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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549



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FORM 10-Q


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|           |  |                                                                                         
|---------- |  | ----------------------------------------------------------------------------------------
|(Mark One) |  |                                                                                         
|x          |  | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 
|           |  |                                                                                         
|           |  | For the quarterly period ended June 30, 2003                                            
|           |  |                                                                                         
|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: 0-20135



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AMERICA SERVICE GROUP INC.

(Exact name of registrant as specified in its charter)


|                                                                                            |  |                                               
|------------------------------------------------------------------------------------------- |  | ----------------------------------------------
|Delaware(State or other jurisdiction of
incorporation or organization)                      |  | 51-0332317(I.R.S. Employer
Identification No.)
|                                                                                            |  |                                               
|105 Westpark Drive, Suite 200
Brentwood, Tennessee
(Address of principal executive offices) |  | 37027
(Zip Code)                              

(615) 373-3100
(Registrants telephone number, including area code)



| |                                                                                                                                                                                                                                                                                                                                                                               
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Indicate by check mark whether the registrant (1) has filed all reports
required to be filed under 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 [  ]
|
| | Indicate by check mark whether the registrant is an accelerated filer as
defined in Rule 12b-2 of the Act.  Yes [  ]    No [x]                                                                                                                                                                                                                                                
|
| | There were
6,353,505 shares of Common Stock outstanding as of August
11, 2003.                                                                                                                                                                                                                                                                                                



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TABLE OF CONTENTS



|                                              |                                                                                                 |                                                             |  |  |  |  |  | 
|--------------------------------------------- | ----------------------------------------------------------------------------------------------- | ----------------------------------------------------------- |  |  |  |  |  | 
|PART I: FINANCIAL INFORMATION                
|                                              | ITEM 1.  FINANCIAL STATEMENTS                                                                 
|                                              |                                                                                                 | CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)          
|                                              |                                                                                                 | CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
|                                              |                                                                                                 | CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
|                                              |                                                                                                 | NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS       
|                                              | ITEM 2.  MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|                                              | ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                             
|                                              | ITEM 4. CONTROLS AND PROCEDURES                                                                
|PART II: OTHER INFORMATION                   
|                                              | ITEM 1.   LEGAL PROCEEDINGS                                                                   
|                                              | ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                  
|                                              | ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K                                                     
|SIGNATURES                                   
|EX-10.1  TERM LOAN AND SECURITY AGREEMENT    
|EX-31.1  SECTION 302 CERTIFICATION OF THE CEO
|EX-31.2  SECTION 302 CERTIFICATION OF THE CFO
|EX-32.1  SECTION 906 CERTIFICATION OF THE CEO
|EX-32.2  SECTION 906 CERTIFICATION OF THE CFO



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##### Table of Contents



AMERICA SERVICE GROUP INC.

QUARTERLY REPORT ON FORM 10-Q
INDEX

|                                                                                              |                                                                                                                     |  |        |   | 
|--------------------------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------- |  | ------ | - | 
|                                                                                              |                                                                                                                     |  | Page  
|                                                                                              |                                                                                                                     |  | Number
|                                                                                              |                                                                                                                     |  |       
|PART I. FINANCIAL INFORMATION                                                                 |                                                                                                                     |  |        |  
|Item 1. Financial Statements (Unaudited)                                                      |                                                                                                                     |  |        |  
|                                                                                              | Condensed Consolidated Balance Sheets as of June 30, 2003 and December 31, 2002                                     |  |        | 3 | 
|                                                                                              | Condensed Consolidated Statements of Operations for the quarters and six month periods
ended June 30, 2003 and 2002 |  |        | 4 | 
|                                                                                              | Condensed Consolidated Statements of Cash Flows for the six month periods ended June 30,
2003 and 2002              |  |        | 5 | 
|                                                                                              | Notes to Condensed Consolidated Financial Statements                                                                |  |        | 6 | 
|Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations |                                                                                                                     |  | 15     |  
|Item 3. Quantitative and Qualitative Disclosures About Market Risk                            |                                                                                                                     |  | 27     |  
|Item 4. Controls and Procedures                                                               |                                                                                                                     |  | 27     |  
|PART II. OTHER INFORMATION                                                                    |                                                                                                                     |  |        |  
|Item 1. Legal Proceedings                                                                     |                                                                                                                     |  | 28     |  
|Item 4.
Submission of Matters to a Vote of Security Holders                                   |                                                                                                                     |  | 29     |  
|Item 6. Exhibits and Reports on Form 8-K                                                      |                                                                                                                     |  | 30     |  
|Signatures                                                                                    |                                                                                                                     |  | 31     |  

2



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PART I:

FINANCIAL INFORMATION

ITEM 1.  FINANCIAL STATEMENTS

AMERICA SERVICE GROUP INC.

CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)

|                                            |                                                                                                                                                                        |   |                                  |         |              |   |         |         |  
|------------------------------------------- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------- | - | -------------------------------- | ------- | ------------ | - | ------- | ------- | -
|                                            |                                                                                                                                                                        |   | June 30,                         |         | December 31,
|                                            |                                                                                                                                                                        |   | 2003                             |         | 2002        
|                                            |                                                                                                                                                                        |   |                                  |         |             
|                                            |                                                                                                                                                                        |   | (shown in 000's except share and
|                                            |                                                                                                                                                                        |   | per share amounts)              
|ASSETS                                      |                                                                                                                                                                        |   |                                  |         |              |   |         |        
|Current assets:                             |                                                                                                                                                                        |   |                                  |         |              |   |         |        
|                                            | Cash and cash equivalents                                                                                                                                              |   | $                                | 6,799   |              |   | $       | 3,770   |  
|                                            | Restricted cash                                                                                                                                                        |   |                                  |        |              |   |         | 6,250   |  
|                                            | Accounts receivable: healthcare and other, less allowances                                                                                                             |   |                                  | 55,294  |              |   |         | 72,477  |  
|                                            | Inventories                                                                                                                                                            |   |                                  | 6,355   |              |   |         | 6,390   |  
|                                            | Prepaid expenses and other current assets                                                                                                                              |   |                                  | 12,518  |              |   |         | 13,100  |  
|                                            |                                                                                                                                                                        |   |                                  |         |              |   |         |        
|Total current assets                        |                                                                                                                                                                        |   | 80,966                           |         |              |   | 101,987 |        
|Property and equipment, net                 |                                                                                                                                                                        |   | 5,225                            |         |              |   | 6,240   |        
|Goodwill                                    |                                                                                                                                                                        |   | 43,896                           |         |              |   | 43,896  |        
|Contracts, net                              |                                                                                                                                                                        |   | 11,234                           |         |              |   | 12,048  |        
|Other intangibles, net                      |                                                                                                                                                                        |   | 1,383                            |         |              |   | 1,483   |        
|Other assets                                |                                                                                                                                                                        |   | 5,327                            |         |              |   | 5,852   |        
|                                            |                                                                                                                                                                        |   |                                  |         |              |   |         |        
|Total assets                                |                                                                                                                                                                        | $ | 148,031                          |         |              | $ | 171,506 |        
|                                            |                                                                                                                                                                        |   |                                  |         |              |   |         |        
|LIABILITIES AND STOCKHOLDERS EQUITY        |                                                                                                                                                                        |   |                                  |         |              |   |         |        
|Current liabilities:                        |                                                                                                                                                                        |   |                                  |         |              |   |         |        
|                                            | Accounts payable                                                                                                                                                       |   | $                                | 34,627  |              |   | $       | 40,892  |  
|                                            | Medical claims liability                                                                                                                                               |   |                                  | 11,743  |              |   |         | 13,697  |  
|                                            | Accrued expenses                                                                                                                                                       |   |                                  | 32,758  |              |   |         | 33,482  |  
|                                            | Deferred revenue                                                                                                                                                       |   |                                  | 2,234   |              |   |         | 6,203   |  
|                                            | Current portion of loss contract reserve                                                                                                                               |   |                                  | 5,013   |              |   |         | 3,306   |  
|                                            | Current portion of long-term debt                                                                                                                                      |   |                                  | 1,667   |              |   |         | 1,667   |  
|                                            | Revolving credit facility classified as current (see Note 11)                                                                                                          |   |                                  | 28,351  |              |   |         | 41,135  |  
|                                            |                                                                                                                                                                        |   |                                  |         |              |   |         |        
|Total current liabilities                   |                                                                                                                                                                        |   | 116,393                          |         |              |   | 140,382 |        
|Noncurrent portion of accrued expenses      |                                                                                                                                                                        |   | 6,524                            |         |              |   | 7,924   |        
|Noncurrent portion of loss contract reserve |                                                                                                                                                                        |   | 5,562                            |         |              |   | 5,681   |        
|Long-term debt, net of current portion      |                                                                                                                                                                        |   | 2,361                            |         |              |   | 3,194   |        
|                                            |                                                                                                                                                                        |   |                                  |         |              |   |         |        
|Total liabilities                           |                                                                                                                                                                        |   | 130,840                          |         |              |   | 157,181 |        
|                                            |                                                                                                                                                                        |   |                                  |         |              |   |         |        
|Commitments and contingencies               |                                                                                                                                                                        |   |                                  |         |              |   |         |        
|Stockholders equity                        |                                                                                                                                                                        |   |                                  |         |              |   |         |        
|                                            | Common stock, $.01 par value, 10,000,000 shares authorized; 6,334,000 and
6,122,000 shares issued and outstanding at June 30, 2003 and December 31, 2002,
respectively |   |                                  | 63      |              |   |         | 61      |  
|                                            | Additional paid-in capital                                                                                                                                             |   |                                  | 38,488  |              |   |         | 36,561  |  
|                                            | Stockholders notes receivable                                                                                                                                         |   |                                  | (1,278  | )            |   |         | (1,241  | )
|                                            | Accumulated deficit                                                                                                                                                    |   |                                  | (20,082 | )            |   |         | (21,056 | )
|                                            |                                                                                                                                                                        |   |                                  |         |              |   |         |        
|Total stockholders equity                  |                                                                                                                                                                        |   | 17,191                           |         |              |   | 14,325  |        
|                                            |                                                                                                                                                                        |   |                                  |         |              |   |         |        
|Total liabilities and stockholders equity  |                                                                                                                                                                        | $ | 148,031                          |         |              | $ | 171,506 |        
|                                            |                                                                                                                                                                        |   |                                  |         |              |   |         |        

The accompanying notes to condensed consolidated financial statements
are an integral part of these balance sheets. The condensed consolidated balance sheet at
December 31, 2002 is taken from the audited financial statements at that date.

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AMERICA SERVICE GROUP INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)

|                                                  |                                                              |                                                   |         |                                           |       |                           |         |       |      |      |         |        |      |   |         |        |      | 
|------------------------------------------------- | ------------------------------------------------------------ | ------------------------------------------------- | ------- | ----------------------------------------- | ----- | ------------------------- | ------- | ----- | ---- | ---- | ------- | ------ | ---- | - | ------- | ------ | ---- | 
|                                                  |                                                              |                                                   |         | Quarter ended June 30,                    |       | Six months ended June 30,
|                                                  |                                                              |                                                   |         |                                           |       |                          
|                                                  |                                                              |                                                   |         | 2003                                      |       | 2002                      |         | 2003  |      | 2002
|                                                  |                                                              |                                                   |         |                                           |       |                           |         |       |      |     
|                                                  |                                                              |                                                   |         | (shown in 000's except per share amounts)
|Healthcare revenues                               |                                                              | $                                                 | 136,760 |                                           |       | $                         | 112,375 |       |      | $    | 269,355 |        |      | $ | 221,600 |       
|Healthcare expenses                               |                                                              |                                                   | 128,536 |                                           |       |                           | 105,962 |       |      |      | 252,825 |        |      |   | 208,711 |       
|Increase in reserve for loss contracts            |                                                              |                                                   | 4,500   |                                           |       |                           |        |       |      |      | 4,500   |        |      |   |        |       
|Reduction in reserve for loss contracts           |                                                              |                                                   |        |                                           |       |                           | 3,320   |       |      |      |        |        |      |   | 3,320   |       
|                                                  |                                                              |                                                   |         |                                           |       |                           |         |       |      |      |         |        |      |   |         |       
|                                                  | Gross margin                                                 |                                                   |         | 3,724                                     |       |                           |         | 9,733 |      |      |         | 12,030 |      |   |         | 16,209 |     
|Selling, general, and administrative expenses     |                                                              |                                                   | 3,524   |                                           |       |                           | 3,479   |       |      |      | 7,002   |        |      |   | 7,564   |       
|Depreciation and amortization                     |                                                              |                                                   | 1,070   |                                           |       |                           | 1,106   |       |      |      | 2,158   |        |      |   | 2,267   |       
|                                                  |                                                              |                                                   |         |                                           |       |                           |         |       |      |      |         |        |      |   |         |       
|Income (loss) from operations                     |                                                              |                                                   | (870    | )                                         |       |                           | 5,148   |       |      |      | 2,870   |        |      |   | 6,378   |       
|Interest, net                                     |                                                              |                                                   | 1,001   |                                           |       |                           | 1,905   |       |      |      | 2,064   |        |      |   | 3,404   |       
|                                                  |                                                              |                                                   |         |                                           |       |                           |         |       |      |      |         |        |      |   |         |       
|                                                  | Income (loss) from continuing operations before
income taxes |                                                   |         | (1,871                                    | )     |                           |         | 3,243 |      |      |         | 806    |      |   |         | 2,974  |     
|Income tax provision (benefit)                    |                                                              |                                                   | 251     |                                           |       |                           | 71      |       |      |      | 411     |        |      |   | (107    | )     
|                                                  |                                                              |                                                   |         |                                           |       |                           |         |       |      |      |         |        |      |   |         |       
|Income (loss) from continuing operations          |                                                              |                                                   | (2,122  | )                                         |       |                           | 3,172   |       |      |      | 395     |        |      |   | 3,081   |       
|Income from discontinued operations, net of taxes |                                                              |                                                   | 197     |                                           |       |                           | 2,136   |       |      |      | 579     |        |      |   | 4,206   |       
|                                                  |                                                              |                                                   |         |                                           |       |                           |         |       |      |      |         |        |      |   |         |       
|Net income (loss)                                 |                                                              | $                                                 | (1,925  | )                                         |       | $                         | 5,308   |       |      | $    | 974     |        |      | $ | 7,287   |       
|                                                  |                                                              |                                                   |         |                                           |       |                           |         |       |      |      |         |        |      |   |         |       
|Net income (loss) per common share  basic:       |                                                              |                                                   |         |                                           |       |                           |         |       |      |      |         |        |      |   |         |       
|                                                  |                                                              | Income (loss) from continuing operations          |         | $                                         | (0.34 | )                         |         | $     | 0.58 |      |         | $      | 0.06 |   |         | $      | 0.57 | 
|                                                  |                                                              | Income from discontinued operations, net of taxes |         |                                           | 0.03  |                           |         |       | 0.39 |      |         |        | 0.10 |   |         |        | 0.77 | 
|                                                  |                                                              |                                                   |         |                                           |       |                           |         |       |      |      |         |        |      |   |         |       
|                                                  |                                                              | Net income (loss)                                 |         | $                                         | (0.31 | )                         |         | $     | 0.97 |      |         | $      | 0.16 |   |         | $      | 1.34 | 
|                                                  |                                                              |                                                   |         |                                           |       |                           |         |       |      |      |         |        |      |   |         |       
|Net income (loss) per common share  diluted:     |                                                              |                                                   |         |                                           |       |                           |         |       |      |      |         |        |      |   |         |       
|                                                  |                                                              | Income (loss) from continuing operations          |         | $                                         | (0.34 | )                         |         | $     | 0.57 |      |         | $      | 0.06 |   |         | $      | 0.56 | 
|                                                  |                                                              | Income from discontinued operations, net of taxes |         |                                           | 0.03  |                           |         |       | 0.38 |      |         |        | 0.09 |   |         |        | 0.75 | 
|                                                  |                                                              |                                                   |         |                                           |       |                           |         |       |      |      |         |        |      |   |         |       
|                                                  |                                                              | Net income (loss)                                 |         | $                                         | (0.31 | )                         |         | $     | 0.95 |      |         | $      | 0.15 |   |         | $      | 1.31 | 
|                                                  |                                                              |                                                   |         |                                           |       |                           |         |       |      |      |         |        |      |   |         |       
|Weighted average common shares outstanding:       |                                                              |                                                   |         |                                           |       |                           |         |       |      |      |         |        |      |   |         |       
|Basic                                             |                                                              |                                                   | 6,294   |                                           |       |                           | 5,450   |       |      |      | 6,251   |        |      |   | 5,445   |       
|                                                  |                                                              |                                                   |         |                                           |       |                           |         |       |      |      |         |        |      |   |         |       
|Diluted                                           |                                                              |                                                   | 6,294   |                                           |       |                           | 5,576   |       |      |      | 6,385   |        |      |   | 5,551   |       
|                                                  |                                                              |                                                   |         |                                           |       |                           |         |       |      |      |         |        |      |   |         |       

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

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AMERICA SERVICE GROUP INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)

|                                                                                  |                                                        |                                           |                                           |       |                           |        |         |        |        |         |  
|--------------------------------------------------------------------------------- | ------------------------------------------------------ | ----------------------------------------- | ----------------------------------------- | ----- | ------------------------- | ------ | ------- | ------ | ------ | ------- | -
|                                                                                  |                                                        |                                           |                                           |       | Six months ended June 30,
|                                                                                  |                                                        |                                           |                                           |       |                          
|                                                                                  |                                                        |                                           |                                           |       | 2003                      |        | 2002   
|                                                                                  |                                                        |                                           |                                           |       |                           |        |        
|                                                                                  |                                                        |                                           |                                           |       | (Amounts shown in 000's) 
|Operating Activities                                                              |                                                        |                                           |                                           |       |                           |        |         |       
|Net income                                                                        |                                                        | $                                         | 974                                       |       |                           | $      | 7,287   |       
|Adjustments to reconcile net income to net cash provided by
operating activities: |                                                        |                                           |                                           |       |                           |        |         |       
|                                                                                  | Depreciation and amortization                          |                                           |                                           | 2,175 |                           |        |         | 2,317  |       
|                                                                                  | Loss on retirement of fixed assets                     |                                           |                                           | 143   |                           |        |         | 17     |       
|                                                                                  | Finance cost amortization                              |                                           |                                           | 280   |                           |        |         | 505    |       
|                                                                                  | Increase in reserve for loss contracts                 |                                           |                                           | 4,500 |                           |        |         |       |       
|                                                                                  | Decrease in reserve for loss contracts                 |                                           |                                           |      |                           |        |         | (3,320 | )     
|                                                                                  | Interest on stockholders notes receivable             |                                           |                                           | (37   | )                         |        |         | (34    | )     
|                                                                                  | Other comprehensive income charged to interest expense |                                           |                                           |      |                           |        |         | 361    |       
|                                                                                  | Changes in operating assets and liabilities:           |                                           |                                           |       |                           |        |         |        |       
|                                                                                  |                                                        | Accounts receivable, net                  |                                           |       | 17,182                    |        |         |        | 269    |        
|                                                                                  |                                                        | Inventories                               |                                           |       | 35                        |        |         |        | (99    | )      
|                                                                                  |                                                        | Prepaid expenses and other current assets |                                           |       | 584                       |        |         |        | (6,896 | )      
|                                                                                  |                                                        | Other assets                              |                                           |       | 244                       |        |         |        | 930    |        
|                                                                                  |                                                        | Accounts payable                          |                                           |       | (6,265                    | )      |         |        | 7,191  |        
|                                                                                  |                                                        | Medical claims liability                  |                                           |       | (1,954                    | )      |         |        | (1,048 | )      
|                                                                                  |                                                        | Accrued expenses                          |                                           |       | (2,124                    | )      |         |        | 4,238  |        
|                                                                                  |                                                        | Deferred revenue                          |                                           |       | (3,969                    | )      |         |        | (3,426 | )      
|                                                                                  |                                                        | Loss contract reserve                     |                                           |       | (2,911                    | )      |         |        | (3,984 | )      
|                                                                                  |                                                        |                                           |                                           |       |                           |        |         |       
|                                                                                  |                                                        |                                           | Net cash provided by operating activities |       |                           | 8,857  |         |        |        | 4,308   |  
|                                                                                  |                                                        |                                           |                                           |       |                           |        |         |       
|Investing Activities                                                              |                                                        |                                           |                                           |       |                           |        |         |       
|Capital expenditures                                                              |                                                        |                                           | (390                                      | )     |                           |        | (608    | )     
|                                                                                  |                                                        |                                           |                                           |       |                           |        |         |       
|                                                                                  |                                                        |                                           | Net cash used in investing activities     |       |                           | (390   | )       |        |        | (608    | )
|                                                                                  |                                                        |                                           |                                           |       |                           |        |         |       
|Financing Activities                                                              |                                                        |                                           |                                           |       |                           |        |         |       
|Net payments on line of credit and term loan                                      |                                                        |                                           | (13,617                                   | )     |                           |        | (13,422 | )     
|Decrease in restricted cash                                                       |                                                        |                                           | 6,250                                     |       |                           |        |        |       
|Payment of deferred financing costs                                               |                                                        |                                           |                                          |       |                           |        | (493    | )     
|Proceeds from stockholders notes receivable                                      |                                                        |                                           |                                          |       |                           |        | 83      |       
|Issuance of common stock                                                          |                                                        |                                           | 205                                       |       |                           |        |        |       
|Exercise of stock options                                                         |                                                        |                                           | 1,724                                     |       |                           |        |        |       
|                                                                                  |                                                        |                                           |                                           |       |                           |        |         |       
|                                                                                  |                                                        |                                           | Net cash used in financing activities     |       |                           | (5,438 | )       |        |        | (13,832 | )
|                                                                                  |                                                        |                                           |                                           |       |                           |        |         |       
|Net increase (decrease) in cash and cash equivalents                              |                                                        |                                           | 3,029                                     |       |                           |        | (10,132 | )     
|Cash and cash equivalents at beginning of period                                  |                                                        |                                           | 3,770                                     |       |                           |        | 10,382  |       
|                                                                                  |                                                        |                                           |                                           |       |                           |        |         |       
|Cash and cash equivalents at end of period                                        |                                                        | $                                         | 6,799                                     |       |                           | $      | 250     |       
|                                                                                  |                                                        |                                           |                                           |       |                           |        |         |       

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

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AMERICA SERVICE GROUP INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2003(dollar amounts shown in 000s except per share amounts)
(unaudited)

1.  Basis of Presentation

The interim condensed consolidated financial statements of America Service
Group Inc. and its consolidated subsidiaries (the Company) as of June 30,
2003 and for the quarters and six month periods ended June 30, 2003 and 2002
are unaudited, but in the opinion of management, have been prepared in
conformity with accounting principles generally accepted in the United States
applied on a basis consistent with those of the annual audited consolidated
financial statements. Such interim condensed consolidated financial statements
reflect all adjustments (consisting of normal recurring accruals) necessary for
a fair presentation of the financial position and the results of operations for
the quarters and six month periods presented. The results of operations for
the quarters and six month periods presented are not necessarily indicative of
the results to be expected for the year ending December 31, 2003. The interim
condensed consolidated financial statements should be read in connection with
the audited consolidated financial statements for the year ended December 31,
2002.

2.  Description of Business

The Company provides managed healthcare services to correctional
facilities under capitated contracts (with certain adjustments) with state and
local governments, certain private entities and medical facilities operated by
the Department of the Navy and Veterans Administration. The health status of
inmates may impact results of operations under such contractual arrangements.

3.  Recently Issued Accounting Pronouncements

In August 2001, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards (SFAS) No. 144, Accounting for
the Impairment or Disposal of Long-Lived Assets. SFAS No. 144 supercedes SFAS
No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed ofand resolves significant implementation issues that
had evolved since the issuance of SFAS No. 121. SFAS No. 144 established a
single accounting model for long-lived assets to be disposed of by sale or
abandonment. Additionally, SFAS No. 144 expanded the scope of financial
accounting and reporting of discontinued operations to require that all
components of an entity that have either been disposed of (by sale, by
abandonment, or in a distribution to owners) or are held for sale and whose
operations and cash flows can be clearly distinguished, operationally and for
financial reporting purposes from the rest of the entity, should be presented
as discontinued operations. SFAS No. 144 is effective for financial
statements issued for fiscal years beginning after December 15, 2001. The
provisions for presenting the components of an entity as discontinued
operations are effective only for disposal activities after the effective date
of SFAS No. 144. The Company adopted the provisions of SFAS No. 144 effective
January 1, 2002. Pursuant to SFAS No. 144, each of the Companys contracts is
a component of the entity, whose operations can be distinguished from the rest
of the Company. Therefore, when a contract terminates, by expiration or
otherwise, the contracts operations generally will be eliminated from the
ongoing operations of the Company. Accordingly, the operations of such
contracts, net of applicable income taxes, have been presented as discontinued
operations and prior period Consolidated Statements of Operations have been
reclassified. See Note 5 for a further discussion of discontinued operations.

In January 2003, the FASB issued Interpretation No. 46, Consolidation of
Variable Interest Entities (FIN 46), which requires the consolidation of
certain variable interest entities, as defined by FIN 46. FIN 46 requires an
assessment of contractual arrangements to determine if they represent interests
in variable interest entities. Variable interest entities created prior to
February 1, 2003, are subject to the consolidation provisions of FIN 46
effective July 1, 2003. Disclosures are required currently if the Company
expects to consolidate any variable interest entities. The Company is
currently evaluating the consolidation requirements of FIN 46.

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4.  Stock Options

The Company has elected to follow Accounting Principles Board Opinion
(APB) No. 25, Accounting for Stock Issued to Employeesand related
Interpretations in accounting for its employee stock options because the
alternative fair value accounting provided for under SFAS No. 123, Accounting
for Stock-Based Compensationrequires use of option valuation models that were
not developed for use in valuing employee stock options. Under APB No. 25,
compensation expense is generally recognized as the difference between the
exercise price of the Companys employee stock options and the market price of
the underlying stock on the date of grant.

Pro forma information regarding net income and earnings per share is
required by SFAS No. 123, which also requires that the information be
determined as if the Company has accounted for its employee stock options
granted subsequent to December 31, 1994 under the fair value method of that
Statement. The fair value of options issued during 2003 and 2002 was estimated
at the date of grant using a Black-Scholes option pricing model with the
following weighted-average assumptions:

|                      |  |      |      |      |  |  |      |  
|--------------------- |  | ---- | ---- | ---- |  |  | ---- | -
|                      |  | 2003 |      | 2002
|                      |  |      |      |     
|Volatility            |  |      | 0.85 |      |  |  | 0.80 |  
|Interest rate         |  |      | 4-5  | %    |  |  | 3-4  | %
|Expected life (years) |  |      | 3    |      |  |  | 3    |  
|Dividend yields       |  |      | 0.0  | %    |  |  | 0.0  | %

The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options, which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Companys employee stock options have characteristics
significantly different from those of traded options, and because changes in
the subjective input assumptions can materially affect the fair value estimate,
in managements opinion, the existing models do not necessarily provide a
reliable single measure of the fair value of its employee stock options.

The following table illustrates the effect on net income per common share
as if the Company had applied the fair value recognition provisions of SFAS 123
for each of the quarters and six month periods ended June 30, 2003 and 2002:

|                                                                                    |                                                    |   |                        |       |                           |   |       |      |      |   |     |      |  |   |       |      | 
|----------------------------------------------------------------------------------- | -------------------------------------------------- | - | ---------------------- | ----- | ------------------------- | - | ----- | ---- | ---- | - | --- | ---- |  | - | ----- | ---- | 
|                                                                                    |                                                    |   | Quarter ended June 30, |       | Six months ended June 30,
|                                                                                    |                                                    |   |                        |       |                          
|                                                                                    |                                                    |   | 2003                   |       | 2002                      |   | 2003  |      | 2002
|                                                                                    |                                                    |   |                        |       |                           |   |       |      |     
|Income
(loss) from continuing operations as reported                                |                                                    | $ | (2,122                 | )     |                           | $ | 3,172 |      |      | $ | 395 |      |  | $ | 3,081 |     
|Add: Stock based compensation expense included in
reported net income, net of taxes |                                                    |   |                       |       |                           |   |      |      |      |   |    |      |  |   |      |     
|Deduct: Stock based compensation expense determined
under SFAS 123, net of taxes    |                                                    |   | 163                    |       |                           |   | 453   |      |      |   | 304 |      |  |   | 853   |     
|                                                                                    |                                                    |   |                        |       |                           |   |       |      |      |   |     |      |  |   |       |     
|Pro forma income (loss) from continuing operations                                  |                                                    |   | (2,285                 | )     |                           |   | 2,719 |      |      |   | 91  |      |  |   | 2,228 |     
|Income from discontinued operations                                                 |                                                    |   | 197                    |       |                           |   | 2,136 |      |      |   | 579 |      |  |   | 4,206 |     
|                                                                                    |                                                    |   |                        |       |                           |   |       |      |      |   |     |      |  |   |       |     
|Pro
forma net income (loss) attributable to common shares                           |                                                    | $ | (2,088                 | )     |                           | $ | 4,855 |      |      | $ | 670 |      |  | $ | 6,434 |     
|                                                                                    |                                                    |   |                        |       |                           |   |       |      |      |   |     |      |  |   |       |     
|Pro forma net income (loss) per common share  basic:                               |                                                    |   |                        |       |                           |   |       |      |      |   |     |      |  |   |       |     
|                                                                                    | Pro forma income (loss) from continuing operations |   | $                      | (0.36 | )                         |   | $     | 0.50 |      |   | $   | 0.01 |  |   | $     | 0.41 | 
|                                                                                    | Pro forma income from discontinued operations      |   |                        | 0.03  |                           |   |       | 0.39 |      |   |     | 0.10 |  |   |       | 0.77 | 
|                                                                                    |                                                    |   |                        |       |                           |   |       |      |      |   |     |      |  |   |       |     
|                                                                                    | Pro
forma net income (loss)                        |   | $                      | (0.33 | )                         |   | $     | 0.89 |      |   | $   | 0.11 |  |   | $     | 1.18 | 
|                                                                                    |                                                    |   |                        |       |                           |   |       |      |      |   |     |      |  |   |       |     
|Pro forma net income (loss) per common share  diluted:                             |                                                    |   |                        |       |                           |   |       |      |      |   |     |      |  |   |       |     
|                                                                                    | Pro forma income (loss) from continuing operations |   | $                      | (0.36 | )                         |   | $     | 0.49 |      |   | $   | 0.01 |  |   | $     | 0.41 | 
|                                                                                    | Pro forma income from discontinued operations      |   |                        | 0.03  |                           |   |       | 0.38 |      |   |     | 0.09 |  |   |       | 0.75 | 
|                                                                                    |                                                    |   |                        |       |                           |   |       |      |      |   |     |      |  |   |       |     
|                                                                                    | Pro
forma net income (loss)                        |   | $                      | (0.33 | )                         |   | $     | 0.87 |      |   | $   | 0.10 |  |   | $     | 1.16 | 
|                                                                                    |                                                    |   |                        |       |                           |   |       |      |      |   |     |      |  |   |       |     

The resulting pro forma disclosures may not be representative of that to
be expected in future years. The weighted average fair value of options granted
during the quarter and six month period ended June 30, 2002 as determined under
the fair value provisions of SFAS No. 123, is $6.39 and 6.10, respectively. The
weighted average fair value of options granted during the quarter and six month
period ended June 30, 2003 as determined under the fair value provisions of
SFAS No. 123, is $9.33. The above pro forma adjustments
do not include any offsetting income tax benefits due to the Companys use of a
tax valuation allowance during the periods presented.

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5.  Discontinued Operations

Pursuant to the provisions of SFAS No. 144 and as previously described in
Note 3, the Company has classified contracts that expired subsequent to January
1, 2002, the effective date of SFAS No. 144, as discontinued operations. The
components of income from discontinued operations, net of taxes, are as
follows:

|                                                  |  |                        |     |                           |  |      |        |      |  |   |       |  |  |   |        | 
|------------------------------------------------- |  | ---------------------- | --- | ------------------------- |  | ---- | ------ | ---- |  | - | ----- |  |  | - | ------ | 
|                                                  |  | Quarter ended June 30, |     | Six months ended June 30,
|                                                  |  |                        |     |                          
|                                                  |  | 2003                   |     | 2002                      |  | 2003 |        | 2002
|                                                  |  |                        |     |                           |  |      |        |     
|Healthcare revenues                               |  | $                      | 583 |                           |  | $    | 26,130 |      |  | $ | 4,871 |  |  | $ | 54,760 | 
|Healthcare expenses                               |  |                        | 369 |                           |  |      | 23,962 |      |  |   | 4,252 |  |  |   | 50,492 | 
|                                                  |  |                        |     |                           |  |      |        |      |  |   |       |  |  |   |        | 
|Gross margin                                      |  |                        | 214 |                           |  |      | 2,168  |      |  |   | 619   |  |  |   | 4,268  | 
|Depreciation and amortization                     |  |                        | 6   |                           |  |      | 28     |      |  |   | 19    |  |  |   | 50     | 
|                                                  |  |                        |     |                           |  |      |        |      |  |   |       |  |  |   |        | 
|Income from discontinued operations before taxes  |  |                        | 208 |                           |  |      | 2,140  |      |  |   | 600   |  |  |   | 4,218  | 
|Income tax provision                              |  |                        | 11  |                           |  |      | 4      |      |  |   | 21    |  |  |   | 12     | 
|                                                  |  |                        |     |                           |  |      |        |      |  |   |       |  |  |   |        | 
|Income from discontinued operations, net of taxes |  | $                      | 197 |                           |  | $    | 2,136  |      |  | $ | 579   |  |  | $ | 4,206  | 
|                                                  |  |                        |     |                           |  |      |        |      |  |   |       |  |  |   |        | 

6.  Prepaid Expenses and Other Current Assets

Prepaid expenses and other current assets are stated at cost and comprised
of the following:

|                                 |  |          |        |              |  |   |        | 
|-------------------------------- |  | -------- | ------ | ------------ |  | - | ------ | 
|                                 |  | June 30, |        | December 31,
|                                 |  | 2003     |        | 2002        
|                                 |  |          |        |             
|Prepaid insurance                |  | $        | 10,190 |              |  | $ | 10,458 | 
|Prepaid performance bonds        |  |          | 68     |              |  |   | 390    | 
|Deposit  appeal bond collateral |  |          | 2,035  |              |  |   | 2,035  | 
|Prepaid other                    |  |          | 225    |              |  |   | 217    | 
|                                 |  |          |        |              |  |   |        | 
|                                 |  | $        | 12,518 |              |  | $ | 13,100 | 
|                                 |  |          |        |              |  |   |        | 

7.  Property and Equipment

Property and equipment are stated at cost and comprised of the following:

|                               |  |          |         |              |  |              |         |   |  |         |  | 
|------------------------------ |  | -------- | ------- | ------------ |  | ------------ | ------- | - |  | ------- |  | 
|                               |  | June 30, |         | December 31, |  | Estimated   
|                               |  | 2003     |         | 2002         |  | Useful Lives
|                               |  |          |         |              |  |             
|Leasehold improvements         |  | $        | 1,195   |              |  | $            | 1,183   |   |  | 5 years
|Equipment and furniture        |  |          | 11,475  |              |  |              | 11,327  |   |  | 5 years
|Computer software              |  |          | 1,423   |              |  |              | 1,404   |   |  | 3 years
|Medical equipment              |  |          | 2,353   |              |  |              | 2,384   |   |  | 5 years
|Automobile                     |  |          | 14      |              |  |              | 14      |   |  | 5 years
|                               |  |          |         |              |  |              |         |   |  |         |  | 
|                               |  |          | 16,460  |              |  |              | 16,312  |   |  |         |  | 
|Less: Accumulated depreciation |  |          | (11,235 | )            |  |              | (10,072 | ) |  |         |  | 
|                               |  |          |         |              |  |              |         |   |  |         |  | 
|                               |  | $        | 5,225   |              |  | $            | 6,240   |   |  |         |  | 
|                               |  |          |         |              |  |              |         |   |  |         |  | 

Depreciation expense for the quarters ended June 30, 2003 and 2002 was
$618 and $690, respectively. Depreciation expense for the six months ended
June 30, 2003 and 2002 was $1,262 and $1,385, respectively.

8.  Contracts and Other Intangible Assets

The gross and net values of contracts and other intangible assets consist of the following:

|                         |  |          |        |              |  |   |        |  
|------------------------ |  | -------- | ------ | ------------ |  | - | ------ | -
|                         |  | June 30, |        | December 31,
|                         |  | 2003     |        | 2002        
|                         |  |          |        |             
|Contracts:               |  |          |        |              |  |   |        |  
|Gross value              |  | $        | 15,200 |              |  | $ | 15,200 |  
|Accumulated amortization |  |          | (3,966 | )            |  |   | (3,152 | )
|                         |  |          |        |              |  |   |        |  
|                         |  | $        | 11,234 |              |  | $ | 12,048 |  
|                         |  |          |        |              |  |   |        |  
|Non-compete agreements:  |  |          |        |              |  |   |        |  
|Gross value              |  | $        | 2,400  |              |  | $ | 2,400  |  
|Accumulated amortization |  |          | (1,017 | )            |  |   | (917   | )
|                         |  |          |        |              |  |   |        |  
|                         |  | $        | 1,383  |              |  | $ | 1,483  |  
|                         |  |          |        |              |  |   |        |  

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|   |  | Estimated aggregate amortization expense related to the above intangibles
for the remainder of 2003 is $913 and for each of the next four years is
$1,827.
|-- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------
|  
|9. |  | Accrued Expenses                                                                                                                                          
|  
|   |  | Accrued expenses consist of the following:                                                                                                                

|                                                          |  |          |        |              |  |   |        |  
|--------------------------------------------------------- |  | -------- | ------ | ------------ |  | - | ------ | -
|                                                          |  | June 30, |        | December 31,
|                                                          |  | 2003     |        | 2002        
|                                                          |  |          |        |             
|Salaries and employee benefits                            |  | $        | 20,893 |              |  | $ | 21,818 |  
|Professional liability claims                             |  |          | 8,517  |              |  |   | 8,924  |  
|Accrued workers compensation                             |  |          | 3,959  |              |  |   | 3,773  |  
|Other                                                     |  |          | 5,913  |              |  |   | 6,891  |  
|                                                          |  |          |        |              |  |   |        |  
|                                                          |  |          | 39,282 |              |  |   | 41,406 |  
|Less: Noncurrent portion of professional liability claims |  |          | (6,524 | )            |  |   | (7,924 | )
|                                                          |  |          |        |              |  |   |        |  
|                                                          |  | $        | 32,758 |              |  | $ | 33,482 |  
|                                                          |  |          |        |              |  |   |        |  

10.  Reserve for Loss Contracts

The Company performs a periodic comprehensive review of its portfolio of
contracts for the purpose of identifying loss contracts and developing a
contract loss reserve for succeeding periods. As a result of its 2001 review,
the Company identified five non-cancelable contracts that, based upon managements projections, were expected to continue to
incur negative gross margins over their remaining terms. In December 2001, the
Company recorded a charge of $18.3 million to establish a reserve for future
losses under these non-cancelable contracts. The five contracts covered by the
charge had expiration dates ranging from June 30, 2002 through June 30, 2005.
Ninety percent of the charge related to the State of Kansas contract, which
expires June 30, 2005, and the City of Philadelphia contract, which was
renewable annually, at the clients option, through June 30, 2004.

In June 2002, the Company and the City of Philadelphia reached a mutual
agreement that the contract between the Companys subsidiary and the City of
Philadelphia would expire effective June 30, 2002. As a result of the earlier
than anticipated expiration of this loss contract, the Company performed a
reassessment of its loss contract reserve requirements. Based upon the
reassessment, the Company recorded a gain of $3,320, in the second quarter of
2002, to reduce its reserve for loss contracts.

During the second quarter of 2003, the Company experienced a significant
increase in healthcare expenses associated with its contract to provide
healthcare service to the State of Kansas. As a result of this negative
trend, in June 2003, the Company recorded a charge of $4,500 to increase its
reserve for future losses under its contract with the State of
Kansas. The State of Kansas contract expires June 30, 2005.

As of June 30, 2003, the Company had a loss contract reserve totaling
$10,575, which relates to two remaining loss contracts, the State of Kansas
contract and a county contract, both of which expire on June 30, 2005.
Negative gross margin and overhead costs charged against the loss contract
reserve related to loss contracts totaled $1,783 and $2,078 for the quarters
ended June 30, 2003 and 2002, respectively. Negative gross margin and overhead
costs charged against the loss contract reserve related to loss contracts
totaled $2,912 and $3,984 for the six month period ended June 30, 2003 and
2002, respectively. The amounts charged against the loss contract reserve
during 2002 represented losses associated with all five of the contracts that
were identified during 2001. The amounts charged against the loss contract
reserve during 2003 relate only to the two remaining loss contracts, the State
of Kansas contract and a county contract, both of which expire on June 30,
2005.

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11.  Banking Arrangements

On October 31, 2002, the Company entered into a new credit facility with
CapitalSource Finance LLC (the CapitalSource Credit Facility). The
CapitalSource Credit Facility matures on October 31, 2005 and includes both a
$55,000 revolving credit facility (the Revolver) and a $5,000 term loan (the
Term Loan). Proceeds from the CapitalSource Credit Facility were used to
repay the borrowings outstanding pursuant to the Companys previously existing
revolving credit facility (the Prior Credit Facility), at which time the
Company wrote off approximately $726 of deferred loan costs related to the
Prior Credit Facility.

The CapitalSource Credit Facility is secured by substantially all assets
of the Company and its operating subsidiaries. At June 30, 2003, the Company
had borrowings outstanding under the CapitalSource Credit Facility totaling
$28,351 and $8,823 available for additional borrowing, based on the Companys collateral base on that
date and outstanding standby letters of credit.

In June 2003, the Company and CapitalSource Finance LLC entered into an
amendment to the CapitalSource Credit Facility. Under the terms of the
amendment, the Company may have standby letters of credit
issued under the loan agreement in amounts up to $10,000. The amount available to the Company for borrowings under the
CapitalSource Credit Facility is reduced by the amount of each outstanding
standby letter of credit. At June 30, 2003, the Company had outstanding
standby letters of credit totaling $6,250, which were used to collateralize
performance bonds. Prior to this amendment, the performance bonds were
collateralized by restricted cash. As a result of this amendment, the Company
is no longer required to maintain the restricted cash balances that were
previously used as collateral for the performance bonds.

Borrowings under the Revolver are limited to the lesser of (1) 85% of
eligible receivables (as defined) or (2) $55,000 (the Revolver Capacity).
Interest under the Revolver is payable monthly at the greater of 5.75% or the
Citibank N.A. prime rate plus 1.0%. The Company is
also required to pay a monthly collateral management fee, equal to an annual
rate of 1.38%, on average borrowings outstanding under the Revolver. Additionally, the Company is required to pay a
monthly letter of credit fee equal to an annual rate of 3.5% on the outstanding
balance of letters of credit issued pursuant to the Revolver.

Under the terms of the CapitalSource Credit Facility, the Company is
required to pay a monthly unused line fee equal to an annual rate of 0.6% on
the Revolver Capacity less the actual average borrowings outstanding under the Revolver
for the month and the balance of any outstanding letters of credit.

All amounts outstanding under the Revolver will be due and payable on
October 31, 2005. If the Revolver is extinguished prior to July 1, 2005, the
Company will be required to pay an early termination fee equal to 1.0% of the
Revolver Capacity. In connection with the Revolver, the CapitalSource Credit
Facility requires a lockbox agreement, which provides for all cash receipts to
be swept daily to reduce borrowings outstanding. This agreement, combined with
the existence of a Material Adverse Effect (MAE) clause in the Capital Source
Credit Facility, requires the Revolver to be classified as a current liability,
in accordance with the Financial Accounting Standards Boards Emerging Issues
Task Force Issue No. 95-22, Balance Sheet Classification of Borrowings
Outstanding under Revolving Credit Agreements that Include Both a Subjective
Acceleration Clause and a Lock-Box Arrangement. The MAE clause, which is a
typical requirement in commercial credit agreements, allows the lender to
require the loan to become due if the lender determines there has been a
material adverse effect on the Companys operations, business, properties,
assets, liabilities, condition or prospects. The classification of the Revolver
as a current liability is a result only of the combination of the two
aforementioned factors: the lockbox agreements and the MAE clause. The
Revolver does not expire or have a maturity date within one year. As discussed
above, the Revolver has a final expiration date of October 31, 2005.

The Term Loan requires monthly principal payments of $139 through its
maturity on October 31, 2005. Interest under the Term Loan is payable monthly
at the greater of 8.5% or the Citibank, N.A. prime rate plus 3.5%. Upon
expiration of the Term Loan, the Company will be required to pay a fee of $100.

The CapitalSource Credit Facility requires the Company to meet certain
financial covenants related to minimum levels of earnings. At June 30, 2003,
the Company was in compliance with the covenants. The CapitalSource

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Credit Facility also contains restrictions on the Company with respect to
certain types of transactions including acquisition of the Companys own stock,
payment of dividends, indebtedness and sales or transfers of assets.

The Company is dependent on the availability of borrowings pursuant to the
CapitalSource Credit Facility to meet its working capital needs, capital
expenditure requirements and other cash flow requirements during 2003.
Management believes that the Company can comply with the terms of the
CapitalSource Credit Facility and meet its expected obligations throughout
2003. However, should the Company fail to meet its projected results, it may
be forced to seek additional sources of financing in order to fund its working
capital needs.

12.  Professional and General Liability Insurance

The Company records a liability for reported and unreported professional
and general liability claims based upon an actuarial estimate of the cost of
settling losses and loss adjustment expenses. Amounts accrued were $8,517 and
$8,924 at June 30, 2003 and December 31, 2002, respectively, and are included
in accrued expenses and non-current portion of accrued expenses. Changes in
estimates of losses resulting from the continuous review process and
differences between estimates and actual loss payments are recognized in the
period in which the estimates are changed or payments are made. Reserves for
professional liability exposures are subject to fluctuations in frequency and
severity. Given the inherent degree of variability in any such estimates, the
reserves reported at June 30, 2003 represent managements best estimate of the
amounts necessary to discharge the Companys obligations.

13.  Commitments and Contingencies

Catastrophic Limits

Many of the Companys contracts require the Companys customers to
reimburse the Company for all treatment costs or, in some cases, only
out-of-pocket treatment costs related to certain catastrophic events, and/or
for AIDS or AIDS-related illnesses. Certain contracts do not contain such
limits. The Company attempts to compensate for the increased financial risk
when pricing contracts that do not contain individual, catastrophic or specific
disease diagnosis-related limits. However, the occurrence of severe individual
cases, AIDS-related illnesses or a catastrophic event in a facility governed by
a contract without such limitations could render the contract unprofitable and
could have a material adverse effect on the Companys operations. For contracts
that do not contain catastrophic protection, the Company maintains insurance
from an unaffiliated insurer for annual hospitalization amounts in excess of
$500 per inmate up to an annual per inmate cap of $2,000. The Company believes
this insurance significantly mitigates its exposure to unanticipated expenses
of catastrophic hospitalization. Catastrophic insurance premiums and
recoveries, neither of which is significant, are included in healthcare
expenses. Receivables for insurance recoveries, which are not significant, are
included in accounts receivable.

Litigation and Claims

The Company is appealing a $1,700 judgment against it. In December 1995,
the Florida Association of Counties Trust (FACT), as the insurer for the Polk
County Sheriffs Office, and the Sheriff of Polk County, Florida, brought an
action against Prison Health Services, Inc. (a wholly owned subsidiary of the
Company and PHS) in the Circuit Court, 10th Judicial Circuit, Polk County,
Florida seeking indemnification for $1,000 paid on behalf of the plaintiffs for
settlement of a lawsuit brought against the Sheriffs Office. The recovery is
sought for amounts paid in settlement of a wrongful death claim brought by the
estate of an inmate who died as a result of injuries sustained from a beating
from several corrections officers employed by the Sheriffs Office. The
plaintiffs contend that an indemnification provision in the contract between
PHS and the Sheriffs Office obligates the Company to indemnify the Sheriffs
Office against losses caused by its own wrongful acts. The Company was
represented by counsel provided by Reliance Insurance Company (Reliance), the
Companys insurer. In April 2001, FACTs motion for summary judgment on the
question of liability for indemnity was denied, but on rehearing in July 2001
the prior denial was reversed and summary judgment was granted. In October
2001, Reliance filed for receivership. In January 2002, the court entered
final judgment in favor of FACT for approximately $1,700 at a hearing at which
the Company was not represented, as counsel provided by Reliance had
simultaneously filed a motion to withdraw. The Company retained new counsel in
February 2002 and has filed a notice of appeal on the judgment. The Company
expects a decision on the appeal in 2003. The Company has posted an appeal
bond in the amount of $2,035, which has been classified as a deposit and
included in prepaid expenses and other current assets on its

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Consolidated Balance Sheet. As of June 30, 2003, the Company has reserved
$472 related to costs associated with this proceeding. The Company believes
that it will be successful on appeal. The Company has numerous defenses to
FACTs claim, including the Companys belief that the court that granted
summary judgment in favor of FACT upon rehearing made an error of law when it
ruled that the Companys contract with the Sheriffs Office obligated the
Company to indemnify the Sheriffs Office against its own wrongful acts. In
addition, the Sheriffs Office released the Company from liability for this
claim subsequent to filing the lawsuit. In the event that the Company is not
successful on appeal, the Company does not believe that the adverse judgment
will have a material adverse effect on its financial position, although it may
affect its quarterly or annual results of operations.

In addition to the matter discussed above, the Company is a party to
various legal proceedings incidental to its business. Certain claims, suits and
complaints arising in the ordinary course of business have been filed or are
pending against the Company. An estimate of the amounts payable on existing
claims for which the liability of the Company is probable is included in
accrued expenses at June 30, 2003 and December 31, 2002. The Company is not
aware of any material unasserted claims and, based on its past experience,
would not anticipate that potential future claims would have a material adverse
effect on its consolidated financial position or results of operations.

Performance Bonds

The Company is required under certain contracts to provide performance
bonds. At June 30, 2003, the Company has outstanding performance bonds
totaling approximately $33,000. These performance bonds are collateralized by
standby letters of credit totaling $6,250 (see Note 11).

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14.  Net Income Per Share

Net income per share is measured at two levels: basic income per share and
diluted income per share. Basic income per share is computed by dividing net
income by the weighted average number of common shares outstanding during the
period. Diluted income per share is computed by dividing net income by the
weighted average number of common shares outstanding after considering the
additional dilution related to other dilutive securities. The Companys other
dilutive securities outstanding consist of warrants and options to purchase
shares of the Companys common stock. The table below sets forth the
computation of basic and diluted earnings per share as required by SFAS No.
128, Earnings Per Share,for the quarters and six month periods ended June 30,
2003 and 2002.

|                                                                                                               |                                                   |   |                        |       |                           |   |           |      |      |   |           |      |  |   |           |      | 
|-------------------------------------------------------------------------------------------------------------- | ------------------------------------------------- | - | ---------------------- | ----- | ------------------------- | - | --------- | ---- | ---- | - | --------- | ---- |  | - | --------- | ---- | 
|                                                                                                               |                                                   |   | Quarter Ended June 30, |       | Six months ended June 30,
|                                                                                                               |                                                   |   |                        |       |                          
|                                                                                                               |                                                   |   | 2003                   |       | 2002                      |   | 2003      |      | 2002
|                                                                                                               |                                                   |   |                        |       |                           |   |           |      |     
|Numerator:                                                                                                     |                                                   |   |                        |       |                           |   |           |      |      |   |           |      |  |   |           |     
|Income (loss) from continuing operations                                                                       |                                                   | $ | (2,122                 | )     |                           | $ | 3,172     |      |      | $ | 395       |      |  | $ | 3,081     |     
|Income from discontinued operations, net of taxes                                                              |                                                   |   | 197                    |       |                           |   | 2,136     |      |      |   | 579       |      |  |   | 4,206     |     
|                                                                                                               |                                                   |   |                        |       |                           |   |           |      |      |   |           |      |  |   |           |     
|Numerator for basic and diluted net income (loss)                                                              |                                                   | $ | (1,925                 | )     |                           | $ | 5,308     |      |      | $ | 974       |      |  | $ | 7,287     |     
|                                                                                                               |                                                   |   |                        |       |                           |   |           |      |      |   |           |      |  |   |           |     
|Denominator:                                                                                                   |                                                   |   |                        |       |                           |   |           |      |      |   |           |      |  |   |           |     
|Denominator for basic net income (loss) per share 
weighted average shares                                    |                                                   |   | 6,294,000              |       |                           |   | 5,450,000 |      |      |   | 6,251,000 |      |  |   | 5,445,000 |     
|Effect of dilutive securities:                                                                                 |                                                   |   |                        |       |                           |   |           |      |      |   |           |      |  |   |           |     
|Warrants                                                                                                       |                                                   |   |                       |       |                           |   | 72,000    |      |      |   |          |      |  |   | 70,000    |     
|Employee stock options                                                                                         |                                                   |   |                       |       |                           |   | 54,000    |      |      |   | 134,000   |      |  |   | 36,000    |     
|                                                                                                               |                                                   |   |                        |       |                           |   |           |      |      |   |           |      |  |   |           |     
|Denominator for diluted net income (loss) per share 
adjusted weighted average shares and assumed
conversions |                                                   |   | 6,294,000              |       |                           |   | 5,576,000 |      |      |   | 6,385,000 |      |  |   | 5,551,000 |     
|                                                                                                               |                                                   |   |                        |       |                           |   |           |      |      |   |           |      |  |   |           |     
|Net income (loss) per common share  basic:                                                                    |                                                   |   |                        |       |                           |   |           |      |      |   |           |      |  |   |           |     
|                                                                                                               | Income (loss) from continuing operations          |   | $                      | (0.34 | )                         |   | $         | 0.58 |      |   | $         | 0.06 |  |   | $         | 0.57 | 
|                                                                                                               | Income from discontinued operations, net of taxes |   |                        | 0.03  |                           |   |           | 0.39 |      |   |           | 0.10 |  |   |           | 0.77 | 
|                                                                                                               |                                                   |   |                        |       |                           |   |           |      |      |   |           |      |  |   |           |     
|                                                                                                               | Net income (loss)                                 |   | $                      | (0.31 | )                         |   | $         | 0.97 |      |   | $         | 0.16 |  |   | $         | 1.34 | 
|                                                                                                               |                                                   |   |                        |       |                           |   |           |      |      |   |           |      |  |   |           |     
|Net
income (loss) per common share  diluted:                                                                  |                                                   |   |                        |       |                           |   |           |      |      |   |           |      |  |   |           |     
|                                                                                                               | Income (loss) from continuing operations          |   | $                      | (0.34 | )                         |   | $         | 0.57 |      |   | $         | 0.06 |  |   | $         | 0.56 | 
|                                                                                                               | Income from discontinued operations, net of taxes |   |                        | 0.03  |                           |   |           | 0.38 |      |   |           | 0.09 |  |   |           | 0.75 | 
|                                                                                                               |                                                   |   |                        |       |                           |   |           |      |      |   |           |      |  |   |           |     
|                                                                                                               | Net income (loss)                                 |   | $                      | (0.31 | )                         |   | $         | 0.95 |      |   | $         | 0.15 |  |   | $         | 1.31 | 
|                                                                                                               |                                                   |   |                        |       |                           |   |           |      |      |   |           |      |  |   |           |     

The table below sets forth information regarding options that have been
excluded from the computation of diluted net income (loss) per share because
the options exercise price was greater than the average market price for the
period of the common shares and, therefore, the effect would be anti-dilutive.
For the quarter ended June 30, 2003, no options or warrants were included in
the computation of diluted net income (loss) per share, as, due to the net
loss for the quarter, the effect would be anti-dilutive.

|                                                                                               |  |                        |           |                           |  |      |           |      |  |   |         |  |  |   |           | 
|---------------------------------------------------------------------------------------------- |  | ---------------------- | --------- | ------------------------- |  | ---- | --------- | ---- |  | - | ------- |  |  | - | --------- | 
|                                                                                               |  | Quarter Ended June 30, |           | Six months ended June 30,
|                                                                                               |  |                        |           |                          
|                                                                                               |  | 2003                   |           | 2002                      |  | 2003 |           | 2002
|                                                                                               |  |                        |           |                           |  |      |           |     
|Options excluded from computation of diluted
income per share as effect would be anti-dilutive |  |                        | 1,239,000 |                           |  |      | 1,118,000 |      |  |   | 621,476 |  |  |   | 1,288,000 | 
|                                                                                               |  |                        |           |                           |  |      |           |      |  |   |         |  |  |   |           | 
|Weighted average exercise price of excluded options                                            |  | $                      | 13.90     |                           |  | $    | 15.61     |      |  | $ | 17.20   |  |  | $ | 14.70     | 
|                                                                                               |  |                        |           |                           |  |      |           |      |  |   |         |  |  |   |           | 

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15.  Comprehensive Income

The components of comprehensive income, net of related taxes, are as
follows for the quarters and six month periods ended June 30, 2003 and 2002:

|                                                                                            |  |                        |        |                           |  |      |       |      |  |   |     |  |  |   |       | 
|------------------------------------------------------------------------------------------- |  | ---------------------- | ------ | ------------------------- |  | ---- | ----- | ---- |  | - | --- |  |  | - | ----- | 
|                                                                                            |  | Quarter Ended June 30, |        | Six months ended June 30,
|                                                                                            |  |                        |        |                          
|                                                                                            |  | 2003                   |        | 2002                      |  | 2003 |       | 2002
|                                                                                            |  |                        |        |                           |  |      |       |     
|Net income (loss)                                                                           |  | $                      | (1,925 | )                         |  | $    | 5,308 |      |  | $ | 974 |  |  | $ | 7,287 | 
|                                                                                            |  |                        |        |                           |  |      |       |      |  |   |     |  |  |   |       | 
|Amortization of fair value
of interest rate swaps
previously qualifying as
cash flow hedges |  |                        |       |                           |  |      | 180   |      |  |   |    |  |  |   | 361   | 
|                                                                                            |  |                        |        |                           |  |      |       |      |  |   |     |  |  |   |       | 
|Other comprehensive income                                                                  |  |                        |       |                           |  |      | 180   |      |  |   |    |  |  |   | 361   | 
|                                                                                            |  |                        |        |                           |  |      |       |      |  |   |     |  |  |   |       | 
|Comprehensive income (loss)                                                                 |  | $                      | (1,925 | )                         |  | $    | 5,488 |      |  | $ | 974 |  |  | $ | 7,648 | 
|                                                                                            |  |                        |        |                           |  |      |       |      |  |   |     |  |  |   |       | 

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|          |  |                                                                                      
|--------- |  | -------------------------------------------------------------------------------------
|ITEM 2.  |  | MANAGEMENTS DISCUSSION
AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

General

America Service Group Inc. (ASG or the Company) is the leading
non-governmental provider of managed correctional healthcare services in the
United States and provider of healthcare services to county/municipal jails and
detention centers. The Company provides healthcare services to approximately
165,000 inmates at over 180 sites in 27 states. The Company also distributes
pharmaceuticals and medical supplies to approximately 201,000 inmates at over
350 sites in 33 states. Many of the inmates to whom the Company distributes
pharmaceuticals and medical supplies also receive its healthcare services.

The Company operates through its subsidiaries Prison Health Services, Inc.
(PHS), EMSA Correctional Care, Inc. (EMSA Correctional), EMSA Military
Services, Inc. (EMSA Military), Correctional Health Services, LLC. (CHS),
and Secure Pharmacy Plus, LLC. (SPP). ASG was incorporated in 1990 as a
holding company for PHS. Unless the context otherwise requires, the terms
ASG or the Company refer to ASG and its direct and indirect subsidiaries.
ASGs executive offices are located at 105 Westpark Drive, Suite 200,
Brentwood, Tennessee 37027. Its telephone number is (615) 373-3100.

Forward Looking Statements

This Quarterly Report on Form 10-Q contains forward-looking statements
made pursuant to the safe harbor provisions of the Private Securities
Litigation Reform Act of 1995. Forward-looking statements represent
managements current expectations regarding future events. Forward-looking
statements typically are identified by use of terms such as may, will,
should, plan, expect, anticipate, estimate and similar words,
although some forward-looking statements are expressed differently. Actual
results may differ materially from current expectations. Significant factors
that could cause actual results to differ materially from the forward-looking
statements include the following:



| |  |  | the Companys ability to retain existing client contracts and obtain new contracts;                                                                     
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | whether or not government agencies continue to privatize correctional healthcare services;                                                              
|
| |  |  | increased competition for new contracts and renewals of existing contracts;                                                                             
|
| |  |  | the Companys ability to execute its expansion strategies;                                                                                              
|
| |  |  | the Companys ability to limit its exposure for catastrophic

illnesses and injuries in excess of amounts covered under contracts or
insurance coverage;
|
| |  |  | the Companys dependence on key personnel;                                                                                                              
|
| |  |  | the Companys ability to attract and retain highly skilled healthcare personnel;                                                                        
|
| |  |  | the Companys ability to obtain adequate levels of professional
liability insurance coverage at a reasonable cost;                                      
|
| |  |  | the Companys ability to maintain compliance with the terms of its credit facility; and                                                                 
|
| |  |  | the Companys ability to obtain new or renew existing performance bonds.                                                                                

In addition to the risks referenced above, additional risks are
highlighted in the Companys Annual Report on Form 10-K for the year ended
December 31, 2002 under the heading Item 1. Business  Cautionary Statements

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and the Companys Registration Statement (File No. 333-98355) on Form S-3
filed on August 19, 2002 (as amended) under the heading Risk Factors.
Because these risk factors could cause actual results or outcomes to differ
materially from those expressed in any forward-looking statements made by the
Company or on the Companys behalf, stockholders should not place undue
reliance on any forward-looking statements. Further, any forward-looking
statement speaks only as of the date on which it is made, and the Company
undertakes no obligation to update any forward-looking statement to reflect
events or circumstances after the date on which the statement is made or to
reflect the occurrence of unanticipated events. New factors emerge from time
to time, and it is not possible for the Company to predict which factors will
arise. In addition, the Company cannot assess the impact of each factor on its
business or the extent to which any factor, or combination of factors, may
cause actual results to differ materially from those contained in any
forward-looking statements.

Critical Accounting Policies And Estimates

General

The Companys discussion and analysis of its financial condition and
results of operations are based upon its consolidated financial statements,
which have been prepared in accordance with accounting principles generally
accepted in the United States. The preparation of these financial statements
requires the Company to make estimates and judgments that affect the reported
amounts of assets, liabilities, revenues and expenses, and related disclosure
of contingent assets and liabilities. On an on-going basis, the Company
evaluates its estimates, including, but not limited to, those related to:



| |  |  | revenue and cost recognition,                    
| | - |  | -------------------------------------------------
|
| |  |  | loss contracts,                                  
|
| |  |  | professional and general liability insurance,    
|
| |  |  | legal contingencies,                             
|
| |  |  | impairment of intangible assets and goodwill, and
|
| |  |  | income taxes.                                    

The Company bases its estimates on historical experience and on various
other assumptions that are believed to be reasonable under the circumstances,
the results of which form the basis for making judgments about the carrying
values of assets and liabilities that are not readily apparent from other
sources. Actual results may differ from these estimates under different
assumptions or conditions.

The Company believes the following critical accounting policies are
affected by its more significant judgments and estimates used in the
preparation of its consolidated financial statements.

Revenue and Cost Recognition

The Companys contracts with correctional institutions are principally
fixed price contracts adjusted for census fluctuations. Such contracts
typically have a term of one to three years with subsequent renewal options.
The contracts may also contain certain risk sharing arrangements, such as
stop-loss provisions and aggregate limits for off-site or pharmaceutical costs.
Revenues earned under contracts with correctional institutions are recognized
in the period that services are rendered. Cash received in advance for future
services is recorded as deferred revenue and recognized as income when the
service is performed.

Revenues are calculated based on the specific contract terms and fall into
one of three general categories: fixed fee, population based, or cost plus a
margin. For fixed fee contracts, revenues are recorded based on fixed monthly
amounts established in the service contract. Revenue for population based
contracts is calculated either as a fixed fee adjusted using a per diem rate
for variances in the inmate population from predetermined population levels or
by a per diem rate times the average inmate population for the period of
service. For cost plus contracts, revenues are calculated based on actual
expenses incurred during the service period plus a contractual margin. Under
all contracts, the Company records revenues net of any estimated contractual
allowances for potential adjustments resulting from performance or staffing
related criteria, as well as the impact of any risk sharing arrangements, on an accrual basis in

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the period the services are provided. If necessary, the Company revises
its estimates for such adjustments in future periods when the actual amount of
the adjustment is determined.

Revenues for the distribution of pharmaceutical and medical supplies are
recognized upon delivery of the related products.

Healthcare expenses include the compensation of physicians, nurses and
other healthcare professionals including any related benefits and all other
direct costs of providing the managed care. The cost of healthcare services
provided or contracted for are recognized in the period in which they are
provided based in part on estimates, including an accrual for unbilled medical
services rendered through the balance sheet date. The Company estimates the
accrual for unbilled medical services using an actuarial analysis prepared
monthly by an independent actuary. The analysis takes into account historical
claims experience (including the average historical costs and billing lag time
for such services) and other actuarial data.

Actual payments and future reserve requirements will differ from the
Companys current estimates. The differences could be material if significant
adverse fluctuations occur in the healthcare cost structure or the Companys
future claims experience. Changes in estimates of claims resulting from such
fluctuations and differences between actuarial estimates and actual claims
payments are recognized in the period in which the estimates are changed or the
payments are made.

Loss Contracts

The Company accrues losses under its fixed price contracts when it is
probable that a loss has been incurred and the amount of the loss can be
reasonably estimated. The Company performs this loss accrual analysis on a
specific contract basis taking into consideration such factors as future
contractual revenue, projected future healthcare and maintenance costs,
projected future stop-loss insurance recoveries and each contracts specific
terms related to future revenue increases as compared to increased healthcare
costs. The projected future healthcare and maintenance costs are estimated
based on historical trends and managements estimate of future cost increases.
These estimates are subject to the same adverse fluctuations and future claims
experience as previously noted. Some of the Companys contracts provide for
annual increases in the fixed base fee upon changes in the regional medical
care component of the Consumer Price Index, while others contain fixed
increases.

On a quarterly basis, the Company performs a periodic comprehensive review
of its portfolio of contracts for the purpose of identifying loss contracts and
developing a contract loss reserve for succeeding periods. As a result of its
2001 review, the Company identified five non-cancelable contracts
that, based upon managements projections, were expected to
incur negative gross margins over their remaining terms. In
December 2001, the Company recorded a charge of $18.3 million to establish a
reserve for future losses under these non-cancelable contracts. The five
contracts covered by the charge had expiration dates ranging from June 30, 2002
through June 30, 2005. Ninety percent of the charge related to the State of
Kansas contract, which expires June 30, 2005, and the City of Philadelphia
contract, which was renewable annually, at the clients option, through June
30, 2004.

In June 2002, the Company and the City of Philadelphia reached a mutual
agreement that the contract between PHS and the City of Philadelphia would
expire effective June 30, 2002. As a result of the earlier than anticipated
expiration of this loss contract, the Company performed a reassessment of its
loss contract reserve requirements. Based upon the reassessment, the Company
recorded a gain of $3.3 million, in the second quarter of 2002, to reduce its
reserve for loss contracts.

During the quarter ended June 30, 2003, the Company utilized its loss
contract reserve at a rate greater than previously anticipated. This increase
in utilization was primarily the result of an unexpected increase in healthcare
expenses associated with the Companys contract to provide services to the
State of Kansas. The primary causes for the increase in healthcare expenses
in this contract were hospitalization and outpatient costs. The Company
increased its reserve for loss contracts by $4.5 million, as of June 30, 2003,
to cover estimated future losses that may occur under the State of Kansas
contract. The State of Kansas contract expires in June 2005.

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As of June 30, 2003, the Company had a loss contract reserve totaling
$10.6 million, which relates to two remaining loss contracts, the State of
Kansas and a county contract, both of which expire on June 30, 2005. Negative
gross margin and overhead costs charged against the loss contract reserve
related to these loss contracts totaled $2.9 million and $4.0 million for the
six month periods ended June 30, 2003 and 2002, respectively. The amounts
charged against the loss contract reserve during 2002 represented losses
associated with all five of the contracts that were identified during 2001.
The amounts charged against the loss contract reserve during 2003 relate only
to the two remaining loss contracts, the State of Kansas contract and a county
contract, both of which expire on June 30, 2005.

The Company is in active discussions with the State of Kansas related to a
proposal from the Company that would significantly reduce the remaining length
of the current contract. In response to the proposal, the State of Kansas has
solicited and received proposals from several other vendors to provide
healthcare services to the State of Kansas. The State of Kansas is currently
evaluating the proposals from the other vendors and a conclusion of the process
is anticipated during the third quarter.

Professional and General Liability Insurance

As a healthcare provider, the Company is subject to medical malpractice
claims and lawsuits. The most significant source of potential liability in
this regard is the risk of suits brought by inmates alleging lack of timely or
adequate healthcare services. The Company may also be liable, as employer, for
the negligence of healthcare professionals it employs or the healthcare
professionals it engages as independent contractors. The Companys contracts
generally require it to indemnify the governmental agency for losses incurred
related to healthcare provided by the Company or its agents.

To mitigate a portion of this risk, the Company maintains professional
liability insurance, primarily on a claims made basis. However, the Company assumes
certain self-insurance risks resulting from the use of large deductibles in
2000 and 2001 and the use of adjustable premium policies in 2002 and 2003. For
2002 and 2003, the Company is covered by separate policies each of which
contains a 42-month retro-premium with adjustment based on actual losses after
42 months. The Companys ultimate premium for its 2002 policy and its 2003
policy will depend on the final incurred losses related to each of these
separate policy periods. Reserves for estimated losses are provided for on an
undiscounted basis in the period of the related coverage based on an
independent actuarial analysis. These reserves are monitored for adequacy on a
quarterly basis using internal and external evaluations of the merits of the
individual claims, analysis of claim history and the estimated reserves
assigned by the Companys third-party administrator. Any adjustments resulting
from the review are reflected in current earnings.

In addition to its reserves for known claims, the Company maintains a
reserve for incurred but not reported claims. The reserve for incurred but not
reported claims is recorded on an undiscounted basis. The Companys estimates
of this reserve are supported by an independent actuarial analysis, which is
obtained on a quarterly basis.

Reserves for medical malpractice liability fluctuate because the number of
claims and the severity of the underlying incidents change from one period to
the next. Furthermore, payments with respect to previously estimated
liabilities frequently differ from the estimated liability. Changes in
estimates of losses resulting from such fluctuations and differences between
actuarial estimates and actual loss payments are recognized by an adjustment to
the reserve for medical malpractice liability in the period in which the
estimates are changed or payments are made. The reserves can also be affected
by changes in the financial health of the third-party insurance carriers used
by the Company. Changes in reserve requirements resulting from a change in the
financial health of a third-party insurance carrier are recognized in the
period in which such factor becomes known.

Legal Contingencies

In addition to professional and general liability claims, the Company is
also subject to other legal proceedings in the ordinary course of business.
Such proceedings generally relate to labor, employment or contract matters.
The Company accrues an estimate of the probable costs for the resolution of
these claims. This estimate is developed in consultation with outside counsel
handling the Companys defense in these matters and is based upon an estimated
range of potential results, assuming a combination of litigation and settlement
strategies. The Company does not believe these proceedings will have a
material adverse effect on its consolidated financial position. However, it is

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possible that future results of operations for any particular quarterly or
annual period could be materially affected by changes in assumptions, new
developments or changes in approach, such as a change in settlement strategy in
dealing with such litigation.

Amortization and Impairment of Intangible Assets and Goodwill

The Company adopted Statement of Financial Accounting Standards No. 142
(SFAS 142) on January 1, 2002, at which time it ceased amortization of
goodwill. In accordance with SFAS 142, goodwill acquired is reviewed for
impairment on an annual basis or more frequently whenever events or
circumstances indicate that the carrying value may not be recoverable. The
Company will perform its annual review as of December 31, 2003.

The Companys other identifiable intangible assets, such as customer
contracts acquired in acquisitions and covenants not to compete, are amortized
on the straight-line method over their estimated useful lives. The Company
also assesses the impairment of its other identifiable intangibles whenever
events or changes in circumstances indicate that the carrying value may not be
recoverable.

Important factors taken into consideration when evaluating the need for an
impairment review include the following:



| |  |  | significant underperformance or loss of key contracts
acquired in an acquisition relative to expected historical or
projected future operating results;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | significant changes in the manner of use of the Companys
acquired assets or in the Companys overall business strategy;
and                           
|
| |  |  | significant negative industry or economic trends.                                                                                                      

If the Company determines that the carrying value of goodwill may be
impaired based upon the existence of one or more of the above indicators of
impairment or as a result of its annual impairment review, any impairment is
measured using a fair-value-based goodwill impairment test as required under
the provisions of SFAS 142. Fair value is the amount at which the asset could
be bought or sold in a current transaction between willing parties and may be
estimated using a number of techniques, including quoted market prices or
valuations by third parties, present value techniques based on estimates of
cash flows, or multiples of earnings or revenues. The fair value of the asset
could be different using different estimates and assumptions in these valuation
techniques.

When the Company determines that the carrying value of other intangible
assets may not be recoverable based upon the existence of one or more of the
above indicators of impairment, any impairment is measured using an estimate of
the assets fair value based on the projected net cash flows expected to result
from that asset, including eventual disposition.

Future events could cause the Company to conclude that impairment
indicators exist and that goodwill associated with its acquired businesses is
impaired. Any resulting impairment loss could have a material adverse impact
on the Companys financial position and results of operations.

The Company evaluates the estimated remaining useful life of its contract
intangibles on at least a quarterly basis, taking into account new facts and
circumstances, including its retention rate for acquired contracts. If such
facts and circumstances indicate the current estimated life is no longer
reasonable, the Company adjusts the estimated useful life on a prospective
basis. In the third quarter of 2002, the Company revised the estimated life of
the contract intangibles, acquired in its 1999 acquisition of EMSA, from 20
years to 10 years. The revised life impacted contract intangibles with a gross
value of $11.2 million and, beginning October 1, 2002, resulted in an increase
to annual amortization expense of $867,000.

Income Taxes

The Company accounts for income taxes under Statement of Financial
Accounting Standards (SFAS) No. 109, Accounting for Income Taxes.Under the
asset and liability method of SFAS No. 109, deferred tax assets and liabilities
are recognized for the future tax consequences attributable to differences
between the financial statement carrying amounts of existing assets and
liabilities and their respective tax bases.

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The Company regularly reviews its deferred tax assets for recoverability
taking into consideration such factors as historical losses, projected future
taxable income and the expected timing of the reversals of existing temporary
differences. SFAS No. 109 requires the Company to record a valuation
allowance when it is more likely than not that some portion or all of the
deferred tax assets will not be realized. It further states forming a
conclusion that a valuation allowance is not needed is difficult when there is
negative evidence such as cumulative losses in recent years. At June 30, 2003
and December 31, 2002, a 100% valuation allowance has been recorded equal to
the deferred tax assets after considering deferred tax assets that can be
realized through offsets to existing taxable temporary differences. Assuming
the Company achieves sufficient profitability in future years to realize the
deferred income tax assets, the valuation allowance will be reduced in future
years through a credit to income tax expense (increasing stockholders equity).
Due to the Companys net income in the six months ended June 30, 2003, the
Companys deferred tax valuation allowance was reduced approximately $573,000
from $11.3 million at December 31, 2002 to $10.7 million at June 30, 2003, as a
reduction to the Companys income tax provision.

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Results of Operations

The following table sets forth, for the periods indicated, the percentage
relationship to total revenue of certain items in the Condensed Consolidated
Statements of Operations.

|                                                             |  |                        |       |                           |  |      |       |      |  |  |       |   |  |  |       |  
|------------------------------------------------------------ |  | ---------------------- | ----- | ------------------------- |  | ---- | ----- | ---- |  |  | ----- | - |  |  | ----- | -
|                                                             |  | Quarter ended June 30, |       | Six months ended June 30,
|                                                             |  |                        |       |                          
|Percentage of
Healthcare Revenues                            |  | 2003                   |       | 2002                      |  | 2003 |       | 2002
|                                                             |  |                        |       |                           |  |      |       |     
|Healthcare revenues                                          |  |                        | 100.0 | %                         |  |      | 100.0 | %    |  |  | 100.0 | % |  |  | 100.0 | %
|Healthcare expenses                                          |  |                        | 94.0  |                           |  |      | 94.3  |      |  |  | 93.9  |   |  |  | 94.2  |  
|Increase in reserve for loss contracts                       |  |                        | 3.3   |                           |  |      |      |      |  |  | 1.6   |   |  |  |      |  
|Reduction in reserve for loss contracts                      |  |                        |      |                           |  |      | 3.0   |      |  |  |      |   |  |  | 1.5   |  
|                                                             |  |                        |       |                           |  |      |       |      |  |  |       |   |  |  |       |  
|Gross margin                                                 |  |                        | 2.7   |                           |  |      | 8.7   |      |  |  | 4.5   |   |  |  | 7.3   |  
|Selling, general and administrative expenses                 |  |                        | 2.6   |                           |  |      | 3.1   |      |  |  | 2.6   |   |  |  | 3.4   |  
|Depreciation and amortization                                |  |                        | 0.8   |                           |  |      | 1.0   |      |  |  | 0.8   |   |  |  | 1.0   |  
|                                                             |  |                        |       |                           |  |      |       |      |  |  |       |   |  |  |       |  
|Income (loss) from operations                                |  |                        | (0.7  | )                         |  |      | 4.6   |      |  |  | 1.1   |   |  |  | 2.9   |  
|Interest, net                                                |  |                        | 0.7   |                           |  |      | 1.7   |      |  |  | 0.8   |   |  |  | 1.5   |  
|                                                             |  |                        |       |                           |  |      |       |      |  |  |       |   |  |  |       |  
|Income (loss) from continuing operations before income taxes |  |                        | (1.4  | )                         |  |      | 2.9   |      |  |  | 0.3   |   |  |  | 1.4   |  
|Income tax provision (benefit)                               |  |                        | 0.2   |                           |  |      | 0.1   |      |  |  | 0.1   |   |  |  |      |  
|                                                             |  |                        |       |                           |  |      |       |      |  |  |       |   |  |  |       |  
|Income (loss) from continuing operations                     |  |                        | (1.6  | )                         |  |      | 2.8   |      |  |  | 0.2   |   |  |  | 1.4   |  
|Income from discontinued operations, net of taxes            |  |                        | 0.2   |                           |  |      | 1.9   |      |  |  | 0.2   |   |  |  | 1.9   |  
|                                                             |  |                        |       |                           |  |      |       |      |  |  |       |   |  |  |       |  
|Net income (loss)                                            |  |                        | (1.4  | )%                        |  |      | 4.7   | %    |  |  | 0.4   | % |  |  | 3.3   | %
|                                                             |  |                        |       |                           |  |      |       |      |  |  |       |   |  |  |       |  

Quarter Ended June 30, 2003 Compared to Quarter Ended June 30, 2002

Healthcare revenues.Healthcare revenues for the quarter ended June 30,
2003 increased $24.4 million, or 21.7%, from $112.4 million for the quarter
ended June 30, 2002 to $136.8 million in 2003. Healthcare revenues in 2003
included $5.8 million of revenue growth resulting from contracts added in 2002
and 2003 through marketing activities. Contracts in place at December 31, 2001
and continuing beyond June 30, 2003, provided additional revenue of $13.7
million during the second quarter of 2003 as the result of contract
renegotiations and automatic price adjustments. Correctional contracts in
place throughout the entire quarter during both 2003 and 2002 experienced
revenue growth of 12.2%. In addition to these revenue increases, SPP
pharmaceutical distribution revenue increased $4.9 million as a result of new
contracts added in 2002 and 2003. As discussed in the discontinued operations
section below, all contracts that expired subsequent to January 1, 2002 have
been classified as discontinued operations.

Healthcare expenses.Healthcare expenses for the quarter ended June 30,
2003 increased $22.5 million, or 21.2%, from $106.0 million for the quarter
ended June 30, 2002 to $128.5 million in 2003. Expenses related to new
contracts from marketing activities accounted for $4.9 million of the
increase. Healthcare expenses as a percentage of revenues decreased by 0.3%
in 2003 as compared to 2002. This decrease results primarily from increases in
revenues associated with the Companys ongoing efforts when renewing or
negotiating contracts to negotiate risk-sharing arrangements, such as stop-loss
provisions and aggregate limits for off-site or pharmaceutical costs.
Approximately $1.6 million and $1.8 million in negative operating margin
related to the Companys loss contracts was charged against the loss contract
reserve during the quarter ended June 30, 2003 and 2002, respectively.

Increase in reserve for loss contracts.The Company utilized its loss
contract reserve at a rate greater than previously anticipated during the
quarter ended June 30, 2003. This increase in utilization was primarily the
result of an unexpected increase in healthcare expenses associated with the
Companys contract to provide services to the State of Kansas. The primary
causes for the increase in healthcare expenses in this contract were
hospitalization and outpatient costs. The Company increased its reserve for
loss contracts by $4.5 million, as of June 30, 2003, to cover estimated future
losses that may occur under the State of Kansas contract. The State of Kansas
contract expires in June 2005.

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Reduction in reserve for loss contracts.In June 2002, the Company and
the City of Philadelphia reached a mutual agreement that the contract between
the Companys subsidiary and the City of Philadelphia would expire effective
June 30, 2002. As a result of the earlier than anticipated expiration of this
loss contract, the Company performed a reassessment of its loss contract
reserve requirements. Based upon the reassessment, the Company recorded a
gain of $3,320 in the second quarter of 2002 to reduce its reserve for loss
contracts.

Selling, general and administrative expenses.Selling, general and
administrative expenses were $3.5 million for each of the quarters ended June
30, 2003 and 2002. Selling, general and administrative expenses represented
2.6% of revenues for the quarter ended June 30, 2003 and 3.1% of revenues for
the quarter ended June 30, 2002. The percentage of revenue decrease is
primarily the result of the increased revenue discussed above. Approximately
$0.2 million and $0.3 million in overhead costs associated with the Companys
loss contracts was charged against the loss contract reserve during the
quarters ended June 30, 2003 and 2002, respectively.

Depreciation and amortization. Depreciation and amortization expense for
each of the quarters ended June 30, 2003 and 2002 was $1.1 million.

Interest, net. Net interest expense decreased to $1.0 million, or 0.7% of
revenue, for the quarter ended June 30, 2003 from $1.9 million, or 1.7% of
revenue, for the quarter ended June 30, 2002. This decrease is primarily the
result of a reduction in the level of debt outstanding.

Income tax provision.The provision for income taxes for the quarter
ended June 30, 2003 was $251,000, or 0.2% of revenue, as compared with a
provision of $71,000, or 0.1% of revenue, for the quarter ended June 30, 2002.
The Company established a 100% valuation allowance in the fourth quarter of
2001 related to its deferred tax assets.

Income
(loss) from continuing operations.Loss from continuing operations
for the quarter ended June 30, 2003 was $2.1 million, or 1.6% of revenue, as
compared with income of $3.2 million, or 2.8% of revenue, for the quarter ended
June 30, 2002 as the result of the factors discussed above.

Income from discontinued operations, net of taxes. Income from
discontinued operations for the quarter ended June 30, 2003 was $0.2 million,
or 0.2% of revenue, as compared with $2.1 million, or 1.9% of revenue, for the
quarter ended June 30, 2002. Income from discontinued operations represents
the operating results of the Companys contracts that expired subsequent to
January 1, 2002. The classification of these expired contracts is the result
of the Companys adoption of SFAS No. 144 effective January 1, 2002. See Notes
3 and 5 of the Companys consolidated financial statements for further
discussion of SFAS No. 144.

Net income (loss).Net loss for the quarter ended June 30, 2003 was $1.9
million, or 1.4% of revenue, as compared with net income of $5.3 million, or
4.7% of revenue, for the quarter ended June 30, 2002 as the result of the
factors discussed above.

Six Months Ended June 30, 2003 Compared to Six Months Ended June 30, 2002

Healthcare revenues.Healthcare revenues for the six months ended June
30, 2003 increased $47.8 million, or 21.6%, from $221.6 million for the six
months ended June 30, 2002 to $269.4 million in 2003. Healthcare revenues in
the first six months of 2003 included $13.1 million of revenue growth resulting
from contracts added in 2002 and 2003 through marketing activities. Contracts
in place at December 31, 2001 and continuing beyond June 30, 2003, provided
additional revenue of $25.5 million during the first six months of 2003 as the
result of contract renegotiations and automatic price adjustments.
Correctional contracts in place throughout the entire six months during both
2003 and 2002 experienced revenue growth of 11.3%. In addition to these
revenue increases, SPP pharmaceutical distribution revenue increased $9.2
million as a result of new contracts added in 2002 and 2003. As discussed in
the discontinued operations section below, all contracts that expired
subsequent to January 1, 2002 have been classified as discontinued operations.

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Healthcare expenses.Healthcare expenses for the six months ended June
30, 2003 increased $44.1 million, or 21.1%, from $208.7 million for the six
months ended June 30, 2002 to $252.8 million in 2003. Expenses related to new
contracts from marketing activities accounted for $11.4 million of the
increase. Healthcare expenses as a percentage of revenues decreased by 0.3%
in 2003 as compared to 2002. This decrease results primarily from increases in
revenues associated with the Companys ongoing efforts when renewing or
negotiating contracts to negotiate risk-sharing arrangements, such as stop-loss
provisions and aggregate limits for off-site or pharmaceutical costs.
Approximately $2.6 million and $3.3 million in negative operating margin
related to the Companys loss contracts was charged against the loss contract
reserve during the six months ended June 30, 2003 and 2002, respectively.

Increase in reserve for loss contracts. The Company utilized its loss
contract reserve at a rate greater than previously anticipated during the
quarter ended June 30, 2003. This increase in utilization was primarily the
result of an unexpected increase in healthcare expenses associated with the
Companys contract to provide services to the State of Kansas. The primary
causes for the increase in healthcare expenses in this contract were
hospitalization and outpatient costs. The Company increased its reserve for
loss contracts by $4.5 million, as of June 30, 2003, to cover estimated future
losses that may occur under the State of Kansas contract. The State of Kansas
contract expires in June 2005.

Reduction in reserve for loss contracts.In June 2002, the Company and
the City of Philadelphia reached a mutual agreement that the contract between
the Companys subsidiary and the City of Philadelphia would expire effective
June 30, 2002. As a result of the earlier than anticipated expiration of this
loss contract, the Company performed a reassessment of its loss contract
reserve requirements. Based upon the reassessment, the Company recorded a
gain of $3,320 in the second quarter of 2002 to reduce its reserve for loss
contracts.

Selling, general and administrative expenses.Selling, general and
administrative expenses for the six months ending June 30, 2003 decreased $0.6
million from $7.6 million, or 3.4% of revenues, for the six months ended June
30, 2002 to $7.0 million, or 2.6% of revenues, in 2003. The percentage of
revenue decrease is primarily the result of the increased revenue discussed
above and a reduction in salary expense that occurred in the fourth quarter of
2002. Approximately $0.3 million and $0.7 million in overhead costs associated
with the Companys loss contracts was charged against the loss contract reserve
during the six months ended June 30, 2003 and 2002, respectively.

Depreciation and amortization. Depreciation and amortization expense for
the six months ended June 30, 2003 decreased $0.1 from $2.3 million for the six
months ended June 30, 2002 to $2.2 million in 2003. This overall decrease is
primarily the result of a reduction in amortization associated with certain
contract intangibles that became fully amortized in December 2002 which was
partially offset by an increase in quarterly amortization of $217,000, due to
an adjustment, in the third quarter of 2002, of the estimated life for a
portion of the Companys contract intangibles from 20 years to 10 years.

Interest, net. Net interest expense decreased to $2.1 million, or 0.8% of
revenue, for the six months ended June 30, 2003 from $3.4 million, or 1.5% of
revenue, for the six months ended June 30, 2002. This decrease is primarily
the result of a reduction in the level of debt outstanding.

Income tax provision (benefit).The provision for income taxes for the
six months ended June 30, 2003 was $0.4 million, or 0.1% of revenue, as
compared with a benefit of $0.1 million, or less than one-tenth of one percent
of revenue, for the six months ended June 30, 2002. Due to the Companys net
income in 2003, the Companys deferred tax valuation allowance, established in
the fourth quarter of 2001, was reduced $0.6 million from $11.3 million at
December 31, 2002 to $10.7 million at June 30, 2003 as a reduction to income
tax provision.

Income from continuing operations.Income from continuing operations for
the six months ended June 30, 2003 was $0.4 million, or 0.2% of revenue, as
compared with $3.1 million, or 1.4% of revenue, for the six months ended June
30, 2002 as the result of the factors discussed above.

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Income from discontinued operations, net of taxes. Income from
discontinued operations for the six months ended June 30, 2003 was $0.6
million, or 0.2% of revenue, as compared with $4.2 million, or 1.9% of revenue,
for the six months ended June 30, 2002. Income from discontinued operations
represents the operating results of the Companys contracts that expired
subsequent to January 1, 2002. The classification of these expired contracts
is the result of the Companys adoption of SFAS No. 144 effective January 1,
2002. See Notes 3 and 5 of the Companys consolidated financial statements for
further discussion of SFAS No. 144.

Net income.Net income for the six months ended June 30, 2003 was $1.0
million, or 0.4% of revenue, as compared with net income of $7.3 million, or
3.3% of revenue, for the six months ended June 30, 2002 as the result of the
factors discussed above.

Liquidity and Capital Resources

Overview

The Company generated net income of $1.0 million for the six months ended
June 30, 2003 compared to net income of $7.3 million for the six months ended
June 30, 2002. The Company had stockholders equity of $17.2 million at June
30, 2003 as compared to $14.3 million at December 31, 2002. The Companys cash
and cash equivalents increased to $6.8 million at June 30, 2003 from $3.8
million at December 31, 2002, a increase of $3.0 million. The increase in cash
was primarily the result of increased cash flows from operations and a
reduction of restricted cash. Restricted cash was $6.3 million at December 31,
2002.

Cash flows from operating activities during the six months ended June 30,
2003 were $8.9 million, an increase of $4.6 million, or 107.0%, from cash flows
from operations for the six months ended June 30, 2002 of $4.3 million. The
increase is primarily the result of the favorable impact of a $17.2 million
reduction in accounts receivable as compared with $0.3 million in the
prior year period offset by the unfavorable impact of decreases in
accounts payable of $6.3 million in 2003 as compared with an increase
of $7.2 million in 2002.

Cash flows used in financing activities during the six months ended June
30, 2003 were $5.4 million and include net payments totaling $13.6 million to
reduce the amount of debt outstanding from $46.0 million at December 31, 2002
to $32.4 million at June 30, 2003. Also included in cash flows used in
financing activities during the first six months of 2003 were cash receipts of
$1.7 million resulting from option exercises and issuance of common stock under
an employee stock purchase plan and $6.3 million resulting from the elimination
of restricted cash balances.

Credit Facility

The Companys primary sources of liquidity are cash flows from operating
activities and borrowings under its credit facility. On October 31, 2002, the
Company entered into a new credit facility with CapitalSource Finance LLC (the
CapitalSource Credit Facility). The CapitalSource Credit Facility matures on
October 31, 2005 and includes both a $55.0 million revolving credit facility
(the Revolver) and a $5.0 million term loan (the Term Loan). Proceeds from
the CapitalSource Credit Facility were used to repay the borrowings outstanding
pursuant to the Companys previously existing revolving credit facility (the
Prior Credit Facility) at which time the Company wrote-off approximately
$726,000 of deferred loan costs related to the Prior Credit Facility.

The CapitalSource Credit Facility is secured by substantially all assets
of the Company and its operating subsidiaries. At June 30, 2003, the Company
had borrowings outstanding under the CapitalSource Credit Facility totaling
$28.4 million and $8.8 million available for additional
borrowing, based on the Companys collateral
base and outstanding standby letter of credit on that date.

In June 2003, the Company and CapitalSource Finance LLC entered into an
amendment to the CapitalSource Credit Facility. Under the terms of the
amendment, the Company may have standby letters of
credit issued under the loan agreement in amounts up to $10.0 million. The amount available to the Company for borrowings under
the CapitalSource Credit Facility is reduced by the amount of each outstanding
standby letter of credit. At June 30, 2003, the Company had outstanding
standby letters of credit totaling $6.3 million, which were used to
collateralize performance bonds. Prior to this

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amendment, the performance bonds were collateralized by restricted cash.
As a result of this amendment, the Company is no longer required to maintain
the restricted cash balances that were previously used as collateral for the
performance bonds.

Borrowings under the Revolver are limited to the lesser of (1) 85% of
eligible receivables (as defined) or (2) $55.0 million (the Revolver
Capacity). Interest under the Revolver is payable monthly at the greater of
5.75% or the Citibank N.A. prime rate plus 1.0%. The
Company is also required to pay a monthly collateral management fee, equal to
an annual rate of 1.38%, on average borrowings outstanding under the
Revolver. Additionally, the Company is required
to pay a monthly letter of credit fee equal to an annual rate of 3.5% on the
outstanding balance of letters of credit issued pursuant to the Revolver.

Under the terms of the CapitalSource Credit Facility, the Company is
required to pay a monthly unused line fee equal to an annual rate of 0.6% on
the Revolver Capacity less the actual average borrowings outstanding under the Revolver
for the month and the balance of any outstanding letters of credit.

All amounts outstanding under the Revolver will be due and payable on
October 31, 2005. If the Revolver is extinguished prior to July 1, 2005, the
Company will be required to pay an early termination fee equal to 1.0% of the
Revolver Capacity. In connection with the Revolver, the CapitalSource Credit
Facility requires a lockbox agreement, which provides for all cash receipts to
be swept daily to reduce borrowings outstanding. This agreement, combined with
the existence of a Material Adverse Effect (MAE) clause in the Capital Source
Credit Facility, requires the Revolver to be classified as a current liability,
in accordance with the Financial Accounting Standards Boards Emerging Issues
Task Force Issue (EITF) No. 95-22, Balance Sheet Classification of Borrowings
Outstanding under Revolving Credit Agreements that Include Both a Subjective
Acceleration Clause and a Lock-Box Arrangement. The MAE clause, which is a
typical requirement in commercial credit agreements, allows the lender to
require the loan to become due if the lender determines there has been a
material adverse effect on the Companys operations, business, properties,
assets, liabilities, condition or prospects. The classification of the Revolver
as a current liability is a result only of the combination of the two
aforementioned factors: the lockbox agreements and the MAE clause. The
Revolver does not expire or have a maturity date within one year. As discussed
above, the Revolver has a final expiration date of October 31, 2005.

The Term Loan requires monthly principal payments of $139,000 through its
maturity on October 31, 2005. Interest under the Term Loan is payable monthly
at the greater of 8.5% or the Citibank, N.A. prime rate plus 3.5%. Upon
expiration of the Term Loan, the Company will be required to pay a fee of
$100,000.

The CapitalSource Credit Facility will require the Company to achieve a
minimum level of EBITDA of $3.0 million on a rolling three-month measurement
period. The CapitalSource Credit Facility defines EBITDA as net income plus
interest expense, income taxes, depreciation expense, amortization expense, any
other non-cash non-recurring expense and loss from asset sales outside of the
normal course of business, minus gains on asset sales outside the normal course
of business, non-recurring gains, and charges against the Companys loss
contract reserve.

The CapitalSource Credit Facility also requires the Company to maintain a
minimum fixed charge coverage ratio of 1.5 on a rolling three-month basis. The
CapitalSource Credit Facility defines the fixed charge coverage ratio
as EBITDA, as defined above, divided by the sum of principal payments on outstanding debt, cash interest
expense on outstanding debt, capital expenditures, cash income taxes paid or
accrued, and cash dividends paid or accrued or declared. In addition,
beginning on June 30, 2003 and continuing for each quarter thereafter, the
Company is required to maintain a minimum fixed charge ratio of 1.75 calculated
using the most recent twelve-month period.

The Company was in compliance with these financial covenants as of June
30, 2003.

The CapitalSource Credit Facility also contains restrictions on the
Company with respect to certain types of transactions, including acquisition of
the Companys own stock, payment of dividends, indebtedness and sales or
transfers of assets.

The Company is dependent on the availability of borrowings pursuant to the
CapitalSource Credit Facility to meet its working capital needs, capital
expenditure requirements and other cash flow requirements during 2003.
Management believes that the Company can comply with the terms of the
CapitalSource Credit Facility and meet its expected obligations throughout
2003. However, should the Company fail to meet its projected results, it may
be forced to seek additional sources of financing in order to fund its working
capital needs.

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Other Financing Transactions

At June 30, 2003, the Company had standby letters of credit outstanding
totaling $6.3 million which were collateralized by a reduction
of availability under the Credit
Facility.

Inflation

Some of the Companys contracts provide for annual increases in the fixed
base fee based upon changes in the regional medical care component of the
Consumer Price Index. In all other contracts that extend beyond one year, the
Company utilizes a projection of the future inflation rate when bidding and
negotiating the fixed fee for future years. If the rate of inflation exceeds
the levels projected, the excess costs will be absorbed by the Company.
Conversely, the Company will benefit should the actual rate of inflation fall
below the estimate used in the bidding and negotiation process.

Recently Issued Accounting Pronouncements

In August 2001, the FASB issued SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets. SFAS No. 144 supercedes SFAS No.
121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed ofand resolves significant implementation issues that
had evolved since the issuance of SFAS No. 121. SFAS No. 144 established a
single accounting model for long-lived assets to be disposed of by sale or
abandonment. Additionally, SFAS No. 144 expanded the scope of financial
accounting and reporting of discontinued operations to require that all
components of an entity that have either been disposed of (by sale, by
abandonment, or in a distribution to owners) or are held for sale and whose
operations and cash flows can be clearly distinguished, operationally and for
financial reporting purposes from the rest of the entity, should be presented
as discontinued operations. SFAS No. 144 is effective for financial statements
issued for fiscal years beginning after December 15, 2001. The provisions for
presenting the components of an entity as discontinued operations are effective
only for disposal activities after the effective date of SFAS No. 144. The
Company adopted the provisions of SFAS No. 144 effective January 1, 2002.
Pursuant to SFAS No. 144, each of the Companys contracts is a component of an
entity, whose operations can be distinguished from the rest of the Company.
Therefore, when a contract terminates, by expiration or otherwise, the
contracts operations generally will be eliminated from the ongoing operations
of the Company. Accordingly, the operations of such contracts, net of
applicable income taxes, have been presented as discontinued operations and
prior period Consolidated Statements of Operations have been reclassified to
reflect those contracts consistently. See Note 5 to the Companys consolidated
financial statements for further discussion of discontinued operations.

In January 2003, the FASB issued Interpretation No. 46, Consolidation of
Variable Interest Entities(FIN 46), which requires the consolidation of
certain variable interest entities, as defined by FIN 46. FIN 46 requires an
assessment of contractual arrangements to determine if they represent interests
in variable interest entities. Variable interest entities created prior to
February 1, 2003, are subject to the consolidation provisions of FIN 46
effective July 1, 2003. Disclosures are required currently if the Company
expects to consolidate any variable interest entities. The Company is
currently evaluating the consolidation requirements of FIN 46.

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|        |  |                                                           
|------- |  | ----------------------------------------------------------
|ITEM 3. |  | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market risk represents the risk of loss that may impact the consolidated
financial statements of the Company due to adverse changes in financial market
prices and rates. The Companys exposure to market risk is primarily related
to changes in the variable interest rate under the CapitalSource Credit
Facility. The CapitalSource Credit Facility carries an interest rate based on
the Citibank N.A. prime rate, subject to a minimum stated interest rate;
therefore the Companys cash flow may be affected by changes in the prime rate.
A hypothetical 10% change in the underlying interest rate would have had no
effect on interest expense paid under the Credit Facility, as the resulting
interest rate would have remained below the minimum stated interest rate.
Interest expense represents 0.8% and 1.5% of the Companys revenues, respectively, for
the six month periods ended June 30, 2003 and 2002. Debt of $32.4 million at
June 30, 2003 represents 21.9% of the Companys total liabilities and
stockholders equity.

|        |  |                        
|------- |  | -----------------------
|ITEM 4. |  | CONTROLS AND PROCEDURES

Disclosure controls and procedures are the Companys controls and other
procedures that are designed to ensure that information required to be
disclosed in the reports that the Company files or submits under the Securities
Exchange Act of 1934, as amended, (the Exchange Act) is recorded, processed,
summarized and reported, within the time periods specified in the SECs rules
and forms. Disclosure controls and procedures include, without limitation,
controls and procedures designed to ensure that information required to be
disclosed in the reports that the Company files under the Exchange Act is
accumulated and communicated to management, including the Chief Executive
Officer and Chief Financial Officer, as appropriate, to allow timely decisions
regarding required disclosure.

As of the end of the period covered by this report, the Company evaluated
under the supervision and with the participation of management, including the
Chief Executive Officer and Chief Financial Officer, the effectiveness of the
design and operation of the Companys disclosure controls and procedures,
pursuant to Exchange Act Rule 13a-14 and Rule 13a-15. Based upon that
evaluation, the Chief Executive Officer and Chief Financial Officer concluded
that the Companys disclosure controls and procedures are effective in timely
alerting them to material information that is required to be included in the
Companys periodic SEC filings. There have been no significant changes in the
Companys internal controls during the second quarter of 2003 that have
materially affected, or are reasonably likely to materially affect, the
Companys internal control over financial reporting.

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PART II:

OTHER INFORMATION

|          |                  
|--------- | -----------------
|ITEM 1.  | LEGAL PROCEEDINGS

The Company is appealing a $1.7 million judgment against it. In December
1995, the Florida Association of Counties Trust (FACT), as the insurer for
the Polk County Sheriffs Office, and the Sheriff of Polk County, Florida,
brought an action against Prison Health Services in the Circuit Court, 10th
Judicial Circuit, Polk County, Florida seeking indemnification for $1.0 million
paid on behalf of the plaintiffs for settlement of a lawsuit brought against
the Sheriffs Office. The recovery is sought for amounts paid in settlement of
a wrongful death claim brought by the estate of an inmate who died as a result
of injuries sustained from a beating from several corrections officers employed
by the Sheriffs Office. The plaintiffs contend that an indemnification
provision in the contract between Prison Health Services and the Sheriffs
Office obligates the Company to indemnify the Sheriffs Office against losses
caused by its own wrongful acts. The Company was represented by counsel
provided by Reliance Insurance Company (Reliance), the Companys insurer. In
April 2001, FACTs motion for summary judgment on the question of liability for
indemnity was denied, but on rehearing in July 2001 the prior denial was
reversed and summary judgment was granted. In October 2001, Reliance filed for
receivership. In January 2002, the court entered final judgment in favor of
FACT for approximately $1.7 million at a hearing at which the Company was not
represented, as counsel provided by Reliance had simultaneously filed a motion
to withdraw. The Company retained new counsel in February 2002 and has filed a
notice of appeal on the judgment. The Company expects a decision on the appeal
in early 2003. The Company has posted an appeal bond in the amount of $2.0
million, which has been classified as a deposit and included in prepaid
expenses and other current assets on its consolidated balance sheet. As of
June 30, 2002, the Company has reserved approximately $472,000 related to costs
associated with this proceeding. The Company believes that it will be
successful on appeal. The Company has numerous defenses to FACTs claim,
including the Companys belief that the court that granted summary judgment in
favor of FACT upon rehearing made an error of law when it ruled that the
Companys contract with the Sheriffs Office obligated the Company to indemnify
the Sheriffs Office against its own wrongful acts. In addition, the Sheriffs
Office released the Company from liability for this claim subsequent to filing
the lawsuit. In the event that the Company is not successful on appeal, the
Company does not believe that the adverse judgment will have a material adverse
effect on its financial position, although it may affect its quarterly or
annual results of operations.

In addition to the matter discussed above, the Company is a party to
various legal proceedings incidental to its business. Certain claims, suits and
complaints arising in the ordinary course of business have been filed or are
pending against the Company. An estimate of the amounts payable on existing
claims for which the liability of the Company is probable is included in
accrued expenses at June 30, 2003 and December 31, 2002. The Company is not
aware of any material unasserted claims and, based on its past experience,
would not anticipate that potential future claims would have a material adverse
effect on its consolidated financial position or results of operations.

28



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##### Table of Contents






|          |                                                    
|--------- | ---------------------------------------------------
|ITEM 4.  | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS



| | (a) |  | The Companys Annual Meeting of Stockholders was held on Wednesday, June 12, 2003.                              
| | --- |  | ----------------------------------------------------------------------------------------------------------------
|
| | (b) |  | Not applicable.                                                                                                 
|
| | (c) |  | The following proposal to
elect the Companys Board of Directors was adopted by the stockholders of the Company:

|                          |  |     |           |                    |  |  |         | 
|------------------------- |  | --- | --------- | ------------------ |  |  | ------- | 
|                          |  | For |           | Withhold Authority
|                          |  |     |           |                   
|Michael Catalano          |  |     | 4,140,101 |                    |  |  | 797,807 | 
|William D. Eberle         |  |     | 4,916,936 |                    |  |  | 20,972  | 
|Burton C. Einspruch, M.D. |  |     | 4,912,844 |                    |  |  | 25,064  | 
|Carol R. Goldberg         |  |     | 4,860,536 |                    |  |  | 77,372  | 
|Richard M. Mastaler       |  |     | 4,860,420 |                    |  |  | 77,488  | 
|William C. Stapleton      |  |     | 4,924,036 |                    |  |  | 13,872  | 
|Richard D. Wright         |  |     | 4,924,036 |                    |  |  | 13,872  | 

29



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##### Table of Contents






|          |                                 
|--------- | --------------------------------
|ITEM 6.  | EXHIBITS AND REPORTS ON FORM 8-K



| | (A) |  | Exhibits
| | --- |  | --------

|     |  |   |  |                                                                                                                                                                                                                            
|---- |  | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|3.1  |  |  |  | Amended and Restated Certificate of Incorporation of America Service
Group Inc. (incorporated herein by reference to Exhibit 3.1 to the
Companys Quarterly Report on 10-Q for the three month period ended June
30, 2002).
|     |  |   |  |                                                                                                                                                                                                                            
|3.2  |  |  |  | Amended and Restated Bylaws of America Service Group, Inc.
(incorporated herein by reference to Exhibit 3.2 to the Companys
Quarterly Report on 10-Q for the three month period ended June 30, 2002).                     
|     |  |   |  |                                                                                                                                                                                                                            
|4.1  |  |  |  | Specimen Common Stock Certificate (incorporated herein by reference to
Exhibit 4.1 to the Companys Quarterly Report on 10-Q for the three month
period ended June 30, 2002).                                              
|     |  |   |  |                                                                                                                                                                                                                            
|10.1 |  |  |  | Joinder Agreement
and Amendment No. 1 to Revolving Credit, Term Loan and Security
Agreement between the Company and CapitalSource Finance LLC.                                                                             
|     |  |   |  |                                                                                                                                                                                                                            
|11   |  |  |  | Computation of Per Share Earnings.*                                                                                                                                                                                        
|     |  |   |  |                                                                                                                                                                                                                            
|31.1 |  |  |  | Certification of the Chief Executive Officer Pursuant to Form of Rule
13a-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.                                                                     
|     |  |   |  |                                                                                                                                                                                                                            
|31.2 |  |  |  | Certification of the Chief Financial Officer Pursuant to Form of Rule
13a-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.                                                                     
|     |  |   |  |                                                                                                                                                                                                                            
|32.1 |  |  |  | Certification of the Chief Executive Officer Pursuant to 18 U.S.C.
Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002.                                                                     
|     |  |   |  |                                                                                                                                                                                                                            
|32.2 |  |  |  | Certification of the Chief Financial Officer Pursuant to 18 U.S.C.
Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002.                                                                     



---

|* |  | Data required by SFAS No. 128, Earnings Per Share, is provided in note 14
to the condensed consolidated financial statements in this report.
|- |  | ----------------------------------------------------------------------------------------------------------------------------------------------



| | (B) |  | Reports on Form 8-K
| | --- |  | -------------------

On April 2, 2003, the Company filed a Form 8-K under Item 5 relating to its
press release dated April 2, 2003 which announced that it has received notice
from the New York City Health and Hospitals Corporation of its decision to
extend the current contract of the Companys subsidiary, Prison Health
Services, Inc., for provision of healthcare services to the facilities located
on Rikers Island and the Bernard B. Kerik Detention Center through December 31,
2004.

On April 29, 2003, the Company furnished a Form 8-K under Item 12 related to
its press release dated April 28, 2003 containing information about the
Companys financial position or results of operations for the quarterly period
ended March 31, 2003.

30



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##### Table of Contents






SIGNATURES

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



| | AMERICA SERVICE GROUP INC.
| | --------------------------



| | /s/ MICHAEL CATALANO
Michael Catalano
Chairman, President & Chief Executive Officer
(Duly Authorized Officer)
| | -------------------------------------------------------------------------------------------------------------



| | /s/ MICHAEL W. TAYLOR
Michael W. Taylor
Senior Vice President & Chief Financial Officer
(Principal Financial Officer)
| | ---------------------------------------------------------------------------------------------------------------------

Dated: August 14, 2003

31