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Corrections Corporation of America (NYSE:CXW)

Q3 2012 Earnings Conference Call

November 08, 2012 11:00 a.m. ET

Executives

John Ferguson – Chairman

Damon Hininger – President & CEO

Todd Mullenger – CFO

David Garfinkle – VP of Finance

Steve Groom – General Counsel

Harley G. Lappin – Chief Corrections Officer

Bill Andrews – Board Member

Analysts

Kevin Campbell – Avondale Partners

Tobey Sommer – SunTrust

Todd Van Fleet – First Analysis

Manav Patnaik – Barclays

Kevin McVeigh – Macquarie

Clint Fendley – Davenport

Barry Klein – Macquarie

Operator

Please stand by, we’re about to begin. Today’s call is being recorded.

Good morning, everyone, and welcome to CCA’s Third Quarter 2012 Earnings Conference Call. If you need a copy of our press release or supplemental financial data, both documents are available on the Investor page of our website at www.cca.com.

Before we begin, let me remind today’s listeners that this call contains forward-looking statements pursuant to the Safe Harbor provisions of the Securities and Litigation Reform Act. These statements are subject to risks and uncertainties that could cause actual results to differ materially from statements made today. Factors that could cause operating and financial results to differ are described in the press release as well as our Form 10-K and other documents filed with the SEC. This call may include discussion of non-GAAP measures. The reconciliation of the most comparable GAAP measurement is provided in our corresponding 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’d now like to turn the call over to Mr. Hininger. Please go ahead Sir.

Damon Hininger

Thank you, Melissa, and good morning, everyone, and thank you so much for joining our call today.

Joining me is our Chairman of the Board, John Ferguson; Todd Mullenger, our CFO; our VP of Finance, David Garfinkle. We also have joining us this morning our General Counsel, Steve Groom; our Chief Corrections Officer, Harley G. Lappin; and board member, Bill Andrews.

I wanted to just take a minute initially to give you a couple highlights of the quarter and then I’ll turn it over to Todd to discuss the quarter in more detail and also give a review of guidance for the full year. So let me just talk a little bit about the quarter. And the first thing obviously is we’re very excited about our new contract with the State of Arizona, which we announced earlier this year. This award, as many of you know, will be utilizing capacity at our current Red Rock facility that’s currently being utilized by the State of California.

Also, we’re very pleased with our performance. Cash flow for the quarter was very strong with FFO performing at nearly 10%, or $79 million, and we reported also $0.43 in EPS adjusted, which is up over 16% quarter-over-quarter.

We’re also very pleased with the performance of growth that we’ve seen with existing state partners, most notably Idaho, which they have ramped up into their new contract to about 250 beds. And that also we’ve expanded our relationship with the State of Oklahoma where we now have 340 additional inmates with the state in our facilities in Davis and also in Cimarron.

So overall very pleased with the Q3 performance for CCA. I’m extremely, extremely appreciative of our CCA management team, our wardens out in the field and the entire CCA team of professionals for their work this quarter and also during the course of 2012.

And with that, let me turn it over time to Todd to review the quarter and talk a bit about the guidance for the rest of the year.

Todd Mullenger

Thank you, Damon, and good morning, everyone. In the third quarter of 2012, we generated $0.43 of adjusted EPS compared to $0.37 in the prior year, a 16% increase.

Funds from operations, or FFO, increased 10% to $0.79 per share, while adjusted funds from operations, or AFFO, increased 15% to $0.68 per share.

The third quarter financial performance exceeded our forecast, due primarily to favorable operating cost performance driven by lower-than-average employee medical and inmate medical expenses.

We also benefited from a lower-than-forecasted income tax rate in the quarter. These favorable items were partially offset by lower-than-anticipated U.S. Marshal populations. These three items net added approximately $0.02 to our EPS for Q3, which we do not expect to be replicated in Q4. So we really need to think about Q3 as a $0.41 quarter on a normalized basis.

Year-over-year in the quarter, we saw revenues increase by $13 million driven largely by increases in per diems; the assumption of operations at our Lake Erie, Ohio facility; activation of the Jenkins County Georgia facility; Puerto Rico inmates at Cimarron; partially offset by declines in populations from the U.S. Marshals, Colorado, California and District of Columbia.

Moving next to a discussion of our guidance. As indicated in the press release, full year EPS guidance is in the range of the $1.53 to $1.55. And guidance for Q4 is in the range of $0.39 to $0.41. Full year FFO guidance per share is in a range of $2.89 to $2.93, while AFFO guidance for the full year is a range of $2.37 to $2.45.

Earnings guidance excludes all expenses related to the REIT feasibility project and debt refinancings. Our U.S. Marshals populations are a key flex point in our guidance. We’ve seen these populations decline from their highs during the first half of the year, and they are forecasted to remain at the current levels for the balance of the year. However, a small movement up or down from the range of populations assumed, could have a meaningful impact on our actual earnings as these populations are largely at facilities that are operating at full capacity where the incremental margins are very high.

Finally, on Tuesday the company declared a $0.20 per share dividend, to be paid on Friday, December 14, to shareholders of record as of November 30. I’ll now turn it over to Damon.

Damon Hininger

Thanks so much, Todd. Now I’d like to give a market assessment, and also an update on our project REIT.

Let me just first make a couple global comments, and most notably is – all of you on the phone are looking at the economic environment; we’re all reading the same headlines that you all are. We all have concerns during the near term with economic environment here nationally and internationally, and also the uncertainty we’ve got in Washington DC in the coming months. So we continue to be very cautious in the near term but continue to be optimistic about the mid to long-term prospects for the company and for the industry.

But I can’t tell you how many times I’ve heard here in the last couple of months from our partnership development team when we talk about kind of new business opportunities or maybe decisions on pending projects, kind of a common refrain from our team internally is that most of our partners, if not all of them, are waiting for a significant milestone, either the election or maybe the first of the year.

And so that’s been kind of a common answer internally when we’re talking about either new business prospects or maybe timing on new contract awards within the business and within the industry. And it appears right now we’re seeing a lot of decision makers basically sitting on their hands right now to see a little additional clarity either from the election or for maybe some of the issues that Congress is going to have to deal with after the first of the year.

But specifically, let me just give you a few observations in the book of business. First on the state side, and then also a comment or two on the federal side. On a state book of business, just to reiterate our excitement about the new contract with state of Arizona.

This has been a long process, about two-and-a-half years, the state of Arizona has gone through in putting this procurement and this requirement together, and so obviously they’re excited to receive the award, and also having the award going into a facility that’s currently utilized by the State of California. So in the coming weeks and months we’ll get more clarity on kind of the ramp and the timing of Arizona, which is right now anticipated to be in early 2014, but we’ll continue to give updates in 2013, as it relates to this new contract, and the impact to the State of California.

I’d also reiterate a point that we’ve made here in last couple of years, that this current fiscal year that we’re in, on the state side which is July 1, we’re seeing no new meaningful capacity being developed from our states. A little bit going on in Arizona and California, but really outside of that very minimum investment in new capacity being developed. And this is really the third consecutive year that we’ve seen on the state side where states are not building capacity to deal with either growth and/or overcrowding within their respective states.

We also monitor very closely the growth in our existing portfolio on the state side, and right now over the last 12 months we’ve seen 10 of our state partners grow by a combined total about 5500 inmates, and this has manifested itself into a couple of near-term opportunities that we’ve executed on, the one of which I mentioned earlier which is Idaho. Idaho has grown by about 500 inmates this past year and obviously they did a procurement and we were successful in that procurement in awarding about 250 inmates at our Kit Carson facility.

Another opportunity that’s manifest itself and that’s the State of Oklahoma. As I mentioned earlier, we’ve grown by about 340 inmates here recently with State of Oklahoma with our capacity in the Cimarron and in Davis. And just to give you a sense of Oklahoma, their total population has grown by about 800 inmates in the past year. So we’ve been well situated as some of our state partners grow, we can provide capacity just in time to help them deal with that growth.

Now looking forward on the state side. 10 of our state customers where we provide own and manage solutions, and this is outside of the State of California, those states are forecasting a growth of about 10,000 inmates over the next five years. So again, we feel we’re well suited to deal with that growth as it manifests itself with those existing state partners. But we’re also pursuing many potential new state partners, and eight of them most notably that we’re pursuing, we’re pursuing them in anticipation that they’re either overcrowded or looking to grow by about 15,000 inmates over the next five years.

Now I know there will be some interest on getting an update on the State of California and I’ll do that toward the end of my remarks, but let me just make just a global common about state budgets.

We monitor these obviously very closely, and it looks like most state economies continue to improve, but they are still not above the pre-recessionary levels that they had a couple years ago. So budgets really continue to be very tight at the state level, but we’re also watching states dealing with potential impact from the federal government, and the federal budget situation and how that potentially has impact on state budgets. So we continue to monitor very closely and like in the near-term it appears to be very tight kind of fiscal situation within the state budgets. And as we get into the spring and obviously a lot of legislatures come back in session, we’ll be able to give obviously a better update on what next fiscal year looks like for our state partners.

Now just a couple comments on the federal book of business, most notably is that many of you know that Congress and the President passed a continued resolution earlier this fall that funds the federal government through March of next year. So now with that in place, and then also with the election behind us, we do think we’ll obviously get some clarity here in the coming days and weeks as it relates to the current budget but also sequestration and then also the looming fiscal cliff that’s coming up in the first of the year.

We are – just to mention sequestration, we are watching that closely. It is pretty – and clearly some – a lot of uncertainty with the federal government. There is many people that have reported in the media and another forms that there’s a belief that there is going to be some type of compromise and that they’re going either stop or delay sequestration in advance of January. Again, with the election behind us I think in the coming days we will get more clarity on that, but the bottom line is obviously we’ll continue to monitor it very, very closely.

Now let me just talk about a couple penny procurement to give you a couple of updates, the first of which is New Hampshire and this is the requirement for 1,500 beds in the state of New Hampshire for a new design, build, own and manage facility. Proposals were due back in February and our best estimate right now is there’s probably not going to be action on until the first quarter of next year. If they did award first of next year, we think the actual facility would be built and in operation probably in early 2015.

The next procurement is with the Federal Bureau Prisons, and this is a requirement for 1,600 beds in existing capacity here within the U.S. Proposals were due back in September and our estimate right now is that they’ll probably act on and award probably first quarter of next year. And just a reminder that the requirement is procurement – to whoever is awarded to the contract, I should say, has to have facility ready for operation and ramp up on September 1 of next year. So again it’s only targeting existing capacity.

The final update I wanted to give on the new business opportunities is here in Harris County. And just as a reminder, this is the opportunity to take over the entire jail system within Harris County. This is metropolitan Houston. This would be an opportunity to take over a system that has about 9,000 prisoners on any given day. We submitted our best and final for this procurement back in August of this year, and again we think probably later this year, probably early next year is when the county will make a decision on this requirement

Let me now give you a specific update on California and there’s a couple topics I wanted to cover here but before I do that, let me just give you a quick reminder of what happened in the spring with the State of California. You may remember that the state released in April a plan of what they called The Future of California Corrections. And this was a plan to really talk about their future over the next five years and steps that they were taking to deal with their population within the state and also meet the court requirements as set forth in the recent court case.

A couple of things in this plan, as a reminder, the first of which is that putting forth the realignment plan, making sure not only the realignment plan is in place with counties and cities taking some of this population that used to be in state facilities, but also making sure there’s funding there long-term to support the counties and cities with this new obligation. The second component is to fund some additional capacity within the State of California to deal with overcrowding and or any potential growth within the state.

But the last thing, which is probably the most notable, was the state’s efforts to convince the federal court to raise the cap that’s currently set at 137.5%, raising that to 145%. And this is within their 33 public facilities that they currently operate within the state.

Now as it relates to the last part of their plan, which is the population cap, there’s a couple things to report. Through August of this year through September, the state and the plaintiffs have litigated several parts of this request to the three-judge panel and this whole discussion about potentially raising that cap to 145%. So a couple things that’s happened here recently.

The first of which is about mid-August the state filed to the court a comment to say that if the court insist that the final benchmark cannot be modified, this is again raising it to 145%, that the only way that the state could achieve success, reaching to 137% – assuming they wouldn’t be able to release inmates or get additional legislative action to reduce sentencing would be to maintain the current out-of-state program that they’ve got in place with us. So that was indicated by the state to the court back in August.

In early September, the court rejected the state’s request for a higher population cap. The court indicated that it was considering a six=month extension of the deadline which is right now set for June of 2013. But they would consider an extension to December of 2013, but indicated that they would not entertain any raising of the cap. And again, this was in early September that the court made this point and they also did not automatically give the extension but said they would entertain a request from the state.

In early October, just last month, the court did order the state to come up with plans on achieving a population reduction down to 137.5%. And they actually said they’d like to see a plan for two dates, either go ahead and moving forward with the reduction in June of next year, but they also wanted to see a plan how that state would achieve that if they got the extension through December of next year.

And they have to submit those plans, the state has to submit those back to the court in January of next year, so here in a couple months. Because the state has also expressed through this blueprint that they put out in the spring their preference to return about 5,000 inmates in the out-of-state program by December of next year, the court also directed that the state provide detail on how they plan to return some or all of that population while still meeting the cap by those two alternative dates.

And then just a couple days later, in its monthly status update to the court, the state did acknowledge uncertainty whether it would be able to meet the December 2012 benchmark, which is 145%, on time, indicating that it was reassessing its population projections.

So let me make a comment also on that last point, which is their population projections. The inmate population reductions due to realignment have slowed in recent weeks. We’ve been monitoring their population over the on a weekly basis and in fact CDCRs inmate population has grown in last four weeks by about 400 inmates.

CDCR also indicated this past week that through releasing a revised population projection, they now forecast more inmates in their system than anticipated just six months ago. In the spring, they were projecting that they’re 2017 total inmate population would be just under 124,000 total. But now they are projecting it’s going to be closer to 130,000. So obviously, we’ll be monitoring these developments closely and stand ready to serve the state as they consider alternatives to recent court ordered population levels.

Finally, let me also provide an observation about the successful passage this past Tuesday of Prop 30 in California. I know many of you’ve been tracking this initiative and know that it’s primarily focused on helping the state fix some of the funding gaps in several parts of their budget, most notably in public education. Now part of this funding will also provide certainty to cities and counties for the cost they’re incurring for a realignment.

So our view is that the passage of Prop 30 is really a net neutral, maybe slightly positive for CCA. Because while we do provide California with budget savings, our larger value for the state is our ability to address their capacity concerns and also to provide constitutional level of care in compliance with court mandates. And then obviously the state’s ability to pay that level of service is paramount.

Let me switch gears again and now give an update on Project REIT, and this is our ongoing analysis of the feasibility and potential benefits of converting to a real estate investment trust or a REIT. Now as you may recall, in our last earnings call back in August we announced that the management team with support of the board submitted a request to the IRS for a private letter ruling back in July.

And while there has been much done, and much more work to be done both in working with the Internal Revenue Service and also in fully analyzing the business issues, our continued belief is that a conversion to a real estate investment trust, or REIT, using a TRS or Taxable REIT Subsidiary for provision of services will provide numerous benefits to CCA and assuming it could be properly implemented.

As we said in our last call, we believe a conversion to REIT has the potential to lower our cost of capital, draw in a larger base of potential shareholders, enhance our ability to return value to shareholders, provide greater flexibility to pursue growth opportunities post-conversion and creating a more efficient operating structure. Importantly, under the structure, we would not need to divide the company into an independent REIT and an independent operating company. This would allow us – enable us, I should say, to maintain strategic alignment of our key operating divisions. Accordingly, we believe that this structure would not adversely impact or affect our business, or our vital relationships with our government customers.

Now, it’s important to note that our business involves providing an intensive real estate component, our correctional facilities, and also performing essential services for our government customers, and as always, we will take every step to ensure that we satisfy those responsibilities in a professional and efficient manner.

Since our last call, our advisors have had numerous discussions with representatives of the Internal Revenue Service to discuss our proposed REIT structure and our pending request. Those discussions have been informative and ongoing.

While we believe there is sound legal basis for the IRS to grant the ruling we have requested, there can be no assurance that the IRS will issue a favorable ruling. There is no specific schedule for the IRS to respond to a request for a private letter ruling.

Now, we have also been working on a parallel path on our internal analysis and our work to date led us to provide the new disclosures in our earnings release, estimating the E&P payment, conversion costs and the like. While we have not completed our assessment and continue to evaluate a number of issues associated with the REIT conversion, we wanted to give our investors a sense as to a possible range of distribution costs associated with electing REIT status.

Now, as mentioned in our press release, a REIT election applies on an annual basis and cannot be made for a portion of a taxable year. And for CCA, that means that any re-election would need to be effective January 1.

We intend to work with the IRS and continue our own analysis of the benefit of the reconversion as quickly as we can, and we believe that if everything lines up, and the IRS responds to our proposed request and structure as submitted, an election to become a REIT for the 2013 calendar year remains a possibility, even if the IRS responds after January 1 of 2013. However, this is a complex process and precise timing and outcome of the process are still uncertain.

Now, I know you may have some questions about the potential REIT conversion, but let me just say that we’ve made a lot of progress and we have more steps in this journey. So beyond what I’ve stated, I will be limited on what I can say on the subject during Q&A. And this will be especially true regarding the ongoing dialogue we are having with the IRS.

Finally, let me mention again that we have assembled a strong team of advisors for this project, including Latham & Watkins, Ernst & Young, JPMorgan as well as our corporate counsel, Bass, Berry. CCA’s board has met a couple times recently and has received comprehensive presentations from the management team and our financial and legal advisors on the possible conversion of the company into a REIT.

With that, I want to assure you that we, the board and the management team, are and have been proceeding as quickly as possible to try to reach a favorable conclusion. We expect that our next update on this important initiative will be on our first quarter earnings call. So with that, let me bring a close to my prepared remarks and make these final points.

First of which, is that we still have got some very meaningful business opportunities that hopefully later this year or early next year will be acted on by either existing or new partners, but also, we’re seeing very favorable global dynamics within our business, both at the federal side and the state side, where we’re seeing both levels of government making very limited investments in new capacity, ability for growth and/or overcrowding. And also, that step to move forward and create shareholder value. We obviously now have the dividend program firmly in place for the company and for our shareholders.

And also we have made meaningful progress on another opportunity create shareholder value and that is what we reported earlier with Project REIT. So, at this point, that is the conclusion of our prepared remarks. Thanks again for calling in for the call today. And let me now turn it over to the operator for questions and answers.

Question-and-Answer Session

Operator

(Operator Instructions) And our first question will come from Kevin Campbell from Avondale Partners.

Kevin Campbell – Avondale Partners

Good morning, and thanks for taking my question. Damon, I wanted to follow up on one of the comments you made about being able to convert even if IRS responds after January 1 of 2013. Can you just explain how that process could work?

Damon Hininger

Yeah, So we obviously have still got 33 days left in this year. So the IRS could rule this year, but there is also a possibility that if they rule after the 1st of next year that we could still convert to a REIT. So again, we’re only three month into the process. We’ve got two months left in this year, but if they did rule after the 1st of the year, there is still a possibility where we can convert for the full year.

Kevin Campbell – Avondale Partners

Is there a certain timeframe that you’d have to hear back from them by in 2013, by January 31 or March 1 or something like that, or-

Damon Hininger

Yeah, good question, Kevin, there’s really no drop-dead data or no magical date. We obviously said what we said in our prepared remarks, my prepared remarks, and also, the press release. But based on our disclosure, we’re also doing all the work analysis we can to get ourselves for a potential conversion to 2013. But there is no magical date or no drop-dead date.

Kevin Campbell – Avondale Partners

So okay, just to make clear, even if it pushes in a couple – a month or two, or what have you, into 2013. It could still be made retroactive to the 1st of next year?

Damon Hininger

Yeah, it’s really, the IRS is just making, they’re making a ruling if we would be able to convert to a REIT. So we can behave and operate like a REIT after the 1st of the year, even though we get the letter maybe a few days or a few weeks after the 1st of the year.

Kevin Campbell – Avondale Partners

Okay, that’s helpful. Just as we think about your Arizona that, are you going to have both California and Arizona at that facility at the same time. Will you be moving California elsewhere? Could you just give us some color on how that might work?

Damon Hininger

Yeah. Another good question. Really don’t have any clarity today, so right now, the way the procurement is structured that were awarded to us. Arizona is anticipating a ramp in that facility sometime after the 1st of 2014. So we obviously have got 14 months away from that milestones. So we really have just started kind of the dialogue with Arizona on timing and kind of the physical plant enhancements we’d have to make to the facility. So I think we’ll get a lot more clarity probably the 1st of the year. So too early to tell on both timing on that and then also the potential impact with the State of California in time to them.

Kevin Campbell – Avondale Partners

Okay, great. And your Idaho contract, I know called for 250 beds initially and update 100 beds eventually. Any thoughts on when – if and when they might use those additional 550-plus beds?

Damon Hininger

They ramped up to 250 beds pretty quickly and by all indications from our team and their team, they are basically real satisfied with that solution. So, we don’t have any estimate on timing of additional population, but they opted – did give themselves that flexibility with the what they advertised in the procurement. So my assessment would be probably early next year before we get any kind of feeling if they are going to use additional beds. But we’re also well suited to do that and the contract gives them that flexibility.

Kevin Campbell – Avondale Partners

Okay, great. And the last question, I wanted ask about Ohio. I’m sure you’ve seen some of the media reports about some of the concerns about the facility after it was transferred over to CCA. Maybe you can just talk about that facility and what you guys are doing there from a quality perspective?

Damon Hininger

Yeah. Let me just first say, we’re very excited about our partnership with the state of Ohio. We’re strongly committed to working with them, not only just for the near term with some of the operational issues that they’ve raised, but also long-term being a strong partner for them. In the state of Ohio, they have obviously raised some concerns since the recent audits.

And we’ve taken those very seriously. We deployed a lot of resources both at the facility and here in Nashville to help support the facility to address some of those issues. So, I’m confident we’ll addressed all those issues timely and work through all those various issues. So, I think having a new relationship with a new state customer; this is our first time working with the state of Ohio. You obviously are going to have a period where you are going to learn from each other and make sure there are clearer expectations relative to policies and training and operational requirements. So, we’re going through that a little bit, but we’re committed to working through all these issues that

Ohio has raised.

Kevin Campbell – Avondale Partners

Okay. Great, thank you very much.

Damon Hininger

Thanks, Kevin.

Operator

And our next question will come from Tobey Sommer from SunTrust

Tobey Sommer – SunTrust

Thank you. I guess you have already addressed in your prepared remarks my most important question, which was the timing of an IRS response. To what extent have you had a back and forth dialogue about your submission, and had kind of regular communications with the IRS?

Damon Hininger

Yes. So we’ve had conversations with the IRS since our submittal. As I indicated in my prepared remarks, we basically put a fence on kind of delving into the kind of the discussion back and forth. But we’ve had ongoing dialogue with them since our submittal.

Tobey Sommer – SunTrust

Shifting to fundamentals for a second. Could you describe – give us a little bit more color on Harris County? I kind of had thought that perhaps something might have – a decision might have been made in the fall, and wondering what, if anything, may have changed there?

Damon Hininger

Yeah, good question, I would kind of relate it back to my earlier comment. We just have gotten a sense from our either existing partners or new partners that either opportunities, pending procurements, maybe decisions where they need to move forward on a requirement, a lot of those are just being deferred, either past the election or past the 1st of the year. There was obviously a lot of – everybody in the country was most focused on the national election, but there was a lot of elections going on at the state and local level.

And so, our sense is that we just had a period of time where a lot of decision-makers were sitting on their hands. So I would Harris is probably in that category. And we think we’ve put forth a very compelling and comprehensive and competitive proposal to them, but our sense is probably now that we’re on the other side of the election, either later year or early next year, we’ll see an action being taken by them.

Tobey Sommer – SunTrust

And, Damon, I apologize. I missed part of the call. Did you give any update on the customers – or potential customers that you’re having conversations with, that aren’t part of formalized RFPs? And could you just update us on those discussions?

Damon Hininger

Yes. So we, I mentioned that we’re pursuing eight state partners that are currently not doing business with CCA, and I just gave an indication of their overcrowding projection, which is over the next five years, that would be somewhat near 15,000 inmates. So those would be potential new state partners. One of those partners that was kind of in that category, say 12 months ago, was Puerto Rico. So, Puerto Rico was one of those that I didn’t mention by name, but just said that we were monitoring, we’re pursuing and found an opportunity to provide not only value, but also relief in overcrowding and overgrowth. So that’s kind of typical profile we’re looking at for an opportunity on the state side.

Tobey Sommer – SunTrust

Are those eight customers and potential 15,000 beds larger or smaller than the last time we got an update from you?

Damon Hininger

I think it’s been pretty consistent. It’s been pretty consistent. I think maybe a little higher, maybe a little lower, but I’d say probably no more than 2,000-bed variance.

Tobey Sommer – SunTrust

Thank you very much.

Damon Hininger

Thanks, Tobey.

Operator

And now, we’ll go to Todd Van Fleet from First Analysis.

Todd Van Fleet – First Analysis

Hey, good morning guys.

Damon Hininger

Morning, Todd.

Todd Van Fleet – First Analysis

Damon, on that back and forth that you had with the IRS, have they asked for estimates, either historical or projected, regarding federal taxes under one scenario versus the other that is the conversion versus non-conversion?

Damon Hininger

Yeah, Todd, I would say that’s in the category of providing detail on kind of our conversations with them, so I really can’t go down that path. So, the only thing I would share is that we’ve had several conversations with them since our submittal, but really don’t want to get into any detail on the topics, and what was discussed.

Todd Van Fleet – First Analysis

Okay. So outside the context of any conversations that you’ve had with the IRS, I assume you guys have worked the numbers with respect to federal taxes that would be paid under either path, either conversion or non-conversion. Can you tell us what those figures have shown?

Damon Hininger

Yeah, obviously, we’re working on that analysis, but not prepared to disclose anything to the market today.

Todd Van Fleet – First Analysis

Okay. I think that’s it. Thanks guys.

Damon Hininger

Thanks, Todd.

Operator

And now, we’ll go to Manav Patnaik from Barclays.

Manav Patnaik – Barclays

Hi, good morning, gentlemen. Thank you for all the details on the REIT stuff. Two just follow-up question on the REIT stuff. So one, it seems like, it sounds like that the PLR approval is not necessarily a sort of block in terms of converting on January 1, but could there be any other items per se that could force you to make the decision not to convert in January 1, whether it be board approvals, shareholder approvals, any other items in there that we should think about in terms of not being able to do it January 1?

Damon Hininger

Well, if – so, yes, if you put everything, I guess, with the PLR request and the timing on that, you put that aside, I think it’s, based on our press release, the disclosure we’ve made and our comments, obviously, we’re working towards being prepared for a conversion in 2013. So, we’ve obviously been keeping the board up to date along the way, giving them presentations, getting feedback from them and then obviously, have continued to work with our external advisors on the analysis. But, yeah, we’re taking all the steps internally to get ourselves prepared, and then obviously again, it’ll be in the hands of the IRS on the timing of the ruling.

Manav Patnaik – Barclays

Okay, fair enough. And then, you obviously gave a good amount of detail in terms of the E&P and the cost, et cetera. I guess when – I guess around what timeframe, or how do you guys think about when you guys will give us a sense of what the dividend’s going to look like?

Damon Hininger

It would be later. It would be – if we convert, obviously, in 2013, then we’d be talking about sooner rather than later, but it’ll be later.

Manav Patnaik – Barclays

Okay. Fair enough. Now moving to – I guess as a follow-up somewhat to the eight state customers that you referenced to, new state customers, rather, maybe it’s one of those eight or maybe it’s completely different, but I was hoping that you could give us an update on, if you’re seeing any traction in terms of other states being interested in selling their facilities, like Ohio did?

Damon Hininger

We are – we have and we are. We have seen other states express interest, and so yeah, we continue to see – think that is a great solution, especially in a tough fiscal environment, to where a state can get – do a transaction, maybe help them fund a budget deficit or maybe a hole they’ve got in their upcoming budget. So we continue to pursue that as a solution for state partners and think there’s a couple states that may be close on exploring that type of solution.

Manav Patnaik – Barclays

And I guess, would those decisions also fall under, I guess, how you characterized at the beginning of your call, just them waiting for stuff like the election or the beginning of the fiscal year, those kind of issues to first sort itself out?

Damon Hininger

Yeah, I think that’s exactly right. I think that with the election, and again, all of this has been most focused on the national election, but there was a lot of gubernatorial races around the country. There was a lot of legislative races, there was a lot of local races. So I think anything that government may consider that would have any tinge of controversy, I think most folks, either an existing state portfolio, or existing portfolio or maybe new portfolio opportunity, new potential opportunities, I should say, just saw an opportunity maybe to defer any activity until after the election and get the outcome of those various elections.

Manav Patnaik – Barclays

Okay. Fair enough. And my last question is around, you mentioned you guys are obviously closely monitoring sequestration and the fiscal cliff and those issues. Can you maybe give us a little more detail in terms of what exactly it is there that you’re monitoring, which maybe we can do as well? And also what’s the feel, like what’s the worst case that happens and how it might hit you guys?

Damon Hininger

I don’t know if I have any better assessment than what’s been reported in the media, like I said, probably reading the same things you are, Manav, that kind of the general feel is that it’s a worry. People are concerned about it. But there is a general belief that Congress and the president will come together and work out a plan, either to defer it or work out some type of compromise as part of a bigger deal as it relates to the taxes or the fiscal cliff.

So I don’t know if I have any additional clarity there, but I do know it’s a worry. I mean, I would say if you kind of rewind maybe three, four months ago and talk to many of our federal partners, most of them said, I know it’s there, I know a it’s potential risk. I’ve done some tabletop exercises on what I would do if it materialized, but nothing more than that, whereas I’d say here in the last month or two, we’re just hearing a little more of, people know it’s obviously coming up very soon or first of next year, so about 60 days away, but everybody’s monitored it very closely. But I would say when you talk to our federal partners, they kind of have the same assessment. They think that it is some type of deal or compromise or deferral will be worked out.

Manav Patnaik – Barclays

All right, fair enough. Thanks a lot, guys.

Damon Hininger

Thanks, Manav.

Operator

Our next question will come from Kevin McVeigh from Macquarie.

Kevin McVeigh – Macquarie

Great, thank you. Hey, not to kind of belabor the timing on this, but if we were to get an update, I mean, Damon, it sounded like you said the next update will be on the Q1 call. If for some reason, you were to get the private letter ruling prior to that, I’d imagine you’d update us at that point, correct?

Damon Hininger

Yeah, if we had a material update, obviously, we would do that out to the marketplace.

Kevin McVeigh – Macquarie

And then, just the timing on it, as you think about a potential kind of response, do the holidays come into play at some point, in terms of, should we expect something before you get into December or it’s just, it’s too tough to call?

Damon Hininger

I’d say the latter, too tough to call.

Kevin McVeigh – Macquarie

Okay, fair enough.

Damon Hininger

This is obviously our first time doing this, but I can’t give you any clarity on that.

Kevin McVeigh – Macquarie

Okay and then just, any sense of how the states have reacted to your petition for the REIT and the federal government, as you think about kind of conversations on renewals? Has there been any impact there?

Damon Hininger

Yeah. Absolutely no impact. I mean, as I mentioned in my remarks, I mean, we see this as a non-issue for our customers. And so we’re moving forward with the plan and we obviously proposed a conversion, assuming that it’s a non-event for our customers. So, no concern there.

Kevin McVeigh – Macquarie

Okay, thank you.

Operator

And we’ll now go to Clint Fendley from Davenport.

Clint Fendley – Davenport

Thank you, good morning, guys. On the REIT, another question here. I’m wondering, how would the E&P distribution work if you guys didn’t hear from the IRS until sometime in January? Is there not an incentive to pay that at the 2012 tax rate prior to the end of the year?

Damon Hininger

Yeah. So, I guess, a couple of points there. I mean, the typical, as I understand it, kind of distribution is during the kind of first conversion year. You have to do before the end of the first conversion year. So in that case, if we converted January 2013, we’d have to do by end of next year. But, yeah, sitting here today, we don’t have – obviously don’t have any response from the IRS, and being 53 days away from the 1st of the year makes it challenging for us to think about any type of distribution.

And the other thing I would note is that we have, and we mentioned this in the press release, we’ve got restrictions in our debt agreement about how much we can pay out. So, obviously, we still have that constraint for the company, even if we wanted to do something, which would be very hard to do.

Clint Fendley – Davenport

Okay. Understood. Thank you. And I wondered, have you guys had any additional sit-down meetings with the IRS since your initial meeting earlier this summer?

Damon Hininger

You guys are very persistent today, so we’ve had numerous discussions, well, with the IRS. I’ll leave it at that.

Clint Fendley – Davenport

Okay. Thank you. And I guess the last question then, on just the eight new state opportunities that you guys are pursuing, are any of these states considering asset sales as part of their alternatives?

Damon Hininger

The states that we’re looking at, I would say that the first opportunity as we see it and really, it’s the first play in our playbook when we sit down with a potential prospect, is use an existing capacity. And so, I’d say the majority of the states that we’re looking at that I mentioned earlier, we’re looking at proposing solutions of utilizing existing capacity within the CCA system.

Again, I would liken a Puerto Rico to that type of profile that we’re looking at, where you’ve got Puerto Rico going back 12 months ago, dealing with some issues within their system growing. And we can provide compelling value with them very quickly from a cost perspective, but also provide an asset very quickly. So I’d say it’s more kind of that profile.

Clint Fendley – Davenport

Okay, got it. Thank you.

Damon Hininger

Thank you.

Operator

Our next question comes from Barry Klein from Macquarie.

Barry Klein – Macquarie

Hey. I just wanted to be – following on Kevin’s question, I’m not sure I fully understand the response. Basically, you mentioned in the release that you’d be required to distribute the accumulated E&P by the end of the calendar year preceding the REIT effective date. However, you also said on the call that you could make a retroactive decision after January 1, 2013 for January 1, 2013. So does this mean that you could distribute the E&P prior to the PLR and the decision? So if you’re – if you feel that you’re going to be making that retroactive decision in 2013, you’d really have to decide on paying out the E&P by December 31 this year. Is that correct or am I missing something?

Damon Hininger

Yeah. The E&P, it is very, very likely E&P would be distributed this year, just because like that we’re 53 days away from the 1st of the year and we’re still in a period obviously awaiting a response from the IRS. And, again, we’ve got debt on the books that have restrictions on how much we can pay out. So we still have those restrictions in place. So those would have to be not in place if we were going to do something temporarily from E&P, so hopefully, that gives you more clarity.

Barry Klein – Macquarie

So does that then prevent you from a REIT conversion, because in the release, it says tax rules applicable to REIT conversions require you to distribute the E&P before the end of the colander year?

Todd Mullenger

Yes, I can provide some clarification. This is Todd. The amount you have to distribute is calculated through the end of the preceding year. You have until the end of the year in which you make the REIT election to make that distribution.

Barry Klein – Macquarie

Got you. So you just have to make the payment during 2013, not before the end of the 2012? Okay.

Todd Mullenger

(Inaudible) like the amount through the end of the preceding year.

Barry Klein – Macquarie

Gotcha.

Damon Hininger

Yeah. And as to the last part of your question, I think we say this in the press release. We say, one, that we would obviously have to potentially have additional debt to fund the estimated cash component of the E&P distribution, but also with that, we would also have to refinance to allow us to have the flexibility to not only do the payment, but also do the amount of dividend payment we would have to do post-conversion. So we wouldn’t have those debt restrictions in place.

Barry Klein – Macquarie

Okay. And the 80% common stock, what does that – does that impact shareholders at all, I understand the 20% cash. But does that just – that doesn’t really impact that – is that just a book accounting-type thing? That doesn’t really give us anything, right?

Damon Hininger

No, there is actual shares distributed to the shareholders. So think of it as a stock dividend.

Todd Mullenger

Or split.

Damon Hininger

Or split.

Barry Klein – Macquarie

Okay. Gotcha.

Damon Hininger

But it is taxable, it is taxable to the shareholders.

Barry Klein – Macquarie

Okay. All right. Sounds good. Thanks a lot.

Damon Hininger

Thank you.

Operator

And we do have a follow-up from Kevin Campbell from Avondale Partners.

Kevin Campbell – Avondale Partners

All right. Thanks. I just wanted to ask if there are any sort of shareholder votes that are required, either prior to conversion or post conversion? And what the timing would be on that for getting your proxy out there and having a shareholder meeting, et cetera?

Damon Hininger

Yes. So there would be – as we mentioned in the press release, we would have to have approval to add provisions to the kind of REIT-related ownership restrictions that would have to be incorporated in the company’s charter.

Todd Mullenger

But there is no approval of the REIT conversion required by the shareholders.

Damon Hininger

That would be done by the board.

Kevin Campbell – Avondale Partners

So, you could get that approval, what you need from the shareholders, after the fact as well?

Damon Hininger

Yeah. Yes. After we get the ruling, yes.

Kevin Campbell – Avondale Partners

Okay. Great. And then, and just so I understand this, again, with this whole retroactive thing, it sounds like you would effectively convert January 1, 2013 without the ruling, hope to get the ruling and then if it comes back positively, you just sort of move forward? Is that right?

Damon Hininger

Yes, yeah. So that’s exactly right. Again, like I said, we’ve got a couple months until the 1st of the year, but if it did go into the early next year, then we’d have that flexibility.

Kevin Campbell – Avondale Partners

And if you get back a negative ruling from the IRS, then you just unwind it at that point?

Damon Hininger

Yeah, we just, we would kind of go back to operating as a C-corp.

Kevin Campbell – Avondale Partners

Okay. And would you have to have the shareholder – not shareholder vote, I’m sorry, the board would have to approve before January 1, 2013 that actual conversion?

Damon Hininger

No, I think, yeah, if we get the ruling after the 1st of the year and then obviously have it in hand, then the board could take the action and then, like, so we could make an election for a 2013 conversion.

Kevin Campbell – Avondale Partners

But you don’t have to do anything December 31 or effective January 1, 2013? You can wait until that ruling – you hear back from the IRS?

Todd Mullenger

Yeah, I’d characterize the actions we need to take as administrative, and some corporate entity reorganization. That all happens internally and, but as a general rule, if we have to unwind them later, there’s really no consequence, material consequence of having to unwind them or any consequence to our implementing them in the first place, if we don’t ultimately get that favorable PLR.

Kevin Campbell – Avondale Partners

Okay. So essentially by January 1, you would have all that administrative stuff set up and you would be operating as if you had the conversion, and then get the ruling? And if it’s positive, great, you move forward. And if it’s negative, you can unwind it without any real consequences.

Todd Mullenger

Yeah, that’s correct.

Damon Hininger

That’s what we’re preparing ourselves-

Kevin Campbell – Avondale Partners

Okay.

Damon Hininger

To do.

Kevin Campbell – Avondale Partners

Thank you very much.

Operator

And we do have another follow-up from Todd Van Fleet from First Analysis.

Todd Van Fleet – First Analysis

Hey, On California, with Prop 36 and understand maybe they’re looking at trying to reclassify – make other reclassifications, I guess, within their inmate populations, have you guys – do you have an understanding, would you have a guess as to how many inmates the state thinks it can reclassify and find some room for, I guess, using that approach?

Damon Hininger

Yeah, so our assessment, and I would say it’s a more of a guess, to your kind of last comment, our guess is, is that’s probably going to affect probably about 2,000, maybe 2,500 inmates, and it wouldn’t be effective immediately. So you wouldn’t necessarily have a mass release today or whenever it was put in place. These inmates would be eligible for a resentencing. So this would be a period of time where they’d have to go back or maybe, I guess, in front of a judge or a court to be resentenced. And so the assessment is, is that it would affect about 2,000 inmates, 2,500 inmates. And if all them were resentenced, then this would be over maybe a two-year, three-year, four-year period.

Todd Van Fleet – First Analysis

And that’s with respect to Prop 36 you’re referring, Damon?

Damon Hininger

That’s correct. Yes.

Todd Van Fleet – First Analysis

Okay. And is that, are there additional reclassification efforts underway in the state?

Damon Hininger

I don’t believe so, or we’re not aware of. I do know that they had another proposition on the books for getting rid of or abolishing the death penalty, but I’m not aware of any other additional initiatives.

Todd Van Fleet – First Analysis

Okay. Thank you.

Damon Hininger

Thanks, Todd.

Operator

And at this time, we have no further questions in the queue. And I’d like to turn the call back over to Mr. Hininger for any additional or closing remarks.

Damon Hininger

All right. Melissa, thank you so much, and thank you for everyone participating today and for your time and all your great questions. We’re extremely appreciative of your investment in CCA and so, your management team is continued to be focused on opportunities for not only creating more shareholder value, like Project REIT, but also executing on another good quarter and a strong end to the fiscal year. So, thanks again for participating today, and look forward to talking to you early next year.

Operator

And that does conclude our conference for today. Thank you for your participation.

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