10-Q 1 g90387e10vq.htm CORRECTIONAL PROPERTIES TRUST Correctional Properties Trust
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

     
x
  QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended: June 30, 2004
or
     
o
  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Transition Period From                                        to                                       

Commission File Number: 1- 14031

CORRECTIONAL PROPERTIES TRUST

(Exact name of Registrant as specified in its declaration of trust)
     
Maryland   65-0823232
(State or other jurisdiction   (I.R.S. Employer
of incorporation or organization)   Identification No.)

3300 PGA Blvd., Suite 750, Palm Beach Gardens, Florida 33410
(Address and zip code of principal executive offices)

(561) 630-6336
(Registrant’s telephone number, including area code)

Not Applicable
(Former name, former address and former fiscal
year if changed since last report)

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes x No o

10,983,750
(Outstanding shares of the issuer’s common shares,
$0.001 par value per share, as of August 6, 2004)

 


CORRECTIONAL PROPERTIES TRUST
FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2004

INDEX

         
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    25  
    26  
 CEO Certification Pursuant to Section 302
 CFO Certification Pursuant to Section 302
 CEO Certification Pursuant to Section 906
 CFO Certification Pursuant to Section 906

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PART I - FINANCIAL INFORMATION

Item I - Financial Statements.

CORRECTIONAL PROPERTIES TRUST

CONSOLIDATED BALANCE SHEETS
As of June 30, 2004 and December 31, 2003
(Amounts in thousands, except share amounts)
                 
    June 30,   December 31,
    2004
  2003
    (Unaudited)        
Assets
               
Real estate properties, at cost
               
Correctional and detention facilities
  $ 293,298     $ 293,298  
Less - accumulated depreciation
    (36,946 )     (33,157 )
 
   
 
     
 
 
Net real estate properties
    256,352       260,141  
Cash and cash equivalents
    1,299       668  
Restricted cash
    7,185       7,166  
Deferred financing costs, net
    2,575       2,955  
Other assets
    4,098       3,698  
 
   
 
     
 
 
Total assets
  $ 271,509     $ 274,628  
 
   
 
     
 
 
Liabilities and shareholders’ equity
               
Liabilities
               
Accounts payable and accrued expenses
  $ 1,988     $ 2,225  
Deferred revenue
    2,056        
Bonds payable
    55,285       55,855  
Revolving line of credit
          3,800  
 
   
 
     
 
 
Total liabilities
    59,329       61,880  
 
   
 
     
 
 
Commitments and contingencies
               
Shareholders’ equity
               
Preferred shares, $.001 par value;
               
50,000,000 shares authorized;
               
None outstanding
           
Common shares, $.001 par value;
               
150,000,000 shares authorized;
               
10,983,750 and 10,967,750 shares issued and outstanding
    11       11  
Capital in excess of par value
    220,530       220,268  
Distributions in excess of accumulated earnings
    (8,322 )     (7,531 )
Unearned compensation
    (39 )      
 
   
 
     
 
 
Total shareholders’ equity
    212,180       212,748  
 
   
 
     
 
 
Total liabilities and shareholders’ equity
  $ 271,509     $ 274,628  
 
   
 
     
 
 

The accompanying notes to consolidated financial statements are an integral part of these statements.

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CORRECTIONAL PROPERTIES TRUST

CONSOLIDATED STATEMENTS OF INCOME
For The Three Months Ended June 30, 2004 and 2003
(Amounts in thousands, except per share amounts)
(Unaudited)
                 
    June 30,   June 30,
    2004
  2003
Revenues
               
Rental
  $ 8,430     $ 7,865  
Interest
    15       32  
 
   
 
     
 
 
 
    8,445       7,897  
 
   
 
     
 
 
Expenses
               
Depreciation
    1,895       1,824  
General and administrative
    677       487  
Interest
    1,288       2,759  
 
   
 
     
 
 
 
    3,860       5,070  
 
   
 
     
 
 
Net income
  $ 4,585     $ 2,827  
 
   
 
     
 
 
Net income per common share and common share equivalents:
               
Basic
  $ 0.42     $ 0.37  
 
   
 
     
 
 
Diluted
  $ 0.41     $ 0.37  
 
   
 
     
 
 
Weighted average number of common shares and common share equivalents outstanding:
               
Basic
    10,977       7,627  
 
   
 
     
 
 
Diluted
    11,078       7,721  
 
   
 
     
 
 
Distributions declared per common share outstanding (note 8)
  $ 0.45     $ 0.42  
 
   
 
     
 
 

The accompanying notes to consolidated financial statements are an integral part of these statements.

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CORRECTIONAL PROPERTIES TRUST

CONSOLIDATED STATEMENTS OF INCOME
For The Six Months Ended June 30, 2004 and 2003
(Amounts in thousands, except per share amounts)
(Unaudited)
                 
    June 30,   June 30,
    2004
  2003
Revenues
               
Rental
  $ 16,787     $ 15,435  
Interest
    30       58  
 
   
 
     
 
 
 
    16,817       15,493  
 
   
 
     
 
 
Expenses
               
Depreciation
    3,790       3,607  
General and administrative
    1,341       946  
Interest
    2,590       5,485  
 
   
 
     
 
 
 
    7,721       10,038  
 
   
 
     
 
 
Net income
  $ 9,096     $ 5,455  
 
   
 
     
 
 
Net income per common share and common share equivalents:
               
Basic
  $ 0.83     $ 0.73  
 
   
 
     
 
 
Diluted
  $ 0.82     $ 0.72  
 
   
 
     
 
 
Weighted average number of common shares and common share equivalents outstanding:
               
Basic
    10,975       7,512  
 
   
 
     
 
 
Diluted
    11,085       7,599  
 
   
 
     
 
 
Distributions declared per common share outstanding (note 8)
  $ 0.90     $ 0.82  
 
   
 
     
 
 

The accompanying notes to consolidated financial statements are an integral part of these statements.

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CORRECTIONAL PROPERTIES TRUST

CONSOLIDATED STATEMENTS OF CASH FLOWS
For The Six Months Ended June 30, 2004 and 2003
(Amounts in thousands)
(Unaudited)
                 
    June 30,   June 30,
    2004
  2003
Cash flows from operating activities
               
Net income
  $ 9,096     $ 5,455  
Adjustments to net income:
               
Depreciation of real estate assets
    3,790       3,607  
Amortization of deferred financing costs
    389       449  
Stock based compensation
    18        
Changes in operating assets and liabilities:
               
Other assets
    (400 )     (222 )
Accounts payable and accrued expenses
    (220 )     683  
Deferred revenue
    2,056       1,998  
 
   
 
     
 
 
Net cash provided by operating activities
    14,729       11,970  
 
   
 
     
 
 
Cash flows from investing activities
Acquisition of real estate investments
          (21,308 )
 
   
 
     
 
 
Net cash used in investing activities
          (21,308 )
 
   
 
     
 
 
Cash flows from financing activities
               
Dividends paid
    (9,887 )     (6,176 )
Proceeds from exercise of stock options
    187       6,446  
Repayments under revolving line of credit
    (9,300 )     (8,000 )
Borrowings under revolving line of credit
    5,500       17,000  
Repayments of bonds payable
    (570 )     (440 )
Restricted cash
    (19 )     10  
Deferred financing costs
    (9 )     (118 )
 
   
 
     
 
 
Net cash (used in) provided by financing activities
    (14,098 )     8,722  
 
   
 
     
 
 
Net increase (decrease) in cash and cash equivalents
    631       (616 )
Cash and cash equivalents, beginning of year
    668       4,333  
 
   
 
     
 
 
Cash and cash equivalents, end of quarter
  $ 1,299     $ 3,717  
 
   
 
     
 
 
Supplemental disclosure:
               
Cash paid for interest
  $ 2,218     $ 5,016  
 
   
 
     
 
 

The accompanying notes to consolidated financial statements are an integral part of these statements.

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CORRECTIONAL PROPERTIES TRUST

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2004

1. General

     The consolidated financial statements of Correctional Properties Trust (the “Company”) include all the accounts of the Company and its wholly owned subsidiaries. All significant intercompany balances and transactions have been eliminated.

     The accompanying interim consolidated financial statements are unaudited. However, the financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and in conjunction with the rules and regulations of the Securities and Exchange Commission. Accordingly, they do not include all of the disclosures required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments (consisting solely of normal recurring matters) necessary for a fair presentation of the financial statements for this interim period have been included. The results of operations for the interim period are not necessarily indicative of the results to be obtained for the full fiscal year. These financial statements should be read in conjunction with the financial statements and notes included in the Company’s Form 10-K for the year ended December 31, 2003, filed with the Securities and Exchange Commission.

2. Recent Accounting Pronouncements

     In January 2003, the Financial Accounting Standards Board issued Financial Interpretation Number 46, Consolidation of Variable Interest Entities (FIN No. 46), which addressed consolidation by a business of variable interest entities in which it is the primary beneficiary effective for 2003. FIN No. 46 was amended in December 2003 to include transitional rules for certain entities extending the effective date to the quarter ended March 31, 2004. There was no impact to the Company’s consolidated financial position, results of operations or cash flows upon adoption of FIN No. 46.

3. Amended Bank Credit Facility

     The Company currently has an Amended and Restated Credit Agreement (the “Amended Bank Credit Facility”) consisting of a $95 million secured revolving credit facility. The proceeds of the Amended Bank Credit Facility, which has a term of thirty-six (36) months and matures on November 24, 2006, may be used to finance the construction and acquisition of correctional and detention facilities, to expand or improve current facilities and for general working capital purposes. The Amended Bank Credit Facility includes a swingline component and provisions to increase the Amended Bank Credit Facility up to a total of $200 million by increasing the revolver, and/or by originating a new term loan of up to $100 million, subject to successful syndication and closing.

     The Amended Bank Credit Facility is secured by the Company’s facilities other than the Queens Private Correctional Facility (the “Queens Facility”) the Mountain View Correctional Facility (the “Mountain View Facility”) and the Pamlico Correctional Facility (the “Pamlico Facility’), and permits aggregate borrowings of up to 50% of the lesser of the aggregate of the historical cost of the Company’s facilities or the aggregate of the appraised value of such facilities (the “Total Value”). Under the terms of the Amended Bank Credit Facility, the Company is restricted from paying dividends in excess of the lesser of 100% of Cash Available for Distribution (as defined in the Amended Bank Credit Facility) or 95% of Funds from Operations plus, in either case, 100% of the amount of any capital gain from dispositions of facilities. The Amended Bank Credit Facility includes a requirement that the Company enter into certain interest rate swap agreements for a portion of the amounts drawn, which effectively fixes the interest rate on a significant portion of the borrowings. As of June 30, 2004, the Company has no amounts drawn, and no interest rate swap agreements in effect. The Company’s ability to borrow under the Amended Bank Credit Facility is subject to the Company’s compliance with a number of restrictive covenants and other requirements.

     Borrowings under the Amended Bank Credit Facility bear interest at either the Base Rate or Eurodollar Rate at the option of the Company. The Base Rate is equal to the sum of (a) the higher of (i) the Federal Funds Rate plus 50 basis points and (ii) the Prime Rate plus (b) the Base Rate Applicable Margin, which ranges from 0 to 75 basis points depending upon the ratio of consolidated total liabilities to consolidated total assets. The Eurodollar Rate is equal to LIBOR plus the Eurodollar Rate

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Applicable Margin, which ranges from 275 to 350 basis points depending upon the ratio of consolidated total liabilities to consolidated total assets. The interest period on Eurodollar rate loans may be of one, two, three, six or nine months at the option of the Company. The Applicable Margins for Base Rate Loans and Eurodollar Rate Loans described above in the Amended Bank Credit Facility were 0 and 275 basis points at June 30, 2004, respectively. The Company is required to pay an used fee under the Amended Bank Credit Facility, which ranges from 35 to 50 basis points depending upon the ratio of consolidated total liabilities to consolidated total assets, on the amount by which the available borrowing capacity exceeds the amounts outstanding. Economic conditions could result in higher interest rates, which could increase debt service requirements on borrowings under the Amended Bank Credit Facility and which could, in turn, reduce the amount of cash available for distribution.

     As of June 30, 2004, no amounts were outstanding under the $95 million Amended Bank Credit Facility. As of June 30, 2004, the Company had $95 million of available borrowing capacity under its Amended Bank Credit Facility, including $7.5 million available to be drawn on the swing line component of the Amended Bank Credit Facility for general working capital requirements. All borrowings under the Amended Bank Credit Facility are subject to the Company’s compliance with several restrictive covenants prior to any such amounts being drawn to finance the acquisition of correctional and detention facilities and/or to expand the facilities the Company already owns and for general working capital requirements.

     In order for a facility to be initially included in the Pledge Pool Borrowing Base (“Pledge Pool”), the lessee of the facility must be in full compliance with the material terms and conditions contained in the operating or management contract with the governmental agency. However, in the event that any facility, after becoming a part of the Pledge Pool, becomes vacant such property shall continue to be included in the Pledge Pool so long as the lease agreement with respect to such property is in full force and effect and the inclusion of such property in the Pledge Pool would not cause the sum of the appraised values of all vacant properties in the Pledge Pool to exceed 20% of the Total Value.

     The Geo Group, Inc., a company to which the Company leases a significant number of its facilities, does not presently have a correctional facility operating or management contract with a governmental agency for the Jena Facility and the McFarland Facility. However, the Geo Group, Inc. continues to make rental payments to the Company as required under the terms of the non-cancelable leases. The appraised value of these two facilities is approximately ten percent of the Total Value, and therefore, does not exceed 20% of the Total Value. As a result, both of these facilities continue to be included in the Pledge Pool.

4. Bonds Payable

     On June 28, 2001, Correctional Properties North Carolina Prison Finance LLC (“CP North Carolina”), a newly formed and wholly owned subsidiary of the Company whose assets, liabilities and results of operations are fully consolidated in the consolidated financial statements of the Company, issued $57,535,000 in Taxable Mortgage Revenue Bonds, Series 2001 (the “Bonds”). The proceeds from the Bonds were used to complete the acquisition of the Pamlico Facility, to refinance the Mountain View Facility, provide a debt service reserve fund of approximately $5,754,000, establish a working capital fund of $750,000, and pay the costs of the transaction, including the one time premium for a bond insurance policy. The Bonds, which have a fixed-rate coupon of 7.15%, were privately placed at par value on a negotiated basis to qualified institutional buyers as defined under Rule 144A of the Securities Act of 1933.

     Quarterly payments of principal and interest on the Bonds began in October 2001, with the final payment due in January 2017. The Bonds are non-recourse obligations and are secured by a deed of trust and a security agreement on the Mountain View Facility and Pamlico Facility, as well as an assignment to a trustee of the lease payments to be made by the State of North Carolina under each of the facility leases. As of June 30, 2004, the outstanding balance of the Bonds was $55,285,000.

     In the event of the exercise of the purchase option on the Mountain View Facility, and/or the Pamlico Facility by the State of North Carolina prior to January of 2017 as provided in the respective leases, CP North Carolina is obligated to redeem all or a portion of the Bonds at a redemption price equal to 100% of the principal amount of the Bonds to be redeemed, plus accrued interest to the redemption date. If both of the Mountain View and Pamlico Facilities are purchased, CP North Carolina is obligated to redeem all of the Bonds. If only one of the Mountain View or Pamlico Facilities is purchased, CP North Carolina is obligated to redeem a principal amount of Bonds equal to the purchase price of the facility purchased, net of closing costs, pro rations and adjustments. Please see Note 9 “Sale of Mountain View and Pamlico Facilities” in the notes to the consolidated financial statements included in this Form 10-Q for the quarter ended June 30, 2004 for additional information regarding the exercise of the purchase option for both of these facilities by the State of North Carolina.

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5. Comprehensive Income (Loss)

The components of the Company’s comprehensive income are as follows (dollars in thousands):

                                 
    For the Three Months Ended   For the Six Months Ended
    June 30, 2004
  June 30, 2003
  June 30, 2004
  June 30, 2003
Net income
  $ 4,585     $ 2,827     $ 9,096     $ 5,455  
Unrealized loss on derivative instruments
          (14 )           (69 )
Losses reclassified into earnings from other comprehensive loss
          851             1,675  
 
   
 
     
 
     
 
     
 
 
Comprehensive income
  $ 4,585     $ 3,664     $ 9,096     $ 7,061  
 
   
 
     
 
     
 
     
 
 

6. Earnings Per Share

     The following data show the amounts used in computing earnings per share and the effects on income and the weighted-average number of shares of potential dilutive common stock (in thousands, except per share data):

                                 
    For the Three Months Ended   For the Six Months Ended
    June 30, 2004
  June 30, 2003
  June 30, 2004
  June 30, 2003
Net income
  $ 4,585     $ 2,827     $ 9,096     $ 5,455  
 
   
 
     
 
     
 
     
 
 
Weighted average shares — basic
    10,977       7,627       10,975       7,512  
 
   
 
     
 
     
 
     
 
 
Per Share — Basic
  $ 0.42     $ 0.37     $ 0.83     $ 0.73  
 
   
 
     
 
     
 
     
 
 
Effect of dilutive stock options
    101       94       110       87  
 
   
 
     
 
     
 
     
 
 
Weighted average shares – diluted
    11,078       7,721       11,085       7,599  
 
   
 
     
 
     
 
     
 
 
Per Share — Diluted
  $ 0.41     $ 0.37     $ 0.82     $ 0.72  
 
   
 
     
 
     
 
     
 
 

     As of June 30, 2004 and 2003, all outstanding options to purchase shares of the Company’s stock were included in the computation of diluted EPS.

7. Employee Stock-Based Compensation Plans

     The Company accounts for stock-based compensation utilizing the intrinsic value method in accordance with the provisions of APB Opinion No. 25 and related interpretations. Accordingly, no compensation cost has been recognized for its employee stock plans because the exercise prices of the stock options granted equal the market prices of the underlying stock on the dates of grant. Had compensation for the Company’s stock-based compensation plans been determined pursuant to SFAS No. 123, “Accounting for Stock-Based Compensation”, the Company’s net income and earnings per share would have decreased accordingly.

     The following table represents the effect on net income and earnings per share if the Company had applied the fair value based method pursuant to SFAS No. 123, to employee stock-based compensation plans. (In thousands except per share amounts)

                                 
    For the Three Months Ended   For the Six Months Ended
    June 30, 2004
  June 30, 2003
  June 30, 2004
  June 30, 2003
Net income, as reported
  $ 4,585     $ 2,827     $ 9,096     $ 5,455  
Add: stock-based compensation expense included in net income as reported
                       
Deduct: stock-based compensation expense determined under the fair value based method for all awards
    (14 )     (15 )     (28 )     (97 )
 
   
 
     
 
     
 
     
 
 
Pro forma net income
  $ 4,571     $ 2,812     $ 9,068     $ 5,358  
 
   
 
     
 
     
 
     
 
 
Net income per share
                               
Basic, as reported
  $ 0.42     $ 0.37     $ 0.83     $ 0.73  
Basic, pro forma
  $ 0.42     $ 0.37     $ 0.83     $ 0.71  
Diluted, as reported
  $ 0.41     $ 0.37     $ 0.82     $ 0.72  
Diluted, pro forma
  $ 0.41     $ 0.36     $ 0.82     $ 0.71  

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8. Distributions Declared Per Share

     Distributions are generally declared a quarter in arrears. Distributions declared per share for the three months ended June 30, 2004 and June 30, 2003 represent the first quarter distribution for 2004 and 2003, respectively. Distributions declared per share for the six months ended June 30, 2004 represent the fourth quarter distribution for 2003 and the first quarter distribution for 2004. Distributions declared per share for the six months ended June 30, 2003 represent the fourth quarter distribution for 2002 and the first quarter distribution for 2003.

9. Sale of Mountain View and Pamlico Facilities

     In July 2004, the Company received written notice from the State of North Carolina of the exercise of its option to purchase the Pamlico Facility and the Mountain View Facility, both of which are owned by a subsidiary of the Company, and leased to the State of North Carolina.

     The Pamlico Facility and the Mountain View Facility were purchased in 2001 from an unrelated third party, subject to existing leases on each property for approximately $24.3 million and $25.2 million, respectively including transaction costs. As previously disclosed, each of the leases contain an option under which the State of North Carolina may acquire the facilities for a predetermined purchase price, which declines each year. The options are exercisable annually beginning in 2004. The options provide for the acquisition of the Pamlico Correctional Facility beginning in August 2004 for approximately $25.2 million, and the Mountain View Correctional Facility beginning in December 2004, for approximately $26.2 million.

     As of June 30, 2004, the aggregate net carrying value of the Pamlico Facility and Mountain View Facility assets was approximately $53.9 million, which includes restricted cash held by the trustee for the Bonds of approximately $7.2 million, with related liabilities of approximately $56.2 million. The Pamlico Facility and Mountain View Facility will be accounted for as discontinued operations in future reporting periods. The aggregate rental revenues from these facilities for the three months ended June 30, 2004 and 2003 were approximately $1.7 million. The aggregate rental revenues from these facilities for the six months ended June 30, 2004 and 2003 were approximately $3.3 million.

10. Subsequent Events

     On August 5, 2004, the Company’s Board of Trustees declared a distribution of $0.45 per share for the quarter ended June 30, 2004, to shareholders of record on August 20, 2004. The distribution will be paid on September 2, 2004 and represents a distribution for the period from April 1, 2004 through June 30, 2004.

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Item 2 -Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion should be read in conjunction with the Company’s consolidated financial statements and notes thereto, which are included elsewhere in this report.

Overview

     We were formed in February 1998 as a Maryland real estate investment trust to capitalize on the growing trend toward privatization in the corrections industry by acquiring correctional and detention facilities from both private prison operators and governmental entities and leasing these facilities to experienced correctional and detention facility operators or the governmental entities under long-term, non-cancelable, triple-net leases (leases where the tenant is required to pay all operating expenses, taxes, insurance, structural and non-structural repairs and other costs). Except where the context otherwise requires, the terms “we,” “us,” or “our” refer to the business of Correctional Properties Trust and its consolidated subsidiaries.

     Our principal business strategy is to finance and/or acquire correctional and detention facilities that meet our investment criteria, from private prison managers, developers and government entities, to expand our existing facilities, and to lease all of these facilities under long-term triple-net leases to qualified third-party operators. With the exception of our Mountain View Facility in Spruce Pine, North Carolina and our Pamlico Facility in Bayboro, North Carolina which facilities are leased to and operated by the State of North Carolina, our facilities are privately managed facilities that are leased to and operated by The Geo Group, Inc., or The Geo Group, or Community Educations Center, Inc., or CEC. We lease eleven of our facilities to The Geo Group or its subsidiary and one of our facilities to CEC.

     Substantially all of our revenues are derived from: (i) rents received under triple-net leases of correctional and detention facilities; and (ii) interest earned from the temporary investment of funds in short-term investments.

     A component of the rental revenue we receive consists of increases resulting from rent escalation provisions which appear in all of our leases:

    The Geo Group Leases. The base rent for the first year of each facility leased to The Geo Group before January 1, 2000 was equal to 9.5% of the facility purchase price. After the first year, minimum rent escalates by the greater of 3% or the increase in the Consumer Price Index, or CPI, with a maximum increase of 4% for the first two annual anniversaries of the effective date of each lease and, for each successive annual anniversary for the remaining term of each lease, by an amount equal to increases, if any, in the CPI, subject to a maximum increase of 4.0% per annum throughout the term of the leases. The base rent for the first year of the Jena Juvenile Justice Center in Jena, Louisiana leased to The Geo Group was equal to 11.0% of the facility purchase price with a fixed 4.0% annual escalator. The average remaining life on the eleven leases with The Geo Group as of June 30, 2004, is approximately 4.25 years.

    State of North Carolina Leases. In the year we acquired the Pamlico Facility and assumed the existing lease agreement with the State of North Carolina (which originally commenced in August 1998), the base rent was equal to $2,858,754 or 11.9% of the facility purchase price. In the year we acquired the Mountain View Facility and assumed the existing lease agreement with the State of North Carolina (which originally commenced in December 1998), the base rent was equal to $2,965,900 or 11.9% of the facility purchase price. In both cases, following the first year and continuing during the term of the leases and any renewal terms, base rent will increase annually by the greater of 3.5%, or the percentage of increase, if any, in the CPI, with a maximum annual increase of 4.0%.

    Community Education Centers Lease. On May 29, 2003, we acquired Delaney Hall. The initial base rent is $2,310,000 per annum or 11.0% of the facility purchase price. Following the first year and continuing during the term of the lease, base rent will increase by 3.0% annually on each anniversary.

     We incur operating and administrative expenses, including compensation expense for our executive officers and other employees, office rental and related occupancy costs and various expenses incurred in the process of acquiring additional properties. We are self-administered and managed by our executive officers and staff, and do not engage a separate advisor or pay

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an advisory fee for administrative or investment services, although we do engage legal, accounting, tax and financial advisors from time to time. Our primary non-cash expense is depreciation of our correctional and detention facilities. All facilities owned by us are leased under triple-net leases, which require the lessees to pay substantially all expenses associated with the operation of these facilities. As a result of these arrangements, we do not believe we will be responsible for any major expenses in connection with the facilities during the terms of the leases.

     We have leveraged and anticipate continuing to leverage our portfolio of real estate equity investments, and expect to continue to incur short-term indebtedness and related interest expense. We may also incur long-term indebtedness to make acquisitions, and/or refinance correctional facilities currently owned.

     We intend to make distributions to our shareholders in amounts not less than the amounts required to maintain our status as a real estate investment trust, or REIT, under the Internal Revenue Code.

     Our operating cash flows are dependent on the continued leasing of our properties, the rents that we are able to charge to our tenants, the ability of these tenants to make their rental payments, our ability to renew our leases with our existing tenants as they expire and our ability to re-lease our properties with other suitable tenants if our leases are not renewed by our existing tenants. A principal long-term risk to our business is our dependence on the viability of The Geo Group and our other tenants. Any of the following could have a material adverse impact on our cash flows and earnings:

    We are subject to lease payment collection risks because our lease agreements are for longer terms than those of the facility management services or operating agreements held by and which generate revenue for The Geo Group and CEC. Only a governmental agency that has contracted with The Geo Group and CEC may exercise a renewal option of an existing management services or operating agreement or enter into a new management services or operating agreement. A governmental agency may choose to terminate or not renew an operating agreement or management services agreement. For example, the operating agreement for the Jena Facility has been terminated and the operating agreement for the McFarland Facility has expired. The non-renewal of a facility management services or operating agreement and the inability to secure an alternate agreement or source of inmates could materially and adversely affect The Geo Group’s or CEC’s financial condition and their respective ability to make lease payments to us.

    The Geo Group, the State of North Carolina and CEC are the only parties with whom we have entered into lease agreements. Accordingly, these parties account for 100% of our lease agreement revenue and the failure of any one of them to meet their respective obligations to us may have a material adverse effect upon our operations.

    The Geo Group is either the lessee or sublessee of 11 of the 14 facilities we own. As of June 30, 2004, approximately 72% of our revenue, and our ability to make distributions to our shareholders, will depend substantially upon The Geo Group making rent payments and satisfying its obligations to us. Any failure or delay by The Geo Group in making rent payments or otherwise complying with its obligations under these leases may adversely affect our cash flows and earnings and our ability to make anticipated distributions. Eight of our leases with The Geo Group expire during April 2008. To the extent these leases are not renewed by The Geo Group or re-leased to other suitable tenants on acceptable terms, our total revenue and ability to make distributions to our shareholders will be adversely affected.

    In July 2004, the Company received written notice from the State of North Carolina of the exercise of its option to purchase the Pamlico Facility and the Mountain View Facility, both of which are owned by a subsidiary of the Company, and leased to the State of North Carolina. The options contained in the lease agreements provide for the acquisition of the Pamlico Facility beginning in August 2004 for approximately $25.2 million, and the Mountain View Facility beginning in December 2004, for approximately $26.2 million. Upon the sale of the Mountain View Facility and/or the Pamlico Facility, we would be obligated to redeem all or a portion of the Bonds issued by our subsidiary using net proceeds from the sale of the facility or facilities and the balance of the debt service reserve fund of $5.8 million held by the trustee for the Bonds. In addition, we would recognize a one-time gain on the sale of the facility and/or facilities; however, future results of operations and cash flows

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      would be negatively impacted because we would no longer receive the monthly rental income once a facility is sold. For additional information, please see Note 9 “Sale of Mountain View and Pamlico Facilities” in the notes to the consolidated financial statements included in this Form 10-Q for the quarter ended June 30, 2004.

     Our operating cash flows are also negatively impacted by increases in general and administrative expenses, including increases in salaries and benefits for our employees and officers, increases in professional fees including legal and accounting expenses associated with maintaining compliance with the requirements of the Sarbanes-Oxley Act of 2002 and other regulatory requirements and increases in costs for liability insurance and directors and officers insurance.

     We may finance, purchase or lease properties for long-term investment, expand and improve the facilities presently owned or sell these properties, in whole or in part, when circumstances warrant. We may also participate with other entities in property ownership, through joint ventures or other types of co-ownership. Equity investments may be subject to existing mortgage financing and other indebtedness which have priority over our equity interest. While we emphasize equity real estate investments, we may, in our discretion, invest in mortgages, equity or debt securities of other REITs or partnerships and other real estate interests. Mortgage investments may include participating in convertible mortgages. There are no current limitations on the percentage of our assets that may be invested in any one property, venture or type of security. Our Board of Trustees may establish investment limitations as it deems appropriate from time to time, including investment limitations necessary to maintain our qualification as a REIT. No limitations have been set on the number of properties in which we will seek to invest or on the concentration of investments in any one geographic region.

Critical Accounting Policies

     The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions in certain circumstances that affect amounts reported in our financial statements and related notes. In preparing these financial statements, we have made our best estimates and assumptions that affect the reported assets and liabilities. We believe our most critical accounting policies include revenue recognition, depreciation of real estate, impairment of long-lived assets, and the accounting for interest rate swaps and stock options. Application of these assumptions requires the exercise of judgment as to future uncertainties and, as a result, future results could differ from these estimates. For additional information, please see Note 2 “Basis of Presentation and Summary of Significant Accounting Policies” in the notes to the consolidated financial statements included in Item 8 of our Form 10-K for the year ended December 31, 2003.

     Revenue Recognition

     Lease revenue is recognized on a straight-line basis over the lease term including the impact of scheduled rent increases which are determinable in amount at the inception of the lease. Any increases in lease revenue due to scheduled rent increases which were not determinable at the inception of the lease will be recognized when determinable. Scheduled rent increases which are not determinable at lease inception are dependent upon increases in the CPI.

     Depreciation of Real Estate

     Real estate properties are recorded at cost. Acquisition costs and transaction fees directly related to each property are capitalized as a cost of the respective property. The purchase price of properties is allocated to tangible and intangible assets based on their respective values in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 141, “Business Combinations”, which was effective July 1, 2001. The tangible cost of real estate properties acquired is allocated between land, buildings and improvements, and machinery and equipment based upon the relative fair value of each component at the time of acquisition. Depreciation is provided for on a straight-line basis over an estimated useful life ranging from 27-40 years for buildings and improvements. The intangible costs of real estate properties are allocated to above or below market in-place leases and other lease origination costs. These intangible costs are amortized over the remaining term of the corresponding leases. We are required to make subjective evaluations of the estimated useful lives of our properties, which directly impact our net income.

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     Impairment of Long-lived Assets

     We review the recorded value of our real estate for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset in question may not be recoverable. We have reviewed our long-lived assets and have determined that there are no events requiring impairment loss recognition. The method used to determine impairment would be based on estimates of undiscounted operating cash flows over the remaining amortization period for the related long-lived assets. We would measure impairment as the difference between fair value and the net book value of the related asset.

     Interest Rate Swaps

     In accordance with the amended bank credit facility, we utilize interest rate swap derivative instruments to manage changes in market conditions related to interest rate payments on certain of our variable rate bank debt obligations. These interest rate swaps exchange floating interest rate LIBOR payments on specified established notional amounts for fixed rate interest payments on the same notional amounts. We recognize our interest rate swap derivatives on the balance sheet at fair value, which is determined by the counter party, as either an asset or a liability. Changes in the fair value of interest rate swaps, which are determined to be effective cash flow hedges, are recorded in accumulated other comprehensive loss, which is a component of shareholders’ equity.

     Stock Options

     We account for stock-based compensation utilizing the intrinsic value method in accordance with the provisions of Accounting Principles Board Opinion No. 25 and related interpretations. Accordingly, no compensation cost has been recognized for our stock plans because the exercise prices of the stock options equal the market prices of the underlying stock on the dates of grant. Had compensation for our stock-based compensation plans been determined pursuant to Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation”, our net income and earnings per share would have decreased accordingly. For additional information, please see Note 2 “Basis of Presentation and Summary of Significant Accounting Policies: Employee Stock-Based Compensation Plans” and Note 5 “Share Option and Incentive Plans” in the notes to the consolidated financial statements included in Item 8 of our Form 10-K for the year ended December 31, 2003 along with Note 7 “Employee Stock-Based Compensation Plans” in the notes to the consolidated financial statements included in this Form 10-Q for the quarter ended June 30, 2004.

Three Months ended June 30, 2004 vs. Three Months ended June 30, 2003

     For the three months ended June 30, 2004, rental revenues increased to $8,430,000 from $7,865,000 for the three months ended June 30, 2003. The 7% increase in rental revenues resulted primarily from the acquisition of Delaney Hall on May 29, 2003, which increased rental revenue by $0.4 million. The balance of the increase was primarily due to annual rent escalations, based on the CPI, on some of the facilities of approximately $0.2 million.

     Depreciation for the three months ended June 30, 2004 increased to $1,895,000 from $1,824,000 for the three months ended June 30, 2003. Depreciation associated with the Delaney Hall Facility resulted in the 4% increase in depreciation from 2003 to 2004.

     General and administrative expenses for the three months ended June 30, 2004 increased 39% to $677,000 from $487,000 for the three months ended June 30, 2003. The increase in general and administrative expenses was primarily due to increases in salaries and benefits of $54,000, insurance of $16,000, professional fees of $53,000 and Board of Trustee fees of $51,000.

     Interest expense decreased to $1,288,000 for the three months ended June 30, 2004 from $2,759,000 for the three months ended June 30, 2003. The decrease was primarily due to a reduction in interest on our amended bank credit facility as a result of the reduction in the outstanding balance in July 2003 using the net proceeds from a secondary public offering in July 2003 of 3,250,000 of our common shares at $25.50 per share under our shelf registration statement.

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Six Months ended June 30, 2004 vs. Six Months ended June 30, 2003

     For the six months ended June 30, 2004, rental revenues increased to $16,787,000 from $15,435,000 for the six months ended June 30, 2003. The 9% increase in rental revenues resulted primarily from the acquisition of Delaney Hall on May 29, 2003, which increased rental revenue by $1.1 million. The balance of the increase was primarily due to annual rent escalations, based on the CPI, on some of the facilities of approximately $0.3 million.

     Depreciation for the six months ended June 30, 2004 increased to $3,790,000 from $3,607,000 for the six months ended June 30, 2003. Depreciation associated with the Delaney Hall Facility resulted in the 5% increase in depreciation from 2003 to 2004.

     General and administrative expenses for the six months ended June 30, 2004 increased 42% to $1,341,000 from $946,000 for the six months ended June 30, 2003. The increase in general and administrative expenses was primarily due to increases in salaries and benefits of $92,000, insurance of $53,000, professional fees of $134,000 and Board of Trustee fees of $124,000.

     Interest expense decreased to $2,590,000 for the six months ended June 30, 2004 from $5,485,000 for the six months ended June 30, 2003. The decrease was primarily due to a reduction in interest on our amended bank credit facility as a result of the reduction in the outstanding balance in July 2003 using the net proceeds from a secondary public offering in July 2003 of 3,250,000 of our common shares at $25.50 per share under our shelf registration statement.

Liquidity and Capital Resources

     Our short-term liquidity requirements normally consist primarily of funds necessary to pay for general and administrative expenses (including payroll and costs of legal, accounting and other professionals), interest expense and scheduled principal payments on our outstanding debt, capital expenditures incurred to facilitate the leasing of space, and quarterly dividends and other distributions paid to our common shareholders. As a REIT, we are required to distribute at least 90% of our taxable income to holders of our common shares on an annual basis. Therefore, as a general matter, it is unlikely that we will retain any substantial cash balances that could be used to meet our liquidity needs. Instead, we expect to meet our short-term liquidity requirements generally through our working capital and net cash provided by operations. We believe that our net cash provided by operations will be sufficient to allow us to make distributions necessary to enable us to continue to qualify as a REIT. All facilities owned by us are leased under triple-net leases, which require the lessees to pay substantially all expenses associated with the operation of these facilities. As a result of these arrangements, we do not believe we will be responsible for any major expenses in connection with the facilities during the terms of the leases.

     We currently have an amended bank credit facility consisting of a $95 million secured revolving credit facility. The proceeds of the amended bank credit facility may be used to finance the construction and the acquisition of correctional and detention facilities, to expand or improve current facilities and for general working capital purposes. The amended bank credit facility includes a swing line component and provisions to increase the amended bank credit facility up to a total of $200 million by increasing the revolver, and/or by originating a new term loan of up to $100 million, subject to successful syndication and other specified closing conditions.

     The amended bank credit facility is secured by our facilities, other than the Queens Facility, the Mountain View Facility and Pamlico Facility, and permits aggregate borrowings of up to 50% of the total value of the facilities, known as the Pledge Pool, which is calculated as the lesser of the aggregate of the historical cost of our facilities or the aggregate of the appraised value of those facilities. Under the terms of the amended bank credit facility, we are restricted from paying dividends in excess of (a) the lesser of 100% of cash available for distribution or 95% of funds from operations plus, in either case (b) 100% of the amount of any capital gain from dispositions of facilities. The amended bank credit facility includes a requirement that we enter into specified interest rate swap agreements for a portion of the amounts drawn, which effectively fixes the interest rate on a significant portion of the borrowings. As of June 30, 2004, the Company has no amounts drawn, and no interest rate swap agreements in effect. Our ability to borrow under the amended bank credit facility is subject to our compliance with a number of customary affirmative and negative restrictive covenants and other requirements including certain financial covenants with respect to our consolidated net

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worth and interest coverage ratio and limits on capital expenditures and borrowings in addition to other restrictions. We were in compliance with these covenants at June 30, 2004.

     Borrowings under the amended bank credit facility bear interest at either a base rate or Eurodollar rate at our option. The base rate is equal to the sum of (a) the higher of (i) the Federal Funds Rate plus 50 basis points and (ii) the Prime Rate plus (b) the base rate applicable margin, which ranges from 0 to 75 basis points depending upon our ratio of consolidated total liabilities to consolidated total assets. The Eurodollar rate is equal to LIBOR plus the Eurodollar rate applicable margin, which ranges from 275 to 350 basis points depending upon our ratio of consolidated total liabilities to consolidated total assets. The interest period on Eurodollar rate loans may be one, two, three, six or nine months at our option. The applicable margins for base rate loans and Eurodollar rate loans described above were 0 and 275 basis points at June 30, 2004, respectively. The Company is required to pay an used fee under the Amended Bank Credit Facility, which ranges from 35 to 50 basis points depending upon the ratio of consolidated total liabilities to consolidated total assets, on the amount by which the available borrowing capacity exceeds the amounts outstanding. Economic conditions could result in higher interest rates, which could increase debt service requirements on borrowings under the amended bank credit facility and which could, in turn, reduce the amount of cash available for distribution. As of June 30, 2004, no amounts were outstanding under the $95 million amended bank credit facility. As of June 30, 2004, we had $95 million of available borrowing capacity, including $7.5 million available to be drawn on the swing line component for general working capital requirements.

     In order for a facility to be initially included in the Pledge Pool, the lessee of the facility must be in full compliance with the material terms and conditions contained in the operating or management contract with the governmental agency. However, in the event that any facility, after becoming a part of the Pledge Pool, becomes vacant that property shall continue to be included in the Pledge Pool so long as the lease agreement with respect to such property is in full force and effect and the inclusion of that property in the Pledge Pool would not cause the sum of the appraised values of all vacant properties in the Pledge Pool to exceed 20% of the total value of the Pledge Pool as calculated above.

     The Geo Group does not presently have a correctional facility operating or management contract with a governmental agency for the Jena Facility and the McFarland Facility. However, The Geo Group continues to make rental payments to us as required under the terms of the non-cancelable leases. The appraised value of these two facilities is approximately ten percent of the total value of the facilities as calculated above, and therefore, does not exceed 20% of the total value. As a result, both of these facilities continue to be included in the Pledge Pool.

     Each of our facilities are leased under triple-net leases in which the tenant is required to pay all the operating expenses, taxes, insurance, and structural and non-structural repairs and other costs. As a result, we have no commitments with respect to other capital expenditures on our existing facilities. We have an agreement under which we may acquire, at a price of up to 105% of cost, and lease back to The Geo Group, any correctional or detention facility acquired or developed and owned by The Geo Group, subject to specified limited exceptions, and subject to time constraints on each specific property. Currently there are no properties of The Geo Group eligible for purchase pursuant to this agreement.

     Our long-term liquidity requirements consist primarily of funds necessary to pay for the principal amount of our long-term debt as it matures, significant non-recurring capital expenditures that may need to be made periodically at our properties if the properties are not subject to a lease agreement, and the costs associated with acquisitions of properties. Historically, we have satisfied these long-term liquidity requirements through what we believe to be the most advantageous source of capital available at the time, which has included borrowing under our amended bank credit facility and by issuing equity or debt securities in public or private transactions. We believe that these sources of capital will continue to be available in the future to fund our long-term capital needs. We anticipate that we will be able to obtain financing for our long-term capital needs. However, we cannot assure you that this additional financing or capital will be available on terms acceptable to us. We may, under some circumstances, borrow additional amounts in connection with the renovation or expansion of facilities, the acquisition of additional properties, or as necessary, to meet certain distribution requirements imposed on REITs under the Internal Revenue Code. Our ability to incur additional debt may be affected by a number of factors, including the terms and conditions of our facility leases, the underlying operating and management services agreement between the governmental entities and our lessees, our degree of leverage, the appraised value of our properties, the value of our unencumbered assets, and borrowing restrictions imposed by existing lenders.

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     On June 12, 2002, we filed a “universal shelf” registration statement on Form S-3 with the Securities and Exchange Commission, under Rule 415 under the Securities Act of 1933, as amended, which is now effective. We may, from time to time, offer our common shares, preferred shares, debt securities, which may be senior or subordinated, depositary shares and warrants to acquire any of the foregoing. These securities may only be offered in amounts, at prices and on terms to be set forth in the prospectus contained in the registration statement, and in one or more supplements to the prospectus. The registration statement is intended to provide us flexibility to raise up to $250 million from the offering of these securities, subject to market conditions and capital needs. We currently have approximately $167 million available for issuance under the shelf registration statement. Net proceeds from the offering may be used by us to acquire correctional properties, repay outstanding debt, and for general working capital purposes.

     In July 2004, the Company received written notice from the State of North Carolina of the exercise of its option to purchase the Pamlico Facility and the Mountain View Facility, both of which are owned by a subsidiary of the Company, and leased to the State of North Carolina. On an annualized basis, the Pamlico Facility and the Mountain View Facility each currently contributes approximately 3.5 cents in net income per diluted share for a total of 7 cents. If the State of the North Carolina acquires both facilities in 2004, depending on timing and other variables, the Company would expect to recognize a combined gain on the sale of these facilities of approximately $5 million for financial reporting purposes. The net proceeds of a sale of one or both of these facilities are required to be used to redeem the Bonds at par, which were issued in 2001 to finance these facilities. If the State of North Carolina acquires both of these facilities in 2004, the Company expects to have excess sales proceeds of approximately $2 million, following the redemption of all the Bonds. Please see Note 9 “Sale of Mountain View and Pamlico Facilities” in the notes to the consolidated financial statements included in this Form 10-Q for the quarter ended June 30, 2004

     The Bonds issued by a wholly-owned subsidiary of ours in 2001 to acquire the Pamlico Facility and refinance the Mountain View Facility require quarterly payments of principal and interest. The total quarterly principal payments due in 2004 on the Bonds are $1,185,000. As of June 30, 2004, $55,285,000 in principal amount of Bonds remained outstanding.

Inflation Considerations

     Most of our leases contain provisions designed to partially mitigate the adverse impact of inflation and are indexed in some manner to the CPI. Our leases require the tenant to pay all operating expenses, including maintenance, real estate taxes and insurance, thereby reducing our exposure to increases in costs and operating expenses resulting from inflation.

Funds from Operations

     We believe Funds from Operations, or FFO, is helpful to investors as a measure of the performance of an equity REIT. FFO should not be considered as an alternative to net income (determined in accordance with GAAP) as an indication of our financial performance or to cash flows from operating activities (determined in accordance with GAAP) as a measure of our liquidity, nor is it indicative of funds available to fund our cash needs, including our ability to make distributions

     We compute FFO in accordance with the current standards established by the White Paper on Funds from Operations approved by the Board of Governors of the National Association of Real Estate Investment Trusts, or NAREIT, which may differ from the methodology for calculating FFO utilized by other equity REITs, and accordingly, may not be comparable to such other REITs. The White Paper defines FFO as net income (loss), computed in accordance with GAAP, excluding gains (or losses) from sales of property, plus real estate related depreciation and amortization and after adjustments for unconsolidated partnerships and joint ventures. Further, FFO does not represent amounts available for management’s discretionary use because of needed capital replacement or expansion, debt service obligations, or other commitments and uncertainties.

     We believe that in order to facilitate a clear understanding of our consolidated operating results, FFO should be examined in conjunction with net income as presented in the consolidated financial statements

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The following tables present our Funds from Operations for the three and six months ended June 30, 2004 and June 30, 2003 (in thousands):

                                 
    For the Three Months Ended
  For the Six Months Ended
    June 30, 2004
  June 30, 2003
  June 30, 2004
  June 30, 2003
Net income
  $ 4,585     $ 2,827     $ 9,096     $ 5,455  
Plus real estate depreciation
    1,895       1,824       3,790       3,607  
 
   
 
     
 
     
 
     
 
 
Funds from Operations
  $ 6,480     $ 4,651     $ 12,886     $ 9,062  
 
   
 
     
 
     
 
     
 
 

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The Owned Facilities

     The fourteen facilities owned by us at June 30, 2004 were purchased for an aggregate cash purchase price of approximately $293 million. We lease eleven of these facilities to The Geo Group or its subsidiary, two of these facilities to the State of North Carolina, and one of these facilities to CEC. These fourteen facilities are located in ten states and have an aggregate design capacity of 8,008 beds. The following table sets forth certain information with respect to these facilities as of June 30, 2004.

                                                     
    Date                       Design       Expiration    
    Facility was                       Capacity       of   Operating
    Acquired by                       and   Facility   Underlying   Agreement
Facility and   the   Lease   Type of   Contracting   Security   Occupancy   Opening   Operating   Renewal
Location   Company   Expiration   Facility   Entity   Level (1)   Rate (2)   Date   Agreement (3)   Options
THE GEO GROUP
FACILITIES:
                                                   
Aurora
Processing Center,

  or the Aurora
  Facility,
  Aurora, CO
  April 1998   April 2008   BICE
Processing
Center
  BICE(4)   Minimum/
Medium
    300/89 %   May
1987
  September 2004   Three Six- Month
McFarland Community
Correctional
Facility,

  or the McFarland
  Center Facility,
  McFarland, CA
  April 1998   April 2008   Pre-Release   None   Minimum/
Medium
    224/0 %   February 1998   None (6)      
Queens Private
Correctional
Facility,

  or the Queens
  Facility,
  New York, NY
  April 1998   April 2008   BICE
Detention
Facility
  BICE(7)(4)   Minimum/
Medium
    200/82 %   March
1997
  March 2005   Two One- Year
Central Valley
Community
Correctional
Facility,

  or the Central
  Valley Facility,
  McFarland, CA
  April 1998   April 2008   Adult
Correctional
Facility
  CDOC(5)   Minimum/
Medium
    550/92 %   December
1997
  December 2007      
Golden State
Community
Correctional
Facility,

  or the Golden State
  Facility,
  McFarland, CA
  April 1998   April 2008   Adult
Correctional
Facility
  CDOC   Minimum/
Medium
    550/93 %   December
1997
  December 2007      
Desert View
Community
Correctional
Facility,

  or the Desert View
  Facility,
  Adelanto, CA
  April 1998   April 2008   Adult
Correctional
Facility
  CDOC   Minimum/
Medium
    550/92 %   December
1997
  December 2007      
Broward County
Work Release Center,

  or the Broward
  County Facility,
  Broward County,FL
  April 1998   April 2008   BICE and Work Release Center   Broward County
and BSO(8) and
BICE(9)
  Non-
Secured
    300/52 %(8)   February
1998
  September 2004 (8)(9)     (9 )
Karnes County
Correctional Center,

  or the Karnes
  Facility,
  Karnes County, TX
  April 1998   April 2008   Adult
Correctional
Facility
  Karnes County   Multi-
Security
    480/105 %   January
1996
    2026     Varies
Lawton Correctional
Facility,

  or the Lawton
  Facility,
  Lawton, OK
  January 1999   January 2009   Prison   ODOC(10)   Medium     1,500/98 %   December 1999   June 2005   Three
One-Year

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    Date                       Design       Expiration    
    Facility was                       Capacity       of   Operating
    Acquired by                       and   Facility   Underlying   Agreement
Facility and   the   Lease   Type of   Contracting   Security   Occupancy   Opening   Operating   Renewal
Location   Company   Expiration   Facility   Entity   Level (1)   Rate (2)   Date   Agreement (3)   Options
Lea County
Correctional
Facility,

  or the Hobbs
  Facility,
  Hobbs, NM
  October 1998
(11)
  January 2009   State
Prison
  Lea County   Multi-
Security
    1,200/96 %   May
1998
  June 2005   Annual
Jena Juvenile
Justice Center,

  or the Jena
  Facility,
  Jena, LA
NORTH CAROLINA
FACILITIES:
  January 2000   January 2010   Juvenile
Correctional
Facility
  None   Multi-
Security
    276/0 %   June
1999
  None (15)   None
Mountain View
Correctional
Facility,

  or the Mountain
View
  Facility,
  Spruce Pine, NC
  March
2001
  November
2008 (12)
  State
Prison
    (13 )   Medium     576     December
1998
    (13 )     (13 )
Pamlico
Correctional
Facility,

  or the Pamlico
  Facility,
  Bayboro, NC
FACILITY LEASED
TO CEC:
  June 2001   August
2008 (12)
  State
Prison
    (13 )   Medium     576     August
1998
    (13 )     (13 )
Delaney Hall
  Newark, NJ
  May 2003   May 2013   Adult
Correctional
Facility
    (14 )   Minimum     726/ 99 %   March
2000
    (14 )     (14 )
Total Facilities
                            8,008                      
                           
 
                     

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(1)   Each facility is identified according to the level of security maintained as follows: non-secured facilities are facilities which are access controlled residential facilities; minimum security facilities are facilities having open-housing within an appropriately designated and patrolled institutional perimeter; medium security facilities are facilities having either cells, rooms or dormitories, a secure perimeter, and some form of external patrol; maximum security facilities are facilities having single occupancy cells, a secure perimeter and external patrol or devices; and multi-security facilities are facilities with various components of the previously described security levels.
 
(2)   Design capacity measures the number of beds, and, accordingly, the number of inmates, each facility is designed to accommodate. Occupancy rate measures the percentage of the number of beds which a facility is designed to accommodate which are occupied at any given time or for which payment has been guaranteed by the contracting governmental entity. The facility operating agreement with respect to any facility may provide for occupancy less than the facility design capacity. While the design capacity of each of the Central Valley Community Correctional Facility, the Golden State Community Correctional Facility and the Desert View Community Correctional Facility is 550, the facility operating agreement for each such facility provides for the use and occupancy of only 500 beds per facility. The occupancy rates presented are as of June 30, 2004. We believe design capacity and occupancy rate are appropriate measures for evaluating prison operations because the revenues generated by each facility are generally based on a per diem or monthly rate per inmate housed at the facility paid by the corresponding contracting governmental entities. The ability of The Geo Group, CEC or another private prison operator to satisfy its financial obligations under its leases with us is based in part on the revenues generated by these facilities, which in turn depends on the design capacity and occupancy rate of each facility. The State of North Carolina is not obligated to report occupancy percentages to us.
 
(3)   We are not a party to the underlying operating agreement on each facility. The Geo Group and CEC or their affiliates are the parties to the operating agreements with the contracting governmental entities on the The Geo Group and CEC facilities, respectively. The expiration or termination of any operating agreement between a governmental entity and The Geo Group or CEC does not terminate or cause the expiration of the lease agreement.
 
(4)   The Homeland Security Act of 2002 moved the functions of the Immigration and Naturalization Service, or INS, to the Department of Homeland Security, or DHS. The Bureau of Immigration and Customs Enforcement, or BICE, or ICE, is a division of the DHS.
 
(5)   The State of California Department of Corrections.
 
(6)   The Geo Group’s correctional facility operating contract with the California Department of Corrections, or the CDOC, on the 224 bed McFarland Community Correctional Facility, or the McFarland Facility, expired on December 31, 2003. The Geo Group is continuing its efforts to offer the McFarland Facility to incarcerate inmates from agencies of federal and/or state governments. However, we cannot assure you that a new operating contract will be entered into on the facility. The non-cancelable McFarland Facility lease between us and The Geo Group, which expires in April 2008, requires fixed rental payments to us regardless of whether or not The Geo Group has an operating contract for the leased facility. The current annual cash rent on the McFarland Facility is approximately $782,000.
 
(7)   The facility operating agreement for the Queens Private Correctional Facility includes a minimum guarantee of 150 beds (75% occupancy).
 
(8)   The Broward County Sheriff’s Office, or the BSO. Under the operating agreement between the BSO and The Geo Group, which expires on September 30, 2004, the BSO will utilize between 50-60 beds.
 
(9)   BICE has executed an operating agreement with The Geo Group under which BICE will utilize 200 beds in the Broward Facility, with an option to expand by an additional 50 beds at the request of BICE. The contract is a five-year contract with a one-year base period beginning October 1, 2003, with four one-year options.
 
(10)   State of Oklahoma Department of Corrections.

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(11)   In October 1998, we acquired the 600-bed Hobbs Facility. Subsequently, we acquired the 600-bed expansion of the Hobbs Facility in January 1999, and an industries building in July 1999.
 
(12)   In July 2004, the Company received written notice from the State of North Carolina of the exercise of its option to purchase the Pamlico Facility and the Mountain View Facility, both of which are owned by a subsidiary of the Company, and leased to the State of North Carolina. The options contained in the lease agreements provide for the acquisition of the Pamlico Facility beginning in August 2004 for approximately $25.2 million, and the Mountain View Facility beginning in December 2004, for approximately $26.2 million. Upon the sale of the Mountain View Facility and/or the Pamlico Facility, we would be obligated to redeem all or a portion of the Bonds issued by our subsidiary using net proceeds from the sale of the facility or facilities and the balance of the debt service reserve fund of $5.8 million held by the trustee for the Bonds. In addition, we would recognize a one-time gain on the sale of the facility and/or facilities; however, future results of operations and cash flows would be negatively impacted because we would no longer receive the monthly rental income once a facility is sold. For additional information, please see Note 9 “Sale of Mountain View and Pamlico Facilities” in the notes to the consolidated financial statements included in this Form 10-Q for the quarter ended June 30, 2004. As part of the 2003 Budget Act, the North Carolina General Assembly authorized the acquisition of either or both of the Pamlico and Mountain View facilities under the options contained in their respective leases. However, no funds were appropriated with respect to the exercise of either option, and the issuance of any financing contracts is subject to the approval of both the State Treasurer and the Council of State. In July 2004, the Council of State of North Carolina approved a resolution giving preliminary approval for issuing debt by the State of North Carolina, the proceeds of which would be used to acquire these facilities from the Company.
 
(13)   The facility is leased to the State of North Carolina and operated by the North Carolina Department of Corrections.
 
(14)   CEC operates Delaney Hall under three separate operating agreements with: (1) the New Jersey Department of Corrections, which expires June 30, 2006; (2) Union County, New Jersey, which expires on December 31, 2004; and (3) Essex County, New Jersey, which expires September 30, 2004.
 
(15)   The Jena Facility was operated by The Geo Group under an operating agreement with the State of Louisiana, which was terminated in July 2000. The Geo Group does not presently have an operating contract with a client for the Jena Facility, and as a result, the facility is currently vacant. However, The Geo Group is obligated under the terms of the lease to continue to make rental payments to us.

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Item 3. Quantitative and Qualitative Disclosures about Market Risk.

     We are exposed to market risks inherent in our financial instruments. These instruments arise from transactions entered into in the normal course of business and relate to our acquisitions and financing of correctional and detention facilities. We are subject to interest rate risk on our existing amended bank credit facility and any future financing requirements. We do not use financial instruments for trading or speculative purposes and all financial instruments are entered into in accordance with the amended bank credit facility agreement and Board approved policies.

     Our interest rate risk is related primarily to the variable rates of our amended bank credit facility, which we seek to reduce by entering into the interest rate swaps. We are also exposed to market risk from (i) the interest rate risk on short-term borrowings, (ii) the possibility of non-performance by the counter parties to the interest rate swaps (which we do not anticipate), (iii) our ability to refinance our amended bank credit facility at maturity and (iv) the impact of interest rate movements on our ability to obtain and maintain adequate financing to fund our existing properties and future acquisitions. While we cannot predict or manage our ability to refinance existing debt or the impact interest rate movements will have on our existing debt, we continue to evaluate our financial position on an ongoing basis and may in the future seek to minimize interest rate exposure. Our interest rate risk management objective is to limit the impact of interest rate changes on earnings and cash flows. To achieve this objective, we enter into interest rate swaps and seek long term financing. As of June 30, 2004, we had no interest rate swap agreements in effect. As of June 30, 2004, there were no amounts drawn on the amended bank credit facility.

     The Bonds outstanding at June 30, 2004 of $55,285,000 under the Trust Indenture are non-recourse to us and non-recourse to our subsidiary, which is the obligor under the Bonds, and non-recourse to the subsidiary’s sole member, CPT Operating Partnership L.P., and bear interest at a fixed rate of 7.15% per annum.

Item 4. Controls and Procedures.

     (a) As of June 30, 2004, our principal executive officer and principal financial officer evaluated our controls and procedures related to our reporting and disclosure obligations. These officers have concluded that, based on their evaluation, these disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended), are effective to ensure that (i) material information relating to us is known to these officers, particularly material information related to the period for which this periodic report is being prepared; and (ii) this information is recorded, processed, summarized, evaluated and reported, as applicable, within the time periods specified in the rules and forms promulgated by the Securities and Exchange Commission.

     (b) There have been no significant changes in our internal control over financial reporting during the fiscal quarter ended June 30, 2004 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II - OTHER INFORMATION

Item 1. Legal Proceedings

     In the ordinary course of conducting our business, we may become involved in various legal actions and other claims. Litigation is subject to many uncertainties and we may be unable to accurately predict the outcome of individual litigated matters. Some of these matters possibly may be decided unfavorably to us.

     Except for any routine litigation incidental to our business that may arise from time to time, we are not aware of any pending material legal proceedings to which we or any of our subsidiaries is a party or to which any of our property is subject. Subject to specified exceptions appearing in the applicable leases, each of The Geo Group and CEC has agreed to indemnify us for incidents that arise from operation of facilities leased to them. The State of North Carolina is not required to indemnify us for claims made on account of our ownership of the two facilities leased to the State of North Carolina. North Carolina is, however, required by its leases to carry liability insurance for our benefit against liabilities associated with or arising out of accidents or disasters at the facilities in the coverage amounts equal to $1,000,000 per occurrence and $10,000,000 in the aggregate. To the extent any claim is not covered by North Carolina’s insurance, or ours, or exceeds the amount of the coverage, we may be liable which could have a material adverse effect on our operations, financial position or our future business operations.

Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities

None.

Item 3. Defaults upon Senior Securities

None.

Item 4. Submission of Matters to a Vote of Security Holders

     On April 29, 2004, we held our 2004 Annual Meeting of Shareholders, at which our shareholders re-elected each of Charles R. Jones and James D. Motta to a three-year term as trustees until the 2007 Annual Meeting and until their respective successors have been duly elected and qualified. Our shareholders voted 10,366,669 shares for the election of Mr. Jones and withheld or abstained from voting 152,937 shares. Our shareholders voted 10,410,565 shares for the election of Mr. Motta and withheld or abstained from voting 109,041 shares.

                 
            Votes
    Votes   Withheld
Trustee
  For
  or Abstained
Charles R. Jones
    10,366,669       152,937  
James D. Motta
    10,410,565       109,041  

     Also, at the Annual Meeting, our shareholders did not approve amendments to our 2002 Stock Option Plan. Our shareholders voted 2,521,617 shares for amendments to the Company’s 2002 Stock Option Plan, voted 4,587861 shares against these amendments and abstained from voting 77,189 shares.

     In addition, at the Annual Meeting, our shareholders ratified the appointment of the firm of Ernst & Young LLP to be our independent certified public accountants for the fiscal year 2004. Our shareholders voted 10,432,213 shares for the ratification of Ernst & Young LLP as our independent certified public accountants, voted 59,739 shares against this ratification, and withheld or abstained from voting 27,654 shares.

Item 5. Other Information

None.

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Table of Contents

Item 6. Exhibits and Reports on Form 8-K

(a)   Exhibits

     
Number
  Description of Exhibits
3.1
  Articles of Amendment and Restatement of Declaration of Trust of Correctional Properties Trust (1)
 
   
3.2
  Amended and Restated Bylaws of Correctional Properties Trust (2)
 
   
3.3
  Specimen of certificate representing the Common Shares (3)
 
   
4.1
  Provisions defining the rights of shareholders are found in the Articles of Amendment and Restatement of the Declaration of Trust and the Amended and Restated Bylaws, respectively, of Correctional Properties Trust (included as Exhibits 3.1 and 3.2 hereof)
 
   
31.1
  Chief Executive Officer’s certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002(4).
 
   
31.2
  Chief Financial Officer’s certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002(4).
 
   
32.1
  Chief Executive Officer’s certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002(4).
 
   
32.2
  Chief Financial Officer’s certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002(4).

(1)   Incorporated by reference to exhibit 3.2 to Amendment No. 1 to the Company’s Form S-11 (File No. 333-46681) filed with the Commission on March 20, 1998.
 
(2)   Incorporated by reference to the Company’s Form 10-K for the fiscal year ended December 31, 2003 filed with the Commission on March 15, 2004.
 
(3)   Incorporated by reference to Amendment No. 1 to the Company’s Form S-11 (File No. 333-46681) filed with the Commission on March 20, 1998.
 
(4)   Filed herewith this Quarterly Report on Form 10-Q for the fiscal quarter ended June 30, 2004.
 
(b)   Reports on Form 8-K:

     (1) We furnished a Form 8-K on May 4, 2004, in connection with the release of our earnings for the quarter ended March 31, 2004.

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SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this Quarterly Report to be signed on its behalf by the undersigned, thereunto duly authorized.

CORRECTIONAL PROPERTIES TRUST

     
/s/ David J. Obernesser
   

   
David J. Obernesser
   
Vice President, Chief Financial Officer, Treasurer & Secretary
   
Date: August 9, 2004
   

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