##### 





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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, 2002        
|           |  |                                                     
|           |  | OR                                                  
|           |  |                                                     
|[  ]       |  | 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.

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

(615) 373-3100

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 [  ]

There were 5,552,744 shares of Common Stock outstanding as of July 31,
2002.



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AMERICA SERVICE GROUP INC.





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##### 



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, 2002 and December 31, 2001               |  | 3          
|                                                                                              |  |            
|Condensed Consolidated Statements of Operations for the quarter and six month period          |  |            
|ended June 30, 2002 and 2001.                                                                 |  | 4          
|                                                                                              |  |            
|Condensed Consolidated Statements of Cash Flows for the six month period ended June 30, 2002  |  |            
|and 2001.                                                                                     |  | 5          
|                                                                                              |  |            
|Notes to Condensed Consolidated Financial Statements                                          |  | 6          
|                                                                                              |  |            
|Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations |  | 14         
|                                                                                              |  |            
|Item 3. Quantitative and Qualitative Disclosures About Market Risk                            |  | 24         
|                                                                                              |  |            
|PART II. OTHER INFORMATION                                                                    |  |            
|                                                                                              |  |            
|Item 1. Legal Proceedings                                                                     |  | 25         
|                                                                                              |  |            
|Item 4. Submission of Matters to a Vote of Security Holders                                   |  | 25         
|                                                                                              |  |            
|Item 6. Exhibits and Reports on Form 8-K                                                      |  | 26         
|                                                                                              |  |            
|Signature page                                                                                |  | 27         

2



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##### 



PART I:

FINANCIAL INFORMATION

ITEM 1.  FINANCIAL STATEMENTS

AMERICA SERVICE GROUP INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

|                                                     |                                                                  |   |                                      |         |              |   |         |         |  
|---------------------------------------------------- | ---------------------------------------------------------------- | - | ------------------------------------ | ------- | ------------ | - | ------- | ------- | -
|                                                     |                                                                  |   | June 30,                             |         | December 31,
|                                                     |                                                                  |   | 2002                                 |         | 2001        
|                                                     |                                                                  |   |                                      |         |             
|                                                     |                                                                  |   | (shown in 000's except share and per
|                                                     |                                                                  |   | share amounts)                      
|ASSETS                                               |                                                                  |   |                                      |         |              |   |         |        
|Current assets:                                      |                                                                  |   |                                      |         |              |   |         |        
|                                                     | Cash and cash equivalents                                        |   | $                                    | 250     |              |   | $       | 10,382  |  
|                                                     | Accounts receivable: healthcare and other less allowances        |   |                                      | 64,422  |              |   |         | 64,691  |  
|                                                     | Inventories                                                      |   |                                      | 7,845   |              |   |         | 7,747   |  
|                                                     | Prepaid expenses and other current assets                        |   |                                      | 15,967  |              |   |         | 9,070   |  
|                                                     |                                                                  |   |                                      |         |              |   |         |         |  
|Total current assets                                 |                                                                  |   | 88,484                               |         |              |   | 91,890  |        
|Property and equipment, net                          |                                                                  |   | 7,025                                |         |              |   | 7,827   |        
|Goodwill, net                                        |                                                                  |   | 43,896                               |         |              |   | 43,896  |        
|Contracts, net                                       |                                                                  |   | 13,088                               |         |              |   | 13,912  |        
|Other intangibles, net                               |                                                                  |   | 1,583                                |         |              |   | 1,683   |        
|Other assets                                         |                                                                  |   | 231                                  |         |              |   | 1,172   |        
|                                                     |                                                                  |   |                                      |         |              |   |         |         |  
|Total assets                                         |                                                                  | $ | 154,307                              |         |              | $ | 160,380 |        
|                                                     |                                                                  |   |                                      |         |              |   |         |         |  
|LIABILITIES AND STOCKHOLDERS EQUITY (DEFICIT)       |                                                                  |   |                                      |         |              |   |         |        
|Current liabilities:                                 |                                                                  |   |                                      |         |              |   |         |        
|                                                     | Accounts payable                                                 |   | $                                    | 38,350  |              |   | $       | 31,159  |  
|                                                     | Medical claims liability                                         |   |                                      | 14,190  |              |   |         | 15,238  |  
|                                                     | Accrued expenses                                                 |   |                                      | 33,461  |              |   |         | 30,148  |  
|                                                     | Deferred revenue                                                 |   |                                      | 735     |              |   |         | 4,161   |  
|                                                     | Current portion of loss contract reserve                         |   |                                      | 2,590   |              |   |         | 4,310   |  
|                                                     | Current portion of long-term debt                                |   |                                      | 44,678  |              |   |         | 10,700  |  
|                                                     |                                                                  |   |                                      |         |              |   |         |         |  
|Total current liabilities                            |                                                                  |   | 134,004                              |         |              |   | 95,716  |        
|Noncurrent portion of accrued expenses               |                                                                  |   | 7,655                                |         |              |   | 6,810   |        
|Noncurrent portion of loss contract reserve          |                                                                  |   | 8,424                                |         |              |   | 14,008  |        
|Long-term debt, net of current portion               |                                                                  |   |                                     |         |              |   | 47,400  |        
|                                                     |                                                                  |   |                                      |         |              |   |         |         |  
|Total liabilities                                    |                                                                  |   | 150,083                              |         |              |   | 163,934 |        
|                                                     |                                                                  |   |                                      |         |              |   |         |         |  
|Commitments and contingencies                        |                                                                  |   |                                      |         |              |   |         |        
|Stockholders equity (deficit):                      |                                                                  |   |                                      |         |              |   |         |        
|                                                     | Common stock, $.01 par value, 10,000,000 shares                  |   |                                      |         |              |   |         |         |  
|                                                     | authorized; 5,450,000 and 5,437,000 shares issued and            |   |                                      |         |              |   |         |         |  
|                                                     | outstanding at June 30, 2002 and December 31, 2001,
respectively |   |                                      | 55      |              |   |         | 54      |  
|                                                     | Additional paid-in capital                                       |   |                                      | 31,457  |              |   |         | 31,377  |  
|                                                     | Stockholders notes receivable                                   |   |                                      | (1,334  | )            |   |         | (1,383  | )
|                                                     | Accumulated other comprehensive loss                             |   |                                      | (284    | )            |   |         | (645    | )
|                                                     | Retained deficit                                                 |   |                                      | (25,670 | )            |   |         | (32,957 | )
|                                                     |                                                                  |   |                                      |         |              |   |         |         |  
|Total stockholders equity (deficit)                 |                                                                  |   | 4,224                                |         |              |   | (3,554  | )      
|                                                     |                                                                  |   |                                      |         |              |   |         |         |  
|Total liabilities and stockholders equity (deficit) |                                                                  | $ | 154,307                              |         |              | $ | 160,380 |        
|                                                     |                                                                  |   |                                      |         |              |   |         |         |  

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

3



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##### 



AMERICA SERVICE GROUP INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

|                                                    |         |   |                                                             |           |                           |   |         |           |      |   |         |           |  |   |         |           |  
|--------------------------------------------------- | ------- | - | ----------------------------------------------------------- | --------- | ------------------------- | - | ------- | --------- | ---- | - | ------- | --------- |  | - | ------- | --------- | -
|                                                    |         |   | Quarter Ended June 30,                                      |           | Six Months Ended June 30,
|                                                    |         |   | 2002                                                        |           | 2001                      |   | 2002    |           | 2001
|                                                    |         |   |                                                             |           |                           |   |         |           |     
|                                                    |         |   | (Amounts shown in 000's except share and per share amounts)
|                                                    |         |   |                                                             |           |                           |   |         |           |      |   |         |           |  |   |         |           |  
|Healthcare revenue                                  |         | $ | 138,505                                                     |           |                           | $ | 140,779 |           |      | $ | 276,360 |           |  | $ | 278,720 |          
|Healthcare expenses                                 |         |   | 129,924                                                     |           |                           |   | 146,711 |           |      |   | 259,203 |           |  |   | 273,309 |          
|                                                    |         |   |                                                             |           |                           |   |         |           |      |   |         |           |  |   |         |          
|Gross margin                                        |         |   | 8,581                                                       |           |                           |   | (5,932  | )         |      |   | 17,157  |           |  |   | 5,411   |          
|Selling, general and administrative expenses        |         |   | 3,479                                                       |           |                           |   | 5,984   |           |      |   | 7,564   |           |  |   | 10,126  |          
|Depreciation and amortization                       |         |   | 1,134                                                       |           |                           |   | 1,960   |           |      |   | 2,317   |           |  |   | 3,943   |          
|Strategic initiative expense                        |         |   |                                                            |           |                           |   | 1,267   |           |      |   |        |           |  |   | 1,267   |          
|Impairment of long-lived assets                     |         |   |                                                            |           |                           |   | 13,236  |           |      |   |        |           |  |   | 13,236  |          
|Reduction in loss contract reserve                  |         |   | (3,320                                                      | )         |                           |   |        |           |      |   | (3,320  | )         |  |   |        |          
|                                                    |         |   |                                                             |           |                           |   |         |           |      |   |         |           |  |   |         |          
|Income (loss) from operations                       |         |   | 7,288                                                       |           |                           |   | (28,379 | )         |      |   | 10,596  |           |  |   | (23,161 | )        
|Interest, net                                       |         |   | 1,905                                                       |           |                           |   | 1,237   |           |      |   | 3,404   |           |  |   | 2,525   |          
|                                                    |         |   |                                                             |           |                           |   |         |           |      |   |         |           |  |   |         |          
|Income (loss) before income tax provision (benefit) |         |   | 5,383                                                       |           |                           |   | (29,616 | )         |      |   | 7,192   |           |  |   | (25,686 | )        
|Income tax provision (benefit)                      |         |   | 75                                                          |           |                           |   | (11,237 | )         |      |   | (95     | )         |  |   | (9,645  | )        
|                                                    |         |   |                                                             |           |                           |   |         |           |      |   |         |           |  |   |         |          
|Net income (loss)                                   |         |   | 5,308                                                       |           |                           |   | (18,379 | )         |      |   | 7,287   |           |  |   | (16,041 | )        
|Preferred stock dividends                           |         |   |                                                            |           |                           |   |        |           |      |   |        |           |  |   | 163     |          
|                                                    |         |   |                                                             |           |                           |   |         |           |      |   |         |           |  |   |         |          
|Net income (loss) attributable to common shares     |         | $ | 5,308                                                       |           |                           | $ | (18,379 | )         |      | $ | 7,287   |           |  | $ | (16,204 | )        
|                                                    |         |   |                                                             |           |                           |   |         |           |      |   |         |           |  |   |         |          
|Net income (loss) per common share:                 |         |   |                                                             |           |                           |   |         |           |      |   |         |           |  |   |         |          
|                                                    | Basic   |   | $                                                           | 0.97      |                           |   | $       | (3.39     | )    |   | $       | 1.34      |  |   | $       | (3.14     | )
|                                                    |         |   |                                                             |           |                           |   |         |           |      |   |         |           |  |   |         |          
|                                                    | Diluted |   | $                                                           | 0.95      |                           |   | $       | (3.39     | )    |   | $       | 1.31      |  |   | $       | (3.14     | )
|                                                    |         |   |                                                             |           |                           |   |         |           |      |   |         |           |  |   |         |          
|Weighted average shares outstanding:                |         |   |                                                             |           |                           |   |         |           |      |   |         |           |  |   |         |          
|                                                    | Basic   |   |                                                             | 5,450,000 |                           |   |         | 5,420,000 |      |   |         | 5,445,000 |  |   |         | 5,153,000 |  
|                                                    |         |   |                                                             |           |                           |   |         |           |      |   |         |           |  |   |         |          
|                                                    | Diluted |   |                                                             | 5,576,000 |                           |   |         | 5,420,000 |      |   |         | 5,551,000 |  |   |         | 5,153,000 |  
|                                                    |         |   |                                                             |           |                           |   |         |           |      |   |         |           |  |   |         |          

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

4



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##### 



AMERICA SERVICE GROUP INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

|                                                                                  |                                                        |                                           |         |                           |        |      |         |        |        |  
|--------------------------------------------------------------------------------- | ------------------------------------------------------ | ----------------------------------------- | ------- | ------------------------- | ------ | ---- | ------- | ------ | ------ | -
|                                                                                  |                                                        |                                           |         | Six Months Ended June 30,
|                                                                                  |                                                        |                                           |         | 2002                      |        | 2001
|                                                                                  |                                                        |                                           |         |                           |        |     
|                                                                                  |                                                        |                                           |         | (Amounts shown in 000's) 
|Operating activities:                                                             |                                                        |                                           |         |                           |        |      |         |       
|Net income                                                                        |                                                        | $                                         | 7,287   |                           |        | $    | (16,041 | )     
|Adjustments to reconcile net income to net cash
provided by operating activities: |                                                        |                                           |         |                           |        |      |         |       
|                                                                                  | Depreciation and amortization                          |                                           |         | 2,317                     |        |      |         | 3,943  |       
|                                                                                  | Amortization of deferred financing costs               |                                           |         | 505                       |        |      |         | 190    |       
|                                                                                  | Impairment of long-lived assets                        |                                           |         |                          |        |      |         | 13,236 |       
|                                                                                  | Reduction in loss contract reserve                     |                                           |         | (3,320                    | )      |      |         |       |       
|                                                                                  | Deferred income taxes                                  |                                           |         |                          |        |      |         | (8,736 | )     
|                                                                                  | Interest on stockholders notes receivable             |                                           |         | (34                       | )      |      |         | (40    | )     
|                                                                                  | Other comprehensive loss amortized to interest expense |                                           |         | 361                       |        |      |         |       |       
|                                                                                  | Changes in operating assets and liabilities:           |                                           |         |                           |        |      |         |        |       
|                                                                                  |                                                        | Accounts receivable                       |         |                           | 269    |      |         |        | (5,463 | )
|                                                                                  |                                                        | Prepaid expenses and other current assets |         |                           | (6,995 | )    |         |        | (9,501 | )
|                                                                                  |                                                        | Other assets                              |         |                           | 930    |      |         |        | (27    | )
|                                                                                  |                                                        | Accounts payable                          |         |                           | 7,191  |      |         |        | 4,691  |  
|                                                                                  |                                                        | Accrued expenses                          |         |                           | 3,190  |      |         |        | 16,303 |  
|                                                                                  |                                                        | Reserve for loss contracts                |         |                           | (3,984 | )    |         |        |       |  
|                                                                                  |                                                        | Deferred revenue                          |         |                           | (3,426 | )    |         |        |       |  
|                                                                                  |                                                        |                                           |         |                           |        |      |         |       
|Net cash provided by operating activities                                         |                                                        |                                           | 4,291   |                           |        |      | (1,445  | )     
|                                                                                  |                                                        |                                           |         |                           |        |      |         |       
|Investing activities:                                                             |                                                        |                                           |         |                           |        |      |         |       
|Capital expenditures                                                              |                                                        |                                           | (608    | )                         |        |      | (1,337  | )     
|Other                                                                             |                                                        |                                           | 17      |                           |        |      |        |       
|                                                                                  |                                                        |                                           |         |                           |        |      |         |       
|Net cash used in investing activities                                             |                                                        |                                           | (591    | )                         |        |      | (1,337  | )     
|                                                                                  |                                                        |                                           |         |                           |        |      |         |       
|Financing activities:                                                             |                                                        |                                           |         |                           |        |      |         |       
|Net advances (payments) on line of credit                                         |                                                        |                                           | (13,422 | )                         |        |      | 1,980   |       
|Payment of deferred financing costs                                               |                                                        |                                           | (493    | )                         |        |      |        |       
|Proceeds from stockholder notes receivable                                        |                                                        |                                           | 83      |                           |        |      | 81      |       
|Payment of preferred stock dividends                                              |                                                        |                                           |        |                           |        |      | (61     | )     
|Exercise of stock options                                                         |                                                        |                                           |        |                           |        |      | 578     |       
|                                                                                  |                                                        |                                           |         |                           |        |      |         |       
|Net cash used in financing activities                                             |                                                        |                                           | (13,832 | )                         |        |      | 2,578   |       
|                                                                                  |                                                        |                                           |         |                           |        |      |         |       
|Net increase (decrease) in cash and cash equivalents                              |                                                        |                                           | (10,132 | )                         |        |      | (204    | )     
|Cash and cash equivalents, beginning of period                                    |                                                        |                                           | 10,382  |                           |        |      | 256     |       
|                                                                                  |                                                        |                                           |         |                           |        |      |         |       
|Cash and cash equivalents, end of period                                          |                                                        | $                                         | 250     |                           |        | $    | 52      |       
|                                                                                  |                                                        |                                           |         |                           |        |      |         |       

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

5



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##### 



AMERICA SERVICE GROUP INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
JUNE 30, 2002(shown in 000s except share and per share amounts)

1. Basis of Presentation

The interim condensed consolidated financial statements as of June 30,
2002 and for the quarter and six month period then ended 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
quarter and six month period presented. The results of operations for the
quarter and six month period presented are not necessarily indicative of the
results to be expected for the year ending December 31, 2002. The interim
condensed consolidated financial statements should be read in connection with
the audited consolidated financial statements for the year ended December 31,
2001.

2. Description of Business

America Service Group Inc. and its consolidated subsidiaries (the
Company) provide 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 Defense and Veterans Administration. The health status of inmates
may impact results of operations under such contractual arrangements.

3. Recently Issued Accounting Pronouncements

In June 1998, the Financial Accounting Standards Board (FASB) issued
SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities
(SFAS 133), as amended in June 2000 by SFAS No. 138, Accounting for Certain
Derivative Instruments and Certain Hedging Activities(SFAS 138), which
requires the Company to recognize all derivatives as assets or liabilities
measured at fair value. Changes in fair value are recognized through either
earnings or other comprehensive income dependent on the effectiveness of the
hedge instrument. The Company currently maintains three interest collar
agreements with three of its syndicate banks for a notional amount of $24,000.
The collar agreements expire between October 2002 and May 2003.

On January 1, 2001, the Company adopted SFAS 133 and SFAS 138 resulting in
a charge to other comprehensive income of approximately $212, net of tax, as
the cumulative effect of a change in accounting principle representing the fair
value of the collar agreements on the date of adoption.

In June 2001, the FASB issued SFAS No. 141, Business Combinations(SFAS
141), and SFAS No. 142, Goodwill and Other Intangible Assets(SFAS 142).
SFAS 141 requires that the purchase method of accounting be used for all
business combinations initiated after June 30, 2001. SFAS 141 also specifies
criteria which intangible assets acquired in purchase method business
combinations after June 30, 2001 must meet to be recognized and reported apart
from goodwill. SFAS 142 addresses the initial recognition and measurement of
intangible assets acquired outside of a business combination and the accounting
for goodwill and other intangible assets subsequent to their acquisition. SFAS
142 requires that intangible assets with finite useful lives be amortized, and
that goodwill and intangible assets with indefinite lives no longer be
amortized, but instead be tested for impairment at least annually.

The Company adopted SFAS 141 on July 1, 2001. Such adoption had no effect
on the Companys financial position or results of operations. The Company
adopted SFAS 142 effective January 1, 2002, at which time the amortization of
the Companys existing goodwill ceased. Other than the effect on net income of
not amortizing goodwill, the adoption of SFAS 142 had no effect on the
Companys results of operations or financial position. Amortization expense
related to goodwill during the quarter and six month period ended June 30, 2001
was $794 and $1,598, respectively.

6



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##### 



The following table reflects unaudited pro forma results of operations of
the Company for the quarter and six month period ended June 30, 2002 and 2001,
giving effect to SFAS 142 as if it were adopted on January 1, 2001:

|                                                             |             |   |               |      |                  |   |         |       |      |   |       |      |  |   |         |       |  
|------------------------------------------------------------ | ----------- | - | ------------- | ---- | ---------------- | - | ------- | ----- | ---- | - | ----- | ---- |  | - | ------- | ----- | -
|                                                             |             |   | Quarter ended |      | Six months ended
|                                                             |             |   | June 30,      |      | June 30,        
|                                                             |             |   | 2002          |      | 2001             |   | 2002    |       | 2001
|                                                             |             |   |               |      |                  |   |         |       |     
|Net income (loss) attributable to common shares, as
reported |             | $ | 5,308         |      |                  | $ | (18,379 | )     |      | $ | 7,287 |      |  | $ | (16,204 | )    
|Add back: amortization expense, net of tax                   |             |   |              |      |                  |   | 492     |       |      |   |      |      |  |   | 991     |      
|                                                             |             |   |               |      |                  |   |         |       |      |   |       |      |  |   |         |      
|Pro forma net income (loss) attributable to common shares    |             | $ | 5,308         |      |                  | $ | (17,887 | )     |      | $ | 7,287 |      |  | $ | (15,213 | )    
|                                                             |             |   |               |      |                  |   |         |       |      |   |       |      |  |   |         |      
|Basic net income (loss) per common share:                    |             |   |               |      |                  |   |         |       |      |   |       |      |  |   |         |      
|                                                             | As reported |   | $             | 0.97 |                  |   | $       | (3.39 | )    |   | $     | 1.34 |  |   | $       | (3.14 | )
|                                                             |             |   |               |      |                  |   |         |       |      |   |       |      |  |   |         |      
|                                                             | Pro forma   |   | $             | 0.97 |                  |   | $       | (3.30 | )    |   | $     | 1.34 |  |   | $       | (2.95 | )
|                                                             |             |   |               |      |                  |   |         |       |      |   |       |      |  |   |         |      
|Diluted net income (loss) per common share:                  |             |   |               |      |                  |   |         |       |      |   |       |      |  |   |         |      
|                                                             | As reported |   | $             | 0.95 |                  |   | $       | (3.39 | )    |   | $     | 1.31 |  |   | $       | (3.14 | )
|                                                             |             |   |               |      |                  |   |         |       |      |   |       |      |  |   |         |      
|                                                             | Pro forma   |   | $             | 0.95 |                  |   | $       | (3.30 | )    |   | $     | 1.31 |  |   | $       | (2.95 | )
|                                                             |             |   |               |      |                  |   |         |       |      |   |       |      |  |   |         |      

In August 2001, the FASB issued SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets(SFAS 144) effective for fiscal
years beginning after December 15, 2001. SFAS 144 establishes a single
accounting model for long-lived assets to be disposed of by sale, whether
previously held and used or newly acquired, and broadens the presentation of
discontinued operations to include more disposal transactions. The Company
adopted SFAS 144 effective January 1, 2002. Such adoption had no impact on the
Companys financial position or results of operations.

4. Reduction In Loss Contract Reserve

During 2001, the Company completed a comprehensive review of its portfolio
of 145 contracts for the purpose of identifying loss contracts and developing a
contract loss reserve for succeeding years. As a result of this review, the
Company identified five non-cancelable contracts with combined 2001 annual
revenues of $59,653 and negative gross margin of $4,714. Based upon
managements projections, these contracts were expected to continue to incur
negative gross margin over their remaining terms. In December 2001, the
Company recorded a charge of $18,317 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. The remaining ten
percent of the charge related to the State of Maine contract, which expired
June 30, 2002, and two county contracts, which expire August 15, 2002 and June
30, 2005. Negative gross margin and overhead costs charged against the loss
contract reserve related to these five contracts totaled $2,078 for the quarter
ended June 30, 2002 and $3,984 for the six months ended June 30, 2002.

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 early
expiration of this loss contract, the Company performed a reassessment of its
loss contract reserve requirements. This reassessment included a review of
managements projected future losses under the remaining three loss contracts
as well as a comprehensive review of the Companys portfolio of contracts at
June 30, 2002 for the purpose of identifying any additional loss contracts. No
new loss contracts were identified as a result of this review. Based upon the
reassessment, the Company recorded a gain of $3,320 to reduce its reserve for
loss contracts to $11,014 at June 30, 2002.

The Company will continue to provide services to the State of Maine under
a cost plus a fixed management fee transition agreement through December 31, 2002. The Company has
also entered into a transition agreement with the City of Philadelphia under
which it will continue to provide services through September 30, 2002 under
modified contract terms.

5. Strategic Initiative Expense

During the second quarter of 2001, the Company incurred certain strategic
initiative expenses of $1,267. This initiative was discontinued in the third
quarter of 2001.

7



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##### 



6. Impairment of Long-Lived Assets

During 2001, the Company was notified that another vendor had been
selected to provide healthcare services for the Eastern Region of the
Pennsylvania Department of Corrections upon the expiration of the Companys
contract on December 31, 2002. The Company also determined that it would cease
operations under the contract with the Yonkers Region of the New York
Department of Correctional Services upon the expiration of the Companys
contract on May 31, 2002 as the healthcare services were to be
self-operated by the
client. These contracts represent substantially all of the operations acquired
in the acquisition of Correctional Physician Services, Inc. (CPS) in March
2000. Given these factors, and in accordance with SFAS No. 121, Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed
Of, the Company recorded a non-cash impairment charge of $13,236 during the
second quarter of 2001 representing the excess net goodwill recorded in
connection with the acquisition of CPS over the fair value of the two
contracts. The Company estimated the fair value of the contracts by
calculating the net present value of estimated cash flows during the remaining
term of the contracts adjusted for certain other factors.

7. Changes in Accounting Estimates

During the second quarter of 2001, the Company recorded changes in
accounting estimate charges of approximately $6,000 to strengthen medical
claims reserves due to adverse development of prior years medical claims,
$1,300 for certain legal costs and $400 for various other charges.

The charge for strengthening medical claims reserves is included in
healthcare expense on the accompanying consolidated statements of operations
and was primarily the result of updated second quarter of 2001 information that
indicated actual utilization rates and cost data for inpatient and outpatient
services were higher than the historical levels previously used to estimate the
reserves. The charge for legal and malpractice insurance exposure is included
in selling, general and administrative expense on the accompanying statement of
operations and was primarily related to the bankruptcy of insurance
carriers that provided coverage to the Company from 1992 through
1997. The $400 for various other charges is included in healthcare
expense on the accompanying consolidated statements of operations.

8. Prepaid Expenses and Other Current Assets

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

|                                                           |  |          |        |              |  |   |       |  |  |  |  | 
|---------------------------------------------------------- |  | -------- | ------ | ------------ |  | - | ----- |  |  |  |  | 
|                                                           |  | June 30, |        | December 31, |  |   |       | 
|                                                           |  | 2002     |        | 2001         |  |   |       | 
|                                                           |  |          |        |              |  |   |       | 
|Prepaid insurance                                          |  | $        | 12,259 |              |  | $ | 8,489 | 
|Deferred loan costs on credit facility maturing April 2003 |  |          | 962    |              |  |   |      | 
|Deposit  appeal bond collateral                           |  |          | 2,035  |              |  |   |      | 
|Prepaid performance bonds                                  |  |          | 158    |              |  |   | 281   | 
|Prepaid other                                              |  |          | 553    |              |  |   | 300   | 
|                                                           |  |          |        |              |  |   |       | 
|                                                           |  | $        | 15,967 |              |  | $ | 9,070 | 
|                                                           |  |          |        |              |  |   |       | 

9. Property and Equipment

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

|                               |  |          |        |              |  |              |        |   |  |         |  | 
|------------------------------ |  | -------- | ------ | ------------ |  | ------------ | ------ | - |  | ------- |  | 
|                               |  | June 30, |        | December 31, |  | Estimated   
|                               |  | 2002     |        | 2001         |  | Useful Lives
|                               |  |          |        |              |  |             
|Leasehold improvements         |  | $        | 1,161  |              |  | $            | 1,158  |   |  | 5 years
|Equipment and furniture        |  |          | 10,913 |              |  |              | 10,469 |   |  | 5 years
|Computer software              |  |          | 1,360  |              |  |              | 1,317  |   |  | 3 years
|Medical equipment              |  |          | 2,273  |              |  |              | 2,155  |   |  | 5 years
|Automobile                     |  |          | 14     |              |  |              | 14     |   |  | 5 years
|                               |  |          |        |              |  |              |        |   |  |         |  | 
|                               |  |          | 15,721 |              |  |              | 15,113 |   |  |         |  | 
|Less: Accumulated depreciation |  |          | (8,696 | )            |  |              | (7,286 | ) |  |         |  | 
|                               |  |          |        |              |  |              |        |   |  |         |  | 
|                               |  | $        | 7,025  |              |  | $            | 7,827  |   |  |         |  | 
|                               |  |          |        |              |  |              |        |   |  |         |  | 

Depreciation expense was $1,385 and $1,328 for the six months ended June 30,
2002 and 2001, respectively.

8



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##### 



10. Contracts and Other Intangible Assets

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

|                        |                          |   |          |        |              |   |        |        |  
|----------------------- | ------------------------ | - | -------- | ------ | ------------ | - | ------ | ------ | -
|                        |                          |   | June 30, |        | December 31,
|                        |                          |   | 2002     |        | 2001        
|                        |                          |   |          |        |             
|Contracts:              |                          |   |          |        |              |   |        |       
|                        | Gross value              |   | $        | 15,870 |              |   | $      | 15,870 |  
|                        | Accumulated amortization |   |          | (2,782 | )            |   |        | (1,958 | )
|                        |                          |   |          |        |              |   |        |        |  
|                        |                          | $ | 13,088   |        |              | $ | 13,912 |       
|                        |                          |   |          |        |              |   |        |        |  
|Non-compete agreements: |                          |   |          |        |              |   |        |       
|                        | Gross value              |   | $        | 2,400  |              |   | $      | 2,400  |  
|                        | Accumulated amortization |   |          | (817   | )            |   |        | (717   | )
|                        |                          |   |          |        |              |   |        |        |  
|                        |                          | $ | 1,583    |        |              | $ | 1,683  |       
|                        |                          |   |          |        |              |   |        |        |  



| |                                                                                                                                                                                                                                                                                                                                            
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Amortization expense associated with the above intangibles for the
first six months of 2002 was $922. Estimated aggregate amortization expense
based on current intangibles for the second half of 2002 and the next four
years is as follows: $708 for the second half of 2002, $960 in 2003, $960 in
2004, $960 in 2005 and $960 in 2006.

11. Accrued Expenses

Accrued expenses consist of the following:

|                                             |  |          |        |              |  |   |        |  
|-------------------------------------------- |  | -------- | ------ | ------------ |  | - | ------ | -
|                                             |  | June 30, |        | December 31,
|                                             |  | 2002     |        | 2001        
|                                             |  |          |        |             
|Salaries and employee benefits               |  | $        | 22,075 |              |  | $ | 18,474 |  
|Professional liability claims                |  |          | 8,655  |              |  |   | 7,810  |  
|Accrued workers compensation                |  |          | 3,070  |              |  |   | 2,374  |  
|Other                                        |  |          | 7,316  |              |  |   | 8,300  |  
|                                             |  |          |        |              |  |   |        |  
|                                             |  |          | 41,116 |              |  |   | 36,958 |  
|Less: Noncurrent portion of liability claims |  |          | (7,655 | )            |  |   | (6,810 | )
|                                             |  |          |        |              |  |   |        |  
|                                             |  | $        | 33,461 |              |  | $ | 30,148 |  
|                                             |  |          |        |              |  |   |        |  

12. Banking Arrangements

The Companys debt consists of a revolving credit facility which was
amended on March 15, 2002 (the Amended Credit Facility). At June 30, 2002,
the Company had $44,678 outstanding under the Amended Credit Facility and
$5,722 available for future borrowings. The Amended Credit Facility was
executed with a syndicate of four banks (the Lenders) with Bank of America,
N.A. acting as the lead bank and administrative agent.

The Companys borrowings under the Amended Credit Facility are limited to
the lesser of (1) the sum of eligible accounts and other receivables (as
defined) plus an intangible advance of up to $11,000 (Intangible Advances) or
(2) $57,000 (the Maximum Commitment). Interest under the Amended Credit
Facility is payable monthly at the Bank of America, N.A. prime rate plus 3.0%
(5.0% for balances due under Intangible Advances). The Amended Credit Facility
matures on April 1, 2003 and all amounts outstanding will be due and payable on
such date. In addition, the Company is required to make scheduled reductions
in the Intangible Advances allowed and the Maximum Commitment prior to that
date. The following table presents the Maximum Commitment and the maximum
allowed Intangible Advances (included within the Maximum Commitment) as of June
30, 2002 and each scheduled reduction date.

|                  |  |            |  |           
|----------------- |  | ---------- |  | ----------
|                  |  | Maximum    |  | Intangible
|Date              |  | Commitment |  | Advances  
|                  |  |            |  |           
|June 30, 2002     |  | $57,000    |  | $11,000   
|July 1, 2002      |  | 57,000     |  | 10,000    
|September 1, 2002 |  | 56,000     |  | 10,000    
|October 1, 2002   |  | 55,000     |  | 9,000     
|December 1, 2002  |  | 54,000     |  | 9,000     
|February 1, 2003  |  | 53,000     |  | 9,000     
|March 1, 2003     |  | 52,000     |  | 9,000     

9



---



##### 



The Amended Credit Facility is secured by substantially all of the assets
of the Company and its operating subsidiaries. At June 30, 2002, the Company
has classified the amount outstanding under the Amended Credit Facility as
current due to the Amended Credit Facilitys maturity in April 2003.

At June 30, 2002, the Company had standby letters of credit outstanding
totaling $6,600. The letters of credit were issued pursuant to the Amended
Credit Facility. The amount available to the Company for borrowing under the
Amended Credit Facility is reduced by the amount of each outstanding standby
letter of credit. Under the terms of the Amended Credit Facility, the Company
may have up to $6,600 of standby letters of credit outstanding.

Under the terms of the Amended Credit Facility, the Company is required to
pay an annual commitment fee equal to 0.5% of the unused Maximum Commitment and
an annual standby letter of credit commitment fee equal to 4.5% of the average
standby letters of credit outstanding during the year.

Under the terms of the Amended Credit Facility, if any Amended Credit
Facility obligations remain outstanding at December 31, 2002, the Company will
be required to issue the Lenders warrants to purchase common shares equal to
5.0% of the Companys outstanding common stock on a fully diluted basis. The
number of warrants required to be issued will be reduced to a 2.5% interest if
the balance outstanding under the Amended Credit Facility does not exceed
$45,000, there are no outstanding Intangible Advances and the Company is not in
default under the terms of the Amended Credit Facility. The exercise price of
the warrants will be $.01 per share.

The Amended Credit Facility requires the Company to meet certain financial
covenants related to minimum levels of net worth and earnings. As of June 30,
2002, the Company was in compliance with these financial covenant requirements.
The Amended Credit Facility also contains restrictions on the Company with
respect to certain types of transactions including payment of dividends,
capital expenditures, indebtedness and sales or transfers of assets.

The Company is dependent on the availability of borrowings pursuant to the
Amended Credit Facility to meet its working capital needs, capital expenditure
requirements and other cash flow requirements during the remainder of 2002.
Management believes that the Company can remain in compliance with the terms of
the Amended Credit Facility and meet its expected obligations throughout 2002.
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.

13. Professional and General Liability Insurance

For fiscal 2002, the Company has obtained third party commercial insurance
on a claims-made basis with primary annual limits of $1,000 for each occurrence
and $3,000 in the aggregate on a per site basis, subject to a $10,000 company
wide annual aggregate limit. The Company assumes any liabilities in excess of
the third-party insurance limits.

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 for all years
were $8,655 and $7,810 at June 30, 2002, and December 31, 2001, respectively,
and are included in accrued expenses and the non-current portion of accrued
expenses. 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 estimates and 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. Given the inherent degree of variability in any such
estimates, the reserves reported at June 30, 2002, represent managements best
estimate of the amounts necessary to discharge the Companys obligations.

10



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##### 



14. Commitments and Contingencies

Catastrophic Limits

Many of the Companys contracts require the Companys clients 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 certain
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 illness-related limits.
However, the occurrence of severe individual cases 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 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 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, 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 early
2003. The Company has posted an appeal bond in the amount of $2,000, 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 $600 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, 2002 and December 31, 2001. 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.

11



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##### 



15. 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 for the quarter and six
month period ended June 30, 2002 and 2001.

|                                                                                                     |  |               |           |                  |  |      |           |      |  |   |           |  |  |   |           | 
|---------------------------------------------------------------------------------------------------- |  | ------------- | --------- | ---------------- |  | ---- | --------- | ---- |  | - | --------- |  |  | - | --------- | 
|                                                                                                     |  | Quarter ended |           | Six months ended
|                                                                                                     |  | June 30,      |           | June 30,        
|                                                                                                     |  |               |           |                 
|                                                                                                     |  | 2002          |           | 2001             |  | 2002 |           | 2001
|                                                                                                     |  |               |           |                  |  |      |           |     
|Net income (loss)                                                                                    |  | $             | 5,308     |                  |  | $    | (18,379)  |      |  | $ | 7,287     |  |  | $ | (16,041)  | 
|Preferred stock dividends                                                                            |  |               |          |                  |  |      |          |      |  |   |          |  |  |   | 163       | 
|                                                                                                     |  |               |           |                  |  |      |           |      |  |   |           |  |  |   |           | 
|Numerator for basic net income
(loss) per share  income (loss)
attributable to common stock holders |  | $             | 5,308     |                  |  | $    | (18,379)  |      |  | $ | 7,287     |  |  | $ | (16,204)  | 
|                                                                                                     |  |               |           |                  |  |      |           |      |  |   |           |  |  |   |           | 
|Denominator for basic net income
(loss) per share  weighted
average common shares                   |  |               | 5,450,000 |                  |  |      | 5,420,000 |      |  |   | 5,445,000 |  |  |   | 5,153,000 | 
|Effect of dilutive securities                                                                        |  |               | 126,000   |                  |  |      |          |      |  |   | 106,000   |  |  |   |          | 
|                                                                                                     |  |               |           |                  |  |      |           |      |  |   |           |  |  |   |           | 
|Denominator for diluted net income
(loss) per share  adjusted
weighted average common shares        |  |               | 5,576,000 |                  |  |      | 5,420,000 |      |  |   | 5,551,000 |  |  |   | 5,153,000 | 
|                                                                                                     |  |               |           |                  |  |      |           |      |  |   |           |  |  |   |           | 
|Basic net income (loss) per share                                                                    |  | $             | 0.97      |                  |  | $    | (3.39)    |      |  | $ | 1.34      |  |  | $ | (3.14)    | 
|                                                                                                     |  |               |           |                  |  |      |           |      |  |   |           |  |  |   |           | 
|Diluted net income (loss) per share                                                                  |  | $             | 0.95      |                  |  | $    | (3.39)    |      |  | $ | 1.31      |  |  | $ | (3.14)    | 
|                                                                                                     |  |               |           |                  |  |      |           |      |  |   |           |  |  |   |           | 

Due to the net loss for the quarter and six month period ended June 30, 2001,
the effect of the Companys potential dilutive securities (primarily stock
options) on diluted loss per share was anti-dilutive.

16. Comprehensive Income



| |                                                                                                                                
| | -------------------------------------------------------------------------------------------------------------------------------
| | The components of comprehensive earnings, net of related taxes, are as
follows for the six months ended June 30, 2002 and 2001:

|                                                                                                                       |  |      |       |      |  |   |         |  
|---------------------------------------------------------------------------------------------------------------------- |  | ---- | ----- | ---- |  | - | ------- | -
|                                                                                                                       |  | 2002 |       | 2001
|                                                                                                                       |  |      |       |     
|Net
income (loss) attributable to common shares                                                                        |  | $    | 7,287 |      |  | $ | (16,204 | )
|                                                                                                                       |  |      |       |      |  |   |         |  
|Cumulative effect of change in
accounting principle  fair value of
interest rate swaps qualifying as cash
flow hedges |  |      |      |      |  |   | (212    | )
|Net change in fair value of interest
rate swaps qualifying as cash flow
hedges                                         |  |      |      |      |  |   | (233    | )
|Amortization of fair value of interest
rate swaps previously qualifying as
cash flow hedges                            |  |      | 361   |      |  |   |        |  
|                                                                                                                       |  |      |       |      |  |   |         |  
|Other Comprehensive income (loss)                                                                                      |  |      | 361   |      |  |   | (445    | )
|                                                                                                                       |  |      |       |      |  |   |         |  
|Comprehensive
income (loss)                                                                                            |  | $    | 7,648 |      |  | $ | (16,649 | )
|                                                                                                                       |  |      |       |      |  |   |         |  

17. Segments

The Company generally views its operating segments on a managed healthcare
contract basis. The Company considers its managed healthcare services contract
business to be one reportable segment under Financial Accounting Standards
Board Statement No. 131, Disclosures about Segments of an Enterprise and
Related Information, as the economic characteristics, the nature of the
services, and type and class of customers for the services and the methods used
to provide the services are similar. Consequently, reportable segment
information is not applicable.

18. Reclassifications

Certain amounts in the 2001 financial statements have been reclassified to
conform with the 2002 presentation.

12



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##### 



19. Subsequent Event

In July 2002, the Company issued 67,446 shares of its common stock as the
result of the exercise of a warrant. The exercise price for the warrant was
$0.01 per share. In July 2002, the Company also issued 35,686 shares of
common stock under its employee stock purchase plan.

13



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##### 



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

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:



| |  |  | losses from contracts that the Company cannot terminate;                                                
| | - |  | --------------------------------------------------------------------------------------------------------
|
| |  |  | changes in performance bonding requirements;                                                            
|
| |  |  | the complexity of, and potential changes in, government contracting procedures; and                     
|
| |  |  | the shortage of qualified nurses at reasonable costs in some of the areas in which the Company operates.

Because the risk factors referred to above, as well as the risk factors
set forth in the Companys Annual Report on Form 10-K for the year ended
December 31, 2001 under the heading Item 1. Business  Cautionary
Statements, 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.

General

America Service Group Inc. (ASG or the Company) is the leading
non-governmental provider of managed correctional healthcare services in the
U.S., providing healthcare services to approximately 185,000 inmates at 215
sites in 28 states. The Company also distributes pharmaceuticals and medical
supplies to approximately 208,000 inmates at over 360 sites in 34 states. Many
of the inmates to whom the Company distributes pharmaceuticals and medical
supplies also receive its healthcare services. In addition, the Company
provides managed healthcare services to active and retired military personnel
and their dependants at five sites in three states and the District of
Columbia.

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, Inc. (CHS),
and Secure Pharmacy Plus, Inc. (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.

14



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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 affect 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. The contracts
may also contain certain risk sharing arrangement, 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.

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. As discussed above, 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
do not contain such provisions.

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-

15



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cancelable contracts with combined 2001 annual revenues of $59.7 million
and negative gross margin of $4.7 million. Based upon managements
projections, these contracts were expected to continue to incur negative gross
margin 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. The remaining ten
percent of the charge related to the State of Maine contract, which expired
June 30, 2002, and two county contracts, which expire August 15, 2002 and June
30, 2005. Negative gross margin and overhead costs charged against the loss
contract reserve related to these five contracts totaled $2.1 million for the
quarter ended June 30, 2002 and $4.0 million for the six months ended June 30,
2002.

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 early expiration of this
loss contract, the Company performed a reassessment of its loss contract
reserve requirements. This reassessment included a review of managements
projected future losses under the remaining three loss contracts as well as a
comprehensive review of the Companys portfolio of contracts at June 30, 2002
for the purpose of identifying any additional loss contracts. No new loss
contracts were identified as a result of this review. Based upon the
reassessment, the Company recorded a gain of $3.3 million to reduce its reserve
for loss contracts to $11.0 million at June 30, 2002.

The Company will continue to provide services to the State of Maine under
a cost plus a fixed management fee transition agreement through December 31, 2002. The Company has
also entered into a transition agreement with the City of Philadelphia under
which it will continue to provide services through September 30, 2002 under
modified contract terms.

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 third party
commercial insurance. In 2002, the insurance is maintained on a claims-made
basis with annual primary limits of $1 million for each occurrence and $3
million in the aggregate on a per site basis, subject to a
$10 million company-wide annual aggregate limit. The Company also requires the healthcare
professionals it employs and its independent contractors to maintain
professional liability insurance. The Company assumes liabilities in excess of
these third-party insurance limits.

The Company records a liability for its estimated uninsured exposure to
reported and unreported professional liability claims based upon a quarterly
independent actuarial estimate of the cost of settling losses and projected
loss adjustment expenses using historical claims data, demographic factors,
severity factors and other actuarial assumptions. 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. The reserves can also be affected by changes in the
financial health of the third-party insurance carriers used by the Company.
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.

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 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.

16



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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 annual basis or more frequently whenever events or circumstances
indicate that the carrying value may not be recoverable.

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.                                                                                                      

When 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 performance measures. 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 condition and results of operations.

Income Taxes

The Company accounts for income taxes under SFAS No. 109, Accounting for
Income Taxes(SFAS 109). Under the asset and liability method of SFAS 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.

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 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, 2002 and December 31,
2001, 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 shareholders equity). Due
to the Companys net income in the first six months of 2002, the Companys
deferred tax valuation allowance was reduced $3.3 million from $16.1 million at
December 31, 2001 to $12.8 million at June 30, 2002 as a reduction to income
tax provision.

17



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Results of Operations

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

|                                                 |  |               |       |                  |  |      |       |      |  |  |       |   |  |  |       |  
|------------------------------------------------ |  | ------------- | ----- | ---------------- |  | ---- | ----- | ---- |  |  | ----- | - |  |  | ----- | -
|                                                 |  | Quarter ended |       | Six Months Ended
|                                                 |  | June 30,      |       | June 30,        
|Percentage of Total Revenues                     |  | 2002          |       | 2001             |  | 2002 |       | 2001
|                                                 |  |               |       |                  |  |      |       |     
|Healthcare revenues                              |  |               | 100.0 | %                |  |      | 100.0 | %    |  |  | 100.0 | % |  |  | 100.0 | %
|Healthcare expenses                              |  |               | 93.8  |                  |  |      | 104.2 |      |  |  | 93.8  |   |  |  | 98.1  |  
|                                                 |  |               |       |                  |  |      |       |     
|Gross margin                                     |  |               | 6.2   |                  |  |      | (4.2  | )    |  |  | 6.2   |   |  |  | 1.9   |  
|Selling, general and administrative expenses     |  |               | 2.5   |                  |  |      | 4.3   |      |  |  | 2.8   |   |  |  | 3.6   |  
|Depreciation and amortization                    |  |               | 0.8   |                  |  |      | 1.4   |      |  |  | 0.8   |   |  |  | 1.4   |  
|Strategic initiative expense                     |  |               |      |                  |  |      | 0.9   |      |  |  |      |   |  |  | 0.5   |  
|Impairment of long-lived assets                  |  |               |      |                  |  |      | 9.4   |      |  |  |      |   |  |  | 4.7   |  
|Reduction in loss contract reserve               |  |               | (2.4  | )                |  |      |      |      |  |  | (1.2  | ) |  |  |      |  
|                                                 |  |               |       |                  |  |      |       |     
|Income from operations                           |  |               | 5.3   |                  |  |      | (20.2 | )    |  |  | 3.8   |   |  |  | (8.3  | )
|Interest, net                                    |  |               | 1.4   |                  |  |      | 0.8   |      |  |  | 1.2   |   |  |  | 0.9   |  
|                                                 |  |               |       |                  |  |      |       |     
|Income before income tax provision (benefit)     |  |               | 3.9   |                  |  |      | (21.0 | )    |  |  | 2.6   |   |  |  | (9.2  | )
|Income tax provision (benefit)                   |  |               | 0.1   |                  |  |      | (8.0  | )    |  |  |      |   |  |  | (3.4  | )
|                                                 |  |               |       |                  |  |      |       |     
|Net income (loss)                                |  |               | 3.8   |                  |  |      | (13.0 | )    |  |  | 2.6   |   |  |  | (5.8  | )
|Preferred stock dividends                        |  |               |      |                  |  |      |      |      |  |  |      |   |  |  |      |  
|                                                 |  |               |       |                  |  |      |       |     
|Net income (loss ) attributable to common shares |  |               | 3.8   |                  |  |      | (13.0 | )    |  |  | 2.6   |   |  |  | (5.8  | )
|                                                 |  |               |       |                  |  |      |       |     

Quarter Ended June 30, 2002 Compared to Quarter Ended June 30, 2001

Healthcare revenues.Healthcare revenues for the second quarter of 2002
decreased $2.3 million, or 1.6%, from $140.8 million in 2001 to $138.5 million
in 2002. Healthcare revenues in the second quarter of 2002 included $4.9
million of revenue growth resulting from contracts added in 2001 through
marketing activities. The Company added four new contracts in 2002. Such new contracts provided revenues in the second quarter of 2002 of $1.8 million.
Correctional contracts in place throughout the second quarter of both 2002 and
2001 experienced revenue growth of $11.7 million, or 11.1%, from contract
renegotiations and automatic price adjustments. Company-wide internal revenue
growth for the second quarter of 2002 totaled $5.1 million, or
4.3%. Company-wide internal revenue growth consists of the revenue growth on correctional contracts in place throughout both
periods discussed above offset by a $6.6 million reduction in SPP
pharmaceutical distribution revenue. The decrease in SPP pharmaceutical
distribution revenue was primarily the result of the loss of two pharmaceutical
distribution customers in the third quarter of 2001. During 2002, the
Companys revenues were negatively impacted by the loss of correctional
contracts, some of which the Company elected not to renew, resulting in a
decrease in revenues of approximately $14.1 million from 2001 to 2002

Healthcare expenses.Healthcare expenses decreased $16.8 million, or
11.5%, from $146.7 million in the second quarter of 2001 to $129.9 million in
the second quarter of 2002. Healthcare expenses as a percentage of revenues
decreased by 10.4% from the second quarter of 2001 to the second quarter of
2002. Healthcare expenses for the second quarter of 2001 included a charge of
$6.0 million to increase the Companys reserve for medical claims. This charge
was primarily the result of updated second quarter of 2001 information showing
that actual utilization rates and cost data for inpatient and outpatient
services were higher than the historical levels on which the Companys reserve
had been based. Exclusive of this charge, healthcare expenses for the second
quarter of 2001 were 99.9% of revenues compared to 93.8% of revenues in the
second quarter of 2002. This 6.1% decrease results primarily from a reduction
in pharmacy related expenses as a percent of total revenues, $1.7 million in
negative operating margin related to the Companys five loss contracts that was
charged against the loss contract reserve in the first six months of
2002 and 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.

Selling, general and administrative expenses.Selling, general and
administrative expenses for the second quarter of 2002 decreased $2.5 million
from $6.0 million, or 4.3% of revenues, in the second quarter of 2001 to $3.5
million, or 2.5% of revenues, in the second quarter of 2002. Included in
selling, general and administrative expenses for the second quarter of 2001
were charges to increase the Companys legal reserves by $1.3 million. These
charges were primarily required to reflect the Companys increased exposure to
certain outstanding cases previously covered by insurance carriers now in liquidation. The percentage of revenue decrease in selling, general and
administrative expenses, excluding these charges, is primarily the result of
overhead reductions implemented by the Company subsequent to the first half of
2001 and approximately $345,000 in overhead costs associated with the Companys
five loss contracts that were charged against the loss contract reserve.

18



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Depreciation and amortization.Depreciation and amortization expense
decreased from $2.0 million in the second quarter of 2001 to $1.1 million in
the second quarter of 2002. This decrease is primarily the result of the
Companys adoption of SFAS 142, Goodwill and Other Intangible Assets, effective
January 1, 2002. Under SFAS 142, goodwill is no longer amortized but will be
required to be monitored for impairment. Amortization expense related to
goodwill totaled approximately $794,000 in the second quarter of 2001.

Strategic initiative expense.During the second quarter of 2001, the
Company incurred $1.3 million of expenses related to a strategic initiative,
which was terminated in the third quarter of 2001.

Impairment of long-lived assets.During the second quarter of 2001, the
Company was notified that another vendor had been selected to provide
healthcare services for the Eastern Region of the Pennsylvania Department of
Corrections upon the expiration of the Companys contract on December 31, 2002.
The Company also determined that it would cease operations under the contract
with the Yonkers Region of the New York Department of Correctional Services
upon the expiration of the Companys contract on May 31, 2002 as the healthcare
services are to be self operated by the client. Each of these contracts was acquired
in the Companys acquisition of certain assets of CPS in 2000. In the second
quarter of 2001, the Company recorded a non-cash impairment charge of $13.2
million representing the amount by which goodwill related to these contracts
exceeded the contracts fair value.

Reduction in loss contract reserve.During 2001, the Company completed a
comprehensive review of its portfolio of 145 contracts for the purpose of
identifying loss contracts and developing a contract loss reserve for
succeeding years. As a result of this review, the Company identified five
non-cancelable contracts with combined 2001 annual revenues of $59.7 million
and negative gross margin of $4.7 million. Based upon managements
projections, these contracts were expected to continue to incur negative gross
margin 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. The remaining ten
percent of the charge related to the State of Maine contract, which expired
June 30, 2002, and two county contracts, which expire August 15, 2002 and June
30, 2005.

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 early expiration of this
loss contract, the Company performed a reassessment of its loss contract
reserve requirements. This reassessment included a review of managements
projected future losses under the remaining three loss contracts as well as a
comprehensive review of the Companys portfolio of contracts at June 30, 2002
for the purpose of identifying any additional loss contracts. No new loss
contracts were identified as a result of this review. Based upon the
reassessment, the Company recorded a gain of $3.3 million to reduce its reserve
for loss contracts to $11.0 million at June 30, 2002.

The Company will continue to provide services to the State of Maine under
a cost plus a fixed management fee transition agreement through December 31, 2002. The Company has
also entered into a transition agreement with the City of Philadelphia under
which it will continue to provide services through September 30, 2002 under
modified contract terms.

Interest, net.Net interest expense increased to $1.9 million or 1.4% of
revenue in the second quarter of 2002 from $1.2 million or 0.8% of revenue in
the second quarter of 2001. The increase in net interest expense from the
prior year is primarily the result of increased interest rates on outstanding
debt and expenses related to certain interest rate collars entered into in
2000.

Income tax provision (benefit).The provision for income taxes for the
second quarter of 2002 was $75,000 or 0.1% of revenue, as compared with a
benefit of $11.2 million or 8.0% of revenue in the second quarter of 2001. Due
to the Companys net income in the second quarter of 2002, the Companys
deferred tax valuation allowance was reduced $2.2 million from $15.0 million to
$12.8 million as a reduction to income tax provision.

Net income attributable to common shares.Net income attributable to
common shares was $5.3 million for the second quarter of 2002, or 3.8% of
revenue, as compared with a net loss attributable to common shares of $18.4
million, or 13.0% of revenue, in the prior year quarter.

19



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##### 



Six Months Ended June 30, 2002 Compared to Six Months Ended June 30, 2001

Healthcare revenues.Healthcare revenues for the six months ended June
30, 2002 decreased $2.3 million, or 0.9%, from $278.7 million in the first six
months of 2001 to $276.4 million in the first six months of 2002. Healthcare
revenues in the first six months of 2002 included $11.4 million of revenue
growth resulting from contracts added in 2001 through marketing activities.
The Company added four new contracts in 2002. Such new contracts provided
revenues in the first six months of 2002 of $2.4 million. Correctional
contracts in place throughout the first six months of both 2002 and 2001 experienced
revenue growth of $24.7 million, or 11.9%, from contract renegotiations and
automatic price adjustments. Company-wide internal revenue growth for the six
months ended June 30, 2002 totaled $12.7 million, or 5.4%.
Company-wide internal revenue growth consists of the
revenue growth on correctional contracts in place throughout both periods
discussed above offset by a $12.0 million reduction in SPP pharmaceutical
distribution revenue. The decrease in SPP pharmaceutical distribution revenue
was the result of the loss of two pharmaceutical distribution customers in the
third quarter of 2001. During 2002, the Companys revenues were negatively
impacted by the loss of correctional contracts, some of which the Company
elected not to renew, resulting in a decrease in revenues of approximately
$28.8 million from 2001 to 2002.

Healthcare expenses.Healthcare expenses decreased $14.1 million, or
5.2%, from $273.3 million in the first six months of 2001 to $259.2 million in
the first six months of 2002. Healthcare expenses as a percentage of revenues
decreased by 4.3% from the first six months of 2001 as compared to the same
period in 2002. Healthcare expenses for the first six months of 2001 included
a charge of $6.0 million recorded in the second quarter to increase the
Companys reserve for medical claims. This charge was primarily the result of
updated second quarter of 2001 information showing actual utilization rates and
cost data for inpatient and outpatient services were higher than the historical
levels on which the Companys reserve had been based. Exclusive of this
charge, healthcare expenses for the six months ended June 30,
2001 were 95.9%
of revenues compared to 93.8% of revenues for the same period in 2002. This
2.1% decrease results primarily from a reduction in pharmacy related expenses
as a percent of total revenues, approximately $3.3 million in negative
operating margin related to the Companys five loss contracts
that were charged
against the loss contract reserve in the first six months of 2002 and
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.

Selling, general and administrative expenses.Selling, general and
administrative expenses for the first six months of 2002 decreased $2.5 million
from $10.1 million, or 3.6% of revenues, in the first six months of 2001 to $7.6
million, or 2.8% of revenues, in the first six months of 2002. Included in
selling, general and administrative expenses for the first six months of 2001
were charges to increase the Companys legal reserves by $1.3 million. These
charges were primarily required to reflect the Companys increased exposure to
certain outstanding cases previously covered by insurance carriers now in liquidation. The percentage of revenue decrease in selling, general and
administrative expenses, excluding these charges, is primarily the result of
overhead reductions implemented by the Company subsequent to the first half of
2001 and approximately $710,000 in overhead costs associated with the Companys
five loss contracts that were charged against the loss contract reserve.

Depreciation and amortization.Depreciation and amortization expense
decreased from $3.9 million in the first six months of 2001 to $2.3 million in
the first six months of 2002. This decrease is primarily the result of the
Companys adoption of SFAS 142, Goodwill and Other Intangible Assets, effective
January 1, 2002. Under SFAS 142, goodwill is no longer amortized but will be
required to be monitored for impairment. Amortization expense related to
goodwill totaled approximately $1.6 million for the six months ended June 30,
2001.

Strategic initiative expense.During the first six months of 2001, the
Company incurred $1.3 million of expenses related to a strategic initiative,
which was terminated in the third quarter of 2001.

Impairment of long-lived assets.During the second quarter of 2001, the
Company was notified that another vendor had been selected to provide
healthcare services for the Eastern Region of the Pennsylvania Department of
Corrections upon the expiration of the Companys contract on December 31, 2002.
The Company also determined that it would cease operations under the contract
with the Yonkers Region of the New York Department of Correctional Services
upon the expiration of the Companys contract on May 31, 2002 as the healthcare
services are to be self-operated by the client. Each of these contracts was acquired
in the Companys acquisition of certain assets of CPS in 2000. In the second
quarter of 2001, the Company recorded a non-cash impairment charge of $13.2
million representing the amount by which goodwill related to these contracts
exceeded the contracts fair value.

Reduction in loss contract reserve.During 2001, the Company completed a
comprehensive review of its portfolio of 145 contracts for the purpose of
identifying loss contracts and developing a contract loss reserve for
succeeding years. As a result of this review, the Company identified five
non-cancelable contracts with combined 2001 annual revenues of $59.7 million
and negative gross margin of $4.7 million. Based upon managements
projections, these contracts were expected to continue to incur negative gross
margin 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

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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. The remaining ten percent of the charge related to the State of
Maine contract, which expired June 30, 2002, and two county contracts, which
expire August 15, 2002 and June 30, 2005.

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 early expiration of this
loss contract, the Company performed a reassessment of its loss contract
reserve requirements. This reassessment included a review of managements
projected future losses under the remaining three loss contracts as well as a
comprehensive review of the Companys portfolio of contracts at June 30, 2002
for the purpose of identifying any additional loss contracts. No new loss
contracts were identified as a result of this review. Based upon the
reassessment, the Company recorded a gain of $3.3 million to reduce its reserve
for loss contracts to $11.0 million at June 30, 2002.

The Company will continue to provide services to the State of Maine under
a cost plus a fixed management fee transition agreement through December 31, 2002. The Company has
also entered into a transition agreement with the City of Philadelphia under
which it will continue to provide services through September 30, 2002 under
modified contract terms.

Interest, net.Net interest expense increased to $3.4 million or 1.2% of
revenue in the first six months of 2002 from $2.5 million or 0.9% of revenue in
the first six months of 2001. The increase in net interest expense from the
prior year is primarily the result of increased interest rates on outstanding
debt and expenses related to certain interest rate collars entered into in
2000.

Income tax provision (benefit).The provision for income taxes for the
first six months of 2002 was a benefit of $95,000 or less than one-tenth of
one percent of revenue, as compared with a benefit of $9.6 million or 3.4% of
revenue in the same period of 2001. Due to the Companys net income in the
first six months of 2002, the Companys deferred tax valuation allowance was
reduced $3.3 million from $16.1 million to $12.8 million as a reduction to
income tax provision.

Net income (loss) attributable to common shares.Net income attributable
to common shares was $7.3 million for the six months ended June 30, 2002, or
2.6% of revenue, as compared with a net loss attributable to common shares of
$16.2 million, or 5.8% of revenue, in the same period of 2001.

Liquidity and Capital Resources

The Company generated net income attributable to common shares of $7.3
million in the first six months of 2002 compared to a net loss attributable to
common shares of $16.2 million in the same period of 2001. The Company had
stockholders equity of $4.2 million at June 30, 2002 as compared to a
stockholders deficit of $3.6 million at December 31, 2001. The Companys cash
and cash equivalents decreased to $250,000 at June 30, 2002 from $10.4 million
at December 31, 2001, a decrease of $10.1 million primarily as a result of
payments made to reduce debt outstanding offset by cash flows from operating
activities. Cash flows from operating activities during the first six months
of 2002 were $4.3 million, an increase of $5.7 million from the cash used in
operating activities in the same period of 2001 of $1.4 million. The increase
is primarily the result of increased income from operations. Cash flows used
in financing activities during the first six months of 2002 were $13.8 million
and include net payments totaling $13.4 million to reduce the amount of debt
outstanding under the Amended Credit Facility from $58.1 million at December
31, 2001 to $44.7 million at June 30, 2002.

The Companys debt consists of the Amended Credit Facility. At June 30,
2002, the Company had approximately $44.7 million outstanding under the Amended
Credit Facility and approximately $5.7 million available for future borrowings.
The Amended Credit Facility was executed with a syndicate of four banks (the
Lenders) with Bank of America, N.A. acting as the lead bank and
administrative agent.

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The Companys borrowings under the Amended Credit Facility are limited to
the lesser of (1) the sum of eligible accounts and other receivables (as
defined) plus an intangible advance of up to $11.0 million (Intangible
Advances) or (2) $57.0 million (the Maximum Commitment). Interest under the
Amended Credit Facility is payable monthly at the Bank of America, N.A. prime
rate plus 3.0% (5.0% for balances due under Intangible Advances). The Amended
Credit Facility matures on April 1, 2003 and all amounts outstanding will be
due and payable on such date. In addition, the Company is required to make
scheduled reductions in the Intangible Advances allowed and the Maximum
Commitment prior to that date. The following table presents the Maximum
Commitment and the maximum allowed Intangible Advances (included within the
Maximum Commitment) as of June 30, 2002 and each scheduled reduction date.

|                  |  |             |  |            
|----------------- |  | ----------- |  | -----------
|                  |  | Maximum     |  | Intangible 
|Date              |  | Commitment  |  | Advances   
|                  |  |             |  |            
|June 30, 2002     |  | $57 million |  | $11 million
|July 1, 2002      |  | 57 million  |  | 10 million 
|September 1, 2002 |  | 56 million  |  | 10 million 
|October 1, 2002   |  | 55 million  |  | 9 million  
|December 1, 2002  |  | 54 million  |  | 9 million  
|February 1, 2003  |  | 53 million  |  | 9 million  
|March 1, 2003     |  | 52 million  |  | 9 million  

The Amended Credit Facility is secured by substantially all of the assets
of the Company and its operating subsidiaries.

At June 30, 2002, the Company had standby letters of credit outstanding
totaling approximately $6.6 million. The letters of credit were issued
pursuant to the Amended Credit Facility. The amount available to the Company
for borrowing under the Amended Credit Facility is reduced by the amount of
each outstanding standby letter of credit. Under the terms of the Amended
Credit Facility, the Company may have up to $6.6 million of standby letters of
credit outstanding.

The Amended Credit Facility requires the Company to meet certain financial
covenants related to minimum levels of shareholders equity (deficit) and
earnings.

Under the Amended Credit Facility, the Company is required to maintain
minimum shareholders equity (deficit) as of the end of any fiscal quarter
ending on or after the period specified below as follows:

|                                        |  |                       |            |   |  |  |  | 
|--------------------------------------- |  | --------------------- | ---------- | - |  |  |  | 
|                                        |  | Minimum Shareholders' |            |   |  | 
|Period                                  |  | Equity (Deficit)      |            |   |  | 
|                                        |  |                       |            |   |  | 
|June 30, 2002 to September 29, 2002     |  | $                     | (2,500,000 | )
|September 30, 2002 to December 30, 2002 |  |                       | (1,000,000 | )
|December 31, 2002 to April 1, 2003      |  |                       | 0          |  

The Amended Credit Facility also requires the Company to achieve a minimum
level of cumulative EBITDA from January 1, 2002, through the end of each month
ending on each of the respective dates set forth below. The Amended Credit
Facility defines EBITDA to be the sum of consolidated net income, plus interest
expense, plus any provision for taxes based on income or profits that was
deducted in computing consolidated net income, plus depreciation, amortization
of intangible assets and other non-recurring non-cash charges, which non-cash
charges may not exceed $500,000 in any month or any fiscal quarter and $2
million in any fiscal year, less amounts charged against the Companys reserve
for loss contracts.

|                   |                                   |   |            | 
|------------------ | --------------------------------- | - | ---------- | 
|Period Ending      | Monthly Cumulative Minimum EBITDA
|                   |                                  
|June 30, 2002      |                                   | $ | 3,600,000  | 
|July 31, 2002      |                                   |   | 4,275,000  | 
|August 31, 2002    |                                   |   | 5,300,000  | 
|September 30, 2002 |                                   |   | 6,800,000  | 
|October 31, 2002   |                                   |   | 7,950,000  | 
|November 30, 2002  |                                   |   | 9,200,000  | 
|December 31, 2002  |                                   |   | 10,000,000 | 

After December 31, 2002, the Company will be required to achieve a minimum
monthly EBITDA of $500,000. The Amended Credit Facility also contains
restrictions on the Company with respect to certain types of transactions
including payment of dividends, capital expenditures, indebtedness and sales or
transfers of assets.

As of June 30, 2002, the Company was in compliance with these financial
covenant requirements.

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Under the terms of the Amended Credit Facility, if any Amended Credit
Facility obligations remain outstanding at December 31, 2002, the Company will
be required to issue the Lenders warrants to purchase common shares equal to
5.0% of the Companys outstanding common stock on a fully diluted basis. The
number of warrants required to be issued will be reduced to a 2.5% interest if
the balance outstanding under the Amended Credit Facility does not exceed $45
million, there are no outstanding Intangible Advances and the Company is not in
default under the terms of the Amended Credit Facility. The exercise price of
the warrants will be $.01 per share.

The Company is dependent on availability of borrowings pursuant to the
Amended Credit Facility to meet its working capital needs, capital expenditures
requirements and other cash flow requirements. Management believes that the
Company can remain in compliance with the terms of the Amended Credit Facility
and meet its expected obligations throughout the remainder of 2002. 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.

The Amended Credit Facility matures on April 1, 2003. Management is in
the process of reviewing alternatives for refinancing the Amended Credit
Facility, however, no assurances can be made that the Company can obtain
alternative financing arrangements on acceptable terms or at all.

On February 5, 2001, the Company completed the conversion of 12,500 shares
of Series A Convertible Preferred Stock, having an aggregate liquidation
preference of $12.5 million, into 1,322,751 shares of common stock. The
Company registered the shares of common stock issued upon conversion of the
preferred stock and warrants to purchase an additional 135,000 shares of common
stock. In July 2002, the warrant holder exercised 67,500 of these
warrants.

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 June 1998, the FASB issued SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities(SFAS 133), as amended in June 2000 by
SFAS No. 138, Accounting for Certain Derivative Instruments and Certain Hedging
Activities(SFAS 138), which requires the Company to recognize all
derivatives as assets or liabilities measured at fair value. Changes in fair
value are recognized through either earnings or other comprehensive income
dependent on the effectiveness of the hedge instrument. The Company currently
maintains three interest collar agreements with three of its syndicate banks
for a notional amount of $24.0 million. The collar agreements expire between
October 2002 and May 2003.

On January 1, 2001, the Company adopted SFAS 133 and SFAS 138 resulting in
a charge to other comprehensive income of approximately $212,000, net of tax,
as the cumulative effect of a change in accounting principle representing the
fair value of the collar agreements on the date of adoption.

In June 2001, the FASB issued SFAS No. 141, Business Combinations(SFAS
141) and SFAS No. 142, Goodwill and Other Intangible Assets(SFAS 142). SFAS
141 requires that the purchase method of accounting be used for all business
combinations initiated after June 30, 2001. SFAS 141 also specifies criteria
which intangible assets acquired in purchase method business combinations after
June 30, 2001 must meet to be recognized and reported apart from goodwill. SFAS
142 addresses the initial recognition and measurement of intangible assets
acquired outside of a business combination and the accounting for goodwill and
other intangible assets subsequent to their acquisition. SFAS 142 requires that
intangible assets with finite useful lives be amortized, and that goodwill and
intangible assets with indefinite lives no longer be amortized, but instead be
tested for impairment at least annually.

The Company adopted SFAS 141 on July 1, 2001. Such adoption had no effect
on the Companys financial position or results of operations. The Company
adopted SFAS 142 effective January 1, 2002, at which time the amortization of
the Companys existing goodwill ceased. Other than the effect on net income of
not amortizing goodwill, the adoption of SFAS 142 had no effect on the
Companys results of operations or financial position. Amortization expense
related to goodwill during the quarter and six month period ended June 30, 2001
was approximately $794,000 and $1.6 million, respectively.

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In August 2001, the FASB issued SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets(SFAS 144) effective for fiscal
years beginning after December 15, 2001. SFAS 144 establishes a single
accounting model for long-lived assets to be disposed of by sale, whether
previously held and used or newly acquired, and broadens the presentation of
discontinued operations to include more disposal transactions. The Company
adopted SFAS 144 on January 1, 2002. Such adoption had no impact on the
Companys financial position or results of operations.

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 Amended Credit Facility. The
Amended Credit Facility carries an interest rate based on the Bank of America,
N.A. prime rate, therefore the Companys cash flow may be affected by changes
in the prime rate. For example, a hypothetical 10% change in interest rates
would have increased or decreased interest expense by approximately $187,000
during the six months ended June 30, 2002. As of June 30, 2002, the Company
has approximately $44.7 million outstanding under the Amended Credit Facility,
which represents 29.0% of the Companys total liabilities and stockholders
equity.

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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, 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 $600,000 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, 2002 and December 31, 2001. 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.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

At the annual meeting of stockholders held June 12, 2002, the stockholders
of the Company voted to elect the Companys Board of Directors:



| |  |  | Michael Catalano, Chairman, President and Chief Executive
Officer (4,937,969 affirmative votes; 110 negative votes; 3,167 votes
withheld);
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------
|
| |  |  | William D. Eberle (4,938,055 affirmative votes; 24 negative votes; 3,081 votes withheld);                                                 
|
| |  |  | Burton C. Einspruch (4,927,120 affirmative votes; 10,959 negative votes; 14,016 votes withheld);                                          
|
| |  |  | David A. Freeman (4,938,079 affirmative votes; 0 negative votes; 3,057 votes withheld);                                                   
|
| |  |  | Carol R. Goldberg (4,938,055 affirmative votes; 24 negative votes; 3,081 votes withheld);                                                 
|
| |  |  | Jeffrey L. McWaters (4,938,079 affirmative votes; 0 negative votes; 3,057 votes withheld);                                                
|
| |  |  | Richard M. Mastaler (4,938,079 affirmative votes; 0 negative votes; 3,057 votes withheld);                                                
|
| |  |  | Richard D. Wright (4,938,079 affirmative votes; 0 negative votes; 3,057 votes withheld); and                                              
|
| |  |  | William C. Stapleton (4,938,079 affirmative votes; 0 negative votes; 3,057 votes withheld).                                               

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

(A)  Exhibits

3.1   Amended and Restated Certificate of Incorporation of America Service Group Inc.

3.2   Amended and Restated Bylaws of America Service Group, Inc.

4.1   Specimen Common Stock Certificate

11    Computation of Per Share Earnings.*

99.1 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.

99.2 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 15
to the condensed consolidated financial statements in this report.

(B)  Report on Form 8-K

On July 24, 2002, the Company filed a Form 8-K under Item 5 relating to its
announcement of its financial results for the quarter and six months ended June
30, 2002.

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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, 2002

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