##### 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, 2006
 OR
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
 For the transition period from to
 Commission File Number: 0-20135
 
 AMERICA SERVICE GROUP INC.
  Delaware
    
    51-0332317(State or other jurisdiction of
    
    (I.R.S. Employerincorporation or organization)
    
    Identification No.)
 105 Westpark Drive, Suite 200Brentwood, Tennessee
    
    
    
    37027(Address of principal executive offices)
    
    
    
    (Zip Code)
 (615) 373-3100
  þ o
  o þ o
  o þ




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##### 



AMERICA SERVICE GROUP INC.
 QUARTERLY REPORT ON FORM 10-Q
INDEX
 PageNumberPART I. FINANCIAL INFORMATIONItem 1. Financial Statements (Unaudited)Condensed Consolidated Balance Sheets as of September 30, 2006 and December 31, 2005
    
    
    3Condensed Consolidated Statements of Operations for the quarters and nine month periods ended
September 30, 2006 and 2005
    
    
    4Condensed Consolidated Statements of Cash Flows for the nine month periods ended
September 30, 2006 and 2005
    
    
    5Notes to Condensed Consolidated Financial Statements
    
    
    6Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations
    
    
    25Item 3. Quantitative and Qualitative Disclosures About Market Risk
    
    
    42Item 4. Controls and Procedures
    
    
    42PART II. OTHER INFORMATIONItem 1. Legal Proceedings
    
    
    44Item 1A. Risk Factors
    
    
    48Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    
    
    48Item 3. Defaults Upon Senior Securities
    
    
    49Item 4. Submission of Matters to a Vote of Security Holders
    
    
    49Item 5. Other Information
    
    
    49Item 6. Exhibits
    
    
    50Signatures
    
    
    52EX-10.1 Third Amendment to the Ameneded and Restated Revolving Credit and Security AgreementEX-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 31,2006
    
    
    2005ASSETSCurrent assets:Cash and cash equivalents
    
    $
    14,287
    
    
    $
    Restricted cash
    
    
    
    
    
    
    4,200Accounts receivable, net of allowance for doubtful accounts of $417 and $698, respectively
    
    
    89,075
    
    
    
    99,712Inventories
    
    
    7,938
    
    
    
    6,546Prepaid expenses and other current assets
    
    
    19,040
    
    
    
    18,976Current deferred tax assets
    
    
    8,980
    
    
    
    7,575Total current assets
    
    
    139,320
    
    
    
    137,009Property and equipment, net
    
    
    6,997
    
    
    
    6,336Goodwill, net
    
    
    43,813
    
    
    
    43,813Contracts, net
    
    
    5,945
    
    
    
    7,166Other intangibles, net
    
    
    672
    
    
    
    845Other assets
    
    
    4,447
    
    
    
    10,068Total assets
    
    $
    201,194
    
    
    $
    205,237LIABILITIES AND STOCKHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    27,525
    
    
    $
    36,023Accrued medical claims liability
    
    
    28,295
    
    
    
    31,122Accrued expenses
    
    
    50,769
    
    
    
    44,478Deferred revenue
    
    
    14,823
    
    
    
    8,533Revolving credit facility
    
    
    13,181
    
    
    
    12,500Total current liabilities
    
    
    134,593
    
    
    
    132,656Noncurrent portion of accrued expenses
    
    
    16,856
    
    
    
    15,701Noncurrent deferred tax liabilities
    
    
    876
    
    
    
    876Total liabilities
    
    
    152,325
    
    
    
    149,233Commitments and contingenciesStockholders equity:Preferred stock, $0.01 par value, 2,000,000 shares authorized at September 30, 2006 and
December 31, 2005; no shares issued or outstanding
    
    
    
    
    
    
    Common stock, $0.01 par value, 20,000,000 shares authorized at September 30, 2006 and
December 31, 2005; 10,100,587 and 10,761,526 shares issued and outstanding at September
30, 2006 and December 31, 2005, respectively
    
    
    101
    
    
    
    108Additional paid-in capital
    
    
    47,182
    
    
    
    53,759Retained earnings
    
    
    1,586
    
    
    
    2,137Total stockholders equity
    
    
    48,869
    
    
    
    56,004Total liabilities and stockholders equity
    
    $
    201,194
    
    
    $
    205,237
 
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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 30,2006
    
    
    2005
    
    
    2006
    
    
    2005Healthcare revenues
    
    $
    158,216
    
    
    $
    136,455
    
    
    $
    479,185
    
    
    $
    402,601Healthcare expenses
    
    
    150,269
    
    
    
    132,361
    
    
    
    451,995
    
    
    
    376,328Gross margin
    
    
    7,947
    
    
    
    4,094
    
    
    
    27,190
    
    
    
    26,273Selling, general and administrative expenses
    
    
    6,085
    
    
    
    4,566
    
    
    
    18,608
    
    
    
    13,199Discontinued acquisition expenses
    
    
    
    
    
    
    207
    
    
    
    
    
    
    
    658Audit Committee investigation and related expenses
    
    
    370
    
    
    
    370
    
    
    
    4,967
    
    
    
    370Depreciation and amortization
    
    
    1,057
    
    
    
    1,105
    
    
    
    3,086
    
    
    
    2,995Income (loss) from operations
    
    
    435
    
    
    
    (2,154
    )
    
    
    529
    
    
    
    9,051Interest, net
    
    
    531
    
    
    
    305
    
    
    
    1,546
    
    
    
    848Late fee income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    249Income (loss) from continuing operations before income tax
provision (benefit)
    
    
    (96
    )
    
    
    (2,459
    )
    
    
    (1,017
    )
    
    
    8,452Income tax provision (benefit)
    
    
    (32
    )
    
    
    (752
    )
    
    
    (634
    )
    
    
    3,624Income (loss) from continuing operations
    
    
    (64
    )
    
    
    (1,707
    )
    
    
    (383
    )
    
    
    4,828Income (loss) from discontinued operations, net of taxes
    
    
    147
    
    
    
    545
    
    
    
    (168
    )
    
    
    712Net income (loss)
    
    $
    83
    
    
    $
    (1,162
    )
    
    $
    (551
    )
    
    $
    5,540Net income (loss) per common share  basic:Income (loss) from continuing operations
    
    $
    (0.01
    )
    
    $
    (0.16
    )
    
    $
    (0.04
    )
    
    $
    0.45Income (loss) from discontinued operations, net of taxes
    
    
    0.02
    
    
    
    0.05
    
    
    
    (0.01
    )
    
    
    0.06Net income (loss)
    
    $
    0.01
    
    
    $
    (0.11
    )
    
    $
    (0.05
    )
    
    $
    0.51Net income (loss) per common share  diluted:Income (loss) from continuing operations
    
    $
    (0.01
    )
    
    $
    (0.16
    )
    
    $
    (0.04
    )
    
    $
    0.44Income (loss) from discontinued operations, net of taxes
    
    
    0.02
    
    
    
    0.05
    
    
    
    (0.01
    )
    
    
    0.06Net income (loss)
    
    $
    0.01
    
    
    $
    (0.11
    )
    
    $
    (0.05
    )
    
    $
    0.50Weighted average common shares outstanding:Basic
    
    
    10,410,046
    
    
    
    10,822,759
    
    
    
    10,652,077
    
    
    
    10,847,422Diluted
    
    
    10,410,046
    
    
    
    10,822,759
    
    
    
    10,652,077
    
    
    
    11,106,649
 
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AMERICA SERVICE GROUP INC.
 
 CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS  (shown in 000s)  (UNAUDITED)
 Nine months endedSeptember 30,2006
    
    
    2005Cash flows from operating activities:Net income (loss)
    
    $
    (551
    )
    
    $
    5,540Adjustments to reconcile net income (loss) to net cash provided by (used in)
operating activities:Depreciation and amortization
    
    
    3,116
    
    
    
    3,101Loss on retirement of fixed assets
    
    
    3
    
    
    
    Finance cost amortization
    
    
    82
    
    
    
    437Deferred income taxes
    
    
    (976
    )
    
    
    3,850Share-based compensation expense
    
    
    3,117
    
    
    
    60Increase in loss contract reserve
    
    
    
    
    
    
    1,295Excess tax benefits from share-based compensation expense
    
    
    (429
    )
    
    
    97Changes in operating assets and liabilities:Accounts receivable, net
    
    
    10,637
    
    
    
    4,014Inventories
    
    
    (1,392
    )
    
    
    122Prepaid expenses and other current assets
    
    
    (64
    )
    
    
    876Other assets
    
    
    5,538
    
    
    
    373Accounts payable
    
    
    (8,498
    )
    
    
    (8,494
    )Accrued medical claims liability
    
    
    (2,827
    )
    
    
    2,009Accrued expenses
    
    
    7,446
    
    
    
    (196
    )Deferred revenue
    
    
    6,290
    
    
    
    (7,470
    )Loss contract reserve utilization
    
    
    
    
    
    
    (7,357
    )Net cash provided by (used in) operating activities
    
    
    21,492
    
    
    
    (1,743
    )Cash flows from investing activities:Capital expenditures, net
    
    
    (2,386
    )
    
    
    (2,474
    )Net cash used in investing activities
    
    
    (2,386
    )
    
    
    (2,474
    )Cash flows from financing activities:Net borrowings on line of credit
    
    
    681
    
    
    
    4,104Share repurchases
    
    
    (11,582
    )
    
    
    (2,931
    )Reduction in restricted cash used to collateralize letters of credit
    
    
    4,200
    
    
    
    Excess tax benefits from share-based compensation expense
    
    
    429
    
    
    
    Issuance of common stock, net
    
    
    398
    
    
    
    600Exercise of stock options
    
    
    1,055
    
    
    
    748Net cash provided by (used in) financing activities
    
    
    (4,819
    )
    
    
    2,521Net increase (decrease) in cash and cash equivalents
    
    
    14,287
    
    
    
    (1,696
    )Cash and cash equivalents at beginning of period
    
    
    
    
    
    
    7,191Cash and cash equivalents at end of period
    
    $
    14,287
    
    
    $
    5,495
 
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AMERICA SERVICE GROUP INC.
 
 NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
 1. Basis of Presentation
 Share-Based Payment
   2. Description of Business
  3. Restatement of Financial Statements
  6




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




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Transition Election
Related to Accounting for Tax Effects of Share-Based Payment Awards
  Quarter ended
    
    
    Nine months endedSeptember 30, 2005
    
    
    September 30, 2005Income (loss) from continuing operations as reported
    
    $
    (1,707
    )
    
    $
    4,828Add: Stock based compensation expense included in reported
net income, net of taxes
    
    
    17
    
    
    
    36Deduct: Stock based compensation expense determined under
SFAS No. 123, net of taxes
    
    
    (817
    )
    
    
    (1,740
    )Pro forma income (loss) from continuing operations
    
    
    (2,507
    )
    
    
    3,124Income from discontinued operations, net of taxes
    
    
    545
    
    
    
    712Pro forma net income (loss) attributable to common shares
    
    $
    (1,962
    )
    
    $
    3,836As reported net income (loss) per common share  basic:As reported income (loss) from continuing operations
    
    $
    (0.16
    )
    
    $
    0.45As reported income from discontinued operations, net of taxes
    
    
    0.05
    
    
    
    0.06As reported net income (loss)
    
    $
    (0.11
    )
    
    $
    0.51Pro forma net income (loss) per common share  basic:Pro forma income (loss) from continuing operations
    
    $
    (0.23
    )
    
    $
    0.29Pro forma income from discontinued operations, net of taxes
    
    
    0.05
    
    
    
    0.06Pro forma net income (loss)
    
    $
    (0.18
    )
    
    $
    0.35As reported net income (loss) per common share  diluted:As reported income (loss) from continuing operations
    
    $
    (0.16
    )
    
    $
    0.44As reported income from discontinued operations, net of taxes
    
    
    0.05
    
    
    
    0.06As reported net income (loss)
    
    $
    (0.11
    )
    
    $
    0.50Pro forma net income (loss) per common share  diluted:Pro forma income (loss) from continuing operations
    
    $
    (0.23
    )
    
    $
    0.28Pro forma income from discontinued operations, net of taxes
    
    
    0.05
    
    
    
    0.06Pro forma net income (loss)
    
    $
    (0.18
    )
    
    $
    0.34
 Stock Options
   8




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Nine months endedSeptember 30,2006
    
    2005Weighted average grant date fair value of
options
    
    $
    8.16
    
    
    $
    13.01Assumptions:Volatility
    
    
    0.64
    
    
    
    0.85Interest rate
    
    
    5.03
    %
    
    
    3.95
    %Expected life (years)
    
    
    4.66
    
    
    
    4.50Dividend yields
    
    
    0.00
    %
    
    
    0.00
    %
  Weighted Average
    
    Aggregate IntrinsicWeighted Average
    
    Remaining
    
    Value (inOptions
    
    Exercise Price
    
    Contractual Term
    
    thousands) (1)Outstanding, December 31, 2005
    
    
    1,300,502
    
    
    $
    16.82Granted
    
    
    40,000
    
    
    
    14.10Exercised
    
    
    (92,513
    )
    
    
    4.39Canceled
    
    
    (10,750
    )
    
    
    10.99Outstanding, March 31, 2006
    
    
    1,237,239
    
    
    $
    17.72Granted
    
    
    289,000
    
    
    
    14.55Exercised
    
    
    (59,839
    )
    
    
    9.16Canceled
    
    
    
    
    
    
    Outstanding, June 30, 2006
    
    
    1,466,400
    
    
    $
    17.44Granted
    
    
    
    
    
    
    Exercised
    
    
    (19,240
    )
    
    
    5.23Canceled
    
    
    (60,819
    )
    
    
    19.94Outstanding, September 30, 2006
    
    
    1,386,341
    
    
    $
    17.50
    
    
    
    7.51
    
    
    $
    983Exercisable, September 30, 2006
    
    
    720,616
    
    
    $
    19.07
    
    
    
    6.17
    
    
    $
    983
 
 (1)
    
    Based upon the difference between the closing market price of the Companys common stock on the last trading day of the
quarter and the grant price of in-the-money options. 9




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Restricted Stock
   WeightedRestricted
    
    Average Grant-Shares
    
    Date Fair PriceNonvested, December 31, 2005
    
    
    11,500
    
    
    $
    20.82Granted
    
    
    50,500
    
    
    
    14.16Vested
    
    
    (2,500
    )
    
    
    21.02Forfeited
    
    
    (5,000
    )
    
    
    21.02Nonvested, September 30, 2006
    
    
    54,500
    
    
    $
    14.62
  Employee Stock Purchase Plan
   10




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Quarter ended
    
    Nine months endedSeptember 30, 2006
    
    September 30, 2006Weighted average grant date
fair value
    
    $
    5.50
    
    
    $
    5.97Assumptions:Volatility
    
    
    0.62
    
    
    
    0.70Interest rate
    
    
    4.75
    %
    
    
    4.82
    %Expected life (years)
    
    
    0.50
    
    
    
    0.50Dividend yields
    
    
    0.00
    %
    
    
    0.00
    %
  6. Discontinued Operations
 Accounting for the Impairment
or Disposal of Long-Lived Assets
  Quarter ended
    
    
    Nine months endedSeptember 30,
    
    
    September 30,2006
    
    
    2005
    
    
    2006
    
    
    2005Healthcare revenues
    
    $
    3,494
    
    
    $
    17,852
    
    
    $
    9,979
    
    
    $
    96,960Healthcare expenses
    
    
    3,680
    
    
    
    16,925
    
    
    
    10,575
    
    
    
    94,358Increase in reserve for loss contracts
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,295Gross margin
    
    
    (186
    )
    
    
    927
    
    
    
    (596
    )
    
    
    1,307Depreciation and amortization
    
    
    8
    
    
    
    9
    
    
    
    30
    
    
    
    106Interest, net
    
    
    
    
    
    
    9
    
    
    
    16
    
    
    
    14Income (loss) from discontinued
operations before taxes
    
    
    (194
    )
    
    
    909
    
    
    
    (642
    )
    
    
    1,187Income tax provision (benefit)
    
    
    (341
    )
    
    
    364
    
    
    
    (474
    )
    
    
    475Income (loss) from discontinued
operations, net of taxes
    
    $
    147
    
    
    $
    545
    
    
    $
    (168
    )
    
    $
    712
 7. Accounts Receivable
  September 30,
    
    
    December 31,2006
    
    
    2005Billed accounts receivable
    
    $
    58,350
    
    
    $
    46,735Unbilled accounts receivable
    
    
    29,994
    
    
    
    53,563Other accounts receivable
    
    
    1,148
    
    
    
    11289,492
    
    
    
    100,410Less: Allowances for doubtful accounts
    
    
    (417
    )
    
    
    (698
    )$
    89,075
    
    
    $
    99,712
  11




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8. Prepaid Expenses and Other Current Assets
  September 30,
    
    
    December 31,2006
    
    
    2005Prepaid insurance
    
    $
    10,884
    
    
    $
    10,067Prepaid cash deposits for estimated
professional liability claims losses
    
    
    7,500
    
    
    
    8,400Prepaid performance bonds
    
    
    63
    
    
    
    115Prepaid other
    
    
    593
    
    
    
    394$
    19,040
    
    
    $
    18,976
 9. Property and Equipment
  September 30,
    
    
    December 31,
    
    
    Estimated2006
    
    
    2005
    
    
    Useful LivesLeasehold improvements
    
    $
    1,230
    
    
    $
    1,230
    
    
    5 yearsEquipment and furniture
    
    
    11,055
    
    
    
    9,657
    
    
    5 yearsComputer software
    
    
    4,492
    
    
    
    3,945
    
    
    3-5 yearsMedical equipment
    
    
    2,373
    
    
    
    2,231
    
    
    5 yearsAutomobiles
    
    
    60
    
    
    
    38
    
    
    5 yearsManagement information systems under development
    
    
    170
    
    
    
    59
    
    
    
    19,380
    
    
    
    17,160Less: Accumulated depreciation
    
    
    (12,383
    )
    
    
    (10,824
    )$
    6,997
    
    
    $
    6,336
  Accounting for the Costs of Computer Software Developed or Obtained for Internal
Use
 10. Other Assets
  September 30,
    
    
    December 31,2006
    
    
    2005Deferred financing costs
    
    $
    334
    
    
    $
    251Less: Accumulated amortization
    
    
    (96
    )
    
    
    (14
    )238
    
    
    
    237Prepaid cash deposits for estimated professional
liability claims losses
    
    
    2,955
    
    
    
    5,892Excess deposits for professional liability claims
    
    
    1,177
    
    
    
    3,864Other refundable deposits
    
    
    77
    
    
    
    75$
    4,447
    
    
    $
    10,068
 13




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11. Contracts and Other Intangible Assets
  September 30,
    
    
    December 31,2006
    
    
    2005Contracts:Gross value
    
    $
    15,870
    
    
    $
    15,870Less: Accumulated amortization
    
    
    (9,925
    )
    
    
    (8,704
    )$
    5,945
    
    
    $
    7,166Non-compete agreements:Gross value
    
    $
    2,400
    
    
    $
    2,400Less: Accumulated amortization
    
    
    (1,728
    )
    
    
    (1,555
    )$
    672
    
    
    $
    845
  12. Accrued Expenses
  September 30,
    
    
    December 31,2006
    
    
    2005Salaries and employee benefits
    
    $
    20,841
    
    
    $
    16,390Professional liability claims
    
    
    24,856
    
    
    
    24,600Accrued workers compensation claims
    
    
    6,055
    
    
    
    5,707Other
    
    
    15,873
    
    
    
    13,48267,625
    
    
    
    60,179Less: Noncurrent portion of professional liability claims
    
    
    (16,856
    )
    
    
    (15,701
    )$
    50,769
    
    
    $
    44,478
 13. Reserve for Loss Contracts
    14




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14. Banking Arrangements
      16




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##### Table of Contents



Balance
Sheet Classification of Borrowings Outstanding under Revolving Credit Agreements that Include Both
a Subjective Acceleration Clause and a Lock-Box Arrangement
   15. Income Taxes
 Accounting for Income Taxes
    17




---



##### Table of Contents



16. Professional and General Liability Self-insurance Retention
  17. Commitments and Contingencies
 Catastrophic Limits
  Litigation and Claims
 Lake Professional Liability Suit.
 EMSA lease matter. th
 18




---



##### Table of Contents



Albert Einstein Healthcare Network v. The City of Philadelphia and Prison Health Services,
Inc.
 The Health and Hospital Corporation of Marion County, Indiana v. Prison Health Services, Inc.
 Andrew Berkowitz, M.D., Individually and on behalf of all others similarly situated v. Prison
Health Services, Inc. and City of Philadelphia.
 19




---



##### Table of Contents



Matters involving PHS and Baltimore County, Maryland.
    Matters Related to the Audit Committee Investigation
  SEC and United States Attorney Informal Inquiries.
 Shareholder Litigation.
 20




---



##### Table of Contents



Shareholder Derivative Litigation.
 Delaware Department of Justice Inquiry
 Other Matters
  Performance Bonds
  21




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##### Table of Contents



18. Net Income (Loss) Per Share
 Earnings Per Share,
 Quarter ended
    
    
    Nine months endedSeptember 30,
    
    
    September 30,2006
    
    
    2005
    
    
    2006
    
    
    2005Numerator:Income (loss) from continuing operations
    
    $
    (64
    )
    
    $
    (1,707
    )
    
    $
    (383
    )
    
    $
    4,828Income (loss) from discontinued operations, net of taxes
    
    
    147
    
    
    
    545
    
    
    
    (168
    )
    
    
    712Numerator for basic and diluted net income (loss) per share
    
    $
    83
    
    
    $
    (1,162
    )
    
    $
    (551
    )
    
    $
    5,540Denominator:Denominator for basic net income per share  weighted
average shares
    
    
    10,410,046
    
    
    
    10,822,759
    
    
    
    10,652,077
    
    
    
    10,847,422Effect of dilutive securities:Employee stock options
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    259,227Denominator for diluted net income per share  adjusted
weighted average shares and assumed conversions
    
    
    10,410,046
    
    
    
    10,822,759
    
    
    
    10,652,077
    
    
    
    11,106,649Net income (loss) per common share  basic:Income (loss) from continuing operations
    
    $
    (0.01
    )
    
    $
    (0.16
    )
    
    $
    (0.04
    )
    
    $
    0.45Income (loss) from discontinued operations, net of
taxes
    
    
    0.02
    
    
    
    0.05
    
    
    
    (0.01
    )
    
    
    0.06Net income (loss)
    
    $
    0.01
    
    
    $
    (0.11
    )
    
    $
    (0.05
    )
    
    $
    0.51Net income (loss) per common share  diluted:Income (loss) from continuing operations
    
    $
    (0.01
    )
    
    $
    (0.16
    )
    
    $
    (0.04
    )
    
    $
    0.44Income (loss) from discontinued operations, net of
taxes
    
    
    0.02
    
    
    
    0.05
    
    
    
    (0.01
    )
    
    
    0.06Net income (loss)
    
    $
    0.01
    
    
    $
    (0.11
    )
    
    $
    (0.05
    )
    
    $
    0.50
  Quarter ended
    
    
    Nine months endedSeptember 30,
    
    
    September 30,2006
    
    
    2005
    
    
    2006
    
    
    2005Options excluded from computation of diluted
income per share as effect would be anti-dilutive
    
    
    1,386,341
    
    
    
    1,387,018
    
    
    
    1,386,341
    
    
    
    474,975Weighted average exercise price of excluded options
    
    $
    17.50
    
    
    $
    17.05
    
    
    $
    17.50
    
    
    $
    22.76
 19. Comprehensive Income
  22




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##### Table of Contents



20. Segment Data
   Correctional
    
    
    Pharmaceutical
    
    
    Elimination ofHealthcare
    
    
    Distribution
    
    
    IntersegmentServices
    
    
    Services
    
    
    Sales
    
    
    ConsolidatedQuarter ended September 30, 2006:Healthcare revenues
    
    $
    154,899
    
    
    $
    20,554
    
    
    $
    (17,237
    )
    
    $
    158,216Healthcare expenses
    
    
    146,382
    
    
    
    21,124
    
    
    
    (17,237
    )
    
    
    150,269Gross margin
    
    $
    8,517
    
    
    $
    (570
    )
    
    $
    
    
    
    $
    7,947Depreciation and amortization expense
    
    $
    866
    
    
    $
    191
    
    
    $
    
    
    
    $
    1,057Quarter ended September 30, 2005:Healthcare revenues
    
    $
    129,676
    
    
    $
    19,646
    
    
    $
    (12,867
    )
    
    $
    136,455Healthcare expenses
    
    
    125,318
    
    
    
    19,910
    
    
    
    (12,867
    )
    
    
    132,361Gross margin
    
    $
    4,358
    
    
    $
    (264
    )
    
    $
    
    
    
    $
    4,094Depreciation and amortization expense
    
    $
    748
    
    
    $
    357
    
    
    $
    
    
    
    $
    1,105Nine month period ended September 30, 2006:Healthcare revenues
    
    $
    464,932
    
    
    $
    63,257
    
    
    $
    (49,004
    )
    
    $
    479,185Healthcare expenses
    
    
    435,972
    
    
    
    65,027
    
    
    
    (49,004
    )
    
    
    451,995Gross margin
    
    $
    28,960
    
    
    $
    (1,770
    )
    
    $
    
    
    
    $
    27,190Depreciation and amortization expense
    
    $
    2,519
    
    
    $
    567
    
    
    $
    
    
    
    $
    3,086Nine month period September 30, 2005:Healthcare revenues
    
    $
    373,512
    
    
    $
    65,400
    
    
    $
    (36,311
    )
    
    $
    402,601Healthcare expenses
    
    
    349,257
    
    
    
    63,382
    
    
    
    (36,311
    )
    
    
    376,328Gross margin
    
    $
    24,255
    
    
    $
    2,018
    
    
    $
    
    
    
    $
    26,273Depreciation and amortization expense
    
    $
    2,133
    
    
    $
    862
    
    
    $
    
    
    
    $
    2,995
 Correctional
    
    
    PharmaceuticalHealthcare
    
    
    DistributionServices
    
    
    Services
    
    
    ConsolidatedAs of September 30, 2006:Inventories
    
    $
    5,149
    
    
    $
    2,789
    
    
    $
    7,938Property and equipment, net
    
    $
    4,721
    
    
    $
    2,276
    
    
    $
    6,997Goodwill, net
    
    $
    40,771
    
    
    $
    3,042
    
    
    $
    43,813Total assets
    
    $
    190,442
    
    
    $
    10,752
    
    
    $
    201,194As of December 31, 2005:Inventories
    
    $
    3,944
    
    
    $
    2,602
    
    
    $
    6,546Property and equipment, net
    
    $
    3,670
    
    
    $
    2,666
    
    
    $
    6,336Goodwill, net
    
    $
    40,771
    
    
    $
    3,042
    
    
    $
    43,813Total assets
    
    $
    188,467
    
    
    $
    16,770
    
    
    $
    205,237
 21. Share Repurchases
  23




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##### Table of Contents



22. Related Party Transaction
  24




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##### Table of Contents



ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
 General
    Forward-Looking Statements
  
    
    the risk that government or municipal entities (including the Companys government and
municipal customers) may bring enforcement actions against, seek additional refunds from,
or impose penalties on, the Company or its subsidiaries as a result of the matters
investigated by the Audit Committee or the previous restatement of the Companys financial
results;
    
    the risks arising from shareholder litigation as a result of the matters recently
investigated by the Audit Committee or the previous restatement of the Companys financial
results;
    
    risks associated with the possibility that the Company may be unable to satisfy
covenants under its credit facility;
    
    risks arising from potential weaknesses or deficiencies in the Companys internal
control over financial reporting;
    
    risks arising from the possibility that the Company may be unable to collect accounts
receivable;
 25




---



##### Table of Contents




    
    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;
    
    the Companys ability to comply with government regulations and/or orders of judicial authorities;
    
    increased competition for new contracts and renewals of existing contracts;
    
    the Companys ability to execute its expansion strategies;
    
    the Companys ability to limit its exposure for catastrophic illnesses, injuries or
medical malpractice claims in excess of amounts covered under contracts or insurance
coverage;
    
    the outcome of pending litigation;
    
    the Companys dependence on key personnel; and
    
    the Companys determination whether to repurchase shares under the stock repurchase program.
  Restatement of Financial Statements
   26




---



##### Table of Contents



Critical Accounting Policies And Estimates
 General
  
    
    revenue (net of contractual allowances) and cost recognition (including the
estimated cost of off-site medical claims);
    
    allowance for doubtful accounts;
    
    loss contracts;
    
    professional and general liability self-insurance retention;
    
    other self-funded insurance reserves;
    
    legal contingencies;
    
    impairment of intangible assets and goodwill;
    
    income taxes; and
    
    share-based compensation.
   Revenue and Cost Recognition
   27




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Allowance for Doubtful Accounts
   28




---



##### Table of Contents



29




---



##### Table of Contents



Loss Contracts
       30




---



##### Table of Contents



Professional and General Liability Self-Insurance Retention
  31




---



##### Table of Contents



Other Self-Funded Insurance Reserves
  Legal Contingencies
  32




---



##### Table of Contents



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.
    Income Taxes
 Accounting for Income Taxes
 33




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##### Table of Contents



Share-Based Compensation
  34




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##### Table of Contents



Results of Operations
  Quarter ended
    
    Nine months endedSeptember 30,
    
    September 30,Percentage of Healthcare Revenues
    
    2006
    
    2005
    
    2006
    
    2005Healthcare revenues
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %Healthcare expenses
    
    
    95.0
    
    
    
    97.0
    
    
    
    94.3
    
    
    
    93.5Gross margin
    
    
    5.0
    
    
    
    3.0
    
    
    
    5.7
    
    
    
    6.5Selling, general and administrative expenses
    
    
    3.8
    
    
    
    3.3
    
    
    
    4.0
    
    
    
    3.3Discontinued acquisition expenses
    
    
    
    
    
    
    0.2
    
    
    
    
    
    
    
    0.2Audit Committee investigation and related expenses
    
    
    0.2
    
    
    
    0.3
    
    
    
    1.0
    
    
    
    0.1Depreciation and amortization
    
    
    0.7
    
    
    
    0.8
    
    
    
    0.6
    
    
    
    0.7Income (loss) from operations
    
    
    0.3
    
    
    
    (1.6
    )
    
    
    0.1
    
    
    
    2.2Interest, net
    
    
    0.3
    
    
    
    0.2
    
    
    
    0.3
    
    
    
    0.2Late fee income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    0.1Income (loss) from continuing operations before income
tax provision (benefit)
    
    
    
    
    
    
    (1.8
    )
    
    
    (0.2
    )
    
    
    2.1Income tax provision (benefit)
    
    
    
    
    
    
    (0.5
    )
    
    
    (0.1
    )
    
    
    0.9Income (loss) from continuing operations
    
    
    
    
    
    
    (1.3
    )
    
    
    (0.1
    )
    
    
    1.2Income (loss) from discontinued operations, net of taxes
    
    
    0.1
    
    
    
    0.4
    
    
    
    
    
    
    
    0.2Net income (loss)
    
    
    0.1
    %
    
    
    (0.9
    )%
    
    
    (0.1
    )%
    
    
    1.4
    %
 Quarter Ended September 30, 2006 Compared to Quarter Ended September 30, 2005
 Healthcare revenues.
 Healthcare expenses.
 Selling, general and administrative expenses.
 35




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##### Table of Contents



Discontinued acquisition expenses.
 Audit Committee investigation and related expenses.
 Depreciation and amortization
 Interest, net
 Income tax benefit.
 Loss from continuing operations.
 Income from discontinued operations, net of taxes
 Net income (loss).
 36




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##### Table of Contents



Nine Months Ended September 30, 2006 Compared to Nine Months Ended September 30, 2005
 Healthcare revenues.
 Healthcare expenses.
 Selling, general and administrative expenses.
 Discontinued acquisition expenses.
 Audit Committee investigation and related expenses.
 37




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##### Table of Contents



Depreciation and amortization
 Interest, net
 Late fee income.
 Income tax provision (benefit).
 Income (loss) from continuing operations.
 Income (loss) from discontinued operations, net of taxes
 Net income (loss).
 Liquidity and Capital Resources
 Overview
  38




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##### Table of Contents



Credit Facility
     39




---



##### Table of Contents



Balance Sheet Classification of Borrowings Outstanding under
Revolving Credit Agreements that Include Both a Subjective Acceleration Clause and a Lock-Box
Arrangement
  Other Financing Transactions
  Contractual Obligations and Commercial Commitments
  Current
    
    
    2-3 years
    
    
    4-5 years
    
    
    After 5 yearsOperating leases
    
    $
    409
    
    
    $
    2,262
    
    
    $
    244
    
    
    $
    Revolving credit facility
    
    
    13,181
    
    
    
    
    
    
    
    
    
    
    
    Professional and general liability claims
    
    
    8,000
    
    
    
    12,792
    
    
    
    3,201
    
    
    
    863Total
    
    $
    21,590
    
    
    $
    15,054
    
    
    $
    3,445
    
    
    $
    863
  Off-Balance Sheet Transactions
  Inflation
  40




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##### Table of Contents



Stock Repurchase Program
  Recently Issued Accounting Pronouncement
 Accounting for Uncertainty in Income Taxes  an interpretation of FASB Statement No. 109 Accounting for Income Taxes
 41




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##### Table of Contents



ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
  
 ITEM 4. CONTROLS AND PROCEDURES
  Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures
    42




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##### Table of Contents



Changes in Internal Controls
  
    
    Policies have been developed and communicated to SPP and Company management
concerning the clarity of definitions regarding pricing and returns policies to be
used in proposals and contracts.
    
    All proposals, new contracts and amendments to existing contracts must be reviewed
by the Legal and Finance Departments of the Company prior to delivery or execution.
Additionally, contract record keeping procedures are being enhanced.
    
    The significant terms of all proposals must be reviewed and approved by Executive
Management of the Company prior to delivery.
    
    Changes to customer pricing rules in SPPs information system must be reviewed and
approved by the Legal and Finance Departments of the Company prior to implementation
of the changes. Additionally, SPP has developed an edit report that is reviewed by
the Controller of SPP to ensure that all changes made to customer pricing rules are
appropriately approved and input accurately.
    
    Documentation of changes to the customer pricing rules must be maintained by SPP
with a copy of all changes sent to the Legal Department of the Company.
    
    The Controller of SPP now reports directly to the Finance Department of the Company
rather than to the President of SPP.
    
    Monthly account reconciliations of SPP are being reviewed by the Finance Department
of the Company.
    
    SPP has developed reports that more closely monitor monthly drug price changes.
 43




---



##### Table of Contents



PART II:
 OTHER INFORMATION
 
 ITEM 1. LEGAL PROCEEDINGS
 Lake Professional Liability Suit.
 EMSA lease matter. th
  Albert Einstein Healthcare Network v. The City of Philadelphia and Prison Health Services,
Inc.
 44




---



##### Table of Contents



The Health and Hospital Corporation of Marion County, Indiana v. Prison Health Services, Inc.
 Andrew Berkowitz, M.D., Individually and on behalf of all others similarly situated v. Prison
Health Services, Inc. and City of Philadelphia.
 Matters involving PHS and Baltimore County, Maryland.
   45




---



##### Table of Contents



SEC and United States Attorney Informal Inquiries.
 Shareholder Litigation.
  Shareholder Derivative Litigation.
 46




---



##### Table of Contents



Delaware Department of Justice Inquiry
 Other Matters.
 47




---



##### Table of Contents



ITEM 1A. RISK FACTORS
  Shareholder Litigation.
 Potential Enforcement Actions
 
 ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
  (c) Total Number
    
    (d) Maximum Numberof Shares
    
    (or Approximate Dollar(a) Total
    
    
    
    Purchased as Part
    
    Value) of sharesNumber of
    
    (b) Average
    
    of Publicly
    
    that May Yet BeShares
    
    Price Paid
    
    Announced Plans or
    
    Purchased Under thePeriod
    
    Purchased
    
    per Share
    
    Programs
    
    Plans or Programs (1)July 2006 (7/1/06
to 7/31/06)
    
    
    
    
    
    $
    
    
    
    
    
    
    
    $
    August 2006 (8/1/06
to 8/31/06)
    
    
    695,836
    
    
    $
    12.35
    
    
    
    695,836
    
    
    $
    15,445September 2006
(9/1/06 to 9/30/06)
    
    
    
    
    
    $
    
    
    
    
    
    
    
    $
    
 
 (1)
    
    On July 25, 2005, the Companys Board of Directors approved a stock repurchase program to
repurchase up to $30 million of the Companys common stock over a 24 month period. As of September
30, 2006, the Company has repurchased and retired a total of 1,061,936 common shares at an
aggregate cost of approximately $14.6 million. 48




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##### Table of Contents



ITEM
3. DEFAULTS UPON SENIOR SECURITIES
  
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
  
 ITEM 5. OTHER INFORMATION
  49




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##### Table of Contents



ITEM 6. EXHIBITS
 2.1
    
    
    
    Securities Purchase Agreement, dated as of January 26, 1999, among America Service Group
Inc., Health Care Capital Partners L.P. and Health Care Executive Partners L.P. (incorporated
herein by reference to Exhibit 99.2 to the Companys Current Report on Form 8-K filed on
February 10, 1999).3.1
    
    
    
    Amended and Restated Certificate of Incorporation of America Service Group Inc.
(incorporated herein by reference to Exhibit 3.1 to the Companys Quarterly Report on Form
10-Q for the three month period ended June 30, 2002).3.2
    
    
    
    Amended and Restated By-Laws of America Service Group Inc. (incorporated herein by
reference to Exhibit 3.2 to the Companys Quarterly Report on Form 10-Q for the three-month
period ended June 30, 2002).3.3
    
    
    
    Certificate of Amendment of Amended and Restated Certificate of Incorporation of America
Service Group Inc. (incorporated herein by reference to Exhibit 3.4 to the Companys Quarterly
Report on Form 10-Q for the three month period ended June 30, 2004).4.1
    
    
    
    Specimen Common Stock Certificate (incorporated herein by reference to Exhibit 4.1 to the
Companys Quarterly Report on Form 10-Q for the three month period ended June 30, 2002).4.2
    
    
    
    Certificate of Designation of the Series A Convertible Preferred Stock (incorporated
herein by reference to Exhibit 99.3 to the Companys Current Report on Form 8-K filed on
February 10, 1999).10.1
    
    
    
    Second 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.10.2
    
    
    
    Third 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 10.1 to the
Companys Current Report on Form 8-K filed on November 6, 2006).10.3
    
    
    
    Commissioner of the Alabama
Department of Corrections Emergency Declaration and Amendment to the Health Services Agreement between Alabama Department of Corrections and
Prison Health Services, Inc. (incorporated herein by reference to
Exhibit 10.2 to the
Companys Current Report on Form 8-K filed on November 6, 2006).11
    
    
    
    Computation of Per Share Earnings.*31.1
    
    
    
    Certification of the Chief Executive Officer pursuant to Rule 13a-14(a), as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.31.2
    
    
    
    Certification of the Chief Financial Officer pursuant to Rule 13a-14(a), as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.32.1
    
    
    
    Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.32.2
    
    
    
    Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted
pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
 *
    
    Data required by SFAS No. 128, Earnings Per Share, is provided in Note 18 to the condensed
consolidated financial statements in this report. 50




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##### Table of Contents



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)  51