Description
Filed with the SEC from Aug 30 to Sep 05:
Corrections Corp. Of America (CXW)
Corvex Capital and Marcato Capital, which had previously filed as a group, dissolved their shareholder agreement and commended the prison operator's progress in exploring a conversion into a REIT.
BUSINESS OVERVIEW
Overview
We are the nation’s largest owner and operator of privatized correctional and detention facilities and one of the largest prison operators in the United States behind only the federal government and three states. We currently operate 66 correctional and detention facilities, including 46 facilities that we own, with a total design capacity of approximately 91,000 beds in 20 states and the District of Columbia. We are also constructing our Jenkins Correctional Center, an additional 1,124-bed correctional facility in Millen, Georgia, under a contract awarded by the Georgia Department of Corrections. The facility, which we will own, is currently expected to be completed during the first quarter of 2012. We also own two additional correctional facilities that we lease to third-party operators.
We specialize in owning, operating, and managing prisons and other correctional facilities and providing inmate residential and prisoner transportation services for governmental agencies. In addition to providing the fundamental residential services relating to inmates, our facilities offer a variety of rehabilitation and educational programs, including basic education, religious services, life skills and employment training and substance abuse treatment. These services are intended to help reduce recidivism and to prepare inmates for their successful reentry into society upon their release. We also provide health care (including medical, dental, and psychiatric services), food services, and work and recreational programs.
Our website address is www.cca.com. We make our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), available on our website, free of charge, as soon as reasonably practicable after these reports are filed with or furnished to the Securities and Exchange Commission (the “SEC”). Information contained on our website is not part of this Annual Report.
Operations
Management and Operation of Correctional and Detention Facilities
Our customers consist of federal, state, and local correctional and detention authorities. For the years ended December 31, 2011, 2010, and 2009, federal correctional and detention authorities represented 43%, 43%, and 40%, respectively, of our total revenue. Federal correctional and detention authorities primarily consist of the Federal Bureau of Prisons, or the BOP, the United States Marshals Service, or the USMS, and the U.S. Immigration and Customs Enforcement, or ICE.
Our management services contracts typically have terms of three to five years and contain multiple renewal options. Most of our facility contracts also contain clauses that allow the government agency to terminate the contract at any time without cause, and our contracts are generally subject to annual or bi-annual legislative appropriations of funds.
We are compensated for operating and managing facilities at an inmate per diem rate based upon actual or minimum guaranteed occupancy levels. Occupancy rates for a particular facility are typically low when first opened or immediately following an expansion. However, beyond the start-up period, which typically ranges from 90 to 180 days, the occupancy rate tends to stabilize. For the years 2011, 2010, and 2009, the average compensated occupancy of our facilities, based on rated capacity, was 89.8%, 90.2%, and 90.6%, respectively, for all of the facilities we owned or managed, exclusive of facilities where operations have been discontinued.
As of December 31, 2011, we had approximately 12,300 unoccupied beds at facilities that had availability of 100 or more beds, and an additional 1,124 beds under development committed to the state of Georgia. We have staff throughout the organization actively engaged in marketing this available capacity to existing and prospective customers. Historically, we have been successful in substantially filling our inventory of available beds and the beds that we have constructed, sometimes however after considerable periods of being idle. Filling these available beds would provide substantial growth in revenues, cash flow, and earnings per share. However, we can provide no assurance that we will be able to fill our available beds.
Operating Procedures
Pursuant to the terms of our management contracts, we are responsible for the overall operations of our facilities, including staff recruitment, general administration of the facilities, facility maintenance, security, and supervision of the offenders. We are required by our contracts to maintain certain levels of insurance coverage for general liability, workers’ compensation, vehicle liability, and property loss or damage. We are also required to indemnify the contracting agencies for claims and costs arising out of our operations and, in certain cases, to maintain performance bonds and other collateral requirements. Approximately 88% of the facilities we operated at December 31, 2011 were accredited by the American Correctional Association Commission on Accreditation. The American Correctional Association, or ACA, is an independent organization comprised of corrections professionals that establish accreditation standards for correctional and detention institutions.
We provide a variety of rehabilitative and educational programs at our facilities. Inmates at most facilities we manage may receive basic education through academic programs designed to improve literacy levels and the opportunity to acquire GED certificates. We also offer vocational training to inmates who lack marketable job skills. Our craft vocational training programs are accredited by the National Center for Construction Education and Research. This foundation provides training curriculum and establishes industry standards for over 4,000 construction and trade organizations in the United States and several foreign countries. In addition, we offer life skills transition-planning programs that provide inmates with job search skills, health education, financial responsibility training, parenting training, and other skills associated with becoming productive citizens. At many of our facilities, we also offer counseling, education and/or treatment to inmates with alcohol and drug abuse problems through our “Strategies for Change” and Residential Drug Addictions Treatment Program, or RDAP. Equally significant, we offer cognitive behavioral programs aimed at changing the anti-social attitudes and behaviors of offenders, and faith-based and religious programs that offer all offenders the opportunity to practice their spiritual beliefs. These programs incorporate the use of thousands of volunteers, along with our staff, that assist in providing guidance, direction, and post-incarceration services to offenders. We believe these programs help reduce recidivism.
We operate our facilities in accordance with both company and facility-specific policies and procedures. The policies and procedures reflect the high standards generated by a number of sources, including the ACA, The Joint Commission, the National Commission on Correctional Healthcare, the Occupational Safety and Health Administration, federal, state, and local government guidelines, established correctional procedures, and company-wide policies and procedures that may exceed these guidelines. Outside agency standards, such as those established by the ACA, provide us with the industry’s most widely accepted operational guidelines. We have sought and received accreditation for 58 of the facilities we operated as of December 31, 2011, and we intend to apply for ACA accreditation for all of our eligible facilities that are not currently accredited where it is economically feasible to complete the 18-24 month accreditation process. Our facilities not only operate under these established standards, but they are consistently challenged by management to exceed them. This challenge is presented, in large part, through our extensive and comprehensive Quality Assurance Program.
Our Quality Assurance Division independently operates under the auspices of, and reports directly to, the Company’s Office of General Counsel. The Company has devoted significant resources to the Quality Assurance Division, enabling us to monitor our facilities’ compliance with contractual requirements, as well as outside agency and accrediting organization standards and guidelines. The Quality Assurance Division oversees all efforts by our facilities to deliver high quality services and operations, with an absolute commitment to continuous quality improvement through the efforts of two major sections: the Research and Analysis Section and the Audit and Compliance Systems Section.
The Research and Analysis Section collects and analyzes performance metrics across multiple databases. Through rigorous reporting and analyses of comprehensive, comparative statistics across disciplines, divisions, business units and the Company as a whole, the Research and Analysis Section provides timely, independently generated performance and trend data to senior management. The Audit and Compliance Systems Section consists of two full time audit teams comprised of subject matter experts from all major disciplines within institutional operations, as well as management staff that oversee the process. The Audit and Compliance Systems Section coordinates the development of performance measurement tools with subject matter experts and other stakeholders having risk management responsibilities. Routinely, these two audit teams conduct rigorous, on site annual evaluations of each facility we operate with no advance notice. Highly specialized, discipline- specific audit tools, containing over 1,600 audited items across eleven major operational areas, are employed in this detailed, comprehensive process. The results of these on site evaluations are used to discern areas of operational strength and areas in need of management attention. The audit findings also comprise a major part of our continuous operational risk assessment and management process. Audit teams are also available to work with facilities on specific areas of need, such as meeting requirements of new partner contracts or providing detailed training of new departmental managers. In addition, our Quality Assurance Division contracts with teams of seasoned, ACA certified correctional auditors to help ensure continuous compliance with ACA standards at accredited facilities. Our teams of auditors are deployed several times a year as well (in advance of contractually mandated ACA accreditation audits) to help ensure that our facilities are operating at the highest possible levels.
Prisoner Transportation Services
We currently provide transportation services to governmental agencies through our wholly-owned subsidiary, TransCor America, LLC, or TransCor. During the years ended December 31, 2011, 2010, and 2009, TransCor generated total consolidated revenue of $3.6 million, $4.0 million, and $4.0 million, respectively, 0.2% of our total consolidated revenue in each of those years. We believe TransCor provides a complementary service to our core business that enables us to respond quickly to our customers’ transportation needs.
Business Development
We are currently the nation’s largest provider of outsourced correctional management services. We believe we manage approximately 45% of all beds under contract with private operators of correctional and detention facilities in the United States. Under the direction of our partnership development department and senior management and with the aid, where appropriate, of certain independent consultants, we market our services to government agencies responsible for federal, state, and local correctional and detention facilities in the United States.
Business from our federal customers, including primarily the BOP, USMS, and ICE, continues to be a significant component of our business accounting for 43%, 43%, and 40% of total revenue in 2011, 2010, and 2009, respectively. The BOP, USMS, and ICE, along with the State of California Department of Corrections and Rehabilitation ("CDCR"), were our only customers that accounted for 10% or more of our total revenue during these years. The BOP accounted for 12%, 15%, and 13% of total revenue for 2011, 2010, and 2009, respectively. The USMS accounted for 20%, 16%, and 15% of total revenue for 2011, 2010, and 2009, respectively. ICE accounted for 12% of total revenue for each of 2011, 2010, and 2009. Certain federal contracts contain “take-or-pay” clauses that guarantee us a certain amount of management revenue, regardless of occupancy levels.
Business from our state customers, which constituted 50%, 50%, and 52% of total revenue during 2011, 2010, and 2009, respectively, increased 3.2% from $838.5 million during 2010 to $865.4 million during 2011. The CDCR accounted for 13%, 13%, and 11% of total revenue for 2011, 2010, and 2009, respectively.
Despite the increase in management revenue in 2011, economic conditions remain challenging, putting continued pressure on our government partners’ budgets. Some states may be forced to further reduce their expenses if their tax revenues, which typically lag the overall economy, do not meet their expectations. Actions to control their expenses could include reductions in inmate populations through early release programs, alternative sentencing, or inmate transfers from facilities managed by private operators to facilities operated by the state or other local jurisdictions. Further, certain states have requested, and additional state customers could request, reductions in per diem rates or that we forego prospective rate increases in the future as methods of addressing the budget shortfalls they may be experiencing. We believe we have been successful in working with our government partners to help manage their correctional costs while minimizing the financial impact to us, and will continue to provide unique solutions to their correctional needs. We believe the long-term growth opportunities of our business remain very attractive as certain states consider efficiency and savings opportunities we can provide. Further, we expect insufficient bed development by our partners to result in a return to the supply and demand imbalance that has benefited the private corrections industry.
Facilities Under Construction or Development
In early 2008, we announced our intention to construct a new 2,040-bed correctional facility in Trousdale County, Tennessee. However, during the first quarter of 2009, we temporarily suspended the construction of this facility until we have greater clarity around the timing of future bed absorption by our customers. We will continue to monitor our customers’ needs, and could promptly resume construction of the facility.
In September 2010, we announced that we were awarded a contract by the Georgia Department of Corrections to manage up to 1,150 male inmates in the Jenkins Correctional Center, which will be constructed, owned and operated by us in Millen, Georgia. We commenced development of the new Jenkins Correctional Center during the third quarter of 2010, with an estimated total construction cost of approximately $51.0 million. Construction is expected to be completed during the first quarter of 2012. The contract has an initial one-year base term with 24 one-year renewal options. Additionally the contract provides for a population guarantee of 90% following a 120-day ramp-up period.
In October 2011, we announced that pursuant to a competitive re-bid we received a new contract from the BOP for the expansion and continued management of our McRae Correctional Facility in McRae, Georgia. Under the new contract we will have the ability to house up to 2,275 male inmates for the BOP after completing a 454-bed expansion of the McRae facility. We began the 454-bed expansion of the McRae facility in the fourth quarter of 2011 and expect construction to be complete in the fourth quarter of 2012. The total cost of the expansion is estimated to be approximately $17.1 million.
In order to retain federal inmate populations we currently manage in the San Diego Correctional Facility, we will be required to construct a new facility in the future at a site we are currently developing. The San Diego Correctional Facility is subject to a ground lease with the County of San Diego. Under the provisions of the lease, the facility is divided into different premises whereby, pursuant to an amendment to the ground lease executed in January 2010, ownership of the entire facility reverts to the County upon expiration of the lease on December 31, 2015. As of December 31, 2011, we have invested approximately $44.0 million to acquire property, conduct environmental studies, obtain building permits, and complete various other design activities. We have developed plans to build a detention facility and a construction timeline that coincides with the expiration of the ground lease with the County of San Diego. We currently estimate the total construction cost, inclusive of land and site development costs already incurred, will range from approximately $142.0 million to $150.0 million. We plan to use this new facility to house the existing federal inmate populations at the San Diego Correctional Facility. However, we can provide no assurance that we will be able to retain these inmate populations.
Competitive Strengths
We believe that we benefit from the following competitive strengths:
The Largest and Most Recognized Private Prison Operator. Our recognition as the industry’s leading private prison operator provides us with significant credibility with our current and prospective clients. We believe we manage approximately 45% of all privately managed prison beds in the United States. We pioneered modern-day private prisons with a list of notable accomplishments, such as being the first company to design, build, and operate a private prison, the first company to manage a private maximum-security facility under a direct contract with the federal government and, most recently, the first company to purchase a government-owned correctional facility from a governmental agency in the United States and to manage the facility for the government agency. In addition to providing us with extensive experience and institutional knowledge, our size also helps us deliver value to our customers by providing purchasing power and allowing us to achieve certain economies of scale.
Available Beds within Our Existing Facilities. As of December 31, 2011, we had approximately 12,300 unoccupied beds in facilities that had availability of 100 or more beds, and an additional 1,124 beds under construction committed to the state of Georgia. We have staff throughout the organization actively engaged in marketing this available capacity to existing and prospective customers. Historically, we have been successful in substantially filling our inventory of available beds and the beds that we have constructed. Filling these available beds would provide substantial growth in revenues, cash flow, and earnings per share. However, we can provide no assurance that we will be able to fill our available beds.
CEO BACKGROUND
JOHN D. FERGUSON Director since 2000
Mr. Ferguson, age 66, has served as a director since August 2000 and also serves as Chairman of our Board and member of our Executive Committee. Mr. Ferguson formerly served as our Chief Executive Officer from August 2000 to October 2009 and as our President from August 2000 until July 2008. Mr. Ferguson’s career in business and government includes service as the Commissioner of Finance for the State of Tennessee and as the chairman and chief executive officer of Community Bancshares, Inc., the parent corporation of The Community Bank of Germantown (Tennessee), as well as service on the State of Tennessee Board of Education and the Governor’s Commission on Practical Government for the State of Tennessee. Mr. Ferguson serves as a director of the Community Foundation of Middle Tennessee, the Boy Scouts of America - Middle Tennessee Council, the Nashville Symphony Association and the Nashville Public Education Foundation. Mr. Ferguson graduated from Mississippi State University in 1967.
In making the decision to nominate Mr. Ferguson to serve as a director, the Nominating and Governance Committee considered, in addition to the criteria referred to above, Mr. Ferguson’s knowledge of the Company and its business and management team by virtue of his past service as our President and Chief Executive Officer; his demonstrated business acumen and leadership skills; his understanding of government gained through his experience in state government; and his civic and community involvement.
DAMON T. HININGER Director since 2009
Damon T. Hininger, age 42, has served as a director and our President and Chief Executive Officer since October 2009. From July 2008 until October 2009, Mr. Hininger served as our President and Chief Operating Officer. From 2007 until July 2008, Mr. Hininger served as our Senior Vice President, Federal and Local Customer Relations. Mr. Hininger joined the Company in 1992 and held several positions, including Vice President, Business Analysis and Vice President, Federal Customer Relations before being promoted to Senior Vice President. Mr. Hininger earned a bachelor’s degree from Kansas State University and an M.B.A. from the Jack Massey School of Business at Belmont University.
In making the decision to nominate Mr. Hininger to serve as a director, the Nominating and Governance Committee considered, in addition to the criteria referred to above, his current service as our President and Chief Executive Officer and his comprehensive knowledge of the Company, its business, operations and management team through his current position and past roles with the Company, including roles at the facility operations level and as Chief Operations Officer and Senior Vice President, Federal and Local Customer Relations.
DONNA M. ALVARADO Director since 2003
Ms. Alvarado, age 63, has served as a director and member of our Audit Committee since December 2003. Ms. Alvarado is the founder and current president of Aguila International, an international business-consulting firm that specializes in human resources and leadership development. She also serves as a director and member of the audit and compensation committees of CSX Corporation, a publicly-traded provider of rail and other transportation services, as a director of Park National Bank, the lead affiliate bank of Park National Corporation, a publicly-held bank holding company, and as a member and the immediate past Chairwoman of the Ohio Board of Regents. Ms. Alvarado has held senior management positions in government, including Deputy Assistant Secretary of Defense with the U.S. Department of Defense and Director of ACTION, the federal domestic volunteer agency. Ms. Alvarado earned both a master’s and a bachelor’s degree in Spanish from Ohio State University, completed doctoral coursework in Latin American Literature at the University of Oklahoma and earned a postgraduate certificate in Financial Management from the Wharton School of Business at the University of Pennsylvania.
In making the decision to nominate Ms. Alvarado to serve as a director, the Nominating and Governance Committee considered, in addition to the criteria referred to above, her understanding of government through her public sector experience; her experience as a public company director and audit committee member; her human resources and leadership development expertise; her civic and community involvement; and her contribution to the Board’s gender and cultural diversity.
WILLIAM F. ANDREWS Director since 2000
Mr. Andrews, age 80, has served as a director since August 2000. Mr. Andrews also serves as Chair of our Executive Committee. From August 2000 until July 2008, Mr. Andrews served as Chairman of our Board. Mr. Andrews has been a principal of Kohlberg & Company, a private equity firm specializing in middle market investing, since 1995. He also currently serves as chairman of Katy Industries, Inc., a publicly-traded diversified manufacturing company with consumer and commercial product lines; a director of Black Box Corporation, a publicly-traded provider of information technology infrastructure solutions; a director of Trex Corporation, a publicly-traded producer of decking and railing products; a director of O’Charley’s Inc., a publicly-traded restaurant company; and a director of SVP Holdings, Ltd., Central Parking Corporation and Thomas Nelson Publishing, all private companies. Mr. Andrews is a graduate of the University of Maryland and received an M.B.A. from Seton Hall University. Mr. Andrews was selected as an Outstanding Director of the Year in 2011 by ODX, a division of the Financial Times.
In making the decision to nominate Mr. Andrews to serve as a director, the Nominating and Governance Committee considered, in addition to the criteria referred to above, Mr. Andrews’ past or current experience as a director of several publicly-traded companies, including his experience as Chairman of our Board; his leadership and oversight experience across a diverse array of industries; and his knowledge and experience with respect to corporate finance and investing.
JOHN D. CORRENTI Director since 2000
Mr. Correnti, age 65, has served as a director since December 2000 and is a member of our Compensation Committee. Mr. Correnti is the chairman and executive officer of Steel Development Company, a steel development and operations company. Mr. Correnti served as chief executive officer of SeverCorr, LLC, a steel mill operator, from 2005 through January 2008 and as chairman and chief executive officer of SteelCorr, LLC from 2002 through 2005. Mr. Correnti also serves as a director of Navistar International Corporation, a publicly traded holding company of transportation related and other businesses, and as executive chairman of Silicor Materials, a private company formerly known as Calisolar. Mr. Correnti holds a B.S. degree in civil engineering from Clarkson University.
In making the decision to nominate Mr. Correnti to serve as a director, the Nominating and Governance Committee considered, in addition to the criteria referred to above, his executive leadership experience gained through his service as a chief executive of established and start-up companies, both public and private, and his public company director experience.
DENNIS W. DECONCINI Director since 2008
Mr. DeConcini, age 74, was appointed as a director and member of our Nominating and Governance Committee in February 2008. Mr. DeConcini served as a member of the United States Senate as a Senator from Arizona for three terms (18 years). During his Senate tenure, he served on the Senate Select Committee on Intelligence (as Chairman from 1993 – 1994), the Judiciary Committee and the Appropriations Committee, and served as rotating Chairman to the Commission on Security and Cooperation in Europe (the Helsinki Commission). He currently is a partner in the law firm DeConcini McDonald Yetwin & Lacy, P.C. in Tucson, Arizona. He also is a member of the Arizona Board of Regents, the governing body for the Arizona State University system, and the boards of directors of both the National and International Centers for Missing and Exploited Children. He also served as county attorney for Pima County, Arizona from 1973 through 1976. Mr. DeConcini served in the United States Army and Reserve from 1959 to 1967. He received his B.A. from the University of Arizona in 1959 and his L.L.B. from the University of Arizona in 1963.
In making the decision to nominate Mr. DeConcini to serve as a director, the Nominating and Governance Committee considered, in addition to the criteria referred to above, his understanding of government, politics and the public sector through his service as a United States Senator, a member of the Arizona Board of Regents and as a registered lobbyist; his understanding of and experience with the State of Arizona, a state where a significant portion of our operations is located; his understanding of corporate governance, legal and compliance matters through his education and background as a lawyer and former prosecutor; and his civic and community involvement.
JOHN R. HORNE Director since 2001
Mr. Horne, age 74, has served as a director since December 2001 and is a member of our Compensation Committee. Mr. Horne served as chairman of Navistar International Corporation from April 1996 to February 2004 and prior to that as Navistar’s president and chief executive officer. Mr. Horne currently serves on the board of directors of Junior Achievement of Chicago. Mr. Horne received his M.S. degree in mechanical engineering from Bradley University in 1964, a B.S. degree in mechanical engineering from Purdue University in 1960, which also awarded him an Honorary Doctor of Engineering degree in May 1998, and is a graduate of the management program at Harvard Graduate School of Business Administration.
In making the decision to nominate Mr. Horne to serve as a director, the Nominating and Governance Committee considered, in addition to the criteria referred to above, his leadership experience as chairman and as chief executive officer of a large, publicly traded industrial company and his extensive educational and business achievements.
C. MICHAEL JACOBI Director since 2000
Mr. Jacobi, age 70, has served as a director and as Chair of the Audit Committee since December 2000. Mr. Jacobi is the owner and president of Stable House, LLC, a private company engaged in residential real estate development. From June 2001 through May 2005, Mr. Jacobi served as the president and chief executive officer and a director of Katy Industries, Inc., a publicly-traded diversified manufacturing company. He is chairman of the board of Sturm, Ruger and Company, Inc., a publicly-traded maker of firearms, a director of Webster Financial Corporation, a publicly-traded banking and financial services company, and a director and member of the audit committee of Kohlberg Capital Corporation, a publicly-traded business development company specializing in term loans, mezzanine investments and selected equity positions in middle market companies. Mr. Jacobi is a certified public accountant and holds a B.S. degree from the University of Connecticut.
In making the decision to nominate Mr. Jacobi to serve as a director, the Nominating and Governance Committee considered, in addition to the criteria referred to above, his leadership experience as chief executive officer and chief financial officer of a public company; his extensive experience as a public company director and audit committee member and chairman; and his financial and accounting experience and expertise.
ANNE L. MARIUCCI Director since 2011
Ms. Mariucci, age 54, has served as a director since December 2011. Ms. Mariucci is affiliated with the private equity firms Hawkeye Partners (Austin, Texas), Inlign Capital Partners (Phoenix, Arizona), and Glencoe Capital (Chicago, Illinois) since 2003. Prior to 2003, Ms. Mariucci was employed by Del Webb Corporation in a variety of senior management capacities involved in the large-scale community development and home building business, including serving as President following its merger with Pulte Homes, Inc. Ms. Mariucci received her undergraduate degree in accounting and finance from the University of Arizona and completed the corporate finance program at the Stanford University Graduate School of Business. She presently serves on the Arizona Board of Regents, and is its immediate past-chairman. She also serves as a director of Southwest Gas Company, Scottsdale Healthcare, the Arizona State University Foundation, and the Fresh Start Women’s Foundation. She is a past director of the Arizona State Retirement System and Action Performance Companies, as well as a past Trustee of the Urban Land Institute.
In making the decision to nominate Ms. Mariucci to serve as a director, the Nominating and Governance Committee considered, in addition to the criteria referred to above, her public company executive leadership experience; her understanding of and experience with the State of Arizona, a state where a significant portion of our operations is located; her background in accounting and corporate finance; her experience and knowledge with real estate; her experience as a public company director and member of audit and compensation committees; her civic and community involvement; and her contribution to the Board’s gender diversity.
THURGOOD MARSHALL, JR. Director since 2002
Mr. Marshall, age 55, has served as a director and member of the Nominating and Governance Committee since December 2002. Mr. Marshall is a partner in the law firm of Bingham McCutchen LLP in Washington D.C., and a principal in Bingham Consulting Group LLC, a wholly owned subsidiary of Bingham McCutchen LLP that assists business clients with communications, political and legal strategies. Mr. Marshall, the son of the historic Supreme Court Justice Thurgood Marshall, has held appointments in each branch of the federal government, including Cabinet Secretary to President Clinton and Director of Legislative Affairs and Deputy Counsel to Vice President Al Gore. In November of 2011, Mr. Marshall was appointed as the Chairman of the Board of Governors of the United States Postal Service. In March of 2012, he was appointed to the board of directors of Genesco, a publicly traded specialty retailer. He also serves on the boards of the Ford Foundation and the Supreme Court Historical Society. He serves on the American Bar Association Election Law Committee and the Ethics Oversight Committee of the United States Olympic Committee. Mr. Marshall earned a B.A. in 1978 and a J.D. in 1981 from the University of Virginia, after which he clerked for United States District Judge Barrington D. Parker.
In making the decision to nominate Mr. Marshall to serve as a director, the Nominating and Governance Committee considered, in addition to the criteria referred to above, his understanding of politics and the public sector through his varied government service and consulting work; his understanding of organizational governance and oversight through his service as a director in the public, non-profit and for-profit sectors; his understanding of legal, regulatory and compliance issues through his education and experience as a lawyer; and his contribution to the Board’s cultural diversity.
CHARLES L. OVERBY Director since 2001
Mr. Overby, age 65, has served as a director since December 2001. Mr. Overby has served as a member of the Audit Committee since February 2002 and as the Chair of the Nominating and Governance Committee since the committee was established in December 2002. From 1997 through 2011, Mr. Overby was the chairman and chief executive officer of The Freedom Forum, an independent, non-partisan foundation dedicated to the First Amendment and media issues, as well as chief executive officer of its affiliates, The Diversity Institute and the Newseum, a museum about news and history in Washington, D.C. Mr. Overby continues to serve on the Board of Trustees of the Freedom Forum. Mr. Overby is a former Pulitzer Prize-winning editor in Jackson, Mississippi. He worked 16 years for Gannett Co., the nation’s largest newspaper company, in various capacities, including as reporter, editor, and corporate executive. He was vice president for news and communications for Gannett and served on the management committees of Gannett and USA TODAY. Mr. Overby currently serves on the boards of the Horatio Alger Association of Distinguished Americans and the University of Mississippi Foundation.
In making the decision to nominate Mr. Overby to serve as a director, the Nominating and Governance Committee considered, in addition to the criteria referred to above, his executive leadership experience and understanding of corporate governance as chief executive of several non-profit organizations; his understanding of media and public relations through his career as a journalist, print media executive and executive with other media related organizations; his political experience; and his civic and community involvement and leadership.
JOHN R. PRANN, JR. Director since 2000
Mr. Prann, age 61, has served as a director and member of the Compensation Committee since December 2000. Mr. Prann’s business experience includes service as the president and chief executive officer of Katy Industries, Inc., as a partner with the accounting firm of Deloitte & Touche and as a director of several private companies. Mr. Prann earned a B.A. in Biology from the University of California, Riverside and an M.B.A. from the University of Chicago.
In making the decision to nominate Mr. Prann to serve as a director, the Nominating and Governance Committee considered, in addition to the criteria referred to above, his executive leadership experience as president and chief executive of a public company and his understanding of accounting and finance issues through his education and career.
JOSEPH V. RUSSELL Director since 1999
Mr. Russell, age 71, has served as a director since 1999. Mr. Russell is the Chair of the Compensation Committee and a member of the Executive and the Nominating and Governance Committees. Mr. Russell is the co-chairman and co-chief executive officer of Elan-Polo, Inc., a privately-held, world-wide producer and distributor of footwear. Mr. Russell graduated from the University of Tennessee in 1963 with a B.S. in Finance.
In making the decision to nominate Mr. Russell to serve as a director, the Nominating and Governance Committee considered, in addition to the criteria referred to above, his experience as the owner and chief executive officer of a manufacturing company; his familiarity with the Company through his long tenure as a Director; his demonstrated leadership skills as a director and Chair of the Compensation Committee; and his knowledge, experience and judgment with respect to executive compensation issues.
HENRI L. WEDELL Director since 2000
Mr. Wedell, age 70, has served as a director and member of the Audit Committee since December 2000. Mr. Wedell is a private investor in Memphis, Tennessee. Prior to his retirement in 1999, Mr. Wedell was the senior vice president of sales of The Robinson Humphrey Co., an investment banking subsidiary of Smith-Barney, Inc., with which he was employed for over 24 years. Mr. Wedell’s business career also includes service as a member of the board of directors of Community Bancshares, Inc. He currently serves on the boards of the Dixon Gallery and Gardens of Memphis, Tennessee and the Exceptional Foundation of West Tennessee. Mr. Wedell earned an M.B.A. from the Tulane University School of Business.
In making the decision to nominate Mr. Wedell to serve as a director, the Nominating and Governance Committee considered, in addition to the criteria referred to above, his understanding of accounting and corporate finance issues through his career in the securities industry; his perspective as a private investor and significant stockholder of the Company; and his civic and community involvement.
MANAGEMENT DISCUSSION FROM LATEST 10K
OVERVIEW
We currently operate 66 facilities, including 46 facilities that we own, with a total design capacity of approximately 91,000 beds in 20 states and the District of Columbia. We also own two additional correctional facilities that we lease to third-party operators. We are also constructing an additional correctional facility in Millen, Georgia, under a contract awarded by the Georgia Department of Corrections. The Jenkins Correctional Center, which we will own, is expected to house approximately 1,150 inmates and be completed during the first quarter of 2012. We are the nation’s largest owner and operator of privatized correctional and detention facilities and one of the largest prison operators in the United States behind only the federal government and three states. Our size and experience provide us with significant credibility with our current and prospective customers, and enable us to generate economies of scale in purchasing power for food services, health care and other supplies and services we offer to our government partners.
We are compensated for operating and managing prisons and correctional facilities at an inmate per diem rate based upon actual or minimum guaranteed occupancy levels. The significant expansion of the prison population in the United States has led to overcrowding in the federal and state prison systems, providing us with opportunities for growth. Federal, state, and local governments are constantly under budgetary constraints putting pressure on governments to control correctional budgets, including per diem rates our customers pay to us as well as pressure on appropriations for building new prison capacity. These pressures have been compounded by the recent economic downturn. Economic conditions remain very challenging, putting continued pressure on government budgets. All of our state partners have balanced budget requirements, which may force them to further reduce their expenses if their tax revenues, which typically lag the overall economy, do not meet their expectations. Actions to control their expenses could include reductions in inmate populations through early release programs, alternative sentencing, or inmate transfers from facilities managed by private operators to facilities operated by the state or other local jurisdictions. Further, certain government partners have requested, and additional government partners could request, reductions in per diem rates or request that we forego prospective rate increases in the future as methods of addressing the budget shortfalls they may be experiencing. We believe we have been successful in working with our government partners to help them manage their correctional costs while minimizing the financial impact to us, and will continue to provide unique solutions to their correctional needs. We believe the long-term growth opportunities of our business remain very attractive as certain states consider efficiency and savings opportunities we can provide. Further, we expect insufficient bed development by our partners to result in a return to the supply and demand imbalance that has benefited the private corrections industry.
Governments continue to experience many significant spending demands which have constrained correctional budgets limiting their ability to expand existing facilities or construct new facilities. We believe the outsourcing of prison management services to private operators allows governments to manage increasing inmate populations while simultaneously controlling correctional costs and improving correctional services. We believe our customers discover that partnering with private operators to provide residential services to their inmates introduces competition to their prison system, resulting in improvements to the quality and cost of corrections services throughout their correctional system. Further, the use of facilities owned and managed by private operators allows governments to expand correctional capacity without incurring large capital commitments and allows them to avoid long-term pension obligations for their employees.
We also believe that having beds immediately available to our partners provides us with a distinct competitive advantage when bidding on new contracts. While we have been successful in winning contract awards to provide management services for facilities we do not own, and will continue to pursue such management contracts, we believe the most significant opportunities for growth are in providing our government partners with available beds within facilities we currently own or that we develop. We also believe that owning the facilities in which we provide management services enables us to more rapidly replace business lost compared with managed-only facilities, since we can offer the same beds to new and existing customers and, with customer consent, may have more flexibility in moving our existing inmate populations to facilities with available capacity. Our management contracts generally provide our customers with the right to terminate our management contracts at any time without cause.
As of December 31, 2011, we had approximately 12,300 unoccupied beds in inventory at facilities that had availability of 100 or more beds, and an additional 1,124 beds under development committed to the state of Georgia. We have staff throughout the organization actively engaged in marketing this available capacity to existing and prospective customers. Historically, we have been successful in substantially filling our inventory of available beds and the beds that we have constructed. Filling these available beds would provide substantial growth in revenues, cash flow, and earnings per share. However, we can provide no assurance that we will be able to fill our available beds.
Although the demand for prison beds in the short term has been affected by the severe budget challenges many of our customers currently face, these challenges put further pressure on our customers’ ability to construct new prison beds of their own, which we believe could result in further reliance on the private sector for providing the capacity we believe our customers will need in the long term. We will continue to pursue build-to-suit opportunities like the aforementioned 1,124-bed Jenkins Correctional Center we are constructing for the state of Georgia, where the availability of our bed capacity is not in a location acceptable to a customer and where the returns meet our minimum threshold for new investment. Further, we will also continue to pursue purchases of state-owned facilities such as our recent purchase of the 1,798-bed Lake Erie Correctional Institution from the state of Ohio, which we believe represents the first purchase of its kind (e.g. with a management contract) by a private corrections operator of a correctional facility from a state, which we believe signifies that states are looking for innovative solutions to their budgetary challenges. In the long-term, we would like to see continued and meaningful utilization of our remaining capacity and better visibility from our customers before we add any additional capacity on a speculative basis.
We also remain steadfast in our efforts to contain costs. Approximately 64% of our operating expenses consist of salaries and benefits. The turnover rate for correctional officers for our company, and for the corrections industry in general, remains high. Although we have been successful in containing workers’ compensation and medical benefits costs for our employees, such costs continue to increase primarily as a result of continued rising healthcare costs throughout the country. Reducing these staffing costs requires a long-term strategy to control such costs, and we continue to dedicate resources to enhance our benefits, provide training and career development opportunities to our staff and attract and retain quality personnel. Recognizing the challenges we faced as a result of the economic downturn, our efforts to contain costs were intensified, as we implemented a company-wide initiative to improve operating efficiencies, and established a framework for accelerating the process and ensuring continuous delivery over the long-term. We continue to generate favorable results from this initiative.
Through the combination of our initiatives to increase our revenues by taking advantage of our available beds as well as delivering new bed capacity through new facility construction and expansion opportunities, and our strategies to contain our operating expenses, we believe we will be able to maintain our competitive advantage and continue to improve the quality services we provide to our customers at an economical price, thereby producing value to our stockholders.
We re-perform the impairment analyses on an annual basis for each of the idle facilities and for the suspended construction project, and evaluate on a quarterly basis market developments for the potential utilization of each of these facilities in order to identify events that may cause us to reconsider our most recent assumptions. Such events could include negotiations with a prospective customer for the utilization of an idle facility at terms significantly less favorable than used in our most recent impairment analysis, or changes in legislation surrounding a particular facility that could impact our ability to house certain types of inmates at such facility. Further, a substantial increase in the number of available beds at other facilities we own could lead to a deterioration in market conditions and cash flows that we might be able to obtain under a new management contract at our idle facilities. We have historically secured contracts with customers at existing facilities that were already operational, allowing us to move the existing population to other idle facilities. Although they are not frequently received, an unsolicited offer to purchase any of our idle facilities, or facilities under construction in the case of the Trousdale project, at amounts that are less than the carrying value could also cause us to reconsider the assumptions used in our most recent impairment analysis. We have identified recent prospects to utilize each of the currently idled facilities and do not see any catalysts that would result in an impairment in the near term. However, we can provide no assurance that we will be able to secure management contracts to utilize our idle facilities, or that we will not incur impairment charges in the future.
The estimates of recoverability are initially based on projected undiscounted cash flows that are comparable to historical cash flows from management contracts at similar facilities to the idled facilities and sensitivity analyses that consider reductions to such cash flows. Our sensitivity analyses included reductions in projected cash flows by as much as half of the historical cash flows generated by the respective facility as well as prolonged periods of vacancies. In all cases except for our Shelby Training Center, the projected undiscounted cash flows in our analyses as of December 31, 2011, exceeded the carrying amounts of each facility by material amounts. The Shelby Training Center is a facility much smaller in size than almost all of our other facilities, and was designed as a non-secure juvenile detention facility, which is atypical for our portfolio. In the case of the Shelby Training Center, our estimate of fair value took into consideration proposed purchase prices where third parties have expressed an interest in purchasing this facility, and estimates of the replacement cost of the facility based on our extensive experience in designing and constructing prison facilities. Our estimate of the fair value exceeded the carrying value of this facility.
In the case of the construction project in Trousdale County, Tennessee, we temporarily suspended the construction until we have greater clarity around the timing of future bed absorption by our customers. The $29.0 million carrying amount includes $0.6 million in equipment and $15.2 million of pre-fabricated concrete cells that are constructed and being stored on this site but are transferable to other potential development projects we may commence in the future should we identify a more immediate use. We continually monitor and perform any routine maintenance on these pre-fabricated concrete cells to ensure they maintain their value. We incurred operating expenses of $0.1 million primarily for property insurance, property taxes, and repairs and maintenance for this project during 2011. Our impairment analysis of this project considers both the costs to complete the facility and an estimate of cash flows based on historical cash flows from management contracts at similar facilities. We continue to pursue prospects which would indicate the need for the ultimate completion of construction of the Trousdale County facility, and will continue to monitor developments that may impact our most recent assumptions. Although we are not currently considering a decision to abandon this site, a decision to transfer the pre-fabricated cells to another development project and to abandon the Trousdale County project site would cause us to reconsider our assumptions related to the recoverability of the land and site development costs incurred compared to a prospective sales price we might be able to obtain for the land.
Our evaluations also take into consideration our historical experience in securing new management contracts to utilize facilities that had been previously idled for periods comparable to or in excess of the periods our currently idle facilities have been idle. Such previously idle facilities are currently being operated under contracts that generate cash flows resulting in the recoverability of the net book value of the previously idled facilities by substantial amounts. Due to a variety of factors, the lead time to negotiate contracts with our federal and state partners to utilize idle bed capacity is generally lengthy which has historically resulted in periods of idleness similar to the ones we are currently experiencing at these facilities. As a result of our analyses, we determined each of these assets to have recoverable values in excess of the corresponding carrying values.
By their nature, these estimates contain uncertainties with respect to the extent and timing of the respective cash flows due to potential delays or material changes to historical terms and conditions in contracts with prospective customers that could impact the estimate of cash flows. Notwithstanding the effects the current economy has had on our customers’ demand for prison beds in the short term which has led to our decision to idle certain facilities, we believe the long-term trends favor an increase in the utilization of our correctional facilities and management services. This belief is also based on our experience in operating in recessionary environments and based on our experience in working with governmental agencies faced with significant budgetary challenges which is a primary contributing factor to the lack of appropriated funding to build new bed capacity by the federal and state governments with which we partner.
Goodwill impairments . As of December 31, 2011, we had $12.0 million of goodwill related to certain of our managed-only facilities. We evaluate the carrying value of goodwill during the fourth quarter of each year, in connection with our annual budgeting process, and whenever circumstances indicate the carrying value of goodwill may not be recoverable. Such circumstances primarily include, but are not limited to, the termination of a management contract or a significant decrease in inmate populations within a reporting unit.
In September 2011, the Financial Accounting Standards Board issued Accounting Standards Update ("ASU") 2011-08 that gives companies the option to perform a qualitative assessment that may allow them to skip the annual two-step impairment test. Under the amendments in ASU 2011-08, a company has the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events or circumstances, an entity determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then performing the two-step impairment test is unnecessary. If the two-step impairment test is required, we determine the fair value of a reporting unit using a collaboration of various common valuation techniques, including market multiples and discounted cash flows. We evaluated our goodwill for impairment in the fourth quarter by using the qualitative factors described in ASU 2011-08 and concluded that it was not more likely than not that the fair value of our reporting units was less than the carrying amounts thus allowing us to forego the two-step impairment test. We do not expect our estimates or assumptions used in this analysis to change in the near term such that they would trigger an impairment of goodwill, except for notification of a contract termination or non-renewal of a contract by a customer at a managed-only facility with goodwill. Each of these techniques requires considerable judgment and estimations which could change in the future.
Income taxes. Deferred income taxes reflect the available net operating losses and the net tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Realization of the future tax benefits related to deferred tax assets is dependent on many factors, including our past earnings history, expected future earnings, the character and jurisdiction of such earnings, unsettled circumstances that, if unfavorably resolved, would adversely affect utilization of our deferred tax assets, carryback and carryforward periods, and tax planning strategies that could potentially enhance the likelihood of realization of a deferred tax asset.
We have approximately $3.9 million in net operating losses applicable to various states that we expect to carry forward in future years to offset taxable income in such states. We have a valuation allowance of $0.7 million for the estimated amount of the net operating losses that will expire unused. In addition, we have $5.1 million of state tax credits applicable to various states that we expect to carry forward in future years to offset taxable income in such states. We have a $1.8 million valuation allowance related to state tax credits that are expected to expire unused. Although our estimate of future taxable income is based on current assumptions we believe to be reasonable, our assumptions may prove inaccurate and could change in the future, which could result in the expiration of additional net operating losses or credits. We would be required to establish a valuation allowance at such time that we no longer expected to utilize these net operating losses or credits, which could result in a material impact on our results of operations in the future.
Self-funded insurance reserves . As of December 31, 2011 and 2010, we had $32.7 million and $33.9 million, respectively, in accrued liabilities for employee health, workers’ compensation, and automobile insurance claims. We are significantly self-insured for employee health, workers’ compensation, and automobile liability insurance claims. As such, our insurance expense is largely dependent on claims experience and our ability to control our claims. We have consistently accrued the estimated liability for employee health insurance claims based on our history of claims experience and the estimated time lag between the incident date and the date the cost is paid by us. We have accrued the estimated liability for workers’ compensation and automobile insurance claims based on an actuarial valuation of the outstanding liabilities, discounted to the net present value of the outstanding liabilities, using a combination of actuarial methods used to project ultimate losses. The liability for employee health, workers’ compensation, and automobile insurance includes estimates for both claims incurred and for claims incurred but not reported. These estimates could change in the future. It is possible that future cash flows and results of operations could be materially affected by changes in our assumptions, new developments, or by the effectiveness of our strategies.
Legal reserves. As of December 31, 2011 and 2010, we had $11.3 million and $19.2 million, respectively, in accrued liabilities related to certain legal proceedings in which we are involved. We have accrued our estimate of the probable costs for the resolution of these claims based on a range of potential outcomes. In addition, we are subject to current and potential future legal proceedings for which little or no accrual has been reflected because our current assessment of the potential exposure is nominal. These estimates have been developed in consultation with our General Counsel’s office and, as appropriate, outside counsel handling these matters, and are based upon an analysis of potential results, assuming a combination of litigation and settlement strategies. It is possible that future cash flows and results of operations could be materially affected by changes in our assumptions, new developments, or by the effectiveness of our strategies.
MANAGEMENT DISCUSSION FOR LATEST QUARTER
OVERVIEW
The Company
As of June 30, 2012, we operated 67 facilities, including 47 facilities that we owned, with a total design capacity of approximately 92,000 beds in 20 states and the District of Columbia. We also own two additional correctional facilities that we lease to third party operators.
We specialize in owning, operating, and managing prisons and other correctional facilities and providing inmate residential and prisoner transportation services for governmental agencies. In addition to providing the fundamental residential services relating to inmates, our facilities offer a variety of rehabilitation and educational programs, including basic education, religious services, life skills and employment training and substance abuse treatment. These services are intended to reduce recidivism and to prepare inmates for their successful re-entry into society upon their release. We also provide inmates health care (including medical, dental and psychiatric services), food services and work and recreational programs.
Our website address is www.cca.com. We make our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), available on our website, free of charge, as soon as reasonably practicable after these reports are filed with or furnished to the SEC. Information on our website is not part of this report.
Assessment of REIT Structure
In May 2012, we announced we were assessing the feasibility of a real estate investment trust (“REIT”) conversion and had assembled a team of outside tax, legal and financial advisors to assist us in determining if we could structure our operations in such a way as to allow us to maintain the strategic alignment of our real estate and operations under a single publicly traded umbrella, qualify for status as a REIT and continue to provide correctional services at both facilities owned by our government partners and facilities we own.
While there is more work to be done – both in working with the Internal Revenue Service (“IRS”) and also in fully analyzing the business issues – our preliminary analysis indicates that a conversion to a REIT using a taxable REIT subsidiary (“TRS”) for the provision of services would provide numerous benefits to CCA, assuming it could be properly implemented. We believe such a conversion has the potential to lower our cost of capital, draw a larger base of potential shareholders, provide greater flexibility to pursue growth opportunities post-conversion, and create a more efficient operating structure.
Since the time of the release in May, our advisors have had a number of preliminary discussions, including an in person meeting, with representatives of the IRS to discuss our proposed REIT structure, including owning our properties through the REIT and providing incarceration-related services through a subsidiary of the REIT that would be treated as a TRS. Those discussions helped us identify issues we would need to address, and led us to file a formal request for a private letter ruling from the IRS. There is no specific schedule for the IRS to respond to a request for a private letter ruling, so the timing is inherently uncertain. While we believe that there is a sound legal basis for the IRS to grant the ruling we have requested, we cannot predict whether the IRS will issue a favorable ruling.
We intend to work with the IRS and to continue our own analysis of the benefits of a REIT conversion as quickly as we can, and we believe that, if our preliminary analyses are substantiated, an election to become a REIT effective January 1, 2013 remains a possibility. However, this is a very complex process, and it is not possible for us to predict when or if we will receive a favorable response from the IRS, or whether other developments could affect the timing or desirability of making a REIT election. For these reasons, the timing and outcome of the process are still uncertain. We have assembled a strong team of advisors and are proceeding as quickly as possible to reach a favorable conclusion. If we obtain a favorable private ruling and decide to convert to a REIT, we will incur material expenses associated with the conversion.
CRITICAL ACCOUNTING POLICIES
The consolidated financial statements in this report are prepared in conformity with U.S. generally accepted accounting principles. As such, we are required to make certain estimates, judgments, and assumptions that we believe are reasonable based upon the information available. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. A summary of our significant accounting policies is described in our 2011 Form 10-K. The significant accounting policies and estimates which we believe are the most critical to aid in fully understanding and evaluating our reported financial results include the following:
Asset impairments. As of June 30, 2012, we had $2.6 billion in property and equipment, including $134.7 million in long-lived assets excluding equipment, at seven currently idled facilities, including two that were idled during 2012. We also had $29.0 million invested in a construction project in Trousdale County, Tennessee at which we have suspended construction activities until we have greater clarity around the timing of future bed absorption by our customers. The impairment analyses we performed for each of these facilities excluded the net book value of equipment, as a substantial portion of the equipment is easily transferrable to other company-owned facilities without significant cost. From the date each facility became idle, the idled facilities incurred combined operating expenses of $2.7 million and $2.8 million for the six months ended June 30, 2012 and 2011, respectively.
During the first quarter of 2012, we were notified by the Kentucky Department of Corrections that Kentucky would remove all of the inmates housed in the 656-bed Otter Creek Correctional Center, a facility we own in Wheelwright, Kentucky, by mid-2012. Accordingly, we tested the Otter Creek facility for impairment during the first quarter of 2012. Our impairment analysis was based on projected undiscounted cash flows that are comparable to historical cash flows from management contracts at similar facilities and were supported by discussions we have had with prospective customers with a need for additional bed capacity. In addition to estimates of future cash flows, our impairment analysis included estimates of the remaining useful life of the facility which we currently believe approximates 30 years. The carrying value of the long-lived assets, excluding equipment, at the Otter Creek facility was $26.1 million as of June 30, 2012.
During the second quarter of 2012, we were notified by Community Education Partners (“CEP”) that it had ceased operating and would no longer be able to make the required lease payments on the educational facility we owned in Houston, Texas. We leased the Houston educational facility to CEP under a lease that was scheduled to mature in June 2014. We notified CEP in June 2012 that we were exercising our termination rights pursuant to the lease. Accordingly, we tested the Houston, Texas facility for impairment during the second quarter of 2012. Our impairment analysis was based on projected undiscounted cash flows that are comparable to historical cash flows from the lease we had with CEP. In addition to estimates of future cash flows, our impairment analysis included estimates of the remaining useful life of the facility which we currently believe approximates 30 to 35 years. The carrying value of the long-lived assets, excluding equipment, at the Houston, Texas educational facility was $6.8 million as of June 30, 2012.
We evaluate the recoverability of the carrying values of our long-lived assets, other than goodwill, when events suggest that an impairment may have occurred. Such events primarily include, but are not limited to, the termination of a management contract or a significant decrease in inmate populations within a correctional facility we own or manage. Accordingly, we tested each of the aforementioned seven currently idled facilities for impairment when we were notified by the respective customers that they would no longer be utilizing such facility. We tested the facility under construction for impairment when we suspended construction of the facility.
We re-perform the impairment analyses on an annual basis for each of the idle facilities and for the suspended construction project, and evaluate on a quarterly basis market developments for the potential utilization of each of these facilities in order to identify events that may cause us to reconsider our most recent assumptions. Such events could include negotiations with a prospective customer for the utilization of an idle facility at terms significantly less favorable than used in our most recent impairment analysis, or changes in legislation surrounding a particular facility that could impact our ability to house certain types of inmates at such facility. Further, a substantial increase in the number of available beds at other facilities we own could lead to a deterioration in market conditions and cash flows that we might be able to obtain under a new management contract at our idle facilities. We have historically secured contracts with customers at existing facilities that were already operational, allowing us to move the existing population to other idle facilities. Although they are not frequently received, an unsolicited offer to purchase any of our idle facilities, or facilities under construction such as the Trousdale project, at amounts that are less than the carrying value could also cause us to reconsider the assumptions used in our most recent impairment analysis. However, we can provide no assurance that we will be able to secure management contracts to utilize our idle facilities, or that we will not incur impairment charges in the future.
Our evaluations also take into consideration our historical experience in securing new management contracts to utilize facilities that had been previously idled for periods comparable to or in excess of the periods that our currently idle facilities have been idle. Such previously idled facilities are currently being operated under contracts that generate cash flows resulting in the recoverability of the net book value of the previously idled facilities by substantial amounts. Due to a variety of factors, the lead time to negotiate contracts with our federal and state partners to utilize idle bed capacity is generally lengthy and has historically resulted in periods of idleness similar to the ones we are currently experiencing at our idle facilities. As a result of our analyses, we determined each of these assets to have recoverable values in excess of the corresponding carrying values.
By their nature, these estimates contain uncertainties with respect to the extent and timing of the respective cash flows due to potential delays or material changes to historical terms and conditions in contracts with prospective customers that could impact the estimate of cash flows. Notwithstanding the effects the current economy has had on our customers’ demand for prison beds in the short term which has led to our decision to idle certain facilities, we believe the long-term trends favor an increase in the utilization of our correctional facilities and management services. This belief is based on our experience in operating in recessionary environments and in working with governmental agencies faced with significant budgetary challenges, which is a primary contributing factor to the lack of appropriated funding to build new bed capacity by the federal and state governments with which we partner.
Goodwill impairments . As of June 30, 2012, we had $12.0 million of goodwill related to certain of our managed-only facilities. We evaluate the carrying value of goodwill during the fourth quarter of each year, in connection with our annual budgeting process, and whenever circumstances indicate the carrying value of goodwill may not be recoverable. Such circumstances primarily include, but are not limited to, the termination of a management contract or a significant decrease in inmate populations within a reporting unit.
In September 2011, the Financial Accounting Standards Board issued Accounting Standards Update (“ASU”) 2011-08 that gives companies the option to perform a qualitative assessment that may allow them to skip the annual two-step impairment test. Under the amendments in ASU 2011-08, a company has the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events or circumstances, an entity determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then performing the two-step impairment test is unnecessary. If the two-step impairment test is required, we determine the fair value of a reporting unit using a collaboration of various common valuation techniques, including market multiples and discounted cash flows. We evaluated our goodwill for impairment in the fourth quarter of 2011 by using the qualitative factors described in ASU 2011-08 and concluded that it was not more likely than not that the fair value of our reporting units was less than the carrying amounts thus allowing us to forego the two-step impairment test. We do not expect our estimates or assumptions used in this analysis to change in the near term such that they would trigger an impairment of goodwill, except for notification of a contract termination or non-renewal of a contract by a customer at a managed-only facility with goodwill. Each of these techniques requires considerable judgment and estimations which could change in the future.
Income taxes. Deferred income taxes reflect the available net operating losses and tax credit carryforwards and the net tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Realization of the future tax benefits related to deferred tax assets is dependent on many factors, including our past earnings history, expected future earnings, the character and jurisdiction of such earnings, unsettled circumstances that, if unfavorably resolved, would adversely affect utilization of our deferred tax assets, carryback and carryforward periods, and tax planning strategies that could potentially enhance the likelihood of realization of a deferred tax asset.
We have approximately $4.1 million in net operating losses applicable to various states that we expect to carry forward in future years to offset taxable income in such states. We have a valuation allowance of $0.7 million for the estimated amount of the net operating losses that will expire unused. In addition, we have $4.9 million of state tax credits applicable to various states that we expect to carry forward in future years to offset taxable income in such states. We have a $1.6 million valuation allowance related to state tax credits that are expected to expire unused. Although our estimate of future taxable income is based on current assumptions that we believe to be reasonable, our assumptions may prove inaccurate and could change in the future, which could result in the expiration of additional net operating losses or credits. We would be required to establish a valuation allowance at such time that we no longer expected to utilize these net operating losses or credits, which could result in a material impact on our results of operations in the future.
Self-funded insurance reserves . As of June 30, 2012, we had $33.3 million in accrued liabilities for employee health, workers’ compensation, and automobile insurance claims. We are significantly self-insured for employee health, workers’ compensation, and automobile liability insurance claims. As such, our insurance expense is largely dependent on claims experience and our ability to control our claims. We have consistently accrued the estimated liability for employee health insurance claims based on our history of claims experience and the time lag between the incident date and the date we pay the claims. We have accrued the estimated liability for workers’ compensation and automobile insurance claims based on an actuarial valuation of the outstanding liabilities, discounted to the net present value of the outstanding liabilities, using a combination of actuarial methods used to project ultimate losses. The liability for employee health, workers’ compensation, and automobile insurance includes estimates for both claims incurred and for claims incurred but not reported. These estimates could change in the future. It is possible that future cash flows and results of operations could be materially affected by changes in our assumptions, new developments, or by the effectiveness of our strategies.
Legal reserves. As of June 30, 2012, we had $11.8 million in accrued liabilities related to certain legal proceedings in which we are involved. We have accrued our best estimate of the probable costs for the resolution of these claims based on a range of potential outcomes. In addition, we are subject to current and potential future legal proceedings for which little or no accrual has been reflected because our current assessment of the potential exposure is nominal. These estimates have been developed in consultation with our General Counsel’s office and, as appropriate, outside counsel handling these matters, and are based upon an analysis of potential results, assuming a combination of litigation and settlement strategies. It is possible that future cash flows and results of operations could be materially affected by changes in our assumptions, new developments, or by the effectiveness of our strategies.
CONF CALL
Damon T. Hininger - President and Chief Executive Officer
Thank you, Melisa, and good morning and thank you all for joining our call today. With me today is our Chairman, John Ferguson, and CFO, Todd Mullenger. And also joining us is our Chief Corrections Officer, Harley Lappin and our VP of Finance, David Garfinkle.
In a few minutes, Todd will take you through the numbers for the quarter. Then I’ll discuss the marketplace and also give an update on private REITs, after which we look forward to taking your questions.
First though, let me make some comments on the past quarter. First, we had strong cash flow performance for the quarter with FFO near $54 million and reported $0.38 in adjusted EPS.
We also had a very significant couple of contract wins this past quarter with Idaho and Oklahoma, the two brand new contracts that obviously utilize up to 1,000 beds of existing capacity in our system. Now, Oklahoma is already ramping up into our Cimarron facility, and we expect the ramp up of Idaho to start this month. And we think that these win show again the value of our existing beds which are just-in-time.
So with these two contracts, in addition to our Puerto Rico contract that we got awarded earlier this year, again showed that our existing capacity being very attractive to customers as they grow. And also, we just had a recent development were another customer has come out with the procurement with the Bureau of Prisons looking for 1,000 beds in existing capacity.
We also know two other jurisdictions that are looking for up to a 1,000 beds in existing facilities and we think these procurements could be out the next 6 months to 12 months.
We're also very excited that we’ve kicked off officially our dividend program and we paid our first dividend of $0.20 on June 22. And also with our Cimarron facility ramping up with Puerto Rico and then also, Jenkins facility in Georgia ramping up with the State of Georgia inmates, both of those have ramped up nicely during the four months and both contracts are virtually full today.
On the cost control side, we continue to focus on cost and efficiency as we've announced in our press release, but we did had some noise in the quarter as it relates to activation of our Jenkins and ramp up at Puerto Rico. Also quarter-over-quarter was impacted by salary increases that we had implemented last year.
Look here in a second, I’m going to turn the call over to Todd, but before I do, I would like to thank all of you for the outpouring support you’d given me and the company after we lost one of our team members back in May at our Adams County facility. I visited the facility again this past week and I am so proud of the team there, as we moved forward from this tragic loss.
With that, let me turn it over to Todd.
Todd J. Mullenger - Chief Financial Officer and Executive Vice President
Thank you, Damon, and good morning, everyone. In the second quarter of 2012 we generated $0.38 of adjusted EPS excluding the costs associated with our repayment of senior notes and the re-feasibility study. Funds from operations or FFO totaled $0.55 per share while adjusted funds from operations or AFFO totaled $0.43 per share. As a reminder FFO and AFFO per share are always below average in Q2 due to the fact that nearly 100% of the estimated income tax payments for the first half of the year are made in Q2. FFO per share for the first half of the year totaled $1.37.
Year-over-year in the quarter we saw revenues increased by $13 million driven largely by increases in per diem, the assumption of operations in our Lake Erie, Ohio facility, activation of the Jenkins County, Georgia facility, intake of Puerto Rico inmates at Cimarron, partially offset by declines in populations in our Colorado and CTF facilities. While revenues increased $13 million, we experienced a slight decline year-over-year in net income, largely the result of startup of our Jenkins facility and ramp up of Puerto Rico populations at Cimarron, a decline in populations at our Coffee and Wheeler, Georgia facilities, which were impacted by the opening of Jenkins, increases in wages and benefits expenses and declines in populations at our Colorado and CTF facilities.
Moving next to discussion of our guidance, as indicated in the press release full year EPS guidance is in the range of $1.53 to $1.57. Guidance for Q3 is in the range of $0.39 to $0.41. Full year FFO guidance per share is in the range of $2.86 to $2.91, while FFO guidance for the full year is in the range of $2.31 to $2.41. Our guidance excludes any expenses that will be incurred to pursuit a REIT conversion.
The increase in adjusted EPS from $0.38 in Q2 to a range of $0.39 to $0.41 in Q3 is related primarily to increases in earnings from the normalization of Georgia populations at Jenkins; Puerto Rico and Oklahoma populations at Cimarron; Idaho populations in Kit Carson; partially offset by a reduction in California populations at our North Fork facility.
Our U.S. Marshals populations are key flex point in our guidance. We have seen some variability in those populations during the first half of the year and could experience variability in the second half. A small movement up or down from the range of populations assumed could have a meaningful impact on actual earnings as these populations are largely at facilities that are operating at full capacity where the incremental margins are very high.
General and administrative expenses for 2012 should approximate 5% of revenues excluding costs for the REIT feasibility study. Depreciation and amortization expense is forecasted approximately $115 million for the full year.
Finally, we anticipate that a formal declaration of a $0.20 per share dividend will be made at the upcoming Board meeting next week to paid in September.
I will now turn it back to Damon.
Damon T. Hininger - President and Chief Executive Officer
Thanks so much Todd. Now for our market assessment and a strategic REIT update. Let me just first make a couple of global comments about the business. All of you are reading the same headlines like I’m, which are saying that there is obviously fear of another economic slowdown, turmoil in Europe and fiscal tax and election uncertainty here in the United States, and just like rest of corporate America this continue to keep us cautions and what the near-term look like for us.
Additionally, as you may have read the recent report that was released in the past few weeks that was from the state budget prices task force. There was a greater story in this past weekend in The Wall Street Journal titled Coming to a State Near You, they give a gloomy summary of the issues that are facing the states.
Notably, saying that Medicaid is now the largest part of state budgets and forecast to grow by 8% annually over the next decade, and also increasing burdens the states are feeling from pension and retiree health benefit obligations. As this made great volatility for all of us in the near-term, we think for us in the mid to long term integrated solutions like Ohio, we did the Lake Erie transaction or the new Jenkins Georgia facility are going to be more attractive as states grapple with (inaudible) budgets.
Let me now shift gears and talk a little bit about our state book of business and first to say that for this new fiscal year that started on July 1, no new meaningful new capacity has been founded except for some bed at Arizona and California. And this would be the third consecutive year of minimal appropriation for new state prison capacity.
We’ve also seen a year of our existing state customers grow in the past 12 months, at a combined total of 5,700 inmates, an example of one of these is at Idaho. Idaho has grown by 400 this past year and as reported earlier, it did a recent procurement in contract was also do with that growth.
And looking forward, our 10 state customers, where we provide owned and managed solutions and this is excluding California they are expecting a best shortfall by 10,000 inmate over the next five years. We’re also pursing eight new state prospects with their projected over crowding and the next five years to be just over 14,000 inmates.
I want to talk here a minute about California, but just let me say that as it relates to our remaining state customers, and their budgets all of our state partners have completed and passed their respective budgets.
And I want to report that we had about a half a dozen that gave us increases starting on July 1, and we didn't have any per diem reduction request this past spring. And one encouraging development, we had one existing state customer; who did implement a meaningful partial risk restoration of our per diem effective on July 1. I won’t indicate who the customer was, but the reduction we incurred a few years ago was probably the most significant one in our state portfolio.
And they now move over to the federal book of business and talk first about the federal budget. The President’s request for our three federal customers is largely in line with the fiscal year 2012 enacted levels. Now there has been some activity this summer in both chambers that I think it is safe to say that a final budget likely will not be completed until after the November elections.
We are hearing that a continuing resolution, maybe as long as six months could be passed in September to allow enough time to take this up after the election. And we are also watching the possibility of sequestration which potentially could go in place from the first of the year, I don’t have any new information to report on this, but also we're watching very closely, and again we think this will be something that will be dealt with after the November election.
Also to note that there was no new funding for new BOP beds in President Obama's budget, and is requesting funding for 1,000 new contact beds, and in fact this is the funding that's being used for this new contract procurement that was released last week.
And likely going forward for the BOP, no new capacity is being appropriated. I’ll give you a little bit of context on this significant events. Nearly $4 billion of appropriations in last 10 years for new BOP capacity, that we don't see any capacity coming online for the next five to eight years for the Bureau of Prisons. And as a reminder, this is the largest system in the country with 218,000 inmates and are projected to growth on a rate of 4,000 to 6,000 a year and have a unmet bed demand in the six years of 26,000.
Let me now move over to significant pending procurements and the first of which is Arizona and the requirement for new beds owned and operated in state. Arizona released a procurement earlier this year for contractor owned and contractor operated up to 1,000 beds in state facility. Proposals were due on March 6 and we anticipate an award by September 1. We also still anticipate a start date in early 2014.
To New Hampshire, they released a series of procurements late last year, the primary one being for a new 1,550 bed in state facility. Proposals were due on February 24, and we anticipate an award no sooner than the fourth quarter. We also anticipate a start date in 2015.
To the BOP, which I gave a little bit of detail earlier, on August 1, they released a procurement for contractor owned and operated 1,000 bed facilities that must be ready to accept inmates within 150 days of award no later than September 1, 2013. This is a CAR solicitation, so it has very similar requirements that the BOP has done in the past. Proposals are due on September 18, and based on their timeline, we think an award will be likely in the first quarter of next year.
And finally, to Harris County Texas, which is Houston of course. They issued an RFP in June of last year, under which the county is seeking proposals for the management of the entire Harris County jail system of approximately 9,000 beds. We understand it currently costs the County more than $200 million per year to operate their jail systems. We submitted a best and final offers this past week and we think the county could act on this sometime later this summer or early fall.
Now, a brief update on a couple of topics relative to California. As a reminder, the state and CDCR released a report titled The Future of California Corrections in April. This is a proposal that will have many stakeholders that will have to weigh in. The legislature, the Plaintiff Council on the Federal Court case, the court appointed federal medical receiver, and of course the Federal Court. The plan’s effectiveness and impact on CCA’s California population in contingent on several key provisions; first, the state realignment plan secures long-term funding, and results in continued declines in the state’s inmate population.
Second, the state completes in state prison correction projects, and finally, the most notable, the assumption that the state is successful in convincing the Federal Court to raise the capacity limit of their 33 facilities from 137.5% to 145%. The plan noted that if the court did not raise the cap that quote alternatives such as continuing to house inmates out of state will have to be considered.
So what in next? So some of the key milestones that were watching very closely and one of which has already happened, that is as predicted by us back in May, the state passed funding bill for this fiscal year that is consistent with the plan. The good news for us is that, we now know what the next 11 months look like for us in our contract.
The second significant milestone is the action by the court. And we think the plaintiffs in the case could be pushing for actions sooner rather than later, but the timing is uncertain. I will note though that just this past Friday, the court released an order to the state asking more questions on the potential request. There is some activity by the court as we speak on this potential issue.
And finally, the Schools and Local Public Safety Act of 2012 tax increase that will be on the ballot in November. This is the long-term funding vehicle for realignment. It is currently falling just over 50% support state wise.
Counties are obviously watching this closely not only for the funding, but also securities that the funding will be there long term, so they could possibly do jail expansions or enter into agreements for bed space. What we do know at this time that both the state and legislative analyst’s office has said publicly, that all key provisions must be effective to meet the court order count. If certain provisions are not effective, then alternatives such as continued to house inmate out of state will have to be considered.
Now, I’d like to provide an update regarding our ongoing analysis of the feasibility and potential benefits converting into a real state investment trust or REIT. As you may recall on our last earnings call, we discussed how following a review with the Board of various REIT structures, the management team with support of the Board initiated a project to do a deeper dive into conversion to a REIT making use of a Taxable REIT subsidiary, or TRS.
Under this structure, we would own our own properties to the real estate investment trusts and provide incarcerated related services through a subsidiary of the real estate investment trust that would be treated as a Taxable REIT subsidiary. While there is more work to be done, both in working with the Internal Revenue Service and also in fully analyzing the business issues, our preliminary conclusion is that a conversion to a REIT using a TRS for the provision of services would provide numerous benefits to CCA, assuming it could be done properly implemented.
Accordingly the management team is looking forward to recently file a request with the IRS for a private letter ruling with respect to our possible implementation of the REIT structure.
As we said in our last call, we believe a conversion to a REIT is essential to lower our cost to capital drawing a larger base of potential shareholders, provide greater flexibility to pursue growth opportunities post-conversion, and create a more efficient operating structure.
Importantly, under this structure, we would not need to divide the Company into an independent REIT and an independent operating company. This would also enable us to maintain the strategic alignment of our key operating divisions.
Accordingly, we believe that this structure would not adversely impact our business or our vital relations with the government customers. It is important to note that our business involves providing significant facilities and performing essential services for our government customers. And as always we will take every step to ensure we satisfy our responsibilities in a professional and efficient manner.
Since our last earnings call, our advisors have had a number of discussions including an in-person meeting with representatives of the Internal Revenue Service to discuss our proposed REIT structure. Those discussions were informative and as mentioned earlier led us to move forward with our request for a private letter ruling. While we believe there is a sound legal basis for the IRS to grant the ruling we have requested, there can be no assurances 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.
As you may know, a REIT election applies on an annual basis and cannot be made for a portion of a taxable year. For CCA, that means any REIT election will be need to be effective January 1. We intend to work with the IRS and continue our own analysis of the benefits of a REIT conversion as quickly as we can and we believe that if everything lines up an election to become a REIT for 2013 calendar year remains a possibility. However, this is a complex process and the precise timing and outcome of the process are still uncertain.
Now I know you may some questions about the potential REIT conversion, but let me say that we have reached a significant milestone with our filing and we have more steps in this journey. So beyond what I have just stated I would be limited to what I could say on this subject and this is especially true regarding the ongoing dialog we are having with the IRS.
Having said all that, as we provided on our last call, we have assembled a strong team of advisors for this project, including Latham & Watkins, Ernst & Young and JPMorgan as well as our corporate counsel Bass Berry. I want to assure you that we are and have been proceeding as quickly as possible to reach a favorable conclusion. We expect that our next update on this important initiative will be on our third quarter earnings call. With regards to our near-term capital strategy, as you know, the Company in the past has deployed its cash primarily on speculative capacity, build-to-suit opportunities and facility acquisitions.
We are still holding off on new spec capacity and aggressively pursuing build-to-suit opportunities and also facility acquisition opportunities, like New Hampshire and Ohio. But now with the dividend program fully in place, we will now allocate a third of our AFFO towards our dividend and the remaining towards organic growth. Any unused cash not used for these two the dividend and growth CapEx may be used for debt repayments.
So let me bring to close my comments and make these final points. Obviously we are very excited about some of the contract wins we had this summer with Idaho and also with Oklahoma and obviously looking forward the opportunities with the BOP. Again these are partners that are looking at existing capacity where we think we have got some very competitive and attractive solutions for them. Also in our steps to create more shareholder value we have the dividend program now firmly in place. Then the last is obviously we have taken a meaningful step on our opportunity to create even more shareholder value which is the progress we just reported on our Project REIT.
So that concludes my prepared remarks. Thank you again for calling in today's conference. Let me now turn it over to Melissa for Q&A.
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Fund Letters
