The GEO Group, Inc. (GEO) Q3 2013 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Quarter 3 2013 GEO Group, Inc. Earnings Conference Call. My name is Matthew, and I will be your operator for today. [Operator Instructions] As a reminder, this call is being recorded for replay purposes. And now I would like to turn the call over to Mr. Pablo Paez, Vice President, Corporate Relations. Please proceed, sir.

Thank you, operator. Good morning, everyone, and thank you for joining us for today's discussion of The GEO Group's Third Quarter 2013 Earnings Results. With us today is George Zoley, Chairman and Chief Executive Officer; Brian Evans, Chief Financial Officer; John Hurley, President of GEO Corrections and Detention; and George Dominicis, Senior Vice President of GEO Community Services. This morning, we will discuss our third quarter performance and current business development activities. We will conclude the call with a question-and-answer session. This conference call is also being webcast live on our website at www.geogroup.com. Today, we will discuss non-GAAP basis information. A reconciliation from non-GAAP basis information to GAAP basis results is included in the press release and supplemental disclosure we issued this morning. Additionally, much of the information we will discuss today, including the answers we give in response to your questions, may include forward-looking statements regarding our beliefs and current expectations with respect to various matters. These forward-looking statements are intended to fall within the Safe Harbor provisions of the securities laws. Our actual results may differ materially from those in the forward-looking statements as a result of various factors contained in our Securities and Exchange Commission filings, including the Form 10-K, 10-Q and 8-K reports. With that, please allow me to turn this call over to our Chairman and CEO, George Zoley. George?

Thanks, Pablo, and good morning to everyone. Thanks for joining us as we review our third quarter results and provide an update of our efforts to pursue quality growth opportunities, and return value to our shareholders. Our strong quarterly earnings results continue to be driven by sound operational financial performance from our diversified business units in the U.S. and internationally. During the third quarter and the early part of the fourth quarter, we achieved a number of important milestones. Over the last 2 months, we've signed new contracts or have been awarded contracts for more than 5,700 new correctional and detention beds, which are expected to generate approximately $98 million in annualized revenues. In early September, we signed a contract memo [ph] with the U.S. Immigration and Customs Enforcement for the development of a 400-bed immigration transfer center at the England Airpark in Alexandria, Louisiana. The new transfer center is being developed as an annex to our LaSalle detention facility in Jena, Louisiana through our existing contract with ICE. The development of the new center is expected to be completed during the fourth quarter of 2014, and is expected to generate approximately $8.5 million in additional annual revenues. Also in September, we announced the signing of two 5-year contracts with the California Department of Corrections and rehabilitation for the reactivation of two of our company-owned in-state facilities totaling 1,400 beds. The reactivation of our Central Valley and our Desert View facilities is expected to generate approximately $31 million in annualized revenues, following the ramp-up period, which we expect to complete during the first quarter of 2014. Additionally, we signed a new long-term agreement for our Golden State facility in California, which expanded the facility's contract capacity by 100 beds to 700 effective this month. This contract capacity expansion is expected to generate more than $2 million in additional annual revenues. In Florida, the state Department of Management Services recently awarded GEO 3 contracts for the management of 3,854 beds at the Graceville, Moore Haven and Bay Correctional Facilities effective this coming February. These managed-only agreements are expected to generate more than $56 million in annualized revenues. In addition to these important contract awards, we have also taken additional steps to strengthen our balance sheet. In October, we completed a $250 million offering of senior notes at a rate of 5.875%, and a tender offer and redemption of our existing notes due 2017, which had a coupon rate of 7.75%. Additionally, we completed the defeasance of non recourse bonds associated with our company-owned South Texas detention complex, which is expected to save us $5.5 million in annual principal debt repayments. All of these important steps have given us more flexibility as we continue to pursue accretive growth opportunities and look for return increasingly for more value to our shareholders. As we announced a couple of days ago, we have increased our quarterly dividend to $0.55 per share, which represents a 10% increase and a payout of AFFO of approximately 75%. As we expressed to you in the past, our board and our management team remain focused on the careful evaluation of our allocation of capital to enhance shareholder value. With respect to our outlook, we continue to be optimistic regarding several new opportunities we are currently pursuing. Our most immediate potential catalysts are the prospective reactivation of our current inventory of idle facilities with approximately 6,000 beds. We estimate the reactivation of our 6,000 idle beds would add approximately $0.65 to $0.70 in annualized AFFO. There are several publicly known opportunities we are currently pursuing, which total approximately 17,000 beds. Further, we are exploring a number of nonpublic opportunities that relate to both new project development, as well as potential asset purchases. We believe our company is well positioned to benefit from these important opportunities. We also believe that our company has attractive investment characteristics, which are underpinned by a robust real estate portfolio of company-owned and leased facilities. Our total real estate portfolio encompasses approximately 13 million square feet in owned, leased and managed facilities, and we own more than 4,000 acres of land across the United States. We currently own or lease approximately 70% of our facilities and 60% of our beds worldwide. And approximately 70% of our net operating income is generated by our company-owned and company-leased facilities. We have stable and sustainable income through increasingly longer-term contract arrangements. We have a diversified base of investment-grade government customers with multiple individual contract arrangements, with no single customer contract representing more than 5% of our revenues. We have historically enjoyed solid occupancy rates in the mid-to-high 90s and strong customer retention in excess of 90%. Our long-term assets have a physical useful life of 75 years plus, and require relatively low levels of maintenance CapEx, estimated at approximately 6% of our 2013 net operating income. Now I would like to turn over the call to Brian Evans for a review of our financial performance and outlook.

Thank you, George. Good morning, everyone. We are pleased with our third quarter results, as well as our outlook for the remainder of 2013. As disclosed in our press release today, our adjusted funds from operations for the third quarter increased to $0.72 per share from $0.64 per share last year. On a GAAP basis, we reported third quarter 2013 income from continuing operations of $0.45 per share compared to $0.25 per share a year ago. Our total revenues for the third quarter 2013 increased to approximately $380 million from $369 million a year ago. Approximately, 60% of our revenues are generated by our company-owned and company-leased properties. For the third quarter 2013, we reported net operating income of approximately $96 million compared to $100 million a year ago. Approximately, 70% of our NOI is generated by our company-owned and company-leased properties. Our third quarter 2013 results reflect a normalization of our Adelanto Detention Facility expansion, which was activated in the second half of 2012, as well as a normalization of new contract wins by our community reentry and electronic monitoring services divisions during 2012. Our third quarter results also reflect offsetting non-ordinary charges and benefits including a net tax benefit of $4.6 million, offset by $1.5 million after tax related to the write-off of deferred financing fees in connection with the recently completed defeasance of non-recourse bonds for our South Texas detention complex. Additionally, our third quarter operating expenses reflect $6.2 million in noncash adjustments to our insurance reserves. This adjustments reduced our NOI and adjusted EBITDA for the quarter. Moving to our outlook for the remainder of 2013. We expect fourth quarter 2013 revenues to be in a range of $378 million to $383 million and our fourth quarter 2013 AFFO per share to be in a range of $0.70 to $0.73. On a GAAP basis, we expect income from continuing operations for the fourth quarter 2013 to be in a range of $0.29 to $0.31 per share, which includes $0.12 per share, related to the write-off of deferred financing fees associated with our recent senior notes offering. Our fourth quarter guidance also reflects $1 million in after-tax start-up costs associated with the reactivation of our Central Valley and Desert View facilities in the fourth quarter. We expect our full year AFFO per share to be in a range of $2.85 to $2.88 or $204 million to $207 million. On a GAAP basis, we expect our income from continuing operations for the year to be between $1.54 and $1.56 per share, which includes $0.20 per share in deferred financing fees and $0.07 per share in onetime REIT conversion expenses, offset by $0.18 per share in net tax benefits. Our 2013 net operating income is expected to be in a range of $403 million to $413 million, including approximately $34 million in operating lease expenses. As George mentioned, in early October we completed the offering of $250 million in senior notes at a yield of 5.875%. And we used the proceeds from this offering to repurchase and redeem our senior notes due 2017, which had a coupon rate of 7.75%. Additionally, we recently completed the defeasance of non-recourse bonds associated with our South Texas detention complex for approximately $2.5 million net of cash reserves. The defeasance is expected to result in annual principal debt payment phase [ph] of approximately $5.5 million. With respect to our liquidity position, as of the end of the quarter, we had $53 million in cash on hand, and $342 million in available capacity under our revolving credit facilities, exclusive of $300 million in outstanding borrowings and $58 million set aside for letters of credit. With respect to our uses of cash, we expect our project growth CapEx to be $25 million to $30 million in 2013, of which $22 million was spent in the first 3 quarters of this year. With that, I will turn the call to John Hurley for a review of our corrections and detention market. John?

Thanks, Brian, and good morning, everyone. I'd like to address select publicly known business development opportunities in our key segments, starting with the federal market and the 3 federal government agencies we serve. We have long-standing partnerships with the Federal Bureau of Prisons, the United States Marshals Service and U.S. Immigration and Customs Enforcement, or ICE. And we provide cost-effective solutions for them at a number of facilities across the country. We continue to see meaningful opportunities for us to partner with all 3 of these federal agencies. The Federal Bureau of Prisons continues to face capacity constraints coupled with a growing offender population and ICE and the U.S. Marshals continue to consolidate existing populations into larger, more modern facilities, which has driven the need for additional private beds. With respect to recent contract awards, we have signed a contract with ICE for the development and operation of a new $20 million, 400-bed immigration transfer center in Alexandria, Louisiana, as an annex to our LaSalle Detention Facility. The new company-owned center will be completed in the fourth quarter of 2014 and will generate an additional $8.5 million in annual revenues. With regard to pending procurements, the Bureau of Prisons has issued a solicitation with two requirements. Each requirement is to house approximately 1,565 to 2,000 low security adult males. One facility must be located in one of the following states: Ohio, Michigan, Pennsylvania, New Jersey or New York. The other proposed facility may be located anywhere in the Continental United States. This procurement will include the rebid of our company-owned facility in Pennsylvania, whose contract expires in April 2016, and the rebid of another BOP privately operated facility in Ohio, whose contract expires in May 2015. Proposals for this procurement were submitted in August with awards expected in mid-2014. Additionally, ICE has issued requests for information for 3 company-owned and operated detention facilities ranging from 800 to 2,000 beds in the Chicago, Atlanta and Houston areas. Turning to our State Market segment. As states across the country continue to face budgetary pressures, their ability to achieve cost savings becomes an even more important priority, which leads to increased interest in privatization projects. Several states across the country continue to face capacity constraints and inmate population growth. Many of our state clients require additional beds, as inmate populations continue to increase and aging inefficient prisons need to be replaced with new, more cost-efficient facilities. For instance, in the states where we currently operate, the average age of state prisons ranges from approximately 30 to 60 years. With respect to recent contract awards, we recently signed 2 contracts in California for 1,400 community correctional facility beds at our company-owned Central Valley and Desert View facilities. Intake at the facilities began in late October and we expect to be completed by the end of the year. So these are expected to generate approximately $31 million in annualized revenues. Additionally, we recently signed a new long-term agreement with California for our Golden State facility, which expanded the facility's contract capacity by 100 beds effective November 1. And is expected to generate an additional $2.2 million in annual revenues. As has been reported in the media, California continues to have a significant need for medium and high-security beds. It is estimated that the state will need more than 8,000 beds to meet the court-mandated population cap by next February. The governor and the legislator have approved a plan to increase California's present capacity by contracting for both in-state and out-of-state beds. And the state has already taken steps to contract for additional in-state capacity. In the interim, the 3 federal judge panel has ordered a mediation period through November 18, and has temporarily halted additional contracts for out-of-state beds. We understand that the state has appealed this temporary restriction to the 3-judge panel and to the United States Supreme Court. The new deadline for the state to comply with the court-mandated inmate population cap has been extended to February 24, 2014. In Florida, the Department of Management Services has awarded GEO 3 contracts for the management of 3,854 beds at the Graceville, Moore Haven and Bay Correctional Facilities effective February 2014. These managed-only agreements are expected to generate approximately $56 million in annualized revenues. These important awards strengthen our long-standing partnership with the state of Florida, which has generated significant savings for Florida's taxpayers, and has provided significant inmate rehabilitation and treatment programs since the 1990s. Finally, in our international markets. We have been shortlisted by the State of Victoria in Australia for the development and management of a new 1,000-bed prison. An award under this procurement is expected to be made in the second half of 2014. At this time, I'll turn the call over to Jorge Dominicis for a review our GEO community services.

Thank you, John. Good morning, everyone. Turning to our GEO community services segment, each of our community services divisions continues to pursue several new growth opportunities. Our reentry services division is competing for a number of formal solicitations from the Federal Bureau of Prisons for residential community-based reentry centers across the country. Additionally, we're working with our existing local and state correctional clients to leverage new opportunities in the provision of community-based reentry services in both residential facilities, as well as nonresidential day reporting centers. In the last year, our reentry services division added more than $11 million in annual revenues through the expanded use of one of our Alaska facilities, and with the activation of several new day reporting centers in California, North Carolina and Pennsylvania. Specifically, a California Department of Corrections and Rehabilitation procurement for day reporting centers resulted in contract awards for our reentry services division for 4 of 9 available sites. In Pennsylvania, we were recently awarded a contract for 6 new day reporting centers, which are expected to generate more than $5 million in annualized revenues. We also expect to compete for several other new opportunities to activate residential and nonresidential community reentry facilities around the country. Our Youth Services division continues to work towards maximizing the utilization of our existing asset base. We recently successfully undertook a number of marketing and consolidation initiatives to increase the overall utilization of our existing Youth Services facilities in states like Pennsylvania, Ohio, Illinois, Texas and Colorado, and we expect to continue to pursue similar initiatives. Our BI subsidiary continues to market its supervision and electronic monitoring services to local, state and federal correctional agencies nationwide. In the last year, BI added more than $5 million in annual revenues. And we expect to compete on additional opportunities as correctional agencies across the U.S. increase their use of electronic monitoring technologies to track offenders who have been placed under community supervision. At this time, I'll turn the call back to George for his closing remarks.

Thanks, Jorge. In closing, we are very pleased with our third quarter results and outlook, which continue to be driven by solid operational and financial performance from our core operations in the U.S. and internationally. Our company remains focused on effectively allocating capital to enhance value for our shareholders. In the last quarter, we achieved a number of important milestones and have been awarded contracts for more than 5,700 new beds that are expected to add approximately $98 million in annual revenues. We've also continued to take important steps to strengthen our balance sheet and attain flexibility to return a higher portion of our funds available for distribution to our shareholders over time. In line with these important steps, we've increased our quarterly dividend to $0.55 per share, which represents a 10% increase, and a payout of AFFO of approximately 75%. We remain focused on the reactivation of our 6,000 idle beds in inventory, which we estimate would add $0.65 to $0.70 per share to our AFFO. We are actively participating in a number of publicly known opportunities totaling approximately 17,000 beds, and we are exploring a number of other growth opportunities for the development of new projects and the potential purchase of assets. We expect that all these efforts will continue to drive growth for our company and create value for our shareholders. We also believe that our diversified growth and investment strategies have positioned GEO as the leading provider of corrections, detention and community reentry services through a GEO continuum of care that can deliver performance-based outcomes and significant cost savings for our clients worldwide. As I've expressed to you in the past, we view all these different initiatives to enhance shareholder value as complementary and none are pursued to the detriment of the others. This concludes our presentation. We would now like to open the call to your questions.

[Operator Instructions] The first question comes from the line of Kevin Campbell of Avondale Partners.

I just wanted to start with a question on the fourth quarter guidance. Brian, does that have any -- are you guys incurring any costs there in anticipation, potentially of some out-of-state California business?

A modest amount, Kevin.

Okay. Not enough to call out?

No.

Okay. And maybe you could talk a little bit more about the tax benefit and the insurance reserves, what -- when does it -- that's your second quarter in a row where you've had a tax benefit, when do you think it will normalize and what sort of tax rate should we think about on a normalized basis? And then secondly, the insurance reserves. I don't think I heard you say exactly what they were for, and maybe what the after-tax impact of that is, you gave us pretax, but what's the after-tax impact?

Sure. Let's start with the taxes. On the tax reserves, as you know, we've converted to a REIT. At the beginning of the year, there's been a number of items associated with that relative to taxes. I think most of those items have been settled out, this specifically related to some embedded operating losses in one of our subsidiaries. So we're working through these things with the IRS. And as we clear them, we're adjusting our reserves as appropriate for those items. There's probably another up to anywhere from 0 to $3 million or $4 million that we need to settle out. There's nothing that would be a negative adjustment, but there's the potential for some additional positive adjustments. I think that could occur in the fourth quarter or maybe the first quarter of next year. On the insurance reserves, it's specifically related to prior period adjustments or adjustments for prior period cases in Worker's Compensation and general liability. So there was some adverse development. And on an annual basis, we go through a process with an actuary to look at our historical reserves, as well as give us an estimate for the future. This related to some historical cases and some adjustments relative to those. It's a noncash adjustment and we don't expect anything of that nature going forward, but that's what it's specifically related to.

Okay. And how should we think about the tax rate on a normalized basis?

On a normalized basis, when these items are resolved, I'd say somewhere in the 7% to 10% range. So -- and our TRS business will continue to be a full taxpayer. But I think on a consolidated basis, that will look like 7% to 10%.

Okay. And as we think about things like these insurance reserves, are they taxed at the TRS level at the, call it, 38%, 39% level or is that 7% to 10%?

No, if there's a specific adjustment like that, it would be benefited to the degree that it's in the TRS. And most of this was relatively, and the TRS would be at the 40% rate.

Okay, great. So the margins, I wanted to talk about that both on the U.S. corrections segment and the GEO community services, margins were down sequentially a couple of hundred basis points. I'm assuming on the U.S. corrections side, that's because of this adjustment -- insurance reserve adjustment, but maybe you can confirm that. And then secondly, what caused the community service margins to decline sequentially?

So the insurance reserve adjustment impacted, about 2/3 of it was in U.S. corrections, so about $4 million of the pretax amount, and about $2 million was in the community services division. And that's the biggest single item affecting that. Then you had, in the U.S. corrections divisions, obviously we exited the Hudson facility during the quarter, so you had that. And then you had some preparation in the quarter as we're getting ready to start up the California facilities, so that affected the U.S. corrections margins as well. And again, we're going to continue in the third -- fourth quarter to normalize those operations in California. And we would expect those facilities to complete the normalization process in the first quarter of next year with the second quarter of next year being the first fully normalized quarter for those facilities.

Okay. And then with all the changes you made on the balance sheet, maybe you could give us a normalized quarterly interest expense or annual interest expense for next year?

Interest expense, I think will continue to be around $18 million to $20 million mark. So right around $70 million -- $78 million to $80 million, on an annualized basis, $75 million to $80 million. Remember, during the year, we do get the benefit from redoing the bonds this quarter, but part of those were swapped out, so the effective of interest rate was slightly lower, but those swaps would have been called this quarter. So there's some transition related to that as well.

Your next question comes from the line of Kevin McVeigh of Macquarie.

I just want to make sure, as we think about the Californian opportunity kind of, the 8,000 beds, is that in addition to what the State has already done? And then as we think about the 8,000, George, relative to the 17,000 out there, does -- is 8,000 embedded in the 17,000 or in addition to kind of the 8,000 in the California as there's another 17,000 on top of that?

The 8,000 is embedded in the 17,000. And the 8,000 would be approximately in addition to what has already been done.

So as you think about the -- kind of from a pricing perspective, as of those beds get put into market, I mean, you take, since [ph] you have a lot of access capacity out of the system, how should we think about the pricing once those beds have kind of been awarded, assuming that obviously you're successful in some aspect of that.

I think pricing would tighten with the -- if all 18,000 beds were taken, I think it would remove half of the capacity in the country that's available presently and pricing would tighten, I would think.

Okay. And then any impact from the shutdown or sequester? Obviously, the quarter looked pretty good, but just relative. Anything in the numbers from that?

Yes. All of our services are considered essential government services, so there may have been a very minor blip, a reduction in census. But overall, there was no material impact.

[Operator Instructions] Your next question comes from the line of Tobey Sommer of SunTrust.

If some of the -- a good portion of the existing available capacity in the marketplace is absorbed, and you said pricing would probably tighten, improve, in that kind of context, in market historically, what kind of price increases have been experienced?

I'm not sure how to answer that question. But the kind of housing that California's seeking, for instance, is of a higher security housing. So throughout the country, there may be dormitory facilities and some self facilities, but the higher security facilities are what California is interested in. And that would leave, I guess, by definition, lower-level security facilities available around the country. So there would be a particular scarcity, I think, of higher security level. When I say higher security, I mean medium security and up.

Right. So historically, when there hasn't really been available capacity, what kind of price increases have you experienced at the firm? Just trying to get a context for maybe where we could be sitting in a year or two?

I'm sorry, I really can't answer that question in any specificity. I just can't recall. I can only respond generically that it would -- pricing would increase.

Okay. That's fair. And what kind of incremental margin may be achieved by increases in the rate of per diem?

Well, it would be a higher margin than the base per diem margin would generate.

Okay. But nothing -- you can't offer anything more specific than just greater than?

No, I really can't. I'm sorry.

And then relative to California and what's been ongoing in terms of the kind of month-by-month delays, is it your expectation that the delays could continue? And we're talking more broadly about perhaps a resolution in the first half as opposed to something that would give us visibility here in the fourth quarter for how that may proceed?

Well, the next milestone is the mediator's report that's due by the end of next week. And I would think the court would respond fairly quickly as it did last time. So we could very well know something by the end of the month.

Okay. And then my last question has to do with the dividend payout. I think you're at around 75% now. What are your thoughts on how high that could go? Or said another way, would future increases likely be driven by AFFO growth?

Well, I think we are committing ourselves to pay out at least 75% on a go forward basis. And our -- have as a tentative goal to achieve 80% eventually.

[Operator Instructions] Your next question comes from the line of Kevin Campbell of Avondale Partners.

I just wanted to talk about some of the other states that maybe we've talked about in the past, but didn't hear much of an update on today. Michigan, obviously decided not to move forward with their RFP. I'd love to get your thoughts on that and any view on whether or not they will reconsider?

I guess -- specifically, I don't know. I think there's some interest in the legislature as to what happened and why, just as there was in the food service contract, which was initially rejected and subsequently reactivated and successfully implemented. So that's a possibility, but we don't know what's going to happen at this point.

Okay. And then maybe a little bit more on Florida. I'm curious, I was reading earlier this week that the state's seeing some strong growth in their prison population and is considering reopening some of the facilities that they idled in prior years. And so I'm curious if there's any thought as to whether or not if and when those are reopened, if that's going to be an opportunity for the private sector to manage those?

I don't know. And in order to do so, I believe they would have to have legislative authorization. And the legislature does not convene until, I think, February or March.

Okay. And then 2 quick questions for you, Brian. The discontinued ops, what was moved to discontinued ops?

Discontinued ops also had a piece of insurance adjustment that went through it, so that was related to some facilities that we discontinued in Mississippi and some other facilities.

Okay. And then last question, traditionally, going from Q4 to Q1, you have a negative impact from payroll taxes. But now that you've converted to a REIT, I'm not sure if you have the same level of impact or not. And so I just wanted to get your thoughts on that. Should we expect in Q1 of next year a similar type of sequential headwind in margins, in earnings or will it be less than normal?

I think, it will be the same as it is historically. Those expenses will be incurred in the TRS. They're still related to all of our employees, and those taxes are generally increasing given the state of the economy and unemployment benefits and so forth. So we will experience that kind of step down. And the first quarter, as you know, is historically a lower quarter because of those issues, as well as some cyclicality of population. So we'll see some of that step down in the first quarter. Like I mentioned, we also have -- we'll still be normalizing the operations of our California facilities that just came online. And then we'll see that fairly significant step up going into second quarter, with the full -- with our expectations that those California beds will be fully operational and then we'll also have relieved the overhang of that extra payroll tax.

Okay. And can you remind us what the -- if you know at the top of your head, what that payroll tax impact was this year, for instance, in terms of earnings or dollar amount or...

Call it $0.04 to $0.06, call it $0.05.

I would now like to turn the call over to George Zoley for closing remarks.

Thank you very much. And we look forward to addressing you in the next conference call.

Thank you for joining today's conference. Ladies and gentlemen, this concludes the presentation. You may now disconnect. Have a very good day.