##### Table of Contents



UNITED STATES SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, D.C. 20549
 
 FORM 10-Q
 
 (Mark One)
 þ
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
 For the quarterly period ended September 30, 2005
 OR
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
 For the transition period from  to
 Commission File Number: 0-20135
 
 AMERICA SERVICE GROUP INC.
  Delaware(State or other jurisdiction of
incorporation or organization)
    
    51-0332317(I.R.S. Employer
Identification No.)
 105 Westpark Drive, Suite 200
Brentwood, Tennessee
(Address of principal executive offices)
    
    37027
(Zip Code)
 (615) 373-3100
 o þ
  o þ o
 o þ




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##### 



AMERICA SERVICE GROUP INC.
 QUARTERLY REPORT ON FORM 10-Q
INDEX
 PageNumberPART I. FINANCIAL INFORMATIONItem 1. Financial Statements (Unaudited)Condensed Consolidated Balance Sheets as of September 30, 2005 and December 31, 2004
    
    
    3Condensed Consolidated Statements of Operations for the quarters and nine months ended
September 30, 2005 and 2004
    
    
    4Condensed Consolidated Statements of Cash Flows for the nine months ended
September 30, 2005 and 2004
    
    
    5Notes to Condensed Consolidated Financial Statements
    
    
    6Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    28Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    46Item 4. Controls and Procedures
    
    
    46PART II. OTHER INFORMATIONItem 1. Legal Proceedings
    
    
    48Item 1A. Risk Factors
    
    
    50Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    50Item 3. Defaults Upon Senior Securities
    
    
    50Item 4. Submission of Matters to a Vote of Security Holders
    
    
    50Item 5. Other Information
    
    
    50Item 6. Exhibits
    
    
    51Signatures
    
    
    53EX-31.1 SECTION 302 CERTIFICATION OF THE CEOEX-31.2 SECTION 302 CERTIFICATION OF THE CFOEX-32.1 SECTION 906 CERTIFICATION OF THE CEOEX-32.2 SECTION 906 CERTIFICATION OF THE CFO
  2




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##### Table of Contents



PART I:
 FINANCIAL INFORMATION
 
 ITEM 1. FINANCIAL STATEMENTS
 AMERICA SERVICE GROUP INC.
 
 CONDENSED CONSOLIDATED BALANCE SHEETS
 (shown in
000s except share and per share amounts)  (UNAUDITED)
 September 30,
    
    
    December 31,2005
    
    
    2004(Restated)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    5,495
    
    
    $
    7,191Accounts receivable, less allowances of $744 and $162, respectively
    
    
    89,228
    
    
    
    93,242Inventories
    
    
    7,389
    
    
    
    7,511Prepaid expenses and other current assets
    
    
    16,310
    
    
    
    17,186Current deferred tax assets
    
    
    6,830
    
    
    
    10,733Total current assets
    
    
    125,252
    
    
    
    135,863Property and equipment, net
    
    
    5,983
    
    
    
    5,357Goodwill, net
    
    
    43,813
    
    
    
    43,813Contracts, net
    
    
    7,573
    
    
    
    8,793Other intangibles, net
    
    
    903
    
    
    
    1,076Other assets
    
    
    11,879
    
    
    
    12,548Total assets
    
    $
    195,403
    
    
    $
    207,450LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    41,292
    
    
    $
    49,786Accrued medical claims liability
    
    
    27,817
    
    
    
    25,808Accrued expenses
    
    
    42,184
    
    
    
    48,709Deferred revenue
    
    
    4,399
    
    
    
    11,869Loss contract reserve
    
    
    
    
    
    
    6,062Revolving credit facility
    
    
    4,104
    
    
    
    Total current liabilities
    
    
    119,796
    
    
    
    142,234Noncurrent portion of accrued expenses
    
    
    17,588
    
    
    
    11,259Noncurrent deferred tax liabilities
    
    
    964
    
    
    
    1,017Total liabilities
    
    
    138,348
    
    
    
    154,510Commitments and contingenciesStockholders equity:Preferred stock, $0.01 par value, 2,000,000 shares authorized at
September 30, 2005 and December 31, 2004; no shares issued or
outstanding
    
    
    
    
    
    
    Common stock, $0.01 par value, 20,000,000 shares authorized at
September 30, 2005 and December 31, 2004; 10,752,526 and
10,811,093 shares issued and outstanding at September 30, 2005 and
December 31, 2004, respectively
    
    
    108
    
    
    
    108Additional paid-in capital
    
    
    53,892
    
    
    
    55,203Deferred compensation
    
    
    (258
    )
    
    
    (143
    )Retained earnings (accumulated deficit)
    
    
    3,313
    
    
    
    (2,228
    )Total stockholders equity
    
    
    57,055
    
    
    
    52,940Total liabilities and stockholders equity
    
    $
    195,403
    
    
    $
    207,450
 
 3




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##### Table of Contents



AMERICA SERVICE GROUP INC.
 
 CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
 (shown in 000s except share and per share amounts)  (UNAUDITED)
 Quarter ended
    
    
    Nine months endedSeptember 30,
    
    
    September 30,2005
    
    
    2004
    
    
    2005
    
    
    2004(Restated)
    
    
    
    
    
    
    (Restated)Healthcare revenues
    
    $
    140,083
    
    
    $
    134,784
    
    
    $
    413,373
    
    
    $
    386,920Healthcare expenses
    
    
    135,766
    
    
    
    123,204
    
    
    
    386,217
    
    
    
    352,776Gross margin
    
    
    4,317
    
    
    
    11,580
    
    
    
    27,156
    
    
    
    34,144Selling, general, and administrative expenses
    
    
    4,566
    
    
    
    4,199
    
    
    
    13,199
    
    
    
    13,080Discontinued acquisition expenses
    
    
    207
    
    
    
    
    
    
    
    658
    
    
    
    Audit Committee investigation and related expenses
    
    
    370
    
    
    
    
    
    
    
    370
    
    
    
    Depreciation and amortization
    
    
    1,107
    
    
    
    933
    
    
    
    3,052
    
    
    
    2,796Charge for settlement of Florida legal matter
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,200Income (loss) from operations
    
    
    (1,933
    )
    
    
    6,448
    
    
    
    9,877
    
    
    
    13,068Interest, net
    
    
    305
    
    
    
    530
    
    
    
    847
    
    
    
    1,573Late fee income
    
    
    
    
    
    
    
    
    
    
    249
    
    
    
    Income (loss) from continuing operations before income tax
provision (benefit)
    
    
    (2,238
    )
    
    
    5,918
    
    
    
    9,279
    
    
    
    11,495Income tax provision (benefit)
    
    
    (671
    )
    
    
    2,368
    
    
    
    3,954
    
    
    
    (3,903
    )Income (loss) from continuing operations
    
    
    (1,567
    )
    
    
    3,550
    
    
    
    5,325
    
    
    
    15,398Income (loss) from discontinued operations, net of taxes
    
    
    405
    
    
    
    (3,469
    )
    
    
    215
    
    
    
    (10,342
    )Net income (loss)
    
    $
    (1,162
    )
    
    $
    81
    
    
    $
    5,540
    
    
    $
    5,056Net income (loss) per common share  basic:Income (loss) from continuing operations
    
    $
    (0.14
    )
    
    $
    0.33
    
    
    $
    0.49
    
    
    $
    1.44Income (loss) from discontinued operations, net of taxes
    
    
    0.03
    
    
    
    (0.32
    )
    
    
    0.02
    
    
    
    (0.97
    )Net income (loss)
    
    $
    (0.11
    )
    
    $
    0.01
    
    
    $
    0.51
    
    
    $
    0.47Net income
(loss) per common share  diluted:Income (loss) from continuing operations
    
    $
    (0.14
    )
    
    $
    0.32
    
    
    $
    0.48
    
    
    $
    1.40Income (loss) from discontinued operations, net of taxes
    
    
    0.03
    
    
    
    (0.31
    )
    
    
    0.02
    
    
    
    (0.94
    )Net income (loss)
    
    $
    (0.11
    )
    
    $
    0.01
    
    
    $
    0.50
    
    
    $
    0.46Weighted average common shares outstanding:Basic
    
    
    10,822,759
    
    
    
    10,780,242
    
    
    
    10,847,422
    
    
    
    10,692,396Diluted
    
    
    10,822,759
    
    
    
    11,083,849
    
    
    
    11,106,649
    
    
    
    11,016,674
 
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AMERICA SERVICE GROUP INC.
 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
 (shown in 000s)  (UNAUDITED)
 Nine months endedSeptember 30,2005
    
    
    2004(Restated)Cash flows from operating activities:Net income
    
    $
    5,540
    
    
    $
    5,056Adjustments to reconcile net income to net cash provided by (used in)
operating activities:Depreciation and amortization
    
    
    3,101
    
    
    
    2,938Finance cost amortization
    
    
    437
    
    
    
    493Stock option income tax benefits
    
    
    97
    
    
    
    Deferred income taxes
    
    
    3,850
    
    
    
    (7,437
    )Amortization of deferred compensation
    
    
    60
    
    
    
    Increase in reserve for loss contracts
    
    
    1,295
    
    
    
    12,800Interest on stockholder note receivable
    
    
    
    
    
    
    (2
    )Changes in operating assets and liabilities:Accounts receivable, net
    
    
    4,014
    
    
    
    (18,413
    )Inventories
    
    
    122
    
    
    
    (934
    )Prepaid expenses and other current assets
    
    
    876
    
    
    
    619Other assets
    
    
    373
    
    
    
    (2,296
    )Accounts payable
    
    
    (8,494
    )
    
    
    12,921Accrued medical claims liability
    
    
    2,009
    
    
    
    8,670Accrued expenses
    
    
    (196
    )
    
    
    3,832Deferred revenue
    
    
    (7,470
    )
    
    
    1,535Loss contract reserve utilization
    
    
    (7,357
    )
    
    
    (4,024
    )Net cash provided by (used in) operating activities
    
    
    (1,743
    )
    
    
    15,758Cash flows from investing activities:Capital expenditures, net
    
    
    (2,474
    )
    
    
    (1,743
    )Net cash used in investing activities
    
    
    (2,474
    )
    
    
    (1,743
    )Cash flows from financing activities:Net borrowings (payments) on line of credit and term loan
    
    
    4,104
    
    
    
    (3,559
    )Proceeds from stockholder note receivable
    
    
    
    
    
    
    50Share repurchases, net
    
    
    (2,931
    )
    
    
    Issuance of common stock, net
    
    
    600
    
    
    
    515Exercise of stock options
    
    
    748
    
    
    
    1,848Net cash provided by (used in) financing activities
    
    
    2,521
    
    
    
    (1,146
    )Net increase (decrease) in cash and cash equivalents
    
    
    (1,696
    )
    
    
    12,869Cash and cash equivalents at beginning of period
    
    
    7,191
    
    
    
    1,157Cash and cash equivalents at end of period
    
    $
    5,495
    
    
    $
    14,026
 
 5




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AMERICA SERVICE GROUP INC.
 
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 September 30, 2005
 1. Basis of Presentation
  2. Description of Business
  3. Restatement of Financial Statements
 Restatement of Financial Statements
   6




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Restatement adjustments by category:Pricing adjustment including interest
    
    $
    (4,304
    )Accruals and reserves
    
    
    356Other
    
    
    (85
    )Total adjustments prior to income taxes
    
    
    (4,033
    )Income tax adjustments
    
    
    1,622Total adjustments
    
    $
    (2,411
    )
    Pricing Adjustment
  Accruals and Reserves
  7




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Other
  Income Tax Adjustments
  Reconciliation to Previously Filed Interim Financial Statements
  CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS  (shown in 000s except share and per share amounts)  (UNAUDITED)
Quarter Ended June 30, 2005
 RestatementAs Previously
    
    
    RelatedReported (1)
    
    
    Adjustments
    
    
    As RestatedHealthcare revenues
    
    $
    140,029
    
    
    $
    (81
    )
    
    $
    139,948Healthcare expenses
    
    
    128,264
    
    
    
    387
    
    
    
    128,651Gross margin
    
    
    11,765
    
    
    
    (468
    )
    
    
    11,297Selling, general, and administrative expenses
    
    
    4,329
    
    
    
    
    
    
    
    4,329Depreciation and amortization
    
    
    983
    
    
    
    
    
    
    
    983Discontinued acquisition expenses
    
    
    451
    
    
    
    
    
    
    
    451Income (loss) from operations
    
    
    6,002
    
    
    
    (468
    )
    
    
    5,534Interest, net
    
    
    205
    
    
    
    60
    
    
    
    265Late fee income
    
    
    249
    
    
    
    
    
    
    
    249Income (loss) from continuing operations before income tax provision
(benefit)
    
    
    6,046
    
    
    
    (528
    )
    
    
    5,518Income tax provision (benefit)
    
    
    2,419
    
    
    
    (206
    )
    
    
    2,213Income (loss) from continuing operations
    
    
    3,627
    
    
    
    (322
    )
    
    
    3,305Income (loss) from discontinued operations, net of taxes
    
    
    (480
    )
    
    
    14
    
    
    
    (466
    )Net income (loss)
    
    $
    3,147
    
    
    $
    (308
    )
    
    $
    2,839Net income (loss) per common share  basic:Income (loss) from continuing operations
    
    $
    0.33
    
    
    $
    (0.03
    )
    
    $
    0.30Income (loss) from discontinued operations, net of taxes
    
    
    (0.04
    )
    
    
    
    
    
    
    (0.04
    )Net income (loss)
    
    $
    0.29
    
    
    $
    (0.03
    )
    
    $
    0.26Net income
(loss) per common share  diluted:Income (loss) from continuing operations
    
    $
    0.33
    
    
    $
    (0.03
    )
    
    $
    0.30Income (loss) from discontinued operations, net of taxes (2)
    
    
    (0.05
    )
    
    
    
    
    
    
    (0.04
    )Net income (loss) (2)
    
    $
    0.28
    
    
    $
    (0.03
    )
    
    $
    0.26Weighted average common shares outstanding:Basic
    
    
    10,873,100
    
    
    
    10,873,100
    
    
    
    10,873,100Diluted
    
    
    11,123,438
    
    
    
    10,873,100
    
    
    
    11,123,438
 
 (1)
    
    Certain amounts have been reclassified due to accounting for discontinued operations in
accordance with SFAS No. 144.(2)
    
    Does not sum due to rounding. 8




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CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS  (shown in 000s except share and per share amounts)  (UNAUDITED)
Quarter Ended March 31, 2005
 RestatementAs Previously
    
    
    RelatedReported (1)
    
    
    Adjustments
    
    
    As RestatedHealthcare revenues
    
    $
    133,379
    
    
    $
    (37
    )
    
    $
    133,342Healthcare expenses
    
    
    121,805
    
    
    
    (5
    )
    
    
    121,800Gross margin
    
    
    11,574
    
    
    
    (32
    )
    
    
    11,542Selling, general, and administrative expenses
    
    
    4,304
    
    
    
    
    
    
    
    4,304Depreciation and amortization
    
    
    962
    
    
    
    
    
    
    
    962Income (loss) from operations
    
    
    6,308
    
    
    
    (32
    )
    
    
    6,276Interest, net
    
    
    228
    
    
    
    49
    
    
    
    277Income (loss) from continuing operations before income tax
provision (benefit)
    
    
    6,080
    
    
    
    (81
    )
    
    
    5,999Income tax provision (benefit)
    
    
    2,442
    
    
    
    (30
    )
    
    
    2,412Income (loss) from continuing operations
    
    
    3,638
    
    
    
    (51
    )
    
    
    3,587Income from discontinued operations, net of taxes
    
    
    275
    
    
    
    1
    
    
    
    276Net income (loss)
    
    $
    3,913
    
    
    $
    (50
    )
    
    $
    3,863Net income (loss) per common share  basic:Income (loss) from continuing operations (2)
    
    $
    0.34
    
    
    $
    
    
    
    $
    0.33Income from discontinued operations, net of taxes (2)
    
    
    0.02
    
    
    
    
    
    
    
    0.03Net income (loss)
    
    $
    0.36
    
    
    $
    
    
    
    $
    0.36Net income
(loss) per common share  diluted:Income (loss) from continuing operations (2)
    
    $
    0.33
    
    
    $
    
    
    
    $
    0.32Income from discontinued operations, net of taxes (2)
    
    
    0.02
    
    
    
    
    
    
    
    0.03Net income (loss)
    
    $
    0.35
    
    
    $
    
    
    
    $
    0.35Weighted average common shares outstanding:Basic
    
    
    10,846,671
    
    
    
    10,846,671
    
    
    
    10,846,671Diluted
    
    
    11,161,051
    
    
    
    11,161,051
    
    
    
    11,161,051
 
 (1)
    
    Certain amounts have been reclassified due to accounting for discontinued operations in
accordance with SFAS No. 144.(2)
    
    Does not sum due to rounding. 9




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CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS  (shown in 000s except share and per share amounts)  (UNAUDITED)
Quarter Ended September 30, 2004
 RestatementAs Previously
    
    
    RelatedReported (1)
    
    
    Adjustments
    
    
    As RestatedHealthcare revenues
    
    $
    134,833
    
    
    $
    (49
    )
    
    $
    134,784Healthcare expenses
    
    
    122,937
    
    
    
    267
    
    
    
    123,204Gross margin
    
    
    11,896
    
    
    
    (316
    )
    
    
    11,580Selling, general, and administrative expenses
    
    
    4,199
    
    
    
    
    
    
    
    4,199Depreciation and amortization
    
    
    933
    
    
    
    
    
    
    
    933Income (loss) from operations
    
    
    6,764
    
    
    
    (316
    )
    
    
    6,448Interest, net
    
    
    493
    
    
    
    37
    
    
    
    530Income (loss) from continuing operations before income tax
provision (benefit)
    
    
    6,271
    
    
    
    (353
    )
    
    
    5,918Income tax provision (benefit)
    
    
    2,508
    
    
    
    (140
    )
    
    
    2,368Income (loss) from continuing operations
    
    
    3,763
    
    
    
    (213
    )
    
    
    3,550Income (loss) from discontinued operations, net of taxes
    
    
    (3,470
    )
    
    
    1
    
    
    
    (3,469
    )Net income (loss)
    
    $
    293
    
    
    $
    (212
    )
    
    $
    81Net income (loss) per common share  basic:Income (loss) from continuing operations
    
    $
    0.35
    
    
    $
    (0.02
    )
    
    $
    0.33Income (loss) from discontinued operations, net of taxes
    
    
    (0.32
    )
    
    
    
    
    
    
    (0.32
    )Net income (loss)
    
    $
    0.03
    
    
    $
    (0.02
    )
    
    $
    0.01Net income (loss) per common share  diluted:Income (loss) from continuing operations
    
    $
    0.34
    
    
    $
    (0.02
    )
    
    $
    0.32Income (loss) from discontinued operations, net of taxes
    
    
    (0.31
    )
    
    
    
    
    
    
    (0.31
    )Net income (loss)
    
    $
    0.03
    
    
    $
    (0.02
    )
    
    $
    0.01Weighted average common shares outstanding:Basic
    
    
    10,780,242
    
    
    
    10,780,242
    
    
    
    10,780,242Diluted
    
    
    11,083,849
    
    
    
    11,083,849
    
    
    
    11,083,849
 
 (1)
    
    Certain amounts have been reclassified due to accounting for discontinued operations in
accordance with SFAS No. 144. 10




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##### Table of Contents



CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS  (shown in 000s except share and per share amounts)  (UNAUDITED)
Quarter Ended June 30, 2004
 RestatementAs Previously
    
    
    RelatedReported (1)
    
    
    Adjustments
    
    
    As RestatedHealthcare revenues
    
    $
    128,746
    
    
    $
    (2
    )
    
    $
    128,744Healthcare expenses
    
    
    116,680
    
    
    
    50
    
    
    
    116,730Gross margin
    
    
    12,066
    
    
    
    (52
    )
    
    
    12,014Selling, general, and administrative expenses
    
    
    4,465
    
    
    
    
    
    
    
    4,465Depreciation and amortization
    
    
    940
    
    
    
    
    
    
    
    940Income (loss) from operations
    
    
    6,661
    
    
    
    (52
    )
    
    
    6,609Interest, net
    
    
    453
    
    
    
    44
    
    
    
    497Income (loss) from continuing operations before income tax benefit
    
    
    6,208
    
    
    
    (96
    )
    
    
    6,112Income tax benefit
    
    
    (5,329
    )
    
    
    (1,294
    )
    
    
    (6,623
    )Income from continuing operations
    
    
    11,537
    
    
    
    1,198
    
    
    
    12,735Income (loss) from discontinued operations, net of taxes
    
    
    (7,234
    )
    
    
    
    
    
    
    (7,234
    )Net income
    
    $
    4,303
    
    
    $
    1,198
    
    
    $
    5,501Net income per common share  basic:Income from continuing operations
    
    $
    1.08
    
    
    $
    0.11
    
    
    $
    1.19Income (loss) from discontinued operations, net of taxes
    
    
    (0.68
    )
    
    
    
    
    
    
    (0.68
    )Net income
    
    $
    0.40
    
    
    $
    0.11
    
    
    $
    0.51Net income per common share  diluted:Income from continuing operations (2)
    
    $
    1.05
    
    
    $
    0.11
    
    
    $
    1.15Income (loss) from discontinued operations, net of taxes (2)
    
    
    (0.66
    )
    
    
    
    
    
    
    (0.65
    )Net income
    
    $
    0.39
    
    
    $
    0.11
    
    
    $
    0.50Weighted average common shares outstanding:Basic
    
    
    10,692,357
    
    
    
    10,692,357
    
    
    
    10,692,357Diluted
    
    
    11,034,272
    
    
    
    11,034,272
    
    
    
    11,034,272
 
 (1)
    
    Certain amounts have been reclassified due to accounting for discontinued operations in
accordance with SFAS No. 144.(2)
    
    Does not sum due to rounding. 11




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##### Table of Contents



CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS  (shown in 000s except share and per share amounts)  (UNAUDITED)
Quarter Ended March 31, 2004
 RestatementAs Previously
    
    
    RelatedReported (1)
    
    
    Adjustments
    
    
    As RestatedHealthcare revenues
    
    $
    123,646
    
    
    $
    (254
    )
    
    $
    123,392Healthcare expenses
    
    
    112,961
    
    
    
    (119
    )
    
    
    112,842Gross margin
    
    
    10,685
    
    
    
    (135
    )
    
    
    10,550Selling, general, and administrative expenses
    
    
    4,416
    
    
    
    
    
    
    
    4,416Depreciation and amortization
    
    
    923
    
    
    
    
    
    
    
    923Charge for settlement of Florida legal matter
    
    
    5,200
    
    
    
    
    
    
    
    5,200Income (loss) from operations
    
    
    146
    
    
    
    (135
    )
    
    
    11Interest, net
    
    
    511
    
    
    
    35
    
    
    
    546Loss from continuing operations before income tax provision
    
    
    (365
    )
    
    
    (170
    )
    
    
    (535
    )Income tax provision
    
    
    352
    
    
    
    
    
    
    
    352Loss from continuing operations
    
    
    (717
    )
    
    
    (170
    )
    
    
    (887
    )Income from discontinued operations, net of taxes
    
    
    359
    
    
    
    2
    
    
    
    361Net loss
    
    $
    (358
    )
    
    $
    (168
    )
    
    $
    (526
    )Net loss per common share  basic:Loss from continuing operations (2)
    
    $
    (0.07
    )
    
    $
    (0.02
    )
    
    $
    (0.08
    )Income from discontinued operations, net of taxes (2)
    
    
    0.04
    
    
    
    
    
    
    
    0.03Net loss
    
    $
    (0.03
    )
    
    $
    (0.02
    )
    
    $
    (0.05
    )Net loss per
common share  diluted:Loss from continuing operations (2)
    
    $
    (0.07
    )
    
    $
    (0.02
    )
    
    $
    (0.08
    )Income from discontinued operations, net of taxes (2)
    
    
    0.04
    
    
    
    
    
    
    
    0.03Net loss
    
    $
    (0.03
    )
    
    $
    (0.02
    )
    
    $
    (0.05
    )Weighted average common shares outstanding:Basic
    
    
    10,603,625
    
    
    
    10,603,625
    
    
    
    10,603,625Diluted
    
    
    10,603,625
    
    
    
    10,603,625
    
    
    
    10,603,625
 
 (1)
    
    Certain amounts have been reclassified due to accounting for discontinued operations in
accordance with SFAS No. 144.(2)
    
    Does not sum due to rounding. 12




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##### Table of Contents



CONSOLIDATED BALANCE SHEET
December 31, 2004  (shown in 000s except share and per share amounts)
 RestatementAs Previously
    
    
    RelatedReported
    
    
    Adjustments
    
    
    As RestatedASSETSCurrent assets:Cash and cash equivalents
    
    $
    7,191
    
    
    $
    
    
    
    $
    7,191Accounts receivable: healthcare and other, less allowances of $162
    
    
    93,111
    
    
    
    131
    
    
    
    93,242Inventories
    
    
    7,639
    
    
    
    (128
    )
    
    
    7,511Prepaid expenses and other current assets
    
    
    17,186
    
    
    
    
    
    
    
    17,186Current deferred tax assets
    
    
    9,349
    
    
    
    1,384
    
    
    
    10,733Total current assets
    
    
    134,476
    
    
    
    1,387
    
    
    
    135,863Property and equipment, net
    
    
    5,356
    
    
    
    1
    
    
    
    5,357Goodwill, net
    
    
    43,896
    
    
    
    (83
    )
    
    
    43,813Contracts, net
    
    
    8,793
    
    
    
    
    
    
    
    8,793Other intangibles, net
    
    
    1,076
    
    
    
    
    
    
    
    1,076Other assets
    
    
    12,548
    
    
    
    
    
    
    
    12,548Total assets
    
    $
    206,145
    
    
    $
    1,305
    
    
    $
    207,450LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    49,786
    
    
    $
    
    
    
    $
    49,786Accrued medical claims liability
    
    
    25,808
    
    
    
    
    
    
    
    25,808Accrued expenses
    
    
    45,351
    
    
    
    3,358
    
    
    
    48,709Deferred revenue
    
    
    11,869
    
    
    
    
    
    
    
    11,869Loss contract reserve
    
    
    6,062
    
    
    
    
    
    
    
    6,062Total current liabilities
    
    
    138,876
    
    
    
    3,358
    
    
    
    142,234Noncurrent portion of payables and accrued expenses
    
    
    11,259
    
    
    
    
    
    
    
    11,259Noncurrent deferred tax liabilities
    
    
    1,017
    
    
    
    
    
    
    
    1,017Total liabilities
    
    
    151,152
    
    
    
    3,358
    
    
    
    154,510Commitments and contingenciesStockholders equity:Preferred stock, $0.01 par value, 2,000,000 shares authorized; no
shares issued or outstanding
    
    
    
    
    
    
    
    
    
    
    Common stock, $0.01 par value, 20,000,000 shares authorized;
10,811,093 shares issued and outstanding
    
    
    108
    
    
    
    
    
    
    
    108Additional paid-in capital
    
    
    55,203
    
    
    
    
    
    
    
    55,203Deferred compensation
    
    
    (143
    )
    
    
    
    
    
    
    (143
    )Accumulated deficit
    
    
    (175
    )
    
    
    (2,053
    )
    
    
    (2,228
    )Total stockholders equity
    
    
    54,993
    
    
    
    (2,053
    )
    
    
    52,940Total liabilities and stockholders equity
    
    $
    206,145
    
    
    $
    1,305
    
    
    $
    207,450
 13




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##### Table of Contents



CONSOLIDATED STATEMENT OF CASH FLOWS
Nine Months Ended September 30, 2004  (shown in 000s)
 RestatementAs Previously
    
    
    RelatedReported
    
    
    Adjustment
    
    
    As RestatedCash Flows from Operating ActivitiesNet income
    
    $
    4,238
    
    
    $
    818
    
    
    $
    5,056Adjustments to reconcile net income to net cash provided by
operating activities:Depreciation and amortization
    
    
    2,938
    
    
    
    
    
    
    
    2,938Finance cost amortization
    
    
    493
    
    
    
    
    
    
    
    493Deferred income taxes
    
    
    (6,002
    )
    
    
    (1,435
    )
    
    
    (7,437
    )Increase in loss contract reserve
    
    
    12,800
    
    
    
    
    
    
    
    12,800Interest on stockholder note receivable
    
    
    (2
    )
    
    
    
    
    
    
    (2
    )Changes in operating assets and liabilities:Accounts receivable, net
    
    
    (18,509
    )
    
    
    96
    
    
    
    (18,413
    )Inventories
    
    
    (850
    )
    
    
    (84
    )
    
    
    (934
    )Prepaid expenses and other current assets
    
    
    619
    
    
    
    
    
    
    
    619Other assets
    
    
    (2,299
    )
    
    
    3
    
    
    
    (2,296
    )Accounts payable
    
    
    12,921
    
    
    
    
    
    
    
    12,921Accrued medical claims liability
    
    
    8,670
    
    
    
    
    
    
    
    8,670Accrued expenses
    
    
    3,230
    
    
    
    602
    
    
    
    3,832Deferred revenue
    
    
    1,535
    
    
    
    
    
    
    
    1,535Loss contract reserve utilization
    
    
    (4,024
    )
    
    
    
    
    
    
    (4,024
    )Net cash provided by operating activities
    
    
    15,758
    
    
    
    
    
    
    
    15,758Cash Flows from Investing ActivitiesCapital expenditures, net
    
    
    (1,743
    )
    
    
    
    
    
    
    (1,743
    )Net cash used in investing activities
    
    
    (1,743
    )
    
    
    
    
    
    
    (1,743
    )Cash Flows from Financing ActivitiesNet payments on line of credit and term loan
    
    
    (3,559
    )
    
    
    
    
    
    
    (3,559
    )Proceeds from stockholder note receivable
    
    
    50
    
    
    
    
    
    
    
    50Issuance of common stock, net
    
    
    515
    
    
    
    
    
    
    
    515Exercise of stock options
    
    
    1,848
    
    
    
    
    
    
    
    1,848Net cash used in financing activities
    
    
    (1,146
    )
    
    
    
    
    
    
    (1,146
    )Net increase in cash and cash equivalents
    
    
    12,869
    
    
    
    
    
    
    
    12,869Cash and cash equivalents at beginning of year
    
    
    1,157
    
    
    
    
    
    
    
    1,157Cash and cash equivalents at end of year
    
    $
    14,026
    
    
    $
    
    
    
    $
    14,026
 4. Recently Issued Accounting Pronouncements
 Share-Based Payment Accounting for Stock-Based Compensation
   14




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##### Table of Contents



Accounting for Stock Issued to
Employees,
 5. Settlement of Florida Legal Matter
    6. Stock Options
   2005
    
    2004Volatility
    
    
    0.85
    
    
    
    0.84Interest rate
    
    
    3-4
    %
    
    
    3-4
    %Expected life (years)
    
    
    4.5
    
    
    
    4.0Dividend yields
    
    
    0.0
    %
    
    
    0.0
    %
 15




---



##### Table of Contents



Quarter ended
    
    
    Nine months endedSeptember 30,
    
    
    September 30,2005
    
    
    2004
    
    
    2005
    
    
    2004(Restated)
    
    
    
    
    
    
    (Restated)Income (loss) from continuing operations as reported
    
    $
    (1,567
    )
    
    $
    3,550
    
    
    $
    5,325
    
    
    $
    15,398Add: Stock based compensation expense included in
reported net income, net of taxes
    
    
    17
    
    
    
    
    
    
    
    36
    
    
    
    Deduct: Stock based compensation expense determined
under SFAS No. 123, net of taxes
    
    
    (802
    )
    
    
    (540
    )
    
    
    (1,695
    )
    
    
    (1,006
    )Pro forma income (loss) from continuing operations
    
    
    (2,352
    )
    
    
    3,010
    
    
    
    3,666
    
    
    
    14,392Income (loss) from discontinued operations, net of taxes
    
    
    405
    
    
    
    (3,469
    )
    
    
    215
    
    
    
    (10,342
    )Pro forma net income (loss) attributable to common shares
    
    $
    (1,947
    )
    
    $
    (459
    )
    
    $
    3,881
    
    
    $
    4,050As reported net income (loss) per common share  basic:As reported income (loss) from continuing operations
    
    $
    (0.14
    )
    
    $
    0.33
    
    
    $
    0.49
    
    
    $
    1.44As reported income (loss) from discontinued operations,
net of taxes
    
    
    0.03
    
    
    
    (0.32
    )
    
    
    0.02
    
    
    
    (0.97
    )As reported net income (loss)
    
    $
    (0.11
    )
    
    $
    0.01
    
    
    $
    0.51
    
    
    $
    0.47Pro forma net income (loss) per common share  basic:Pro forma income from continuing operations
    
    $
    (0.21
    )
    
    $
    0.28
    
    
    $
    0.34
    
    
    $
    1.35Pro forma income (loss) from discontinued operations
    
    
    0.03
    
    
    
    (0.32
    )
    
    
    0.02
    
    
    
    (0.97
    )Pro forma net income (loss)
    
    $
    (0.18
    )
    
    $
    (0.04
    )
    
    $
    0.36
    
    
    $
    0.38As reported net income (loss) per common share  diluted:As reported income (loss) from continuing operations
    
    $
    (0.14
    )
    
    $
    0.32
    
    
    $
    0.48
    
    
    $
    1.40As reported income (loss) from discontinued operations,
net of taxes
    
    
    0.03
    
    
    
    (0.31
    )
    
    
    0.02
    
    
    
    (0.94
    )As reported net income (loss)
    
    $
    (0.11
    )
    
    $
    0.01
    
    
    $
    0.50
    
    
    $
    0.46Pro forma net income (loss) per common share  diluted:Pro forma income from continuing operations
    
    $
    (0.21
    )
    
    $
    0.27
    
    
    $
    0.33
    
    
    $
    1.31Pro forma income (loss) from discontinued operations
    
    
    0.03
    
    
    
    (0.31
    )
    
    
    0.02
    
    
    
    (0.94
    )Pro forma net income (loss)
    
    $
    (0.18
    )
    
    $
    (0.04
    )
    
    $
    0.35
    
    
    $
    0.37
  7. Discontinued Operations
 Accounting for the Impairment
or Disposal of Long-Lived Assets
 16




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##### Table of Contents



Quarter ended
    
    
    Nine months endedSeptember 30,
    
    
    September 30,2005
    
    
    2004
    
    
    2005
    
    
    2004(Restated)
    
    
    
    
    
    
    (Restated)Healthcare revenues
    
    $
    14,224
    
    
    $
    44,739
    
    
    $
    86,187
    
    
    $
    133,316Healthcare expenses
    
    
    13,520
    
    
    
    44,480
    
    
    
    84,469
    
    
    
    133,005Increase in reserve for loss contracts
    
    
    
    
    
    
    6,000
    
    
    
    1,295
    
    
    
    12,800Gross margin
    
    
    704
    
    
    
    (5,741
    )
    
    
    423
    
    
    
    (12,489
    )Depreciation and amortization
    
    
    7
    
    
    
    40
    
    
    
    49
    
    
    
    141Interest, net
    
    
    9
    
    
    
    2
    
    
    
    14
    
    
    
    6Income (loss) from discontinued operations before taxes
    
    
    688
    
    
    
    (5,783
    )
    
    
    360
    
    
    
    (12,636
    )Income tax provision (benefit)
    
    
    283
    
    
    
    (2,314
    )
    
    
    145
    
    
    
    (2,294
    )Income (loss) from discontinued operations, net of taxes
    
    $
    405
    
    
    $
    (3,469
    )
    
    $
    215
    
    
    $
    (10,342
    )
 8. Accounts Receivable
  September 30,
    
    
    December 31,2005
    
    
    2004(Restated)Billed accounts receivable
    
    $
    51,391
    
    
    $
    60,822Unbilled accounts receivable
    
    
    38,235
    
    
    
    31,723Other accounts receivable
    
    
    346
    
    
    
    85989,972
    
    
    
    93,404Less: Allowances
    
    
    (744
    )
    
    
    (162
    )$
    89,228
    
    
    $
    93,242
     17




---



##### Table of Contents



9. Prepaid Expenses and Other Current Assets
  September 30,
    
    
    December 31,2005
    
    
    2004Prepaid insurance
    
    $
    9,949
    
    
    $
    10,979Prepaid cash deposits for estimated professional liability claims losses
    
    
    5,900
    
    
    
    5,700Prepaid performance bonds
    
    
    69
    
    
    
    230Prepaid other
    
    
    392
    
    
    
    277$
    16,310
    
    
    $
    17,186
 10. Property and Equipment
  September 30,
    
    
    December 31,
    
    
    Estimated2005
    
    
    2004
    
    
    Useful Lives(Restated)Leasehold improvements
    
    $
    1,230
    
    
    $
    1,200
    
    
    5 yearsEquipment and furniture
    
    
    9,257
    
    
    
    8,519
    
    
    5 yearsComputer software
    
    
    3,280
    
    
    
    1,436
    
    
    3-5 yearsMedical equipment
    
    
    2,543
    
    
    
    2,560
    
    
    5 yearsAutomobiles
    
    
    63
    
    
    
    32
    
    
    5 yearsManagement information systems under development
    
    
    381
    
    
    
    1,076
    
    
    
    16,754
    
    
    
    14,823Less: Accumulated depreciation
    
    
    (10,771
    )
    
    
    (9,466
    )$
    5,983
    
    
    $
    5,357
  Accounting for the Costs of Computer Software Developed or Obtained for Internal
Use
 18




---



##### Table of Contents



11. Other Assets
  September 30,
    
    
    December 31,2005
    
    
    2004Deferred financing costs
    
    $
    1,699
    
    
    $
    1,695Less: Accumulated amortization
    
    
    (1,649
    )
    
    
    (1,212
    )50
    
    
    
    483Prepaid cash deposits for estimated professional liability claims losses
    
    
    7,705
    
    
    
    4,674Excess deposits for professional liability claims
    
    
    4,055
    
    
    
    7,321Other refundable deposits
    
    
    69
    
    
    
    70$
    11,879
    
    
    $
    12,548
 12. Contracts and Other Intangible Assets
  September 30,
    
    
    December 31,2005
    
    
    2004Contracts:Gross value
    
    $
    15,870
    
    
    $
    15,870Less: Accumulated amortization
    
    
    (8,297
    )
    
    
    (7,077
    )$
    7,573
    
    
    $
    8,793Non-compete agreements:Gross value
    
    $
    2,400
    
    
    $
    2,400Less: Accumulated amortization
    
    
    (1,497
    )
    
    
    (1,324
    )$
    903
    
    
    $
    1,076
  13. Accounts Payable and Accrued Expenses
  September 30,
    
    
    December 31,2005
    
    
    2004Trade payables
    
    $
    41,292
    
    
    $
    48,095Payable to Health Cost Solutions, Inc.
    
    
    
    
    
    
    1,691$
    41,292
    
    
    $
    49,786
  September 30,
    
    
    December 31,2005
    
    
    2004(Restated)Salaries and employee benefits
    
    $
    18,852
    
    
    $
    20,461Professional liability claims
    
    
    24,189
    
    
    
    18,659Accrued workers compensation claims
    
    
    6,163
    
    
    
    6,557Other
    
    
    10,568
    
    
    
    14,29159,772
    
    
    
    59,968Less: Noncurrent portion of professional liability claims
    
    
    (17,588
    )
    
    
    (11,259
    )$
    42,184
    
    
    $
    48,709
 14. Reserve for Loss Contracts
  19




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##### Table of Contents



20




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##### Table of Contents



15. Banking Arrangements
      21




---



##### Table of Contents



Balance Sheet Classification of Borrowings
Outstanding under Revolving Credit Agreements that Include Both a Subjective Acceleration Clause
and a Lock-Box Arrangement
 16. Income Taxes
 Accounting for Income Taxes
  22




---



##### Table of Contents



17. Professional and General Liability Self-insurance Retention
  18. Commitments and Contingencies
 Catastrophic Limits
  Litigation and Claims
 Lake Professional Liability Suit.
 23




---



##### Table of Contents



EMSA lease matter. th
  Albert Einstein Healthcare Network v. The City of Philadelphia and Prison Health Services,
Inc.
 Other Matters.
 24




---



##### Table of Contents



Performance Bonds
  19. Net Income (Loss) Per Share
 Earnings Per Share,
 Quarter ended
    
    
    Nine months endedSeptember 30,
    
    
    September 30,2005
    
    
    2004
    
    
    2005
    
    
    2004(Restated)
    
    
    
    
    
    
    (Restated)Numerator:Income (loss) from continuing operations
    
    $
    (1,567
    )
    
    $
    3,550
    
    
    $
    5,325
    
    
    $
    15,398Income (loss) from discontinued operations, net of taxes
    
    
    405
    
    
    
    (3,469
    )
    
    
    215
    
    
    
    (10,342
    )Numerator for basic and diluted net income (loss)
    
    $
    (1,162
    )
    
    $
    81
    
    
    $
    5,540
    
    
    $
    5,056Denominator:Denominator for basic net income per share 
weighted average shares
    
    
    10,822,759
    
    
    
    10,780,242
    
    
    
    10,847,422
    
    
    
    10,692,396Effect of dilutive securities:Employee stock options
    
    
    
    
    
    
    303,607
    
    
    
    259,227
    
    
    
    324,278Denominator for diluted net income per share 
adjusted weighted average shares and assumed
conversions
    
    
    10,822,759
    
    
    
    11,083,849
    
    
    
    11,106,649
    
    
    
    11,016,674Net income (loss) per common share  basic:Income (loss) from continuing operations
    
    $
    (0.14
    )
    
    $
    0.33
    
    
    $
    0.49
    
    
    $
    1.44Income (loss) from discontinued operations, net of
taxes
    
    
    0.03
    
    
    
    (0.32
    )
    
    
    0.02
    
    
    
    (0.97
    )Net income (loss)
    
    $
    (0.11
    )
    
    $
    0.01
    
    
    $
    0.51
    
    
    $
    0.47Net income (loss) per common share  diluted:Income (loss) from continuing operations
    
    $
    (0.14
    )
    
    $
    0.32
    
    
    $
    0.48
    
    
    $
    1.40Income (loss) from discontinued operations, net of
taxes
    
    
    0.03
    
    
    
    (0.31
    )
    
    
    0.02
    
    
    
    (0.94
    )Net income (loss)
    
    $
    (0.11
    )
    
    $
    0.01
    
    
    $
    0.50
    
    
    $
    0.46
  Quarter ended
    
    
    Nine months endedSeptember 30,
    
    
    September 30,2005
    
    
    2004
    
    
    2005
    
    
    2004Options excluded from computation of diluted
income per share as effect would be anti-dilutive
    
    
    836,212
    
    
    
    22,500
    
    
    
    474,975
    
    
    
    7,500Weighted average exercise price of excluded options
    
    $
    22.17
    
    
    $
    24.67
    
    
    $
    22.76
    
    
    $
    24.67
 20. Comprehensive Income
  25




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21. Segment Data
   Correctional
    
    
    Pharmaceutical
    
    
    Elimination ofHealthcare
    
    
    Distribution
    
    
    IntersegmentServices
    
    
    Services
    
    
    Sales
    
    
    ConsolidatedQuarter ended September 30, 2005:Healthcare revenues
    
    $
    133,304
    
    
    $
    19,646
    
    
    $
    (12,867
    )
    
    $
    140,083Healthcare expenses
    
    
    128,723
    
    
    
    19,910
    
    
    
    (12,867
    )
    
    
    135,766Gross margin
    
    $
    4,581
    
    
    $
    (264
    )
    
    $
    
    
    
    $
    4,317Depreciation and amortization expense
    
    $
    750
    
    
    $
    357
    
    
    $
    
    
    
    $
    1,107Quarter ended September 30, 2004 (Restated):Healthcare revenues
    
    $
    123,150
    
    
    $
    23,118
    
    
    $
    (11,484
    )
    
    $
    134,784Healthcare expenses
    
    
    112,623
    
    
    
    22,065
    
    
    
    (11,484
    )
    
    
    123,204Gross margin
    
    $
    10,527
    
    
    $
    1,053
    
    
    $
    
    
    
    $
    11,580Depreciation and amortization expense
    
    $
    694
    
    
    $
    239
    
    
    $
    
    
    
    $
    933Nine months ended September 30, 2005:Healthcare revenues
    
    $
    384,284
    
    
    $
    65,400
    
    
    $
    (36,311
    )
    
    $
    413,373Healthcare expenses
    
    
    359,146
    
    
    
    63,382
    
    
    
    (36,311
    )
    
    
    386,217Gross margin
    
    $
    25,138
    
    
    $
    2,018
    
    
    $
    
    
    
    $
    27,156Depreciation and amortization expense
    
    $
    2,190
    
    
    $
    862
    
    
    $
    
    
    
    $
    3,052Nine months ended September 30, 2004 (Restated):Healthcare revenues
    
    $
    355,879
    
    
    $
    62,742
    
    
    $
    (31,701
    )
    
    $
    386,920Healthcare expenses
    
    
    325,306
    
    
    
    59,171
    
    
    
    (31,701
    )
    
    
    352,776Gross margin
    
    $
    30,573
    
    
    $
    3,571
    
    
    $
    
    
    
    $
    34,144Depreciation and amortization expense
    
    $
    2,085
    
    
    $
    711
    
    
    $
    
    
    
    $
    2,796
 Correctional
    
    
    PharmaceuticalHealthcare
    
    
    DistributionServices
    
    
    Services
    
    
    ConsolidatedAs of September 30, 2005:Inventories
    
    $
    4,005
    
    
    $
    3,384
    
    
    $
    7,389Property and equipment, net
    
    $
    3,199
    
    
    $
    2,784
    
    
    $
    5,983Goodwill, net
    
    $
    40,771
    
    
    $
    3,042
    
    
    $
    43,813Total assets
    
    $
    181,692
    
    
    $
    13,711
    
    
    $
    195,403As of December 31, 2004 (Restated):Inventories
    
    $
    4,410
    
    
    $
    3,101
    
    
    $
    7,511Property and equipment, net
    
    $
    3,118
    
    
    $
    2,239
    
    
    $
    5,357Goodwill, net
    
    $
    40,771
    
    
    $
    3,042
    
    
    $
    43,813Total assets
    
    $
    190,323
    
    
    $
    17,127
    
    
    $
    207,450
 22. Share Repurchases
  26




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23. Related Party Transaction
  27




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ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 General
    Forward-Looking Statements
  
    
    the risk that government entities (including the Companys government customers) may
bring enforcement actions against, or impose penalties on, the company or its subsidiaries
as a result of the matters investigated by the Audit Committee or the restatement of the
companys financial results;
    
    the risk that the Company may be subject to shareholder litigation as a result of the
matters investigated by the Audit Committee or the restatement of the Companys financial
results;
    
    risks associated with the possibility that the Company may be unable to satisfy
covenants under its credit facility;
    
    risks arising from potential weaknesses or deficiencies in the Companys internal
control over financial reporting;
    
    risks arising from the possibility that the Company may be unable to collect accounts
receivable;
    
    the Companys ability to retain existing client contracts and obtain new contracts at
acceptable pricing levels;
    
    whether or not government agencies continue to privatize correctional healthcare services;
    
    the possible effect of adverse publicity regarding the Companys business;
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
    
    increased competition for new contracts and renewals of existing contracts;
    
    the Companys ability to comply with government regulations and/or orders of judicial authorities;
    
    the Companys ability to execute its expansion strategies;
    
    the Companys ability to limit its exposure for catastrophic illnesses, injuries or
medical malpractice claims in excess of amounts covered under contracts or insurance
coverage;
    
    the outcome of pending litigation;
    
    the Companys dependence on key personnel; and
    
    the Companys determination whether to repurchase shares under the stock repurchase program.
  Restatement of Financial Statements
   Critical Accounting Policies And Estimates
 General
  29




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
    
    revenue and cost recognition (including the estimated cost of off-site medical claims);
    
    allowance for doubtful accounts;
    
    loss contracts;
    
    professional and general liability self-insurance retention;
    
    other self-funded insurance reserves;
    
    legal contingencies;
    
    impairment of intangible assets and goodwill; and
    
    income taxes.
   Revenue and Cost Recognition
     30




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Allowance for Doubtful Accounts
     31




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Loss Contracts
     32




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33




---



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Professional and General Liability Self-Insurance Retention
     Other Self-Funded Insurance Reserves
  34




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Legal Contingencies
  Impairment of Intangible Assets and Goodwill
 Goodwill and Other
Intangible Assets,
   
    
    significant underperformance or loss of key contracts relative to expected
historical or projected future operating results;
    
    significant changes in the manner of use of the Companys assets or in the
Companys overall business strategy; and
    
    significant negative industry or economic trends.
    35




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Income Taxes
 Accounting for Income Taxes
    36




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Results of Operations
  Quarter ended
    
    
    Nine months endedSeptember 30,
    
    
    September 30,Percentage of Healthcare Revenues
    
    2005
    
    
    2004
    
    
    2005
    
    
    2004(Restated)
    
    
    
    
    
    
    (Restated)Healthcare revenues
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %Healthcare expenses
    
    
    96.9
    
    
    
    91.4
    
    
    
    93.4
    
    
    
    91.2Gross margin
    
    
    3.1
    
    
    
    8.6
    
    
    
    6.6
    
    
    
    8.8Selling, general and administrative expenses
    
    
    3.3
    
    
    
    3.1
    
    
    
    3.2
    
    
    
    3.4Discontinued acquisition expenses
    
    
    0.1
    
    
    
    
    
    
    
    0.2
    
    
    
    Audit Committee investigation and related expenses
    
    
    0.3
    
    
    
    
    
    
    
    0.1
    
    
    
    Depreciation and amortization
    
    
    0.8
    
    
    
    0.7
    
    
    
    0.7
    
    
    
    0.7Charge for settlement of Florida legal matter
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1.3Income (loss) from operations
    
    
    (1.4
    )
    
    
    4.8
    
    
    
    2.4
    
    
    
    3.4Interest, net
    
    
    0.2
    
    
    
    0.4
    
    
    
    0.2
    
    
    
    0.4Late fee income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Income (loss) from continuing operations before income
tax provision (benefit)
    
    
    (1.6
    )
    
    
    4.4
    
    
    
    2.2
    
    
    
    3.0Income tax provision (benefit)
    
    
    (0.5
    )
    
    
    1.8
    
    
    
    0.9
    
    
    
    (1.0
    )Income (loss) from continuing operations
    
    
    (1.1
    )
    
    
    2.6
    
    
    
    1.3
    
    
    
    4.0Income (loss) from discontinued operations, net of taxes
    
    
    0.3
    
    
    
    (2.5
    )
    
    
    
    
    
    
    (2.7
    )Net income (loss)
    
    
    (0.8
    )%
    
    
    0.1
    %
    
    
    1.3
    %
    
    
    1.3
    %
 Quarter Ended September 30, 2005 Compared to Quarter Ended September 30, 2004 (Restated)
 Healthcare revenues.
 Healthcare expenses.
  37




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Selling, general and administrative expenses.
 Discontinued acquisition expenses.
 Audit Committee investigation and related expenses.
 Depreciation and amortization
 Interest, net
 Income tax provision (benefit).
 Income (loss) from continuing operations.
 Income (loss) from discontinued operations, net of taxes
 38




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Net income (loss).
 Nine Months Ended September 30, 2005 Compared to Nine Months Ended September 30, 2004 (Restated)
 Healthcare revenues.
 Healthcare expenses.
  Selling, general and administrative expenses.
 Discontinued acquisition expenses.
 39




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Audit Committee investigation and related expenses.
 Depreciation and amortization
 Charge for settlement of Florida legal matter.
   Interest, net
 Late fee income.
 Income tax provision (benefit).
 Income from continuing operations.
 40




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Income (loss) from discontinued operations, net of taxes
      41




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Net income.
 Liquidity and Capital Resources
 Overview
      Credit Facility
    42




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Balance Sheet Classification of Borrowings Outstanding under
Revolving Credit Agreements that Include Both a Subjective Acceleration Clause and a Lock-Box
Arrangement
 43




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Other Financing Transactions
  Contractual Obligations And Commercial Commitments
  Current
    
    
    2-3 years
    
    
    4-5 years
    
    
    After 5 yearsOperating leases
    
    $
    400
    
    
    $
    3,018
    
    
    $
    1,028
    
    
    $
    Revolving credit facility
    
    
    4,104
    
    
    
    
    
    
    
    
    
    
    
    Professional and general liability claims
    
    
    6,601
    
    
    
    9,521
    
    
    
    5,125
    
    
    
    2,942Total
    
    $
    11,105
    
    
    $
    12,539
    
    
    $
    6,153
    
    
    $
    2,942
  Off-Balance Sheet Transactions
  Inflation
  Stock Repurchase Program
  Recently Issued Accounting Pronouncement
 Share-Based Payment
   44




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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
  
 ITEM 4. CONTROLS AND PROCEDURES
  Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures
    
    
    The use of legal counsel specializing in pharmaceutical matters to provide
interpretations of all SPP customer contracts.
    
    Utilizing these contract interpretations, the Company, with the assistance of third
party accounting resources, recalculated SPPs revenue for the period.
    
    Company personnel expanded their review of SPP account reconciliations and
transactions.
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
    
    Policies have been developed and communicated to SPP management concerning the
clarity of definitions regarding pricing and returns policies to be used in proposals
and contracts.
    
    All proposals, new contracts and amendments to existing contracts must be reviewed
by the Legal and Finance Departments of the Company prior to delivery or execution.
    
    The significant terms of all proposals must be reviewed and approved by Executive
Management of the Company prior to delivery.
    
    Changes to customer pricing rules in SPPs information system must be reviewed and
approved by the Legal and Finance Departments of the Company prior to implementation
of the changes.
    
    Documentation of changes to the customer pricing rules must be maintained by SPP
with a copy of all changes sent to the Legal Department of the Company.
    
    The Controller of SPP now reports directly to the Finance Department of the Company
rather than to the President of SPP.
    
    Monthly account reconciliations of SPP are being reviewed by the Finance Department
of the Company.
 Changes in Internal Controls
  47




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PART II:
 OTHER INFORMATION
 
 ITEM 1. LEGAL PROCEEDINGS
 Lake Professional Liability Suit.
 EMSA lease matter. th
  Albert Einstein Healthcare Network v. The City of Philadelphia and Prison Health Services,
Inc.
 48




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Internal Investigation
 Other Matters.
 49




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ITEM 1A. RISK FACTORS
  
 ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
  
 ITEM 3. DEFAULTS UPON SENIOR SECURTIES
  
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
  
 ITEM 5. OTHER INFORMATION
  50




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ITEM 6. EXHIBITS
 2.1
    
    
    
    Securities Purchase Agreement, dated as of January 26, 1999, among America Service Group
Inc., Health Care Capital Partners L.P. and Health Care Executive Partners L.P. (incorporated
herein by reference to Exhibit 99.2 to the Companys Current Report on Form 8-K filed on
February 10, 1999).3.1
    
    
    
    Amended and Restated Certificate of Incorporation of America Service Group Inc.
(incorporated herein by reference to Exhibit 3.1 to the Companys Quarterly Report on Form
10-Q for the three month period ended June 30, 2002).3.2
    
    
    
    Amended and Restated By-Laws of America Service Group Inc. (incorporated herein by
reference to Exhibit 3.2 to the Companys Quarterly Report on Form 10-Q for the three-month
period ended June 30, 2002).3.3
    
    
    
    Certificate of Amendment of Amended and Restated Certificate of Incorporation of America
Service Group Inc. (incorporated herein by reference to Exhibit 3.4 to the Companys Quarterly
Report on Form 10-Q for the three month period ended June 30, 2004).4.1
    
    
    
    Specimen Common Stock Certificate (incorporated herein by reference to Exhibit 4.1 to the
Companys Quarterly Report on Form 10-Q for the three month period ended June 30, 2002).4.2
    
    
    
    Certificate of Designation of the Series A Convertible Preferred Stock (incorporated
herein by reference to Exhibit 99.3 to the Companys Current Report on Form 8-K filed on
February 10, 1999).10.1
    
    
    
    Amended and Restated Revolving Credit and Security Agreement dated October 31, 2005
between America Service Group Inc., a Delaware corporation, Prison Health Services, Inc., a
Delaware corporation, EMSA limited partnership, a Florida limited partnership, Prison Health
Services of Indiana, LLC, an Indiana limited liability company, Secure Pharmacy Plus, LLC, a
Tennessee limited liability company, and Correctional Health Services, LLC, a New Jersey
limited liability company, and CapitalSource Finance LLC, a Delaware limited liability
company, as lender and collateral and administrative agent. (incorporated herein by reference
to Exhibit 10.1 to the Companys Current Report on Form 8-K filed on November 1, 2005).10.2
    
    
    
    First Amendment to the Amended and Restated Revolving Credit and Security Agreement dated
October 31, 2005 between the Company, Prison Health Services, Inc., a Delaware corporation,
EMSA Limited Partnership, a Florida limited partnership, Prison Health Services of Indiana,
LLC, an Indiana limited liability company, Secure Pharmacy Plus, LLC, a Tennessee limited
liability company, and Correctional Health Services, LLC, a New Jersey limited liability
company, and CapitalSource Finance LLC, a Delaware limited liability company, as lender and
collateral and administrative agent. (incorporated herein by reference to Exhibit 10.0 to the
Companys Current Report on Form 8-K filed on March 16, 2006).10.3
    
    
    
    Employment Agreement, dated March 28, 2006, between Richard Hallworth and America Service
Group Inc. (incorporated by reference to Exhibit 10.1 to the Companys Current Report on Form
8-K filed on March 29, 2006).11
    
    
    
    Computation of Per Share Earnings.*31.1
    
    
    
    Certification of the Chief Executive Officer pursuant to Rule 13a-14(a), as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.31.2
    
    
    
    Certification of the Chief Financial Officer pursuant to Rule 13a-14(a), as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32.1
    
    
    
    Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
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32.2
    
    
    
    Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 
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SIGNATURES
  AMERICA SERVICE GROUP INC./s/ MICHAEL CATALANOMichael CatalanoChairman, President & Chief Executive Officer(Duly Authorized Officer)/s/ MICHAEL W. TAYLORMichael W. TaylorSenior Vice President & Chief Financial Officer(Principal Financial Officer)
  53