| Additional risks and uncertainties not currently known to us or those we currently deem to be immaterial may also materially and adversely affect our business, financial condition, or results of operations |
| This section contains forward-looking statements |
| You should refer to the explanation of the qualifications and limitations on forward-looking statements on page 2 |
| Risks Related to Our Business We rely on three lessees for 100prca of our revenue As of December 31, 2005, The GEO Group, Inc |
| (or CEC), were the only parties with whom we had lease agreements |
| In January 2006, we entered into a lease agreement with Cornell Companies, Inc |
| Accordingly, these three parties now account for 100prca of our lease agreement revenue and the failure of any of them to meet their respective obligations to us may have a material adverse effect upon our operations |
| There is a limited number of qualified private correctional and detention facility operators available to replace our existing lessees upon expiration or early termination of a lease agreement |
| If we elect to terminate a lease upon our existing lessees’ failure to pay or because of another default under a lease agreement, the contracting government entity is under no obligation to enter into a facility management services or operating agreement with a proposed replacement lessee |
| Our ability to attract a replacement lessee therefore may be dependent on the willingness of the government entity to contract with the replacement lessee for correctional and detention facility services |
| Even if a replacement lessee is identified and willing to lease a facility, the rental rate under the replacement lease may not equal the rental rate payable to us under the lease agreement with our existing lessees |
| We rely on GEO, as the lessee of the majority of our facilities, for approximately 86prca of our total revenue GEO is either the lessee or sublessee of 11 of the 13 facilities we currently own |
| Approximately 86prca of our revenue, and our ability to make distributions to our shareholders, will depend largely upon GEO making rent payments and satisfying its obligations to us |
| Any failure or delay by GEO in making rent payments may adversely affect our earnings and our ability to make anticipated distributions |
| To the extent these leases are not renewed by GEO or are renewed at unfavorable terms, our total revenue and ability to make distributions to our shareholders would be adversely affected |
| Failure by GEO to comply with the material terms of any lease agreement would give us the right to terminate that lease agreement and enforce the obligations of GEO thereunder, but could also require us to find another lessee for such facility or risk losing our ability to elect or maintain our REIT status |
| Similarly, we cannot assure you that GEO will elect to renew a lease agreement upon expiration of its initial or any subsequent term, which would also force us to find a suitable replacement lessee |
| In either circumstance, due to the limited number of qualified operators in the correctional and detention industry, we may be unable to locate a suitable lessee or to attract such a lessee, and may, therefore, be required to reduce the rent, which would have the effect of reducing our cash available for distribution to our shareholders |
| Furthermore, depending on the economy and the financial condition of GEO, it could default on or elect to terminate one or more of its operating agreements, adversely affecting its ability to continue to make payments to us under the related lease agreements |
| We are subject to lease payment collection risks because our lease agreements are longer than facility management services or operating agreements held by our lessees The typical correctional and detention facility management services or operating agreements held by GEO, CEC and CRN generally contain one or more renewal options |
| Only the contracting governmental agency may exercise a renewal 24 _________________________________________________________________ [52]Table of Contents option of a management services or operating agreement or enter into a new management services or operating agreement, and we cannot assure you that any agency will exercise a renewal option or enter into a new management services or operating agreement in the future |
| GEO does not presently have a correctional facility operating agreement with a government agency for the Jena Facility although it continues to make rental payments to us as required under the terms of the non-cancelable leases |
| The expiration of the underlying operating agreement for each facility is listed under the caption “Our Facilities |
| ” Regardless of the terms of the operating agreements, GEO, CEC or CRN, depending on their respective financial condition, could default on or elect to terminate their operating agreements |
| GEO, CEC and CRN are obligated to continue to make payments under the lease agreements for a facility even if the facility management services or operating agreement for such facility is not renewed or is otherwise terminated |
| We cannot assure you that GEO, CEC or CRN will be able to secure an alternate contract or an alternate source of inmates under such circumstances |
| 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 GEO’s, CEC’s or CRN’s financial condition and their respective ability to make lease payments to us |
| A reduction in the pledge pool borrowing base would reduce our ability to borrow under our bank credit facility Our ability to borrow funds under our bank credit facility depends on the number of our facilities which may be included in the pledge pool borrowing base |
| If an operating agreement or management contract between a governmental agency and one of our facility lessees is terminated or expires, the facility may be excluded from the pledge pool borrowing base under the terms of our bank credit facility |
| If any such facility is taken out or excluded from the pledge pool borrowing base, our ability to comply with the restrictive covenants or draw additional amounts from the bank credit facility may be adversely impacted |
| We depend on the services of our President and Chief Executive Officer, Charles Jones, to operate our company and the loss of his services could have a material adverse effect on us We are dependent on the efforts of our trustees and executive officers |
| In particular, we utilize the industry knowledge, experience and contacts of Charles Jones, our President, Chief Executive Officer and our Trustee |
| We have entered into an employment agreement with Mr |
| Jones the term of which expires on April 30, 2009; however, we cannot assure you that Mr |
| Jones will continue his employment with us |
| Jones, we would lose the benefit of his extensive knowledge of, and experience in, the correctional and detention industry, and we would be required to obtain the services of a new chief executive officer in order to execute our business plan |
| We are subject to acquisition and expansion risks We intend to pursue acquisitions of additional correctional and detention facilities |
| In addition, we have expanded our scope to include essential purpose government real estate projects outside the corrections sector, including mental health and higher education facilities |
| We may be unable to attain anticipated profit levels from projects that we may acquire or integrate them successfully without incurring substantial expenses, delays or other problems that could negatively impact our results of operations |
| Acquisitions and expansion generally require the integration of facilities |
| Some facilities may be located in states in which we do not currently have operations |
| Some facilities may be in the mental health sector or higher education sector in which we do not currently have operations |
| Acquisitions and expansions entail risks that investments will fail to perform in accordance with expectations as well as general investment risks associated with any new real estate investment |
| The fact that we must distribute 90prca of REIT taxable income in order to maintain our qualification as a REIT may limit our ability to rely upon lease income from our facilities to finance acquisitions |
| As a result, if debt or equity financing were not available on acceptable terms, further acquisition activities might be curtailed or cash available for distribution might be adversely affected |
| We may raise capital through the sale of securities in anticipation of one or more planned acquisitions and expansions |
| However, we may not be able to close some or all of these planned acquisitions or expansions due to a variety of factors including economic conditions, financial changes with respect to the target company or facility or inability of the parties to agree upon material terms |
| 25 _________________________________________________________________ [53]Table of Contents We may be subject to uninsured losses Our lease agreements require lessees to maintain insurance with respect to each of the facilities |
| Our lessees carry comprehensive liability, fire, earthquake, flood (for certain facilities) and extended insurance coverage with respect to such properties with policy specifications and insurance limits customarily carried for similar properties |
| There are, however, certain types of losses which may be either uninsurable or not economically insurable |
| Subject to the terms of the lease agreements, should an uninsured loss occur, we could lose both our capital invested in, and anticipated profits from, one or more of our facilities |
| We are subject to financing risks and debt financing increases shareholders’ risk of loss In making real estate investments, we may borrow money, which increases the risk of loss of our shareholders’ investments |
| Moreover, our Board of Trustees determines our investment and financing policies with respect to certain activities, including our growth, capitalization, distribution and operating policies |
| Our organizational documents do not contain any limitation on the amount or percentage of indebtedness we may incur and our board of trustees could alter or eliminate any existing debt policy without a vote of our shareholders |
| Provisions of our Declaration of Trust may have a potential anti-takeover effect The provisions of our Declaration of Trust and Bylaws which provide for ownership limitations, a staggered board of trustees, the advance notice provisions of the Bylaws, and authorizing our board of trustees to issue preferred shares without shareholder approval could have the effect of delaying, deferring or preventing a change of control over us or the removal of existing management, and as a result could prevent our shareholders from being paid a premium for their common shares |
| In addition, Maryland’s business combinations law makes it difficult to acquire control of us by means of a tender offer, open market purchase, a proxy fight or otherwise, if the acquisition is not authorized in advance by our board of trustees |
| Risks Related to Our Relationship with GEO Our relationship with GEO may limit acquisition opportunities from other sources Our ongoing relationship with GEO may discourage other correctional and detention facility operators from offering to sell facilities to us or from otherwise engaging in similar sale and leaseback transactions with us |
| These operators may take into account, to our detriment, the substantial alignment of interests between us and GEO and GEO’s competitive position to these operators |
| These factors may have a material adverse effect on our access to opportunities with operators other than GEO We may be subject to future conflicts with GEO We and GEO may be in situations where we have differing interests resulting from our ongoing relationship |
| These situations include the fact that (i) GEO leases 11 facilities from us, (ii) we have the option to acquire certain other facilities from GEO, (iii) GEO will have a right of first refusal on the proposed sale by us of any facilities currently leased to GEO, (iv) until he resigned in May 2002, one of our current trustees, Richard Wackenhut, had served on the board of directors of The GEO Group while also serving on our board of trustees, and (v) two of our current trustees (Messrs |
| Jones and Travisono), the former of whom is our President and CEO, previously served as executive officers or directors of GEO prior to our initial public offering on April 28, 1998 |
| Accordingly, the potential exists for future disagreements as to the compliance with the various agreements or the values of the facilities leased to GEO or lease payments therefor |
| Because of the relationship of certain of our trustees with GEO, such trustees’ decisions relating to the enforcement of our rights under the lease agreements and other matters run the inherent risk of conflict of interest |
| Additionally, the possible need by us, from time to time, to finance, refinance or effect a sale of any of the leased facilities may result in a need to modify the lease agreement applicable to such facility |
| Any such lease modification will require the consent of GEO, and the lack of consent from GEO could adversely affect our ability to consummate such financing or sale |
| Because of the relationships described above, there is the risk that we will not achieve the same results in our dealings with GEO that we might achieve if such relationships did not exist |
| 26 _________________________________________________________________ [54]Table of Contents Risks Related to Our Industry We may be subject to correctional and detention industry risks regarding general demand for facilities and, in many cases, for privatized facilities The ability of our facility operators to operate successfully in the correctional and detention industry depends on a number of factors, the most important of which is the continuation of demand by governmental agencies for additional correctional and detention facilities as well as the continued demand for privatized correctional and detention facilities |
| A deterioration in the demand for correctional and detention facilities in general and, in many cases, for privatized correctional and detention facilities, or a worsening in our facility operators’ relationships with governmental entities or the terms upon which our facility operators operate correctional and detention facilities, may adversely affect our facility operators’ business |
| Neither we nor our facility operators have any control over whether governmental agencies will contract for private prison services |
| Furthermore, because operating agreements are subject to either annual or bi-annual governmental appropriations, the failure by a governmental agency to receive such appropriations could result in termination of the contract by such agency or a reduction of the correctional services management fee payable to the facility operator |
| The termination of a facility management services or operating agreement, or a reduction in fees related to such agreement, by any governmental entity may adversely affect our facility operators’ ability to make lease payments to us |
| The correctional and detention industry is subject to governmental regulation, oversight, audits and investigations The correctional and detention business is highly regulated by a variety of governmental authorities which continuously oversee correctional and detention business and operations |
| For example, the contracting agency typically assigns full-time, on-site personnel to a facility to monitor the facility operator’s compliance with contract terms and applicable regulations |
| Failure to comply with correctional services management contract terms or regulations could expose a facility operator to substantial penalties, including the loss of an operating contract |
| In addition, changes in existing regulations could require the facility operator to modify substantially the manner in which it conducts business and, therefore, could have a material adverse effect on the facility operator |
| Additionally, private facility operating agreements generally give the contracting agency the right to conduct routine audits of the facilities and operations |
| An audit involves a governmental agency’s review of the facility operator’s compliance with the prescribed policies and procedures established with respect to the facility |
| The facility operator also may be subject to investigations as a result of an audit, an inmate’s complaint or other causes |
| The termination of a facility operating agreement or modification of the standards for operation of a facility may adversely affect a facility operator’s ability to make rent payments to us |
| Fluctuations in prison occupancy levels may adversely impact a facility operator’s ability to make payments to us A substantial portion of a correctional and detention private facility operator’s revenues are generally generated under facility operating agreements that specify a net rate to be paid to the operator per day per inmate, referred to as the Per Diem Rate |
| Under a Per Diem Rate structure, a decrease in occupancy rates could cause a decrease in revenues and profitability of a private operator |
| A private facility operator is, therefore, dependent on government agencies housing a sufficient number of inmates to meet the facility’s design capacities |
| A failure by a governmental agency to do so may cause the private facility operator to forgo revenues and income or delay recognition of revenues and income to later periods |
| Any delay in the receipt of revenues from a government entity may adversely affect a private facility operator’s ability to make rent payments to us |
| We are subject to risks associated with the limited acceptance of private prison operation Management of correctional and detention facilities by private entities has not achieved complete acceptance by either governmental entities or the public, and may be subject to adverse campaign efforts from certain groups such as labor unions, local sheriff’s departments and groups that believe correctional and detention facility operations should only be conducted by governmental entities |
| Such resistance may cause a change in government and public acceptance of privatized correctional and detention facilities |
| In addition, changes in dominant political parties in any of the markets in which a facility operator provides services could result in significant changes to previously established views of privatization in such markets |
| An escape, riot or other disturbance at any privately-managed facility may result in publicity adverse to the private facility operator and the correctional and detention industry in general, which could adversely affect the facility operator’s business, including the renewal of the governmental entity’s contract and the availability of suitable investment opportunities to the Company |
| 27 _________________________________________________________________ [55]Table of Contents We are subject to potential legal proceedings As an owner of real property, we may be subject to some proceedings relating to personal injury occurring at the correctional or detention facilities |
| We may be held responsible under state laws for claims based on personal injury to inmates, civil rights assertions by inmates or damage to personal property improvements owned by the lessee |
| While we have included provisions in our leases providing for indemnity against such claims, those indemnity provisions may not be upheld in all circumstances and we may not be able to collect indemnification payments from those operators |
| The indemnification obligations of those operators may adversely affect the ability of that entity to make lease payments to us |
| Furthermore, our failure to collect indemnity payments could adversely affect our ability to make expected distributions to our shareholders |
| We are subject to risks inherent in owning real estate Because we derive substantially all of our income from real estate ownership, we are subject to the general risks of owning real estate-related assets, including: • changes in demand for correctional and detention facilities in a locale; • changes in general economic or local conditions; • changes in supply of or demand for similar or competing facilities in an area; • the impact of environmental protection laws; • changes in interest rates and availability of financing which may render the sale, financing or refinancing of a property difficult or unattractive; • changes in real estate and zoning laws, including special use permits required to operate a correctional facility; and • changes in tax laws and other laws affecting REITs and correctional and detention facilities |
| We may incur significant environmental costs and liabilities As an owner and lessor of real properties, under various federal, state and local environmental laws, we may be required to clean up spills or other releases of hazardous or toxic substances on or from our properties |
| Some environmental laws impose liability whether or not the owner knew of, or was responsible for, the presence of the hazardous or toxic substances |
| In some cases, liability may not be limited to the value of the property |
| The presence of these substances, or the failure to properly remediate any resulting contamination, also may adversely affect our ability to sell, lease or operate the affected property or to borrow using the affected property as collateral |
| Preliminary environmental assessments have been conducted on all of our properties (and we intend to conduct these assessments in connection with new property acquisitions) to evaluate the environmental condition of, and potential environmental liabilities associated with, our properties |
| These assessments generally consist of an investigation of environmental conditions at the property (not including soil or groundwater sampling or analysis), as well as a review of available information regarding the site and publicly available data regarding conditions at other sites in the vicinity |
| Some of our facilities may be subject to federal or state environmental investigations or remedial actions as a result of a property assessment |
| We are subject to valuation and liquidity risks and our properties are special use facilities Real estate investments are relatively illiquid, particularly special use facilities |
| Our ability to vary our portfolio in response to changes in economic and other conditions will be limited |
| If we must sell an investment, we cannot assure you that we will be able to dispose of it in the time period we desire or that the sale price of any investment will recoup or exceed the amount of our investment, particularly given the limited alternate uses of the facilities |
| 28 _________________________________________________________________ [56]Table of Contents Risks Related to Our Qualification as a REIT We would incur adverse tax consequences if we fail to qualify as a REIT Qualification as a REIT involves the application of highly technical and complex provisions of the Internal Revenue Code as to which there are only limited judicial and administrative interpretations and involves the determination of facts and circumstances not entirely within our control |
| Future legislation, new regulations, administrative interpretations or court decisions may significantly change the tax laws or the application of the tax laws with respect to qualification as a REIT for federal income tax purposes or the federal income tax consequences of such qualification |
| If we fail to qualify as a REIT, for federal income tax purposes, we will face serious tax consequences that will substantially reduce the funds available for payment of dividends for each of the years involved because: • we would be subject to federal income tax at regular corporate rates on all of our ordinary income; • we would not be allowed a deduction for dividends paid to shareholders in computing our taxable income; • we also could be subject to the federal alternative minimum tax and possibly increased state and local taxes; • unless we are entitled to relief under statutory provisions, we could not elect to be subject to tax as a REIT for four taxable years following the year during which we were disqualified; and • all dividends will be subject to tax as ordinary income to the extent of our current and accumulated earnings and profits |
| In addition, if we fail to qualify as a REIT, we will no longer be required to pay dividends |
| As a result of all these factors, our failure to qualify as a REIT could impair our ability to expand our business and raise capital, and would adversely affect the value of our common stock |
| We may be forced to borrow funds during unfavorable market conditions in order to maintain our REIT status In order to maintain our REIT status, we may need to borrow funds on a short-term basis to meet the REIT distribution requirements, even if the then prevailing market conditions are not favorable for these borrowings |
| To qualify as REIT, we generally must distribute to our shareholders at least 90prca of our net taxable income each year, excluding capital gains |
| In addition, we will be subject to a 4prca nondeductible excise tax on the amount, if any, by which dividends paid by us in any calendar year are less than the sum of 85prca of our ordinary income, 95prca of our capital gain net income and 100prca of our undistributed income from prior years |
| We may need short-term debt or long-term debt, or proceeds from asset sales, creation of joint ventures or sales of common stock to fund required distributions as a result of differences in timing between the actual receipt of income and the recognition of income for federal income tax purposes, or the effect of non-deductible capital expenditures, the creation of reserves or required debt or amortization payments |
| The inability of our cash flows to cover our distribution requirements could have an adverse impact on our ability to raise short and long-term debt or sell equity securities in order to fund distributions required to maintain our REIT status |
| Limits on changes in control may discourage takeover attempts beneficial to our shareholders To facilitate maintenance of our qualification as a REIT and to otherwise address concerns relating to concentration of capital stock ownership, our organizational documents generally prohibits ownership, directly, indirectly or beneficially, by any single shareholder of more than 9dtta8prca of (i) the number of shares of any class or series of common shares or (ii) the number of shares of any class or series of preferred shares, unless waived by our board of trustees |
| Further, we are subject to provisions of Maryland corporate law, which, subject to certain exceptions, will prohibit us from engaging in any “business combination” with a person who beneficially owns 10prca or more of the voting power of our capital stock, referred to as an interested shareholder, for a period of five years following the date that such person became an interested shareholder, unless the business combination is approved in a prescribed manner |
| These provisions in our organizational documents and in Maryland corporate law may: • delay, deter or prevent a change of control over us or a tender offer, even if such action might be beneficial to our shareholders; 29 _________________________________________________________________ [57]Table of Contents • limit our shareholders’ opportunity to receive a potential premium for their shares of common stock over then-prevailing market price; and • adversely affect the market price of our common shares |
| We lack control over day-to-day operations of our facilities To qualify as a REIT for federal income tax purposes, we may not operate or participate in decisions affecting the operations of any of the facilities acquired or owned by us |
| We have no authority to require any of our lessees to operate the facilities in a particular manner or to govern any particular aspect of their operation except as set forth in lease agreements |
| Thus, even if we believe a lessee is operating a facility inefficiently or in a manner adverse to our interests, we may not be able to require it to change its method of operation |
| We are limited to seeking redress only if a lessee violates the terms of its lease agreement, in which case our primary remedy is to terminate the relevant lease agreement or, in the case of a tenant we have more than one lease with, all of its leases, and seek to recover damages |
| If a lease agreement is terminated, we will be required to find another suitable lessee or risk losing our ability to elect or maintain REIT status |
| We cannot assure you that we will be able to locate a suitable replacement lessee or to attract such lessee, or that we could obtain a rental rate comparable to that paid by our current lessee under the related lease agreement |
| We cannot predict what effect, if any, the enactment of new tax provisions may have on the value of our common shares, either in terms of price or relative to other investments REITs currently enjoy tax advantages relative to regular C corporations because they are not subject to corporate-level income tax on income they distribute to shareholders, but shareholders do include REIT dividends in taxable income (to the extent such dividends do not represent a return of capital) |
| The recently enacted Jobs and Growth Tax Relief Reconciliation Act of 2003, or the Act, generally reduces to 15prca the maximum marginal rate of tax that noncorporate taxpayers will pay on corporate dividends for taxable years ending after December 31, 2002 and before January 1, 2009 |
| This reduced tax rate, however, generally will not apply to dividends paid by a REIT on its shares except in certain circumstances for certain limited amounts |
| While the earnings of a REIT that are distributed to its shareholders will still generally be subject to less federal income taxation in the aggregate than the distributed earnings of a non-REIT C corporation, which are distributed net of a corporate income tax, this legislation could make an investment in us comparatively less attractive than an investment in other corporations because dividends paid by REITs will generally not be eligible for the new reduced tax rates that apply for corporate dividends |