##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, D.C. 20549
 
 FORM 10-Q
 
 (Mark One)
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended June 30, 2006
 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
 
 AMERICA SERVICE GROUP INC.
  Delaware
    
    51-0332317(State or other jurisdiction of
    
    (I.R.S. Employerincorporation or organization)
    
    Identification No.)
 105 Westpark Drive, Suite 200Brentwood, Tennessee
    
    37027(Address of principal executive offices)
    
    (Zip Code)
 (615) 373-3100
 þ o
  o þ o
 o þ




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##### 



AMERICA SERVICE GROUP INC.
 QUARTERLY REPORT ON FORM 10-Q
INDEX
 PageNumberPART I. FINANCIAL INFORMATIONItem 1. Financial Statements (Unaudited)Condensed Consolidated Balance Sheets as of June 30, 2006 and December 31, 2005
    
    
    3Condensed Consolidated Statements of Operations for the quarters and six month periods ended June 30, 2006 and 2005
    
    
    4Condensed Consolidated Statements of Cash Flows for the six month periods ended June 30, 2006 and 2005
    
    
    5Notes to Condensed Consolidated Financial Statements
    
    
    6Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    22Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    38Item 4. Controls and Procedures
    
    
    38PART II. OTHER INFORMATIONItem 1. Legal Proceedings
    
    
    40Item 1A. Risk Factors
    
    
    43Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    43Item 3. Defaults Upon Senior Securities
    
    
    44Item 4. Submission of Matters to a Vote of Security Holders
    
    
    44Item 5. Other Information
    
    
    44Item 6. Exhibits
    
    
    45Signatures
    
    
    46EX-31.1 SECTION 302 CERTIFICATION OF THE CEOEX-31.2 SECTION 906 CERTIFICATION OF THE CFOEX-32.1 SECTION 906 CERTIFICATION OF THE CEOEX-32.2 SECTION 906 CERTIFICATION OF THE CFO
  2




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##### Table of Contents



PART I:
 FINANCIAL INFORMATION
 
 ITEM 1. FINANCIAL STATEMENTS
 AMERICA SERVICE GROUP INC.
 
 CONDENSED CONSOLIDATED BALANCE SHEETS
 (shown in 000s except share and per share amounts)
 (UNAUDITED)
 June 30,
    
    
    December 31,2006
    
    
    2005ASSETSCurrent assets:Cash and cash equivalents
    
    $
    10,033
    
    
    $
    Restricted cash
    
    
    
    
    
    
    4,200Accounts
receivable, net of allowance for doubtful accounts of $768 and $698, respectively
    
    
    95,281
    
    
    
    99,712Inventories
    
    
    8,816
    
    
    
    6,546Prepaid expenses and other current assets
    
    
    17,716
    
    
    
    18,976Current deferred tax assets
    
    
    8,762
    
    
    
    7,575Total current assets
    
    
    140,608
    
    
    
    137,009Property and equipment, net
    
    
    6,766
    
    
    
    6,336Goodwill, net
    
    
    43,813
    
    
    
    43,813Contracts, net
    
    
    6,352
    
    
    
    7,166Other intangibles, net
    
    
    730
    
    
    
    845Other assets
    
    
    7,592
    
    
    
    10,068Total assets
    
    $
    205,861
    
    
    $
    205,237LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    32,924
    
    
    $
    36,023Accrued medical claims liability
    
    
    31,788
    
    
    
    31,122Accrued expenses
    
    
    46,755
    
    
    
    44,478Deferred revenue
    
    
    3,322
    
    
    
    8,533Revolving credit facility
    
    
    18,927
    
    
    
    12,500Total current liabilities
    
    
    133,716
    
    
    
    132,656Noncurrent portion of accrued expenses
    
    
    15,232
    
    
    
    15,701Noncurrent deferred tax liabilities
    
    
    876
    
    
    
    876Total liabilities
    
    
    149,824
    
    
    
    149,233Commitments and contingenciesStockholders equity:Preferred stock, $0.01 par value, 2,000,000 shares authorized at
June 30, 2006 and December 31, 2005; no shares issued or
outstanding
    
    
    
    
    
    
    Common stock, $0.01 par value, 20,000,000 shares authorized at
June 30, 2006 and December 31, 2005; 10,757,340 and 10,761,526
shares issued and outstanding at June 30, 2006 and December 31,
2005, respectively
    
    
    108
    
    
    
    108Additional paid-in capital
    
    
    54,426
    
    
    
    53,759Retained earnings
    
    
    1,503
    
    
    
    2,137Total stockholders equity
    
    
    56,037
    
    
    
    56,004Total liabilities and stockholders equity
    
    $
    205,861
    
    
    $
    205,237
 
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##### Table of Contents



AMERICA SERVICE GROUP INC.
 
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
 (shown in 000s except share and per share amounts)
 (UNAUDITED)
 Quarter ended
    
    
    Six months endedJune 30,
    
    
    June 30,2006
    
    
    2005
    
    
    2006
    
    
    2005Healthcare revenues
    
    $
    160,247
    
    
    $
    139,479
    
    
    $
    327,292
    
    
    $
    272,378Healthcare expenses
    
    
    150,129
    
    
    
    128,212
    
    
    
    307,876
    
    
    
    249,625Gross margin
    
    
    10,118
    
    
    
    11,267
    
    
    
    19,416
    
    
    
    22,753Selling, general and administrative expenses
    
    
    6,611
    
    
    
    4,329
    
    
    
    12,523
    
    
    
    8,633Discontinued acquisition expenses
    
    
    
    
    
    
    451
    
    
    
    
    
    
    
    451Audit Committee investigation and related expenses
    
    
    1,028
    
    
    
    
    
    
    
    4,597
    
    
    
    Depreciation and amortization
    
    
    1,056
    
    
    
    982
    
    
    
    2,032
    
    
    
    1,943Income from operations
    
    
    1,423
    
    
    
    5,505
    
    
    
    264
    
    
    
    11,726Interest, net
    
    
    502
    
    
    
    265
    
    
    
    1,015
    
    
    
    543Late fee income
    
    
    
    
    
    
    249
    
    
    
    
    
    
    
    249Income (loss) from continuing operations before
income tax provision (benefit)
    
    
    921
    
    
    
    5,489
    
    
    
    (751
    )
    
    
    11,432Income tax provision (benefit)
    
    
    277
    
    
    
    2,197
    
    
    
    (403
    )
    
    
    4,584Income (loss) from continuing operations
    
    
    644
    
    
    
    3,292
    
    
    
    (348
    )
    
    
    6,848Loss from discontinued operations, net of taxes
    
    
    (130
    )
    
    
    (453
    )
    
    
    (286
    )
    
    
    (146
    )Net income (loss)
    
    $
    514
    
    
    $
    2,839
    
    
    $
    (634
    )
    
    $
    6,702Net income (loss) per common share  basic:Income (loss) from continuing operations
    
    $
    0.06
    
    
    $
    0.30
    
    
    $
    (0.03
    )
    
    $
    0.63Loss from discontinued operations, net of taxes
    
    
    (0.01
    )
    
    
    (0.04
    )
    
    
    (0.03
    )
    
    
    (0.01
    )Net income (loss)
    
    $
    0.05
    
    
    $
    0.26
    
    
    $
    (0.06
    )
    
    $
    0.62Net income (loss) per common share  diluted:Income (loss) from continuing operations
    
    $
    0.06
    
    
    $
    0.30
    
    
    $
    (0.03
    )
    
    $
    0.61Loss from discontinued operations, net of taxes
    
    
    (0.01
    )
    
    
    (0.04
    )
    
    
    (0.03
    )
    
    
    (0.01
    )Net income (loss)
    
    $
    0.05
    
    
    $
    0.26
    
    
    $
    (0.06
    )
    
    $
    0.60Weighted average common shares outstanding:Basic
    
    
    10,783,918
    
    
    
    10,873,100
    
    
    
    10,775,099
    
    
    
    10,859,959Diluted
    
    
    10,873,073
    
    
    
    11,123,438
    
    
    
    10,775,099
    
    
    
    11,142,318
 
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AMERICA SERVICE GROUP INC.
 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 (shown in 000s)
 (UNAUDITED)
 Six months endedJune 30,2006
    
    
    2005Cash flows from operating activities:Net income (loss)
    
    $
    (634
    )
    
    $
    6,702Adjustments to reconcile net income (loss) to net cash provided by
operating activities:Depreciation and amortization
    
    
    2,051
    
    
    
    1,987Finance cost amortization
    
    
    53
    
    
    
    291Loss on retirement of fixed assets
    
    
    3
    
    
    
    Deferred income taxes
    
    
    (779
    )
    
    
    4,329Share-based compensation expense
    
    
    2,068
    
    
    
    31Excess tax benefits from share-based compensation expense
    
    
    (408
    )
    
    
    81Increase in loss contract reserve
    
    
    
    
    
    
    1,295Changes in operating assets and liabilities:Accounts receivable, net
    
    
    4,431
    
    
    
    3,527Inventories
    
    
    (2,270
    )
    
    
    298Prepaid expenses and other current assets
    
    
    1,260
    
    
    
    1,065Other assets
    
    
    2,423
    
    
    
    3,991Accounts payable
    
    
    (3,099
    )
    
    
    (6,349
    )Accrued medical claims liability
    
    
    666
    
    
    
    2,615Accrued expenses
    
    
    1,808
    
    
    
    2,476Deferred revenue
    
    
    (5,211
    )
    
    
    (9,976
    )Loss contract reserve utilization
    
    
    
    
    
    
    (7,357
    )Net cash provided by operating activities
    
    
    2,362
    
    
    
    5,006Cash flows from investing activities:Capital expenditures, net
    
    
    (1,554
    )
    
    
    (1,829
    )Net cash used in investing activities
    
    
    (1,554
    )
    
    
    (1,829
    )Cash flows from financing activities:Net borrowings on line of credit
    
    
    6,427
    
    
    
    Reduction in restricted cash used to collateralize letters of credit
    
    
    4,200
    
    
    
    Excess tax benefits from share-based compensation expense
    
    
    408
    
    
    
    Share repurchases
    
    
    (2,980
    )
    
    
    Issuance of common stock, net
    
    
    215
    
    
    
    369Exercise of stock options
    
    
    955
    
    
    
    747Net cash provided by financing activities
    
    
    9,225
    
    
    
    1,116Net increase in cash and cash equivalents
    
    
    10,033
    
    
    
    4,293Cash and cash equivalents at beginning of period
    
    
    
    
    
    
    7,191Cash and cash equivalents at end of period
    
    $
    10,033
    
    
    $
    11,484
 
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##### Table of Contents



AMERICA SERVICE GROUP INC.
 
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 June 30, 2006
  1. Basis of Presentation
    2. Description of Business
  3. Restatement of Financial Statements
   6




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4. Recently Issued Accounting Pronouncements
 Accounting for Uncertainty in Income Taxes  an interpretation of FASB Statement No. 109 Accounting for Income Taxes
 5. Share-Based Compensation
 Accounting for Stock Issued to Employees Accounting for Stock-Based Compensation
 Share-Based Payment
   7




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Transition Election
Related to Accounting for Tax Effects of Share-Based Payment Awards
  Quarter ended
    
    
    Six months endedJune 30, 2005
    
    
    June 30, 2005Income from continuing operations as reported
    
    $
    3,292
    
    
    $
    6,848Add: Stock based compensation expense included in reported
net income, net of taxes
    
    
    11
    
    
    
    19Deduct: Stock based compensation expense determined under
SFAS No. 123, net of taxes
    
    
    (516
    )
    
    
    (923
    )Pro forma income from continuing operations
    
    
    2,787
    
    
    
    5,944Loss from discontinued operations, net of taxes
    
    
    (453
    )
    
    
    (146
    )Pro forma net income attributable to common shares
    
    $
    2,334
    
    
    $
    5,798As reported net income per common share  basic:As reported income from continuing operations
    
    $
    0.30
    
    
    $
    0.63As reported loss from discontinued operations, net of taxes
    
    
    (0.04
    )
    
    
    (0.01
    )As reported net income
    
    $
    0.26
    
    
    $
    0.62Pro forma net income per common share  basic:Pro forma income from continuing operations
    
    $
    0.25
    
    
    $
    0.54Pro forma loss from discontinued operations
    
    
    (0.04
    )
    
    
    (0.01
    )Pro forma net income
    
    $
    0.21
    
    
    $
    0.53As reported net income per common share  diluted:As reported income from continuing operations
    
    $
    0.30
    
    
    $
    0.61As reported loss from discontinued operations, net of taxes
    
    
    (0.04
    )
    
    
    (0.01
    )As reported net income
    
    $
    0.26
    
    
    $
    0.60Pro forma net income per common share  diluted:Pro forma income from continuing operations
    
    $
    0.25
    
    
    $
    0.53Pro forma loss from discontinued operations
    
    
    (0.04
    )
    
    
    (0.01
    )Pro forma net income
    
    
    0.21
    
    
    $
    0.52
 Stock Options
   8




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##### Table of Contents



Quarter ended
    
    Six months endedJune 30,
    
    June 30,2006
    
    2005
    
    2006
    
    2005Weighted average grant
date fair value of
options
    
    $
    8.02
    
    
    $
    12.94
    
    
    $
    8.16
    
    
    $
    13.01Assumptions:Volatility
    
    
    0.62
    
    
    
    0.85
    
    
    
    0.64
    
    
    
    0.85Interest rate
    
    
    5.05
    %
    
    
    3.95
    %
    
    
    5.03
    %
    
    
    3.95
    %Expected life (years)
    
    
    4.65
    
    
    
    4.50
    
    
    
    4.66
    
    
    
    4.50Dividend yields
    
    
    0.00
    %
    
    
    0.00
    %
    
    
    0.00
    %
    
    
    0.00
    %
  Weighted Average
    
    
    Aggregate IntrinsicWeighted Average
    
    
    Remaining
    
    
    Value (inOptions
    
    
    Exercise Price
    
    
    Contractual Term
    
    
    thousands) (1)Outstanding, December 31, 2005
    
    
    1,300,502
    
    
    $
    16.82Granted
    
    
    40,000
    
    
    
    14.10Exercised
    
    
    (92,513
    )
    
    
    4.39Canceled
    
    
    (10,750
    )
    
    
    10.99Outstanding, March 31, 2006
    
    
    1,237,239
    
    
    $
    17.72Granted
    
    
    289,000
    
    
    
    14.55Exercised
    
    
    (59,839
    )
    
    
    9.16Canceled
    
    
    
    
    
    
    Outstanding, June 30, 2006
    
    
    1,466,400
    
    
    $
    17.44
    
    
    
    7.69
    
    
    $
    2,253Exercisable, June 30, 2006
    
    
    947,233
    
    
    $
    15.44
    
    
    
    6.06
    
    
    $
    2,985
 
 (1)
    
    Based upon the difference between the closing market price of the Companys common stock on the last trading day of
the quarter and the grant price of in-the-money options.   9




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##### Table of Contents



Restricted Stock
   WeightedRestricted
    
    
    Average Grant-Shares
    
    
    Date Fair PriceNonvested, December 31, 2005
    
    
    11,500
    
    
    $
    20.82Granted
    
    
    44,500
    
    
    
    14.67Vested
    
    
    (2,500
    )
    
    
    21.02Forfeited
    
    
    (5,000
    )
    
    
    21.02Nonvested, June 30, 2006
    
    
    48,500
    
    
    $
    15.15
  Employee Stock Purchase Plan
   10




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6. Discontinued Operations
 Accounting for the Impairment
or Disposal of Long-Lived Assets
  Quarter ended
    
    
    Six months endedJune 30,
    
    
    June 30,2006
    
    
    2005
    
    
    2006
    
    
    2005Healthcare revenues
    
    $
    (356
    )
    
    $
    36,217
    
    
    $
    162
    
    
    $
    72,876Healthcare expenses
    
    
    (18
    )
    
    
    35,653
    
    
    
    745
    
    
    
    71,775Increase in reserve for loss contracts
    
    
    
    
    
    
    1,295
    
    
    
    
    
    
    
    1,295Gross margin
    
    
    (338
    )
    
    
    (731
    )
    
    
    (583
    )
    
    
    (194
    )Depreciation and amortization
    
    
    10
    
    
    
    21
    
    
    
    19
    
    
    
    44Interest, net
    
    
    6
    
    
    
    3
    
    
    
    16
    
    
    
    5Loss from discontinued operations before taxes
    
    
    (354
    )
    
    
    (755
    )
    
    
    (618
    )
    
    
    (243
    )Income tax benefit
    
    
    (224
    )
    
    
    (302
    )
    
    
    (332
    )
    
    
    (97
    )Loss from discontinued operations, net of taxes
    
    $
    (130
    )
    
    $
    (453
    )
    
    $
    (286
    )
    
    $
    (146
    )
 7. Accounts Receivable
  June 30,
    
    
    December 31,2006
    
    
    2005Billed accounts receivable
    
    $
    55,444
    
    
    $
    46,735Unbilled accounts receivable
    
    
    39,854
    
    
    
    53,563Other accounts receivable
    
    
    751
    
    
    
    11296,049
    
    
    
    100,410Less:
Allowance for doubtful accounts
    
    
    (768
    )
    
    
    (698
    )$
    95,281
    
    
    $
    99,712
    11




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##### Table of Contents



8. Prepaid Expenses and Other Current Assets
  June 30,
    
    
    December 31,2006
    
    
    2005Prepaid insurance
    
    $
    8,947
    
    
    $
    10,067Prepaid cash deposits for estimated
professional liability claims losses
    
    
    8,000
    
    
    
    8,400Prepaid performance bonds
    
    
    29
    
    
    
    115Prepaid other
    
    
    740
    
    
    
    394$
    17,716
    
    
    $
    18,976
 9. Property and Equipment
  June 30,
    
    
    December 31,
    
    
    Estimated2006
    
    
    2005
    
    
    Useful LivesLeasehold improvements
    
    $
    1,230
    
    
    $
    1,230
    
    
    5 yearsEquipment and furniture
    
    
    10,652
    
    
    
    9,657
    
    
    5 yearsComputer software
    
    
    4,276
    
    
    
    3,945
    
    
    3-5 yearsMedical equipment
    
    
    2,324
    
    
    
    2,231
    
    
    5 yearsAutomobiles
    
    
    60
    
    
    
    38
    
    
    5 yearsManagement information systems under development
    
    
    7
    
    
    
    59
    
    
    
    18,549
    
    
    
    17,160Less: Accumulated depreciation
    
    
    (11,783
    )
    
    
    (10,824
    )$
    6,766
    
    
    $
    6,336
  Accounting for the Costs of Computer Software Developed or Obtained for Internal
Use
 12




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10. Other Assets
  June 30,
    
    
    December 31,2006
    
    
    2005Deferred financing costs
    
    $
    334
    
    
    $
    251Less: Accumulated amortization
    
    
    (67
    )
    
    
    (14
    )267
    
    
    
    237Prepaid cash deposits for estimated professional
liability claims losses
    
    
    4,123
    
    
    
    5,892Excess deposits for professional liability claims
    
    
    3,124
    
    
    
    3,864Other refundable deposits
    
    
    78
    
    
    
    75$
    7,592
    
    
    $
    10,068
 11. Contracts and Other Intangible Assets
  June 30,
    
    
    December 31,2006
    
    
    2005Contracts:Gross value
    
    $
    15,870
    
    
    $
    15,870Less: Accumulated amortization
    
    
    (9,518
    )
    
    
    (8,704
    )$
    6,352
    
    
    $
    7,166Non-compete agreements:Gross value
    
    $
    2,400
    
    
    $
    2,400Less: Accumulated amortization
    
    
    (1,670
    )
    
    
    (1,555
    )$
    730
    
    
    $
    845
  12. Accrued Expenses
  June 30,
    
    
    December 31,2006
    
    
    2005Salaries and employee benefits
    
    $
    18,348
    
    
    $
    16,390Professional liability claims
    
    
    23,732
    
    
    
    24,600Accrued workers compensation claims
    
    
    5,724
    
    
    
    5,707Other
    
    
    14,183
    
    
    
    13,48261,987
    
    
    
    60,179Less: Noncurrent portion of professional liability claims
    
    
    (15,232
    )
    
    
    (15,701
    )$
    46,755
    
    
    $
    44,478
 13. Reserve for Loss Contracts
  13




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14




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##### Table of Contents



14. Banking Arrangements
     15




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Balance Sheet Classification of Borrowings
Outstanding under Revolving Credit Agreements that Include Both a Subjective Acceleration Clause
and a Lock-Box Arrangement
   15. Income Taxes
 Accounting for Income Taxes
    16




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16. Professional and General Liability Self-insurance Retention
  17. Commitments and Contingencies
 Catastrophic Limits
  Litigation and Claims
 Lake Professional Liability Suit.
 17




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##### Table of Contents



EMSA lease matter. th
  Albert Einstein Healthcare Network v. The City of Philadelphia and Prison Health Services,
Inc.
 The Health and Hospital Corporation of Marion County, Indiana v. Prison Health Services,
Inc.
 Matters Related to the Audit Committee Investigation
  SEC and United States Attorney Informal Inquiries.
 18




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Shareholder Litigation.
 Shareholder Derivative Litigation.
  Delaware Department of Justice Informal Inquiry
 Other Matters
  Performance Bonds
  18. Net Income (Loss) Per Share
 Earnings Per Share,
 19




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##### Table of Contents



Quarter ended
    
    
    Six months endedJune 30,
    
    
    June 30,2006
    
    
    2005
    
    
    2006
    
    
    2005Numerator:Income (loss) from continuing operations
    
    $
    644
    
    
    $
    3,292
    
    
    $
    (348
    )
    
    $
    6,848Loss from discontinued operations, net of taxes
    
    
    (130
    )
    
    
    (453
    )
    
    
    (286
    )
    
    
    (146
    )Numerator for basic and diluted net income (loss) per share
    
    $
    514
    
    
    $
    2,839
    
    
    $
    (634
    )
    
    $
    6,702Denominator:Denominator for basic net income per share 
weighted average shares
    
    
    10,783,918
    
    
    
    10,873,100
    
    
    
    10,775,099
    
    
    
    10,859,959Effect of dilutive securities:Employee stock options
    
    
    89,155
    
    
    
    250,338
    
    
    
    
    
    
    
    282,359Denominator for diluted net income per share 
adjusted weighted average shares and assumed
conversions
    
    
    10,873,073
    
    
    
    11,123,438
    
    
    
    10,775,099
    
    
    
    11,142,318Net income (loss) per common share  basic:Income (loss) from continuing operations
    
    $
    0.06
    
    
    $
    0.30
    
    
    $
    (0.03
    )
    
    $
    0.63Loss from discontinued operations, net of taxes
    
    
    (0.01
    )
    
    
    (0.04
    )
    
    
    (0.03
    )
    
    
    (0.01
    )Net income (loss)
    
    $
    0.05
    
    
    $
    0.26
    
    
    $
    (0.06
    )
    
    $
    0.62Net income (loss) per common share  diluted:Income (loss) from continuing operations
    
    $
    0.06
    
    
    $
    0.30
    
    
    $
    (0.03
    )
    
    $
    0.61Loss from discontinued operations, net of taxes
    
    
    (0.01
    )
    
    
    (0.04
    )
    
    
    (0.03
    )
    
    
    (0.01
    )Net income (loss)
    
    $
    0.05
    
    
    $
    0.26
    
    
    $
    (0.06
    )
    
    $
    0.60
  Quarter ended
    
    
    Six months endedJune 30,
    
    
    June 30,2006
    
    
    2005
    
    
    2006
    
    
    2005Options excluded from computation of diluted
income per share as effect would be anti-dilutive
    
    
    1,092,619
    
    
    
    563,712
    
    
    
    1,466,400
    
    
    
    294,356Weighted average exercise price of excluded options
    
    $
    19.89
    
    
    $
    23.49
    
    
    $
    17.44
    
    
    $
    23.58
 19. Comprehensive Income
  20. Segment Data
   20




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Correctional
    
    
    Pharmaceutical
    
    
    Elimination ofHealthcare
    
    
    Distribution
    
    
    IntersegmentServices
    
    
    Services
    
    
    Sales
    
    
    ConsolidatedQuarter ended June 30, 2006:Healthcare revenues
    
    $
    155,110
    
    
    $
    22,369
    
    
    $
    (17,232
    )
    
    $
    160,247Healthcare expenses
    
    
    144,792
    
    
    
    22,569
    
    
    
    (17,232
    )
    
    
    150,129Gross margin
    
    $
    10,318
    
    
    $
    (200
    )
    
    $
    
    
    
    $
    10,118Depreciation and amortization expense
    
    $
    869
    
    
    $
    187
    
    
    $
    
    
    
    $
    1,056Quarter ended June 30, 2005:Healthcare revenues
    
    $
    128,064
    
    
    $
    23,503
    
    
    $
    (12,088
    )
    
    $
    139,479Healthcare expenses
    
    
    117,863
    
    
    
    22,437
    
    
    
    (12,088
    )
    
    
    128,212Gross margin
    
    $
    10,201
    
    
    $
    1,066
    
    
    $
    
    
    
    $
    11,267Depreciation and amortization expense
    
    $
    711
    
    
    $
    271
    
    
    $
    
    
    
    $
    982Six month period ended June 30, 2006:Healthcare revenues
    
    $
    316,356
    
    
    $
    42,703
    
    
    $
    (31,767
    )
    
    $
    327,292Healthcare expenses
    
    
    295,740
    
    
    
    43,903
    
    
    
    (31,767
    )
    
    
    307,876Gross margin
    
    $
    20,616
    
    
    $
    (1,200
    )
    
    $
    
    
    
    $
    19,416Depreciation and amortization expense
    
    $
    1,656
    
    
    $
    376
    
    
    $
    
    
    
    $
    2,032Six month period ended June 30, 2005:Healthcare revenues
    
    $
    250,051
    
    
    $
    45,790
    
    
    $
    (23,463
    )
    
    $
    272,378Healthcare expenses
    
    
    229,634
    
    
    
    43,454
    
    
    
    (23,463
    )
    
    
    249,625Gross margin
    
    $
    20,417
    
    
    $
    2,336
    
    
    $
    
    
    
    $
    22,753Depreciation and amortization expense
    
    $
    1,438
    
    
    $
    505
    
    
    $
    
    
    
    $
    1,943
 Correctional
    
    
    PharmaceuticalHealthcare
    
    
    DistributionServices
    
    
    Services
    
    
    ConsolidatedAs of June 30, 2006:Inventories
    
    $
    5,861
    
    
    $
    2,955
    
    
    $
    8,816Property and equipment, net
    
    $
    4,331
    
    
    $
    2,435
    
    
    $
    6,766Goodwill, net
    
    $
    40,771
    
    
    $
    3,042
    
    
    $
    43,813Total assets
    
    $
    190,412
    
    
    $
    15,449
    
    
    $
    205,861As of December 31, 2005:Inventories
    
    $
    3,944
    
    
    $
    2,602
    
    
    $
    6,546Property and equipment, net
    
    $
    3,670
    
    
    $
    2,666
    
    
    $
    6,336Goodwill, net
    
    $
    40,771
    
    
    $
    3,042
    
    
    $
    43,813Total assets
    
    $
    188,467
    
    
    $
    16,770
    
    
    $
    205,237
 21. Share Repurchases
  22. Related Party Transaction
  21




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##### Table of Contents



ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 General
    Forward-Looking Statements
  
    
    the risk that government or municipal entities (including the
Companys government and municipal customers) may
bring enforcement actions against, seek additional refunds from, or impose penalties on,
the Company or its subsidiaries as a result of the matters investigated by the Audit
Committee or the previous restatement of the Companys financial results;
    
    the risks arising from shareholder litigation as a result of the matters recently
investigated by the Audit Committee or the previous restatement of the Companys financial
results;
    
    risks associated with the possibility that the Company may be unable to satisfy
covenants under its credit facility;
    
    risks arising from potential weaknesses or deficiencies in the Companys internal
control over financial reporting;
    
    risks arising from the possibility that the Company may be unable to collect accounts receivable;
    
    the Companys ability to retain existing client
contracts and obtain new contracts at acceptable pricing levels;
    
    whether or not government agencies continue to privatize correctional healthcare services;
 22




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##### Table of Contents




    
    the possible effect of adverse publicity regarding the Companys business;
    
    the Companys ability to comply with government
regulations and/or orders of judicial authority;
    
    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, injuries or
medical malpractice claims in excess of amounts covered under contracts or insurance
coverage;
    
    the outcome of pending litigation;
    
    the Companys dependence on key personnel; and
    
    the Companys determination whether to repurchase shares under the stock repurchase program.
  Restatement of Financial Statements
    Critical Accounting Policies And Estimates
 General
  23




---



##### Table of Contents




    
    revenue and cost recognition (including the estimated cost of off-site medical claims);
    
    allowance for doubtful accounts;
    
    loss contracts;
    
    professional and general liability self-insurance retention;
    
    other self-funded insurance reserves;
    
    legal contingencies;
    
    impairment of intangible assets and goodwill;
    
    income taxes; and
    
    share-based compensation.
   Revenue and Cost Recognition
    24




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Allowance for Doubtful Accounts
     25




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##### Table of Contents



Loss Contracts
    26




---



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27




---



##### Table of Contents



Professional and General Liability Self-Insurance Retention
     Other Self-Funded Insurance Reserves
  28




---



##### Table of Contents



Legal Contingencies
  Impairment of Intangible Assets and Goodwill
 Goodwill and Other
Intangible Assets,
   
    
    significant underperformance or loss of key contracts relative to expected
historical or projected future operating results;
    
    significant changes in the manner of use of the Companys assets or in the
Companys overall business strategy; and
    
    significant negative industry or economic trends.
   29




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##### Table of Contents



Income Taxes
 Accounting for Income Taxes
    Share-Based Compensation
  30




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##### Table of Contents



Results of Operations
  Quarter ended
    
    Six months endedJune 30,
    
    June 30,Percentage of Healthcare Revenues
    
    2006
    
    2005
    
    2006
    
    2005Healthcare revenues
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %Healthcare expenses
    
    
    93.7
    
    
    
    91.9
    
    
    
    94.1
    
    
    
    91.6Gross margin
    
    
    6.3
    
    
    
    8.1
    
    
    
    5.9
    
    
    
    8.4Selling, general and administrative expenses
    
    
    4.1
    
    
    
    3.1
    
    
    
    3.8
    
    
    
    3.2Discontinued acquisition expenses
    
    
    
    
    
    
    0.4
    
    
    
    
    
    
    
    0.2Audit Committee investigation and related expenses
    
    
    0.6
    
    
    
    
    
    
    
    1.4
    
    
    
    Depreciation and amortization
    
    
    0.7
    
    
    
    0.7
    
    
    
    0.6
    
    
    
    0.7Income from operations
    
    
    0.9
    
    
    
    3.9
    
    
    
    0.1
    
    
    
    4.3Interest, net
    
    
    0.3
    
    
    
    0.2
    
    
    
    0.3
    
    
    
    0.2Late fee income
    
    
    
    
    
    
    0.2
    
    
    
    
    
    
    
    0.1Income (loss) from continuing operations before income
tax provision (benefit)
    
    
    0.6
    
    
    
    3.9
    
    
    
    (0.2
    )
    
    
    4.2Income tax provision (benefit)
    
    
    0.2
    
    
    
    1.5
    
    
    
    (0.1
    )
    
    
    1.7Income (loss) from continuing operations
    
    
    0.4
    
    
    
    2.4
    
    
    
    (0.1
    )
    
    
    2.5Income (loss) from discontinued operations, net of taxes
    
    
    (0.1
    )
    
    
    (0.4
    )
    
    
    (0.1
    )
    
    
    Net income (loss)
    
    
    0.3
    %
    
    
    2.0
    %
    
    
    (0.2
    )%
    
    
    2.5
    %
 Quarter Ended June 30, 2006 Compared to Quarter Ended June 30, 2005
 Healthcare revenues.
 Healthcare expenses.
 Selling, general and administrative expenses.
 31




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Discontinued acquisition expenses.
 Audit Committee investigation and related expenses.
 Depreciation and amortization
 Interest, net
 Late fee income.
 Income tax provision.
 Income from continuing operations.
 Loss from discontinued operations, net of taxes
 Net income.
 32




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##### Table of Contents



Six Months Ended June 30, 2006 Compared to Six Months Ended June 30, 2005
 Healthcare revenues.
 Healthcare expenses.
 Selling, general and administrative expenses.
 Discontinued acquisition expenses.
 Audit Committee investigation and related expenses.
 33




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Discontinued acquisition expenses.
 Depreciation and amortization
 Interest, net
 Late fee income.
 Income tax provision (benefit).
 Income (loss) from continuing operations.
 Loss from discontinued operations, net of taxes
 Net income (loss).
 Liquidity and Capital Resources
 Overview
  34




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Credit Facility
    35




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##### Table of Contents



Balance Sheet Classification of Borrowings Outstanding under
Revolving Credit Agreements that Include Both a Subjective Acceleration Clause and a Lock-Box
Arrangement
  Other Financing Transactions
  Contractual Obligations and Commercial Commitments
  Current
    
    
    2-3 years
    
    
    4-5 years
    
    
    After 5 yearsOperating leases
    
    $
    816
    
    
    $
    2,379
    
    
    $
    244
    
    
    $
    Revolving credit facility
    
    
    18,927
    
    
    
    
    
    
    
    
    
    
    
    Professional and general liability claims
    
    
    8,511
    
    
    
    10,966
    
    
    
    3,381
    
    
    
    874Total
    
    $
    28,254
    
    
    $
    13,345
    
    
    $
    3,625
    
    
    $
    874
  Off-Balance Sheet Transactions
  Inflation
  36




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##### Table of Contents



Stock Repurchase Program
  Recently Issued Accounting Pronouncement
 Accounting for Uncertainty in Income Taxes  an interpretation of FASB Statement No. 109 Accounting for Income Taxes
 37




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##### Table of Contents



ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
  
 ITEM 4. CONTROLS AND PROCEDURES
  Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures
    38




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##### Table of Contents



Changes in Internal Controls
  
    
    Policies have been developed and communicated to SPP and Company management
concerning the clarity of definitions regarding pricing and returns policies to be
used in proposals and contracts.
    
    All proposals, new contracts and amendments to existing contracts must be reviewed
by the Legal and Finance Departments of the Company prior to delivery or execution.
Additionally, contract record keeping procedures are being enhanced.
    
    The significant terms of all proposals must be reviewed and approved by Executive
Management of the Company prior to delivery.
    
    Changes to customer pricing rules in SPPs information system must be reviewed and
approved by the Legal and Finance Departments of the Company prior to implementation
of the changes. Additionally, SPP is developing an edit report that will be
periodically reviewed by the Controller of SPP to ensure that all changes made to
customer pricing rules are appropriately approved and input accurately.
    
    Documentation of changes to the customer pricing rules must be maintained by SPP
with a copy of all changes sent to the Legal Department of the Company.
    
    The Controller of SPP now reports directly to the Finance Department of the Company
rather than to the President of SPP.
    
    Monthly account reconciliations of SPP are being reviewed by the Finance Department
of the Company.
    
    SPP is developing reports that more closely monitor monthly drug price changes.
 
 39




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##### Table of Contents



PART II:
 OTHER INFORMATION
 
 ITEM 1. LEGAL PROCEEDINGS
 Lake Professional Liability Suit.
 EMSA lease matter. th
  Albert Einstein Healthcare Network v. The City of Philadelphia and Prison Health Services,
Inc.
 40




---



##### Table of Contents



The Health and Hospital Corporation of Marion County, Indiana v. Prison Health Services,
Inc.
 SEC and United States Attorney Informal Inquiries.
 Shareholder Litigation.
 Shareholder Derivative Litigation.
  41




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##### Table of Contents



Delaware Department of Justice Informal Inquiry
 Other Matters.
 42




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##### Table of Contents



ITEM 1A. RISK FACTORS
  Shareholder Litigation.
 Potential Enforcement Actions
 
 ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
  (c) Total Number of
    
    (d) Maximum NumberShares (of Units)
    
    (or Approximate Dollar(a) Total of
    
    (b) Average
    
    Purchased as Part
    
    Value) of shares (orNumber of
    
    Price Paid
    
    of Publicly
    
    Units) that May Yet BeShares (or Units)
    
    per Share (or
    
    Announced Plans or
    
    Purchased Under thePeriod
    
    Purchased
    
    Unit)
    
    Programs
    
    Plans or Programs (1)April 2006 (4/1/06
to 4/30/06)
    
    
    
    
    
    $
    
    
    
    
    
    
    
    $
    May 2006 (5/1/06 to
5/31/06)
    
    
    217,000
    
    
    $
    19.95
    
    
    
    217,000
    
    
    $
    24,000June 2006 (6/1/06
to 6/30/06)
    
    
    
    
    
    $
    
    
    
    
    
    
    
    $
    
 
 (1)
    
    On July 25, 2005, the Companys Board of Directors approved a stock repurchase program to
repurchase up to $30 million of the Companys common stock over a 24 month period. As of June 30,
2006, the Company has repurchased and retired a total of 366,100 common shares at an aggregate cost
of approximately $6.0 million. 43




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##### Table of Contents



ITEM
3. DEFAULTS UPON SENIOR SECURITIES
  
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
  Director
    
    Votes For
    
    Votes WithheldMichael Catalano
    
    
    8,036,326
    
    
    
    1,860,080William D. Eberle
    
    
    9,316,741
    
    
    
    579,665Burton C. Einspruch, M.D.
    
    
    9,896,215
    
    
    
    191Richard D. Wright
    
    
    7,235,944
    
    
    
    2,660,462
  Votes For
    
    Votes Against
    
    Votes Abstained9,835,656
    
    
    159,909
    
    
    
    600
 
 ITEM 5. OTHER INFORMATION
  44




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##### Table of Contents



ITEM 6. EXHIBITS
 2.1
    
    
    
    Securities Purchase Agreement, dated as of January 26, 1999, among America Service Group Inc., Health Care Capital Partners
L.P. and Health Care Executive Partners L.P. (incorporated herein by reference to Exhibit 99.2 to the Companys Current
Report on Form 8-K filed on February 10, 1999).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 Form 10-Q for the three month period ended June 30, 2002).3.2
    
    
    
    Amended and Restated By-Laws of America Service Group Inc. (incorporated herein by reference to Exhibit 3.2 to the Companys
Quarterly Report on Form 10-Q for the three-month period ended June 30, 2002).3.3
    
    
    
    Certificate of Amendment of Amended and Restated Certificate of Incorporation of America Service Group Inc. (incorporated
herein by reference to Exhibit 3.4 to the Companys Quarterly Report on Form 10-Q for the three month period ended June 30,
2004).4.1
    
    
    
    Specimen Common Stock Certificate (incorporated herein by reference to Exhibit 4.1 to the Companys Quarterly Report on Form
10-Q for the three month period ended June 30, 2002).4.2
    
    
    
    Certificate of Designation of the Series A Convertible Preferred Stock (incorporated herein by reference to Exhibit 99.3 to
the Companys Current Report on Form 8-K filed on February 10, 1999).10.1
    
    
    
    Form of New Director Stock Grant Certificate under the America Service Group Inc. Amended and Restated 1999 Incentive Stock
Plan (incorporated herein by reference to Exhibit 10.1 to the Companys Current Report on Form 8-K filed on June 14, 2006).10.2
    
    
    
    2006 Incentive Compensation Plan of America Service Group Inc. (incorporated herein by reference to Exhibit 10.1 to the
Companys Current Report on Form 8-K filed on June 14, 2006).11
    
    
    
    Computation of Per Share Earnings.*31.1
    
    
    
    Certification of the Chief Executive Officer pursuant to 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 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 18 to the condensed
consolidated financial statements in this report. 45




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##### Table of Contents



SIGNATURES
  AMERICA SERVICE GROUP INC./s/ MICHAEL CATALANO
Michael CatalanoChairman, President & Chief Executive Officer(Duly Authorized Officer)/s/ MICHAEL W. TAYLOR
Michael W. TaylorSenior Vice President & Chief Financial Officer(Principal Financial Officer)
  46