one customer? Yes, we would be willing to move our inmates from X facility to the one in Minnesota, for instance.

Todd Mullenger

Well, I won’t say we’ve gotten approval. It’s just a case, like with last year, since the conversation with California marshal service telling them the plan and making sure that company to getting their feedback on it, and then if we do need to execute on it then they’re well briefed and feel comfortable with the plan.

Kevin Campbell – Avondale Partners

Okay. And then the ICE opportunity in South Florida, you mentioned, of course, you’ve been discussing in the press that it hasn’t been selected or at least the preferred bidder there. Any thoughts on timeframe when they might make a final decision, and how long it might take to build, and when you might actually be up and running?

Todd Mullenger

On timetable I would say probably 30 to 60 days on the timetable. That may take a little longer with everything else going on with ICE. And they’re also getting into the fiscal year and have to deal with other priorities, but I would say 30 to 60 days and that’s been right now. Building-wise, I would say it’s probably 12, 15, maybe 18 months on the building side. Again we haven’t sat down and talked about what the total amount would look like so that may dictate a little bit on the time, how long it takes us to build. We do have a site, and it’s got a lot of regulatory issues worked out. And then – so that would also push it into 2013 ramp. That all happens with that timetable.

Kevin Campbell – Avondale Partners

Okay. Georgia, in your new contract that starts next year, remind me, you do have a 90% occupancy guarantee, is that right? And when does that kick in? Would that kick in within 90 days or that once you hit 90%? What are the mechanisms there?

Todd Mullenger

It is a 90% guarantee, and I think it is day one.

Kevin Campbell – Avondale Partners

Okay. All right.

Todd Mullenger

Dave, what you’ve got.

David Garfinkle

I don’t recall on specific effective date.

Todd Mullenger

We can double check on that Kevin, but I think it is day one.

Kevin Campbell – Avondale Partners

And that supposed to be January 1 of next year?

Todd Mullenger

No, I think it’s going to be little late in the quarter, I would say probably more February-March.

Kevin Campbell – Avondale Partners

Okay. Okay, sorry, a couple of smaller smiling questions, capitalized interest in the quarter was 1.1. I am assuming that’s all coming from the facility in Georgia, so that should trend up until that actually comes online, is that right?

Todd Mullenger

Capitalized interest is smaller than that. For the six months it’s around less than $400,000 for the quarters, around 300,000. It will actually trend up a little bit, so call it probably 500,000 for Q3 and little less than $1 million in Q4.

Kevin Campbell – Avondale Partners

Okay. I must have misread that in the supplemental. G&A you’ve always talked about sort of 5% of revenues is that expected to change it all here with this increase in wages or that’s still the number to use for G&A?

Todd Mullenger

Still 5% for G&A full year.

Kevin Campbell – Avondale Partners

Okay. And then lastly, can you give us a sense of the difference in wages from 2Q to 3Q as we think about just dollar wise sort of the magnitude of the increase.

Todd Mullenger

On the wages including the impact from benefits associated with increase in wages about $4 million in a quarter.

Kevin Campbell – Avondale Partners

That can took –

Todd Mullenger..... little over $4 million in the quarter from Q2 to Q3.

Kevin Campbell – Avondale Partners

Right. Thank you very much.

Todd Mullenger

You’re welcome.

Damon Hininger

Thanks Kevin.

Operator

(Operator Instructions) We’ll now go to Scott Grossman with Magnetar Capital.

Scott Grossman – Magnetar Capital

How are you?

Todd Mullenger

Good morning.

Damon Hininger

Hey, good morning, Scott.

Scott Grossman – Magnetar Capital

Thanks for the time. Congrats on the quarter. I just had a few quick follow-up questions. First on the managed-only side you touched on it a little bit, but it looks to be a pretty healthy margin, maybe the best in five years. Can you do me a favor and try and breakout how much that margin left was from leveraging the fixed cost base, some of the cost initiatives you’ve taken and or simply just better mix on higher per diems.

Todd Mullenger

Great question, the managed-only margins are up due largely to the below average employee benefits and legal expenses that I mentioned in my prepared remarks being concentrated in the managed-only facilities. So you will see decline in those margin rates next quarter, that in anomaly. It’s not sustainable as employee benefits expenses and legal settlement expenses are forecasted or returned to the recent average or so. It’s kind of in quarter anomaly you can expect to see those margin rates decline next quarter.

Scott Grossman – Magnetar Capital

Understood. Got it. Second on the pipeline, specifically on Arizona, just a follow up. Can you clarify whether you guys are marketing existing facilities or do you contemplate a potential new build?

Todd Mullenger

No, we’re contemplating existing new – our existing facilities.

Scott Grossman – Magnetar Capital

Okay. And just to confirm, is the right way to think about it as these new – sorry, the existing facilities, is that still – are you still thinking about its being a $1,000 per bed per year cash drag, so filling those beds would effectively allow you to double-dip, i.e., getting rid of the credit cost but having the beds to produce cash flow.

Todd Mullenger

Well, the cash operating recurring costs per vacant bed do average about a $1,000 per bed per year. So fulfilling existing vacant capacity there is still benefit there and then it all comes down to what the margins are in the new bed.

Scott Grossman – Magnetar Capital

Got it. And my last question is on the debt capacity, you guys have delevered about to down to 2.3 times some through pay down, some through EBITDA growth, just given some of the new types of opportunities which seem to require more capital, i.e. buying prisons from Ohio and the Florida procurement which I think requires an surety bonds, how have you guys changed if at all your capital deployment methodology given your AFFO targets which is now on a balance sheet that seems underutilized relative to your history?

Todd Mullenger

Well, I would say from a capital structure balancing perspective, we’re still comfortable with leverage up to four times debt to EBITDA. As you mentioned we are down to two point four times. We’ve been utilizing from free cash flow to buy back stock that’s still an arrow in our clever capital deployment alternatives. Our first preference would be to develop new facilities or acquire facilities. As Damon outlined, we had some opportunities in front of us, Ohio, ICE, we talked about I think New Hampshire in the past. There may be other opportunities, so we’re waiting to see what happens with some of those near-term opportunities and see if there are other opportunities that present themselves in the near to intermediate term. But again we haven’t changed our thinking around maximum leverage if that’s your question.

Scott Grossman – Magnetar Capital

Got it. And do you think the balance sheet is more of a competitive advantage today than ever especially where you sit?

Todd Mullenger

Yes, absolutely. Yeah I would say definitely where you got especially these opportunities where we’re going at Ohio and buying facilities, yeah we think we definitely got an advantage.

Scott Grossman – Magnetar Capital

Got it. Okay thank you, guys.

Damon Hininger

Thank you, Scott.

Operator

And it appears there are no further questions. So I will turn the conference back over to our presenters for any additional or closing remarks.

Damon Hininger

All right, Jessica, thank you very much. And thank you all for calling in today and participating in the second quarter earnings call. More importantly to our investors, thank you so much for your investment in the CCA. I can tell you now that your management team is focused on executing on another good year and good quarter and we look forward to reporting our progress little later this year. Thanks so much.

Operator

This concludes today’s presentation. Thank you for your participation.

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