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



FORM 10-Q



|           |  |                                                                                         
|---------- |  | ----------------------------------------------------------------------------------------
|(Mark One) |  |                                                                                         
|[X]        |  | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 
|           |  |                                                                                         
|           |  | For the quarterly period ended September 30, 2002                                       
|           |  |                                                                                         
|OR        
|           |  |                                                                                         
|[   ]      |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|           |  |                                                                                         
|           |  | For the transition period from      to                                                  

Commission File Number: 0-20135



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AMERICA SERVICE GROUP INC.
(Exact name of registrant as specified in its charter)

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

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

Indicate by check mark whether the registrant (1) has filed all reports
required to be filed under Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [x] No [  ]

There were 6,032,744 shares of Common Stock outstanding as of November 11,
2002.



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TABLE OF CONTENTS



|                                                                                                                     |  |  |  |  |  |  |  | 
|-------------------------------------------------------------------------------------------------------------------- |  |  |  |  |  |  |  | 
|PART I: FINANCIAL INFORMATION                                                                                       
|ITEM 1.  FINANCIAL STATEMENTS                                                                                      
|CONDENSED CONSOLIDATED BALANCE SHEETS                                                                               
|CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS                                                                     
|CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS                                                                     
|NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS                                                                
|ITEM 2.  MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND                      RESULTS OF OPERATIONS
|ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                                  
|ITEM 4. CONTROLS AND PROCEDURES                                                                                     
|PART II:                                                                                                            
|OTHER INFORMATION                                                                                                   
|ITEM 1. LEGAL PROCEEDINGS                                                                                           
|ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS                                                                   
|ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K                                                                          
|SIGNATURES                                                                                                          
|CERTIFICATIONS                                                                                                      
|Revolving Credit, Term Loan & Security Agreement                                                                    
|Section 906 Certification of the CEO                                                                                
|Section 906 Certification of the CFO                                                                                



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AMERICA SERVICE GROUP INC.

QUARTERLY REPORT ON FORM 10-Q
INDEX

|                                                                                                                        |  |        |    | 
|----------------------------------------------------------------------------------------------------------------------- |  | ------ | -- | 
|                                                                                                                        |  | Page  
|                                                                                                                        |  | Number
|                                                                                                                        |  |       
|PART I. FINANCIAL INFORMATION                                                                                           |  |        |    | 
|Item 1. Financial Statements (Unaudited)                                                                                |  |        |    | 
|Condensed Consolidated Balance Sheets as of September 30, 2002 and December 31, 2001                                    |  |        | 3  | 
|Condensed Consolidated Statements of Operations for the quarter and nine month period
ended September 30, 2002 and 2001 |  |        | 4  | 
|Condensed Consolidated Statements of Cash Flows for the nine month period ended September 30, 2002
and 2001             |  |        | 5  | 
|Notes to Condensed Consolidated Financial Statements                                                                    |  |        | 6  | 
|Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations                           |  |        | 15 | 
|Item 3. Quantitative and Qualitative Disclosures About Market Risk                                                      |  |        | 26 | 
|Item 4. Controls and Procedures                                                                                         |  |        | 26 | 
|PART II. OTHER INFORMATION                                                                                              |  |        |    | 
|Item 1. Legal Proceedings                                                                                               |  |        | 27 | 
|Item 2. Changes in Securities and Use of Proceeds                                                                       |  |        | 27 | 
|Item 6. Exhibits and Reports on Form 8-K                                                                                |  |        | 28 | 
|Signatures                                                                                                              |  |        | 29 | 
|Certifications                                                                                                          |  |        | 30 | 

2



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PART I:

FINANCIAL INFORMATION




|        |  |   |  |                     
|------- |  | - |  | --------------------
|ITEM 1. |  |  |  | FINANCIAL STATEMENTS




AMERICA SERVICE GROUP INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

|                                                     |                                                                                                                                                                             |   |                                                     |         |              |   |         |         |  
|---------------------------------------------------- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | - | --------------------------------------------------- | ------- | ------------ | - | ------- | ------- | -
|                                                     |                                                                                                                                                                             |   | September 30,                                       |         | December 31,
|                                                     |                                                                                                                                                                             |   | 2002                                                |         | 2001        
|                                                     |                                                                                                                                                                             |   |                                                     |         |             
|                                                     |                                                                                                                                                                             |   | (shown in 000's except share and
per share amounts)
|ASSETS                                               |                                                                                                                                                                             |   |                                                     |         |              |   |         |        
|Current assets:                                      |                                                                                                                                                                             |   |                                                     |         |              |   |         |        
|                                                     | Cash and cash equivalents                                                                                                                                                   |   | $                                                   | 3,717   |              |   | $       | 10,382  |  
|                                                     | Accounts receivable: healthcare and other, less allowances                                                                                                                  |   |                                                     | 66,485  |              |   |         | 64,691  |  
|                                                     | Inventories                                                                                                                                                                 |   |                                                     | 7,475   |              |   |         | 7,747   |  
|                                                     | Prepaid expenses and other current assets                                                                                                                                   |   |                                                     | 16,481  |              |   |         | 9,070   |  
|                                                     |                                                                                                                                                                             |   |                                                     |         |              |   |         |         |  
|Total current assets                                 |                                                                                                                                                                             |   | 94,158                                              |         |              |   | 91,890  |        
|Property and equipment, net                          |                                                                                                                                                                             |   | 6,672                                               |         |              |   | 7,827   |        
|Goodwill, net                                        |                                                                                                                                                                             |   | 43,896                                              |         |              |   | 43,896  |        
|Contracts, net                                       |                                                                                                                                                                             |   | 12,568                                              |         |              |   | 13,912  |        
|Other intangibles, net                               |                                                                                                                                                                             |   | 1,533                                               |         |              |   | 1,683   |        
|Other assets                                         |                                                                                                                                                                             |   | 503                                                 |         |              |   | 1,172   |        
|                                                     |                                                                                                                                                                             |   |                                                     |         |              |   |         |         |  
|Total assets                                         |                                                                                                                                                                             | $ | 159,330                                             |         |              | $ | 160,380 |        
|                                                     |                                                                                                                                                                             |   |                                                     |         |              |   |         |         |  
|LIABILITIES AND STOCKHOLDERS EQUITY (DEFICIT)       |                                                                                                                                                                             |   |                                                     |         |              |   |         |        
|Current liabilities:                                 |                                                                                                                                                                             |   |                                                     |         |              |   |         |        
|                                                     | Accounts payable                                                                                                                                                            |   | $                                                   | 41,520  |              |   | $       | 31,159  |  
|                                                     | Medical claims liability                                                                                                                                                    |   |                                                     | 13,969  |              |   |         | 15,238  |  
|                                                     | Accrued expenses                                                                                                                                                            |   |                                                     | 31,053  |              |   |         | 30,148  |  
|                                                     | Deferred revenue                                                                                                                                                            |   |                                                     | 6,829   |              |   |         | 4,161   |  
|                                                     | Current portion of loss contract reserve                                                                                                                                    |   |                                                     | 2,647   |              |   |         | 4,310   |  
|                                                     | Current portion of long-term debt                                                                                                                                           |   |                                                     | 41,589  |              |   |         | 10,700  |  
|                                                     |                                                                                                                                                                             |   |                                                     |         |              |   |         |         |  
|Total current liabilities                            |                                                                                                                                                                             |   | 137,607                                             |         |              |   | 95,716  |        
|Noncurrent portion of accrued expenses               |                                                                                                                                                                             |   | 7,886                                               |         |              |   | 6,810   |        
|Noncurrent portion of loss contract reserve          |                                                                                                                                                                             |   | 7,162                                               |         |              |   | 14,008  |        
|Long-term debt, net of current portion               |                                                                                                                                                                             |   |                                                    |         |              |   | 47,400  |        
|                                                     |                                                                                                                                                                             |   |                                                     |         |              |   |         |         |  
|Total liabilities                                    |                                                                                                                                                                             |   | 152,655                                             |         |              |   | 163,934 |        
|                                                     |                                                                                                                                                                             |   |                                                     |         |              |   |         |         |  
|Commitments and contingencies                        |                                                                                                                                                                             |   |                                                     |         |              |   |         |        
|                                                     | Stockholders equity (deficit):                                                                                                                                             |   |                                                     |         |              |   |         |         |  
|                                                     | Common stock, $.01 par value, 10,000,000 shares
authorized; 5,553,000 and 5,437,000 shares issued and
outstanding at September 30, 2002 and December 31, 2001,
respectively |   |                                                     | 56      |              |   |         | 54      |  
|                                                     | Additional paid-in capital                                                                                                                                                  |   |                                                     | 31,465  |              |   |         | 31,377  |  
|                                                     | Stockholders notes receivable                                                                                                                                              |   |                                                     | (1,358  | )            |   |         | (1,383  | )
|                                                     | Accumulated other comprehensive loss                                                                                                                                        |   |                                                     | (103    | )            |   |         | (645    | )
|                                                     | Accumulated deficit                                                                                                                                                         |   |                                                     | (23,385 | )            |   |         | (32,957 | )
|                                                     |                                                                                                                                                                             |   |                                                     |         |              |   |         |         |  
|Total stockholders equity (deficit)                 |                                                                                                                                                                             |   | 6,675                                               |         |              |   | (3,554  | )      
|                                                     |                                                                                                                                                                             |   |                                                     |         |              |   |         |         |  
|Total liabilities and stockholders equity (deficit) |                                                                                                                                                                             | $ | 159,330                                             |         |              | $ | 160,380 |        
|                                                     |                                                                                                                                                                             |   |                                                     |         |              |   |         |         |  

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

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AMERICA SERVICE GROUP INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

|                                                    |         |   |                                                             |           |               |   |         |           |      |   |                   |           |  |   |         |           |  
|--------------------------------------------------- | ------- | - | ----------------------------------------------------------- | --------- | ------------- | - | ------- | --------- | ---- | - | ----------------- | --------- |  | - | ------- | --------- | -
|                                                    |         |   |                                                             |           |               |   |         |           |      |   | Nine Months Ended
|                                                    |         |   | Quarter Ended September 30,                                 |           | September 30,
|                                                    |         |   |                                                             |           |              
|                                                    |         |   | 2002                                                        |           | 2001          |   | 2002    |           | 2001
|                                                    |         |   |                                                             |           |               |   |         |           |     
|                                                    |         |   | (Amounts shown in 000's except share and per share amounts)
|Healthcare revenue                                  |         | $ | 141,375                                                     |           |               | $ | 140,145 |           |      | $ | 417,735           |           |  | $ | 418,865 |          
|Healthcare expenses                                 |         |   | 132,886                                                     |           |               |   | 133,085 |           |      |   | 392,089           |           |  |   | 406,394 |          
|Reduction in loss contract reserve                  |         |   |                                                            |           |               |   |        |           |      |   | 3,320             |           |  |   |        |          
|                                                    |         |   |                                                             |           |               |   |         |           |      |   |                   |           |  |   |         |          
|Gross margin                                        |         |   | 8,489                                                       |           |               |   | 7,060   |           |      |   | 28,966            |           |  |   | 12,471  |          
|Selling, general and administrative expenses        |         |   | 3,394                                                       |           |               |   | 4,303   |           |      |   | 10,958            |           |  |   | 14,429  |          
|Depreciation and amortization                       |         |   | 1,256                                                       |           |               |   | 1,798   |           |      |   | 3,573             |           |  |   | 5,741   |          
|Strategic
initiative and severance expenses         |         |   |                                                            |           |               |   | 1,319   |           |      |   |                  |           |  |   | 2,586   |          
|Impairment of long-lived assets                     |         |   |                                                            |           |               |   |        |           |      |   |                  |           |  |   | 13,236  |          
|                                                    |         |   |                                                             |           |               |   |         |           |      |   |                   |           |  |   |         |          
|Income (loss) from operations                       |         |   | 3,839                                                       |           |               |   | (360    | )         |      |   | 14,435            |           |  |   | (23,521 | )        
|Interest, net                                       |         |   | 1,223                                                       |           |               |   | 1,390   |           |      |   | 4,627             |           |  |   | 3,915   |          
|                                                    |         |   |                                                             |           |               |   |         |           |      |   |                   |           |  |   |         |          
|Income (loss) before income tax provision (benefit) |         |   | 2,616                                                       |           |               |   | (1,750  | )         |      |   | 9,808             |           |  |   | (27,436 | )        
|Income tax provision (benefit)                      |         |   | 331                                                         |           |               |   | (754    | )         |      |   | 236               |           |  |   | (10,399 | )        
|                                                    |         |   |                                                             |           |               |   |         |           |      |   |                   |           |  |   |         |          
|Net income (loss)                                   |         |   | 2,285                                                       |           |               |   | (996    | )         |      |   | 9,572             |           |  |   | (17,037 | )        
|Preferred stock dividends                           |         |   |                                                            |           |               |   |        |           |      |   |                  |           |  |   | 163     |          
|                                                    |         |   |                                                             |           |               |   |         |           |      |   |                   |           |  |   |         |          
|Net income (loss) attributable to common shares     |         | $ | 2,285                                                       |           |               | $ | (996    | )         |      | $ | 9,572             |           |  | $ | (17,200 | )        
|                                                    |         |   |                                                             |           |               |   |         |           |      |   |                   |           |  |   |         |          
|Net income (loss) per common share:                 |         |   |                                                             |           |               |   |         |           |      |   |                   |           |  |   |         |          
|                                                    | Basic   |   | $                                                           | 0.41      |               |   | $       | (0.18     | )    |   | $                 | 1.75      |  |   | $       | (3.28     | )
|                                                    |         |   |                                                             |           |               |   |         |           |      |   |                   |           |  |   |         |          
|                                                    | Diluted |   | $                                                           | 0.41      |               |   | $       | (0.18     | )    |   | $                 | 1.72      |  |   | $       | (3.28     | )
|                                                    |         |   |                                                             |           |               |   |         |           |      |   |                   |           |  |   |         |          
|Weighted average shares outstanding:                |         |   |                                                             |           |               |   |         |           |      |   |                   |           |  |   |         |          
|                                                    | Basic   |   |                                                             | 5,526,000 |               |   |         | 5,428,000 |      |   |                   | 5,472,000 |  |   |         | 5,245,000 |  
|                                                    |         |   |                                                             |           |               |   |         |           |      |   |                   |           |  |   |         |          
|                                                    | Diluted |   |                                                             | 5,631,000 |               |   |         | 5,428,000 |      |   |                   | 5,578,000 |  |   |         | 5,245,000 |  
|                                                    |         |   |                                                             |           |               |   |         |           |      |   |                   |           |  |   |         |          

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

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AMERICA SERVICE GROUP INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

|                                                                                                   |                                                        |                                           |         |                                 |        |      |         |        |         |  
|-------------------------------------------------------------------------------------------------- | ------------------------------------------------------ | ----------------------------------------- | ------- | ------------------------------- | ------ | ---- | ------- | ------ | ------- | -
|                                                                                                   |                                                        |                                           |         | Nine Months Ended September 30,
|                                                                                                   |                                                        |                                           |         |                                
|                                                                                                   |                                                        |                                           |         | 2002                            |        | 2001
|                                                                                                   |                                                        |                                           |         |                                 |        |     
|                                                                                                   |                                                        |                                           |         | (Amounts shown in 000's)       
|Operating activities:                                                                              |                                                        |                                           |         |                                 |        |      |         |       
|Net income (loss)                                                                                  |                                                        | $                                         | 9,572   |                                 |        | $    | (17,037 | )     
|Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities: |                                                        |                                           |         |                                 |        |      |         |       
|                                                                                                   | Depreciation and amortization                          |                                           |         | 3,573                           |        |      |         | 5,741  |        
|                                                                                                   | Amortization of deferred financing costs               |                                           |         | 821                             |        |      |         | 349    |        
|                                                                                                   | Impairment of long-lived assets                        |                                           |         |                                |        |      |         | 13,236 |        
|                                                                                                   | Reduction in loss contract reserve                     |                                           |         | (3,320                          | )      |      |         |       |        
|                                                                                                   | Deferred income taxes                                  |                                           |         |                                |        |      |         | (7,028 | )      
|                                                                                                   | Interest on stockholders notes receivable             |                                           |         | (58                             | )      |      |         | (60    | )      
|                                                                                                   | Other comprehensive loss amortized to interest expense |                                           |         | 542                             |        |      |         |       |        
|                                                                                                   | Changes in operating assets and liabilities:           |                                           |         |                                 |        |      |         |        |        
|                                                                                                   |                                                        | Accounts receivable                       |         |                                 | (2,021 | )    |         |        | (16,748 | )
|                                                                                                   |                                                        | Prepaid expenses and other current assets |         |                                 | (7,139 | )    |         |        | (5,253  | )
|                                                                                                   |                                                        | Other assets                              |         |                                 | 397    |      |         |        | (40     | )
|                                                                                                   |                                                        | Accounts payable                          |         |                                 | 10,361 |      |         |        | 9,967   |  
|                                                                                                   |                                                        | Accrued expenses                          |         |                                 | 1,030  |      |         |        | 14,946  |  
|                                                                                                   |                                                        | Reserve for loss contracts                |         |                                 | (5,188 | )    |         |        |        |  
|                                                                                                   |                                                        | Deferred revenue                          |         |                                 | 2,668  |      |         |        | (1,085  | )
|                                                                                                   |                                                        |                                           |         |                                 |        |      |         |       
|Net cash provided by (used in) operating activities                                                |                                                        |                                           | 11,238  |                                 |        |      | (3,012  | )     
|                                                                                                   |                                                        |                                           |         |                                 |        |      |         |       
|Investing activities:                                                                              |                                                        |                                           |         |                                 |        |      |         |       
|Capital expenditures                                                                               |                                                        |                                           | (925    | )                               |        |      | (1,658  | )     
|                                                                                                   |                                                        |                                           |         |                                 |        |      |         |       
|Net cash used in investing activities                                                              |                                                        |                                           | (925    | )                               |        |      | (1,658  | )     
|                                                                                                   |                                                        |                                           |         |                                 |        |      |         |       
|Financing activities:                                                                              |                                                        |                                           |         |                                 |        |      |         |       
|Net advances (payments) on line of credit                                                          |                                                        |                                           | (16,511 | )                               |        |      | 6,200   |       
|Payment of deferred financing costs                                                                |                                                        |                                           | (550    | )                               |        |      | (786    | )     
|Proceeds from stockholder notes receivable                                                         |                                                        |                                           | 83      |                                 |        |      | 81      |       
|Payment of preferred stock dividends                                                               |                                                        |                                           |        |                                 |        |      | (61     | )     
|Exercise of stock options                                                                          |                                                        |                                           |        |                                 |        |      | 578     |       
|                                                                                                   |                                                        |                                           |         |                                 |        |      |         |       
|Net cash provided by (used in) financing activities                                                |                                                        |                                           | (16,978 | )                               |        |      | 6,012   |       
|                                                                                                   |                                                        |                                           |         |                                 |        |      |         |       
|Net increase (decrease) in cash and cash equivalents                                               |                                                        |                                           | (6,665  | )                               |        |      | 1,342   |       
|Cash and cash equivalents, beginning of period                                                     |                                                        |                                           | 10,382  |                                 |        |      | 256     |       
|                                                                                                   |                                                        |                                           |         |                                 |        |      |         |       
|Cash and cash equivalents, end of period                                                           |                                                        | $                                         | 3,717   |                                 |        | $    | 1,598   |       
|                                                                                                   |                                                        |                                           |         |                                 |        |      |         |       

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

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AMERICA SERVICE GROUP INC.

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

1. Basis of Presentation

The interim condensed consolidated financial statements as of September
30, 2002 and for the quarter and nine month period then ended are unaudited,
but in the opinion of management, have been prepared in conformity with
accounting principles generally accepted in the United States applied on a
basis consistent with those of the annual audited consolidated financial
statements. Such interim condensed consolidated financial statements reflect
all adjustments (consisting of normal recurring accruals) necessary for a fair
presentation of the financial position and the results of operations for the
quarter and nine month period presented. The results of operations for the
quarter and nine month period presented are not necessarily indicative of the
results to be expected for the year ending December 31, 2002. The interim
condensed consolidated financial statements should be read in connection with
the audited consolidated financial statements for the year ended December 31,
2001.

2. Description of Business

America Service Group Inc. and its consolidated subsidiaries (the
Company) provide managed healthcare services to correctional facilities under
capitated contracts (with certain adjustments) with state and local
governments, certain private entities and medical facilities operated by the
Department of the Navy and Veterans Administration. The health status of
inmates may impact results of operations under such contractual arrangements.

3. Recently Issued Accounting Pronouncements

In June 1998, the Financial Accounting Standards Board (FASB) issued
SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities
(SFAS 133), as amended in June 2000 by SFAS No. 138, Accounting for Certain
Derivative Instruments and Certain Hedging Activities(SFAS 138), which
requires the Company to recognize all derivatives as assets or liabilities
measured at fair value. Changes in fair value are recognized through either
earnings or other comprehensive income dependent on the effectiveness of the
hedge instrument. At September 30, 2002, the Company maintained an interest
collar agreement with a bank for a notional amount of $6,000 and an expiration
date of March 2003. On October 31, 2002, the Company terminated this interest
collar agreement at a cost of $165.

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

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

The Company adopted SFAS 141 on July 1, 2001. Such adoption had no effect
on the Companys financial position or results of operations. The Company
adopted SFAS 142 effective January 1, 2002, at which time the amortization of
the Companys existing goodwill ceased. Other than the effect on net income of
not amortizing goodwill, the adoption of SFAS 142 had no effect on the
Companys results of operations or financial position. Amortization expense
related to goodwill during the quarter and nine month period ended September
30, 2001 was $627 and $2,225, respectively.

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

|                                                             |             |   |               |      |                   |   |      |       |      |   |       |      |  |   |         |       |  
|------------------------------------------------------------ | ----------- | - | ------------- | ---- | ----------------- | - | ---- | ----- | ---- | - | ----- | ---- |  | - | ------- | ----- | -
|                                                             |             |   | Quarter ended |      | Nine months ended
|                                                             |             |   | September 30, |      | September 30,    
|                                                             |             |   |               |      |                  
|                                                             |             |   | 2002          |      | 2001              |   | 2002 |       | 2001
|                                                             |             |   |               |      |                   |   |      |       |     
|Net income (loss) attributable to common shares, as
reported |             | $ | 2,285         |      |                   | $ | (996 | )     |      | $ | 9,572 |      |  | $ | (17,200 | )    
|Add back: amortization expense, net of tax                   |             |   |              |      |                   |   | 389  |       |      |   |      |      |  |   | 1,380   |      
|                                                             |             |   |               |      |                   |   |      |       |      |   |       |      |  |   |         |      
|Pro forma net income (loss) attributable to common shares    |             | $ | 2,285         |      |                   | $ | (607 | )     |      | $ | 9,572 |      |  | $ | (15,820 | )    
|                                                             |             |   |               |      |                   |   |      |       |      |   |       |      |  |   |         |      
|Basic net income (loss) per common share:                    |             |   |               |      |                   |   |      |       |      |   |       |      |  |   |         |      
|                                                             | As reported |   | $             | 0.41 |                   |   | $    | (0.18 | )    |   | $     | 1.75 |  |   | $       | (3.28 | )
|                                                             |             |   |               |      |                   |   |      |       |      |   |       |      |  |   |         |      
|                                                             | Pro forma   |   | $             | 0.41 |                   |   | $    | (0.11 | )    |   | $     | 1.75 |  |   | $       | (3.02 | )
|                                                             |             |   |               |      |                   |   |      |       |      |   |       |      |  |   |         |      
|Diluted net income (loss) per common share:                  |             |   |               |      |                   |   |      |       |      |   |       |      |  |   |         |      
|                                                             | As reported |   | $             | 0.41 |                   |   | $    | (0.18 | )    |   | $     | 1.72 |  |   | $       | (3.28 | )
|                                                             |             |   |               |      |                   |   |      |       |      |   |       |      |  |   |         |      
|                                                             | Pro forma   |   | $             | 0.41 |                   |   | $    | (0.11 | )    |   | $     | 1.72 |  |   | $       | (3.02 | )
|                                                             |             |   |               |      |                   |   |      |       |      |   |       |      |  |   |         |      

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

In April 2002, the FASB issued SFAS No. 145, Rescission of FASB
Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections (SFAS 145). SFAS 145 rescinds Statement of Financial Accounting
Standards No. 4, Reporting Gains and Losses from Extinguishment of Debt,
which required all gains and losses from extinguishment of debt to be
aggregated and, if material, classified as an extraordinary item, net of the
related income tax effect. As a result, the criteria in APB 30 will now be used
to classify those gains and losses. SFAS 145 amends SFAS 13, Accounting for
Leases, to require that certain lease modifications that have economic effects
similar to sale-leaseback transactions be accounted for in the same manner as
sale-leaseback transactions. SFAS 145 also makes technical corrections to
existing pronouncements. While those corrections are not substantive in nature,
in some instances, they may change accounting practice. The provisions of SFAS
145 are effective for financial statements issued for fiscal years beginning
after May 15, 2002, and interim periods within those fiscal years, however,
early adoption is encouraged.

As discussed in Note 12, on October 31, 2002, the Company replaced its
existing credit facility with a new credit facility issued by CapitalSource
Finanace LLC. As a result of the transaction, the Company wrote off the
deferred loan costs associated with its existing credit facility. The Company
expects to adopt the provisions of SFAS 145 in the fourth quarter of 2002.
Under the provisions of SFAS 145, the expense resulting from the early
termination of the Companys existing credit facility, primarily consisting of
the write off of the associated deferred loan costs, will be classified as a
component of pre-tax income for the fourth quarter of 2002 versus the
extraordinary item classification that would have been required prior to SFAS
145.

In June 2002, the FASB issued SFAS No. 146, Accounting for Costs
Associated with Exit or Disposal Activities (SFAS 146). SFAS 146 addresses
financial accounting and reporting for costs associated with exit or disposal
activities and nullifies EITF Issue No. 94-3, Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring) (Issue 94-3). SFAS
146 requires that a liability for a cost associated with an exit or disposal
activity be recognized when the liability is incurred. Under Issue 94-3, a
liability for an exit cost as generally defined in Issue 94-3 was recognized at
the date of an entitys commitment to an exit plan. The provisions of SFAS 146
are effective for exit or disposal activities that are initiated after December
31, 2002, with early application encouraged. Adoption of SFAS 146 is not
expected to have a material impact on the Companys financial statements.

7



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4. Reduction In Loss Contract Reserve

During 2001, the Company completed a comprehensive review of its portfolio
of 145 contracts for the purpose of identifying loss contracts and developing a
contract loss reserve for succeeding years. As a result of this review, the
Company identified five non-cancelable contracts with combined 2001 annual
revenues of $59,653 and negative gross margin of $4,714. Based upon
managements projections, these contracts were expected to continue to incur
negative gross margin over their remaining terms. In December 2001, the
Company recorded a charge of $18,317 to establish a reserve for future losses
under these non-cancelable contracts. The five contracts covered by the charge
had expiration dates ranging from June 30, 2002 through June 30, 2005. Ninety
percent of the charge related to the State of Kansas contract, which expires
June 30, 2005, and the City of Philadelphia contract, which was renewable
annually, at the clients option, through June 30, 2004. The remaining ten
percent of the charge related to the State of Maine contract, which expired
June 30, 2002, a county contract that expires on June 30, 2005 and a county
contract that expired on August 15, 2002. Negative gross margin and overhead
costs charged against the loss contract reserve related to these five contracts
totaled $1,204 for the quarter ended September 30, 2002 and $5,189 for the nine
months ended September 30, 2002.

In June 2002, the Company and the City of Philadelphia reached a mutual
agreement that the contract between the Companys subsidiary and the City of
Philadelphia would expire effective June 30, 2002. As a result of the earlier
than anticipated expiration of this loss contract, the Company performed a
reassessment of its loss contract reserve requirements. This reassessment
included a review of managements projected future losses under the remaining
three loss contracts as well as a comprehensive review of the Companys
portfolio of contracts at June 30, 2002 for the purpose of identifying any
additional loss contracts. No new loss contracts were identified as a result
of this review. Based upon the reassessment, the Company recorded a gain of
$3,320, in the second quarter of 2002, to reduce its reserve for loss
contracts.

The Company will continue to provide services to the State of Maine under
a cost plus a fixed management fee transition agreement through December 31,
2002. The Company also entered into a transition arrangement with the City of
Philadelphia under which it continued to provide services through September 30,
2002 under modified contract terms. On September 30, 2002, the Company and the
City of Philadelphia entered into a new contract under which the Company will
continue to provide healthcare services to the City of Philadelphia, under
modified contract terms, through June 30, 2003.

As of September 30, 2002, the Company had a loss contract reserve totaling
$9,809 which relates to two remaining loss contracts, the State of Kansas and a
county contract, both of which expire on June 30, 2005.

5. Strategic Initiative and
Severance Expenses

During 2001, the Company incurred certain strategic initiative expenses
associated with an initiative that was discontinued in the third quarter of
2001. Additionally, during the third quarter of 2001, the Company incurred
severance expenses related to staffing reductions.

6. Impairment of Long-Lived Assets

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

8



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##### Table of Contents



7. Changes in Accounting Estimates

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

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

8. Prepaid Expenses and Other Current Assets

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

|                                                           |  |               |        |              |  |   |       | 
|---------------------------------------------------------- |  | ------------- | ------ | ------------ |  | - | ----- | 
|                                                           |  | September 30, |        | December 31,
|                                                           |  | 2002          |        | 2001        
|                                                           |  |               |        |             
|Prepaid insurance                                          |  | $             | 12,908 |              |  | $ | 8,489 | 
|Deferred loan costs on credit facility maturing April 2003 |  |               | 632    |              |  |   |      | 
|Deposit  appeal bond collateral                           |  |               | 2,035  |              |  |   |      | 
|Prepaid performance bonds                                  |  |               | 507    |              |  |   | 281   | 
|Prepaid other                                              |  |               | 399    |              |  |   | 300   | 
|                                                           |  |               |        |              |  |   |       | 
|                                                           |  | $             | 16,481 |              |  | $ | 9,070 | 
|                                                           |  |               |        |              |  |   |       | 

On October 31, 2002, the deferred loan costs shown above were written off in
connection with the refinancing of the Companys credit facility discussed in
Note 12.

9. Property and Equipment

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

|                               |  |               |        |              |  |              |        |   |  |         |  | 
|------------------------------ |  | ------------- | ------ | ------------ |  | ------------ | ------ | - |  | ------- |  | 
|                               |  | September 30, |        | December 31, |  | Estimated   
|                               |  | 2002          |        | 2001         |  | Useful Lives
|                               |  |               |        |              |  |             
|Leasehold improvements         |  | $             | 1,178  |              |  | $            | 1,158  |   |  | 5 years
|Equipment and furniture        |  |               | 11,146 |              |  |              | 10,469 |   |  | 5 years
|Computer software              |  |               | 1,374  |              |  |              | 1,317  |   |  | 3 years
|Medical equipment              |  |               | 2,341  |              |  |              | 2,155  |   |  | 5 years
|Automobiles                    |  |               | 14     |              |  |              | 14     |   |  | 5 years
|                               |  |               |        |              |  |              |        |   |  |         |  | 
|                               |  |               | 16,053 |              |  |              | 15,113 |   |  |         |  | 
|Less: Accumulated depreciation |  |               | (9,381 | )            |  |              | (7,286 | ) |  |         |  | 
|                               |  |               |        |              |  |              |        |   |  |         |  | 
|                               |  | $             | 6,672  |              |  | $            | 7,827  |   |  |         |  | 
|                               |  |               |        |              |  |              |        |   |  |         |  | 

Depreciation expense was $2,067 and $2,012 for the nine months ended
September 30, 2002 and 2001, respectively.

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10. Contracts and Other Intangible Assets

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

|                        |                          |   |               |        |              |   |        |        |  
|----------------------- | ------------------------ | - | ------------- | ------ | ------------ | - | ------ | ------ | -
|                        |                          |   | September 30, |        | December 31,
|                        |                          |   | 2002          |        | 2001        
|                        |                          |   |               |        |             
|Contracts:              |                          |   |               |        |              |   |        |       
|                        | Gross value              |   | $             | 15,870 |              |   | $      | 15,870 |  
|                        | Accumulated amortization |   |               | (3,302 | )            |   |        | (1,958 | )
|                        |                          |   |               |        |              |   |        |        |  
|                        |                          | $ | 12,568        |        |              | $ | 13,912 |       
|                        |                          |   |               |        |              |   |        |        |  
|Non-compete agreements: |                          |   |               |        |              |   |        |       
|                        | Gross value              |   | $             | 2,400  |              |   | $      | 2,400  |  
|                        | Accumulated amortization |   |               | (867   | )            |   |        | (717   | )
|                        |                          |   |               |        |              |   |        |        |  
|                        |                          | $ | 1,533         |        |              | $ | 1,683  |       
|                        |                          |   |               |        |              |   |        |        |  

The Company evaluates the estimated remaining useful life of its
contract intangibles on at least a quarterly basis, taking into account new
facts and circumstances related to its retention rate for acquired contracts.
If such facts and circumstances indicate the current estimated life is no
longer reasonable, the Company adjusts the estimated useful life on a
prospective basis. In the third quarter of 2002, the Company revised the
estimated life of the contract intangibles, acquired in its 1999 acquisition
of EMSA, from 20 years to 10 years. The revised life impacted contract
intangibles with a gross value of $11,200 and resulted in an increase to
amortization of $217, or $0.04 per fully diluted share, for the third quarter
of 2002. On a prospective basis the revised life will result in an increase
to annual amortization expense of $867.

Amortization expense associated with the above intangibles for the
first nine months of 2002 was $1,494. Estimated aggregate amortization
expense based on current intangibles, giving effect to the change in
estimated life discussed above, for the fourth quarter of 2002 and the next
four years is as follows: $571 for the fourth quarter of 2002, $1,827 in
2003, $1,827 in 2004, $1,827 in 2005 and $1,827 in 2006.

11. Accrued Expenses

Accrued expenses consist of the following:

|                                             |  |               |        |              |  |   |        |  
|-------------------------------------------- |  | ------------- | ------ | ------------ |  | - | ------ | -
|                                             |  | September 30, |        | December 31,
|                                             |  | 2002          |        | 2001        
|                                             |  |               |        |             
|Salaries and employee benefits               |  | $             | 19,506 |              |  | $ | 18,474 |  
|Professional liability claims                |  |               | 8,886  |              |  |   | 7,810  |  
|Accrued workers compensation                |  |               | 3,635  |              |  |   | 2,374  |  
|Other                                        |  |               | 6,912  |              |  |   | 8,300  |  
|                                             |  |               |        |              |  |   |        |  
|                                             |  |               | 38,939 |              |  |   | 36,958 |  
|Less: Noncurrent portion of liability claims |  |               | (7,886 | )            |  |   | (6,810 | )
|                                             |  |               |        |              |  |   |        |  
|                                             |  | $             | 31,053 |              |  | $ | 30,148 |  
|                                             |  |               |        |              |  |   |        |  

12. Banking Arrangements

At September 30, 2002, the Companys debt consisted of a revolving credit
facility, which was amended on March 15, 2002 (the Amended Credit Facility),
with borrowings outstanding of $41,589 and $7,494 available for future
borrowings. The Amended Credit Facility was executed with a syndicate of four
banks with Bank of America, N.A. acting as the lead bank and administrative
agent. The Amended Credit Facility was terminated on October 31, 2002, at
which time the Company wrote-off approximately $750 of deferred loan costs
related to the Amended Credit Facility.

On October 31, 2002, the Company entered into a new credit facility with
CapitalSource Finance LLC (the CapitalSource Credit Facility). The
CapitalSource Credit Facility matures on October 31, 2005 and includes both a
revolving credit facility (the Revolver) and a $5,000 term loan (the Term
Loan). Proceeds from the CapitalSource Credit Facility were used to repay the
borrowings outstanding pursuant to the Amended Credit Facility. The
CapitalSource Credit Facility is secured by substantially all assets of the
Company and its operating subsidiaries. On November 8, 2002, the Company had
borrowings outstanding under the Revolver totaling $35,281 and $6,094 available
for future borrowing. Included in the borrowings outstanding on November 8,
2002, was $6,250 of restricted cash being used to collateralize outstanding
letters of credit.

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##### Table of Contents



Borrowings under the Revolver are limited to the lesser of (1) 85% of
eligible receivables (as defined) or (2) $45,000 (the Revolver Capacity).
Under the terms of the CapitalSource Credit Facility, the Revolver Capacity
will be increased from $45,000 to $55,000 upon the addition of an additional
lending participant. Interest under the Revolver is payable monthly at the
greater of 5.75% or the Citibank N.A. prime rate plus 1.0%. The Company is
also required to pay a monthly letter of credit fee equal to an annual rate of
3.5% on the outstanding balance of letters of credit issued pursuant to the
Revolver. The Company is also required to pay a monthly collateral management
fee, equal to an annual rate of 1.38%, on average borrowings outstanding under
the Revolver.

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

All amounts outstanding under the Revolver will be due and payable on
October 31, 2005. If the Revolver is extinguished prior to July 1, 2005, the
Company will be required to pay an early termination fee equal to 1.0% of the
Revolver Capacity. In connection with the Revolver, the CapitalSource Credit
Facility requires a lockbox agreement which provides for all receipts to be
swept daily to reduce borrowings outstanding. This agreement, combined with the
existence of a Material Adverse Effect (MAE) clause in the Capital Source
Credit Facility, will cause the Revolver to be classified as a current
liability, per guidance in the FASBs Emerging Issues Task Force 95-22,
Balance Sheet Classification of Borrowings Outstanding under Revolving Credit
Agreements that Include Both a Subjective Acceleration Clause and a Lock-Box
Arrangement. The MAE clause, which is a typical requirement in commercial
credit agreements, allows the lender to require the loan to become due if it
determines there has been a material adverse effect on the Companys
operations, business, properties, assets, liabilities, condition or prospects.
The classification of the Revolver as a current liability is a result only of
the combination of the two aforementioned factors: the lockbox agreements and
the MAE clause. The Revolver does not expire or have a maturity date within
one year. As discussed above, the Revolver has a final expiration date of
October 31, 2005.

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

Beginning November 30, 2002, the CapitalSource Credit Facility will
require the Company to meet certain financial covenants related to minimum
levels of earnings. The CapitalSource Credit Facility also contains
restrictions on the Company with respect to certain types of transactions
including payment of dividends, indebtedness and sales or transfers of assets.

The Company is dependent on the availability of borrowings pursuant to the
CapitalSource Credit Facility to meet its working capital needs, capital
expenditure requirements and other cash flow requirements during the remainder
of 2002 and 2003. Management believes that the Company can comply with the
terms of the CapitalSource Credit Facility and meet its expected obligations
throughout 2002 and 2003. However, should the Company fail to meet its
projected results, it may be forced to seek additional sources of financing in
order to fund its working capital needs.

At September 30, 2002, the Company had standby letters of credit outstanding
totaling $6,600. The letters of credit were issued pursuant to the Amended
Credit Facility. On October 31, 2002, there were $6,250 letters of credit
outstanding, which became collateralized by borrowings under the CapitalSource
Credit Facility.

13. Professional and General Liability Insurance

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

The Company records a liability for reported and unreported professional
and general liability claims based upon an actuarial estimate of the cost of
settling losses and loss adjustment expenses. Amounts accrued for all years
were $8,886 and $7,810 at September 30, 2002, and December 31, 2001,
respectively, and are included in accrued expenses and the non-current portion
of accrued expenses. Reserves for medical malpractice liability fluctuate
because the number of claims and the severity of the underlying incidents
change from one period to the next. Furthermore, payments with respect to
previously estimated liabilities frequently differ from the estimated
liability. Changes in estimates of losses resulting from such fluctuations and
differences between estimates and loss payments are recognized by an adjustment
to the reserve for medical malpractice liability in the period in which the
estimates are changed or payments are made. Given the inherent degree of
variability in any such estimates, the reserves reported at September 30, 2002,
represent managements best estimate of the amounts necessary to discharge the
Companys obligations.

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##### Table of Contents



14. Commitments and Contingencies

Catastrophic Limits

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

Litigation and Claims

The Company is appealing a $1,700 judgment against it. In December 1995,
the Florida Association of Counties Trust (FACT), as the insurer for the Polk
County Sheriffs Office, and the Sheriff of Polk County, Florida, brought an
action against Prison Health Services in the Circuit Court, 10th Judicial
Circuit, Polk County, Florida seeking indemnification for $1,000 paid on behalf
of the plaintiffs for settlement of a lawsuit brought against the Sheriffs
Office. The recovery is sought for amounts paid in settlement of a wrongful
death claim brought by the estate of an inmate who died as a result of injuries
sustained from a beating from several corrections officers employed by the
Sheriffs Office. The plaintiffs contend that an indemnification provision in
the contract between Prison Health Services and the Sheriffs Office obligates
the Company to indemnify the Sheriffs Office against losses caused by its own
wrongful acts. The Company was represented by counsel provided by Reliance
Insurance Company, the Companys insurer. In April 2001, FACTs motion for
summary judgment on the question of liability for indemnity was denied, but on
rehearing in July 2001 the prior denial was reversed and summary judgment was
granted. In October 2001, Reliance filed for receivership. In January 2002,
the court entered final judgment in favor of FACT for approximately $1,700 at a
hearing at which the Company was not represented, as counsel provided by
Reliance had simultaneously filed a motion to withdraw. The Company retained
new counsel in February 2002 and has filed a notice of appeal on the judgment.
The Company expects a decision on the appeal in early 2003. The Company has
posted an appeal bond in the amount of $2,000, which has been classified as a
deposit and included in prepaid expenses and other current assets on its
consolidated balance sheet. As of September 30, 2002, the Company has reserved
$522 related to costs associated with this proceeding. The Company believes
that it will be successful on appeal. The Company has numerous defenses to
FACTs claim, including the Companys belief that the court that granted
summary judgment in favor of FACT upon rehearing made an error of law when it
ruled that the Companys contract with the Sheriffs Office obligated the
Company to indemnify the Sheriffs Office against its own wrongful acts. In
addition, the Sheriffs Office released the Company from liability for this
claim subsequent to filing the lawsuit. In the event that the Company is not
successful on appeal, the Company does not believe that the adverse judgment
will have a material adverse effect on its financial position, although it may
affect its quarterly or annual results of operations.

In addition to the matter discussed above, the Company is a party to
various legal proceedings incidental to its business. Certain claims, suits and
complaints arising in the ordinary course of business have been filed or are
pending against the Company. An estimate of the amounts payable on existing
claims for which the liability of the Company is probable is included in
accrued expenses at September 30, 2002 and December 31, 2001. The Company is
not aware of any material unasserted claims and, based on its past experience,
would not anticipate that potential future claims would have a material adverse
effect on its consolidated financial position or results of operations.

12



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##### Table of Contents



15. Net Income Per Share

Net income per share is measured at two levels: basic income per share
and diluted income per share. Basic income per share is computed by dividing
net income by the weighted average number of common shares outstanding during
the period. Diluted income per share is computed by dividing net income by the
weighted average number of common shares outstanding after considering the
additional dilution related to other dilutive securities. The Companys other
dilutive securities outstanding consist of warrants and options to purchase
shares of the Companys common stock. The table below sets forth the
computation of basic and diluted earnings per share for the quarter and nine
month period ended September 30, 2002 and 2001.

|                                                                                                                 |  |               |           |                   |  |      |           |      |  |   |           |  |  |   |           |  
|---------------------------------------------------------------------------------------------------------------- |  | ------------- | --------- | ----------------- |  | ---- | --------- | ---- |  | - | --------- |  |  | - | --------- | -
|                                                                                                                 |  | Quarter ended |           | Nine months ended
|                                                                                                                 |  | September 30, |           | September 30,    
|                                                                                                                 |  |               |           |                  
|                                                                                                                 |  | 2002          |           | 2001              |  | 2002 |           | 2001
|                                                                                                                 |  |               |           |                   |  |      |           |     
|Net income (loss)                                                                                                |  | $             | 2,285     |                   |  | $    | (996      | )    |  | $ | 9,572     |  |  | $ | (17,037   | )
|Preferred stock dividends                                                                                        |  |               |          |                   |  |      |          |      |  |   |          |  |  |   | 163       |  
|                                                                                                                 |  |               |           |                   |  |      |           |      |  |   |           |  |  |   |           |  
|Numerator for basic and diluted
net income (loss) per share 
income (loss) attributable to
common stock holders |  | $             | 2,285     |                   |  | $    | (996      | )    |  | $ | 9,572     |  |  | $ | (17,200   | )
|                                                                                                                 |  |               |           |                   |  |      |           |      |  |   |           |  |  |   |           |  
|Denominator for basic net income
(loss) per share  weighted
average common shares                               |  |               | 5,526,000 |                   |  |      | 5,428,000 |      |  |   | 5,472,000 |  |  |   | 5,245,000 |  
|Effect of dilutive securities                                                                                    |  |               | 105,000   |                   |  |      |          |      |  |   | 106,000   |  |  |   |          |  
|                                                                                                                 |  |               |           |                   |  |      |           |      |  |   |           |  |  |   |           |  
|Denominator for diluted net income
(loss) per share  adjusted
weighted average common shares                    |  |               | 5,631,000 |                   |  |      | 5,428,000 |      |  |   | 5,578,000 |  |  |   | 5,245,000 |  
|                                                                                                                 |  |               |           |                   |  |      |           |      |  |   |           |  |  |   |           |  
|Basic net income (loss) per share                                                                                |  | $             | 0.41      |                   |  | $    | (0.18     | )    |  | $ | 1.75      |  |  | $ | (3.28     | )
|                                                                                                                 |  |               |           |                   |  |      |           |      |  |   |           |  |  |   |           |  
|Diluted net income (loss) per share                                                                              |  | $             | 0.41      |                   |  | $    | (0.18     | )    |  | $ | 1.72      |  |  | $ | (3.28     | )
|                                                                                                                 |  |               |           |                   |  |      |           |      |  |   |           |  |  |   |           |  

Due to the net loss for the quarter and nine month period ended September
30, 2001, options to purchase approximately 1.4 million shares of the
Companys stock at a weighted average exercise price of $13.93 and warrants to
purchase 135,000 shares of the Companys common stock at a weighted average
exercise price of $4.75 were excluded from the calculation of earnings per
share because the effect would have been anti-dilutive. For the quarter and
nine month period ended September 30, 2002, options to purchase approximately
1.3 million shares of the Companys common stock at a weighted average
exercise price of $14.86 were excluded from the calculation of earnings per
share because the effect would have been anti-dilutive.

16. Comprehensive Income

The components of comprehensive income, net of related taxes, are as
follows for the nine months ended September 30, 2002 and 2001:

|                                                                                                                       |  |      |        |      |  |   |         |  
|---------------------------------------------------------------------------------------------------------------------- |  | ---- | ------ | ---- |  | - | ------- | -
|                                                                                                                       |  | 2002 |        | 2001
|                                                                                                                       |  |      |        |     
|Net income (loss) attributable to common shares                                                                        |  | $    | 9,572  |      |  | $ | (17,200 | )
|                                                                                                                       |  |      |        |      |  |   |         |  
|Cumulative effect of change in accounting
principle  fair value of interest rate swaps
qualifying as cash flow hedges |  |      |       |      |  |   | (212    | )
|Net change in fair value of interest rate
swaps qualifying as cash flow hedges                                         |  |      |       |      |  |   | (386    | )
|Amortization of fair value of interest rate
swaps previously qualifying as cash flow
hedges                            |  |      | 542    |      |  |   |        |  
|                                                                                                                       |  |      |        |      |  |   |         |  
|Other comprehensive income (loss)                                                                                      |  |      | 542    |      |  |   | (598    | )
|                                                                                                                       |  |      |        |      |  |   |         |  
|Comprehensive income (loss)                                                                                            |  | $    | 10,114 |      |  | $ | (17,798 | )
|                                                                                                                       |  |      |        |      |  |   |         |  

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17. Segments

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

18. Common Stock Issuances

In July 2002, the Company issued 67,446 shares of its common stock as the
result of the exercise of a warrant. The exercise price for the warrant was
$0.01 per share. In July 2002, the Company also issued 35,686 shares of
common stock under its employee stock purchase plan. See Note 20 for
discussion of common shares issued subsequent to September 30, 2002.

19. Reclassifications

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

20. Subsequent Event

On October 21, 2002, the Company completed a private placement of 480,000
shares of newly issued common stock at $9.50 per share, realizing proceeds of
approximately $4.0 million, net of issuance costs. The net proceeds were used
to repay borrowings under the Companys Amended Credit Facility.
The Company subsequently registered the resale of all of the shares
on a Form S-3 registration statement (No. 333-98355), filed with the
SEC on August 19, 2002 and declared effective on October 18, 2002.

As discussed in Note 12, on October 31, 2002, the Company replaced the
Amended Credit Facility with the CapitalSource Credit Facility.

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##### Table of Contents






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

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



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

Because the risk factors referred to above, as well as the risk factors
set forth in the Companys Annual Report on Form 10-K for the year ended
December 31, 2001 under the heading Item 1. Business  Cautionary Statements
and the Registration Statement (File No. 333-98355) on Form S-3 filed on August
19, 2002 (as amended) under the heading Risk Factors, could cause actual results or outcomes to differ
materially from those expressed in any forward-looking statements made by the
Company or on the Companys behalf, stockholders should not place undue
reliance on any forward-looking statements. Further, any forward-looking
statement speaks only as of the date on which it is made, and the Company
undertakes no obligation to update any forward-looking statement to reflect
events or circumstances after the date on which the statement is made or to
reflect the occurrence of unanticipated events. New factors emerge from time
to time, and it is not possible for the Company to predict which factors will
arise. In addition, the Company cannot assess the impact of each factor on its
business or the extent to which any factor, or combination of factors, may
cause actual results to differ materially from those contained in any
forward-looking statements.

General

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

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

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Critical Accounting Policies And Estimates

General

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



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

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

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

Revenue and Cost Recognition

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

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

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

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

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

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Loss Contracts

The Company accrues losses under its fixed price contracts when it is
probable that a loss has been incurred and the amount of the loss can be
reasonably estimated. The Company performs this loss accrual analysis on a
specific contract basis taking into consideration such factors as future
contractual revenue, projected future healthcare and maintenance costs,
projected future stop-loss insurance recoveries and each contracts specific
terms related to future revenue increases as compared to increased healthcare
costs. The projected future healthcare and maintenance costs are estimated
based on historical trends and managements estimate of future cost increases.
These estimates are subject to the same adverse fluctuations and future claims
experience as previously noted. Some of the Companys contracts provide for
annual increases in the fixed base fee upon changes in the regional medical
care component of the Consumer Price Index, while others do not contain such
provisions.

The Company performs a periodic comprehensive review of its portfolio of
contracts for the purpose of identifying loss contracts and developing a
contract loss reserve for succeeding periods. As a result of its 2001 review,
the Company identified five non-cancelable contracts with combined 2001 annual
revenues of $59.7 million and negative gross margin of $4.7 million. Based
upon managements projections, these contracts were expected to continue to
incur negative gross margin over their remaining terms. In December 2001, the
Company recorded a charge of $18.3 million to establish a reserve for future
losses under these non-cancelable contracts. The five contracts covered by the
charge had expiration dates ranging from June 30, 2002 through June 30, 2005.
Ninety percent of the charge related to the State of Kansas contract, which
expires June 30, 2005, and the City of Philadelphia contract, which was
renewable annually, at the clients option, through June 30, 2004. The
remaining ten percent of the charge related to the State of Maine contract,
which expired June 30, 2002, a county contract that expires on June 30, 2005
and a county contract that expired on August 15, 2002. Negative gross margin
and overhead costs charged against the loss contract reserve related to these
five contracts totaled $1.2 million for the quarter ended September 30, 2002
and $5.2 million for the nine months ended September 30, 2002.

In June 2002, the Company and the City of Philadelphia reached a mutual
agreement that the contract between PHS and the City of Philadelphia would
expire effective June 30, 2002. As a result of the earlier than anticipated
expiration of this loss contract, the Company performed a reassessment of its
loss contract reserve requirements. This reassessment included a review of
managements projected future losses under the remaining three loss contracts
as well as a comprehensive review of the Companys portfolio of contracts at
June 30, 2002 for the purpose of identifying any additional loss contracts. No
new loss contracts were identified as a result of this review. Based upon the
reassessment, the Company recorded a gain of $3.3 million, in the second
quarter of 2002, to reduce its reserve for loss contracts.

The Company will continue to provide services to the State of Maine under
a cost plus a fixed management fee transition agreement through December 31,
2002. The Company also entered into a transition arrangement with the City of
Philadelphia under which it continued to provide services through September 30,
2002 under modified contract terms. On September 30, 2002, the Company and the
City of Philadelphia entered into a new contract under which the Company will
continue to provide healthcare services to the City of Philadelphia, under
modified contract terms, through June 30, 2003.

As of September 30, 2002, the Company had a loss contract reserve totaling
$9.8 million, which relates to two remaining loss contracts, the State of
Kansas and a county contract, both of which expire on June 30, 2005.

Professional and General Liability Insurance

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

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

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##### Table of Contents



The Company records a liability for its estimated uninsured exposure to
reported and unreported professional liability claims based upon a quarterly
independent actuarial estimate of the cost of settling losses and projected
loss adjustment expenses using historical claims data, demographic factors,
severity factors and other actuarial assumptions. Reserves for medical
malpractice liability fluctuate because the number of claims and the severity
of the underlying incidents change from one period to the next. Furthermore,
payments with respect to previously estimated liabilities frequently differ
from the estimated liability. The reserves can also be affected by changes in
the financial health of the third-party insurance carriers used by the Company.
Changes in estimates of losses resulting from such fluctuations and
differences between actuarial estimates and actual loss payments are recognized
by an adjustment to the reserve for medical malpractice liability in the period
in which the estimates are changed or payments are made.

Legal Contingencies

In addition to professional and general liability claims, the Company is
also subject to other legal proceedings in the ordinary course of business.
Such proceedings generally relate to labor, employment or contract matters.
The Company accrues an estimate of the probable costs for the resolution of
these claims. This estimate is developed in consultation with outside counsel
handling the Companys defense in these matters and is based upon an estimated
range of potential results, assuming a combination of litigation and settlement
strategies. The Company does not believe these proceedings will have a
material adverse effect on its consolidated financial position. However, it
is possible that future results of operations for any particular quarterly or
annual period could be materially affected by changes in assumptions, new
developments or changes in approach such as a change in settlement strategy in
dealing with such litigation.

Amortization and Impairment of Intangible Assets and Goodwill

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

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

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



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

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

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

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

The Company evaluates the estimated remaining useful life of its contract
intangibles on at least a quarterly basis, taking into account new facts and
circumstances, including its retention rate for acquired contracts. If such
facts and circumstances indicate the

18



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##### Table of Contents



current estimated life is no longer reasonable, the Company adjusts the
estimated useful life on a prospective basis. In the third quarter of 2002,
the Company revised the estimated life of the contract intangibles, acquired in
its 1999 acquisition of EMSA, from 20 years to 10 years. The revised life
impacted contract intangibles with a gross value of $11.2 million and resulted
in an increase to amortization of $217,000, or $0.04 per fully diluted share,
for the third quarter of 2002. On a prospective basis the revised life will
result in an increase to annual amortization expense of $867,000.

Income Taxes

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

The Company regularly reviews its deferred tax assets for recoverability
taking into consideration such factors as historical losses, projected future
taxable income and the expected timing of the reversals of existing temporary
differences. SFAS 109 requires the Company to record a valuation allowance
when it is more likely than not that some portion or all of the deferred tax
assets will not be realized. It further states forming a conclusion that a
valuation allowance is not needed is difficult when there is negative evidence
such as cumulative losses in recent years. At September 30, 2002 and December
31, 2001, a 100% valuation allowance has been recorded equal to the deferred
tax assets after considering deferred tax assets that can be realized through
offsets to existing taxable temporary differences. Assuming the Company
achieves sufficient profitability in future years to realize the deferred
income tax assets, the valuation allowance will be reduced in future years
through a credit to income tax expense (increasing shareholders equity). Due
to the Companys net income in the first nine months of 2002, the Companys
deferred tax valuation allowance was reduced $4.2 million from $16.1 million at
December 31, 2001 to $11.9 million at September 30, 2002 as a reduction to
income tax provision.

19



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##### Table of Contents



Results of Operations

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

|                                                    |  |               |       |                   |  |      |       |      |  |  |       |   |  |  |       |  
|--------------------------------------------------- |  | ------------- | ----- | ----------------- |  | ---- | ----- | ---- |  |  | ----- | - |  |  | ----- | -
|                                                    |  | Quarter ended |       | Nine Months Ended
|                                                    |  | September 30, |       | September 30,    
|                                                    |  |               |       |                  
|Percentage of Total Revenues                        |  | 2002          |       | 2001              |  | 2002 |       | 2001
|                                                    |  |               |       |                   |  |      |       |     
|Healthcare revenues                                 |  |               | 100.0 | %                 |  |      | 100.0 | %    |  |  | 100.0 | % |  |  | 100.0 | %
|Healthcare expenses                                 |  |               | 94.0  |                   |  |      | 95.0  |      |  |  | 93.9  |   |  |  | 97.0  |  
|Reduction in loss contract reserve                  |  |               |      |                   |  |      |      |      |  |  | 0.8   |   |  |  |      |  
|                                                    |  |               |       |                   |  |      |       |     
|Gross margin                                        |  |               | 6.0   |                   |  |      | 5.0   |      |  |  | 6.9   |   |  |  | 3.0   |  
|Selling, general and administrative expenses        |  |               | 2.4   |                   |  |      | 3.1   |      |  |  | 2.6   |   |  |  | 3.4   |  
|Depreciation and amortization                       |  |               | 0.9   |                   |  |      | 1.3   |      |  |  | 0.9   |   |  |  | 1.4   |  
|Strategic initiative and severance expenses         |  |               |      |                   |  |      | 0.9   |      |  |  |      |   |  |  | 0.6   |  
|Impairment of long-lived assets                     |  |               |      |                   |  |      |      |      |  |  |      |   |  |  | 3.2   |  
|                                                    |  |               |       |                   |  |      |       |     
|Income (loss) from operations                       |  |               | 2.7   |                   |  |      | (0.3  | )    |  |  | 3.4   |   |  |  | (5.6  | )
|Interest, net                                       |  |               | 0.9   |                   |  |      | 1.0   |      |  |  | 1.1   |   |  |  | 1.0   |  
|                                                    |  |               |       |                   |  |      |       |     
|Income (loss) before income tax provision (benefit) |  |               | 1.8   |                   |  |      | (1.3  | )    |  |  | 2.3   |   |  |  | (6.6  | )
|Income tax provision (benefit)                      |  |               | 0.2   |                   |  |      | (0.6  | )    |  |  |      |   |  |  | (2.5  | )
|                                                    |  |               |       |                   |  |      |       |     
|Net income (loss)                                   |  |               | 1.6   |                   |  |      | (0.7  | )    |  |  | 2.3   |   |  |  | (4.1  | )
|Preferred stock dividends                           |  |               |      |                   |  |      |      |      |  |  |      |   |  |  |      |  
|                                                    |  |               |       |                   |  |      |       |     
|Net income (loss) attributable to common shares     |  |               | 1.6   |                   |  |      | (0.7  | )    |  |  | 2.3   |   |  |  | (4.1  | )
|                                                    |  |               |       |                   |  |      |       |     

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

Healthcare revenues.Healthcare revenues for the third quarter of 2002
increased $1.2 million, or 0.9%, from $140.1 million in 2001 to $141.4 million
in 2002. Healthcare revenues in the third quarter of 2002 included $3.3
million of revenue growth resulting from contracts added in 2001 through
marketing activities. The Company added six new contracts in 2002, such new
contracts provided revenues in the third quarter of 2002 of $3.0 million.
Correctional contracts in place throughout the third quarter of both 2002 and
2001 experienced revenue growth of $13.0 million, or 11.6%, from contract
renegotiations and automatic price adjustments. Company wide internal revenue
growth for the third quarter of 2002 totaled $8.6 million, or 6.9%.
Company-wide internal revenue growth consists of the revenue growth on
correctional contracts in place throughout both periods discussed above offset
by a $4.4 million reduction in SPP pharmaceutical distribution revenue. The
decrease in SPP pharmaceutical distribution revenue was primarily the result of
the loss of two pharmaceutical distribution customers in the third quarter of
2001. During 2002, the Companys revenues were negatively impacted by the loss
of 14 correctional contracts resulting in a decrease in revenues of
approximately $13.7 million from 2001 to 2002.

Healthcare expenses.Healthcare expenses decreased $199,000, or 0.1%,
from $133.1 million in the third quarter of 2001 to $132.9 million in the third
quarter of 2002. Healthcare expenses as a percentage of revenues decreased by
1.0% from the third quarter of 2001 to the third quarter of 2002. This 1.0%
decrease results primarily from an increase in diagnostic service and insurance
costs offset by $1,045,000 in negative operating margin related to the
Companys five loss contracts that was charged against the loss contract
reserve in the third quarter of 2002. The Companys ongoing efforts when
renewing or negotiating contracts to negotiate risk-sharing arrangements, such
as stop-loss provisions and aggregate limits for off-site or pharmaceutical
costs, also contributed to the decrease.

Selling, general and administrative expenses.Selling, general and
administrative expenses for the third quarter of 2002 decreased $909,000 from
$4.3 million or 3.1% of revenues in the third quarter of 2001 to $3.4 million
or 2.4% of revenues in the third quarter of 2002. The percentage of revenue
decrease in selling, general and administrative expenses is primarily the
result of a reduction in discretionary compensation in 2002 and approximately
$159,000 in overhead costs associated with the Companys five loss contracts
that was charged against the loss contract reserve. Overhead reductions
implemented by the Company subsequent to the first half of 2001 also
contributed to the overall decrease.

Depreciation and amortization.Depreciation and amortization expense
decreased from $1.8 million in the third quarter of 2001 to $1.3 million in the
third quarter of 2002. This overall decrease is primarily the result of an
increase in amortization of $217,000 in the third quarter of 2002 due to an
adjustment of the estimated life for a portion of the Companys contract
intangibles from 20 years to 10

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years offset by cessation of amortization of goodwill as a result of the
Companys adoption of SFAS 142, Goodwill and Other Intangible Assets, effective
January 1, 2002. Under SFAS 142, goodwill is no longer amortized but will be
required to be monitored for impairment. Amortization expense related to
goodwill totaled approximately $627,000 in the third quarter of 2001.

Strategic
initiative and severance expenses.During 2001, the Company
incurred certain strategic initiative expenses associated with an initiative
that was discontinued in the third quarter of 2001. Additionally, during the
third quarter of 2001, the Company incurred severance expenses related to
staffing reductions.

Interest, net.Net interest expense decreased to $1.2 million or 0.9% of
revenue in the third quarter of 2002 from $1.4 million or 1.0% of revenue in
the third quarter of 2001. The decrease in net interest expense from the
prior year is primarily the result of decreased levels of outstanding debt.

Income tax provision (benefit).The provision for income taxes for the
third quarter of 2002 was $331,000 or 0.2% of revenue, as compared with a
benefit of $754,000 or 0.6% of revenue in the third quarter of 2001. Due to
the Companys net income in the third quarter of 2002, the Companys deferred
tax valuation allowance, established in the fourth quarter of 2001, was reduced
$900,000 from $12.8 million to $11.9 million as a reduction to income tax
provision.

Net income attributable to common shares.Net income attributable to
common shares was $2.3 million for the third quarter of 2002, or 1.6% of
revenue, as compared with a net loss attributable to common shares of $1.0
million, or 0.7% of revenue, in the prior year quarter.

Nine Months Ended September 30, 2002 Compared to Nine Months Ended September
30, 2001

Healthcare revenues.Healthcare revenues for the nine months ended
September 30, 2002 decreased $1.2 million, or 0.3%, from $418.9 million in the
first nine months of 2001 to $417.7 million in the first nine months of 2002.
Healthcare revenues in the first nine months of 2002 included $15.6 million of
revenue growth resulting from contracts added in 2001 through marketing
activities. The Company added six new contracts in 2002. Such new contracts
provided revenues in the first nine months of 2002 of $5.4 million.
Correctional contracts in place throughout the first nine months of 2002 and
2001 experienced revenue growth of $37.0 million, or 11.8%, from contract
renegotiations and automatic price adjustments. Company wide internal revenue
growth for the nine months ended September 30, 2002 totaled $20.6 million, or
5.8%. Company-wide internal revenue growth consists of the revenue growth on
correctional contracts in place throughout both periods discussed above offset
by a $16.4 million reduction in SPP pharmaceutical distribution revenue. The
decrease in SPP pharmaceutical distribution revenue was the result of the loss
of two pharmaceutical distribution customers in the third quarter of 2001.
During 2002, the Companys revenues were negatively impacted by the loss of 26
correctional contracts resulting in a decrease in revenues of approximately
$42.8 million from 2001 to 2002.

Healthcare expenses.Healthcare expenses decreased $14.3 million, or
3.5%, from $406.4 million in the first nine months of 2001 to $392.1 million in
the first nine months of 2002. Healthcare expenses as a percentage of revenues
decreased by 3.1% from the first nine months of 2001 as compared to the same
period in 2002. Healthcare expenses for the first nine months of 2001 included
a charge of $6.0 million recorded in the second quarter to increase the
Companys reserve for medical claims. This charge was primarily the result of
updated second quarter of 2001 information showing actual utilization rates and
cost data for inpatient and outpatient services were higher than the historical
levels on which the Companys reserve had been based. Exclusive of this
charge, healthcare expenses for the nine months ended September 30, 2001 were
95.6% of revenues compared to 93.9% of revenues for the same period in 2002.
This 1.7% decrease results primarily from a decrease in pharmacy related
expenses and approximately $4.3 million in negative operating margin related to
the Companys five loss contracts that was charged against the loss contract
reserve in the first nine months of 2002. The Companys ongoing efforts when
renewing or negotiating contracts to negotiate risk-sharing arrangements, such
as stop-loss provisions and aggregate limits for off-site or pharmaceutical
costs, also contributed to the reduction of healthcare expenses.

Reduction in loss contract reserve.During 2001, the Company completed a
comprehensive review of its portfolio of 145 contracts for the purpose of
identifying loss contracts and developing a contract loss reserve for
succeeding years. As a result of this review, the Company identified five
non-cancelable contracts with combined 2001 annual revenues of $59.7 million
and negative gross margin of $4.7 million. Based upon managements
projections, these contracts were expected to continue to incur negative gross
margin over their remaining terms. In December 2001, the Company recorded a
charge of $18.3 million to establish a reserve for future losses under these
non-cancelable contracts. The five contracts covered by the charge had
expiration dates ranging from June 30, 2002 through June 30, 2005. Ninety
percent of the charge related to the State of Kansas contract, which expires
June 30, 2005, and the City of Philadelphia contract, which was renewable
annually, at the clients option, through June 30, 2004. The remaining ten
percent of the charge related to the State of Maine contract, which expired
June 30, 2002, a county contract that expired on August 15, 2002 and a county
contract that expires on June 30, 2005.

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In June 2002, the Company and the City of Philadelphia reached a mutual
agreement that the contract between PHS and the City of Philadelphia would
expire effective June 30, 2002. As a result of the earlier than anticipated
expiration of this loss contract, the Company performed a reassessment of its
loss contract reserve requirements. This reassessment included a review of
managements projected future losses under the remaining three loss contracts
as well as a comprehensive review of the Companys portfolio of contracts at
June 30, 2002 for the purpose of identifying any additional loss contracts. No
new loss contracts were identified as a result of this review. Based upon the
reassessment, the Company recorded a gain of $3.3 million, in the second
quarter of 2002, to reduce its reserve for loss contracts.

The Company will continue to provide services to the State of Maine under
a cost plus a fixed management fee transition agreement through December 31,
2002. The Company also entered into a transition arrangement with the City of
Philadelphia under which it continued to provide services through September 30,
2002 under modified contract terms. On September 30, 2002, the Company and the
City of Philadelphia entered into a new contract under which the Company will
continue to provide healthcare services to the City of Philadelphia, under
modified contract terms, through June 30, 2003.

As of September 30, 2002, the Company has a loss contract reserve
totaling $9.8 million which relates to two remaining loss contracts, the State
of Kansas and a county contract, both of which expire on June 30, 2005.

Selling, general and administrative expenses.Selling, general and
administrative expenses for the first nine months of 2002 decreased $3.5
million from $14.4 million or 3.4% of revenues in the first nine months of 2001
to $11.0 million or 2.6% of revenues in the first nine months of 2002.
Included in selling, general and administrative expenses for the first nine
months of 2001 were charges to increase the Companys legal reserves by $1.3
million. These charges were primarily required to reflect the Companys
increased exposure to certain outstanding cases previously covered by an
insurance carrier that is now in liquidation. The percentage of revenue
decrease in selling, general and administrative expenses excluding these
charges is primarily the result of overhead reductions implemented by the
Company subsequent to the first half of 2001 and approximately $869,000 in
overhead costs associated with the Companys five loss contracts that was
charged against the loss contract reserve.

Depreciation and amortization.Depreciation and amortization expense
decreased from $5.7 million in the first nine months of 2001 to $3.6 million in
the first nine months of 2002. This overall decrease is primarily the result
of an increase in amortization of $217,000 in the third quarter of 2002 due to
an adjustment of the estimated life for a portion of the Companys contract
intangibles from 20 years to 10 years offset by the cessation of amortization
of goodwill as a result of the Companys adoption of SFAS 142, Goodwill and
Other Intangible Assets, effective January 1, 2002. Under SFAS 142, goodwill
is no longer amortized but will be required to be monitored for impairment.
Amortization expense related to goodwill totaled approximately $2.2 million for
the nine months ended September 30, 2001.

Strategic
initiative and severance expenses.During 2001, the Company
incurred certain strategic initiative expenses associated with an initiative
that was discontinued in the third quarter of 2001. Additionally, during the
third quarter of 2001, the Company incurred severance expenses related to
staffing reductions.

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

Interest, net.Net interest expense increased to $4.6 million or 1.1% of
revenue in the first nine months of 2002 from $3.9 million or 1.0% of revenue
in the first nine months of 2001. The increase in net interest expense from
the prior year is primarily the result of increased interest rates on
outstanding debt and expenses related to certain interest rate collars entered
into in 2000.

Income tax provision (benefit).The provision for income taxes for the
first nine months of 2002 was $236,000 or less than one-tenth of one percent
of revenue, as compared with a benefit of $10.4 million or 2.5% of revenue in
the same period of 2001. Due to the Companys net income in the first nine
months of 2002, the Companys deferred tax valuation allowance, established in
the fourth quarter of 2001, was reduced $4.2 million from $16.1 million to
$11.9 million as a reduction to income tax provision.

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Net income (loss) attributable to common shares.Net income attributable
to common shares was $9.6 million for the nine months ended September 30, 2002,
or 2.3% of revenue, as compared with a net loss attributable to common shares
of $17.2 million, or 4.1% of revenue, in the same period of 2001.

Liquidity and Capital Resources

The Company generated net income attributable to common shares of $9.6
million in the first nine months of 2002 compared to a net loss attributable to
common shares of $17.2 million in the same period of 2001. The Company had
stockholders equity of $6.7 million at September 30, 2002 as compared to a
stockholders deficit of $3.6 million at December 31, 2001. The Companys cash
and cash equivalents decreased to $3.7 million at September 30, 2002 from $10.4
million at December 31, 2001, a decrease of $6.7 million. The decrease in cash
was primarily the result of payments made to reduce debt outstanding offset by
cash flows from operating activities. Cash flows from operating activities
during the first nine months of 2002 were $11.2 million, an increase of $14.2
million from the cash used in operating activities in the same period of 2001
of $3.0 million. The increase is primarily the result of increased net income.
Cash flows used in financing activities during the first nine months of 2002
were $17.0 million and include net payments totaling $16.5 million to reduce
the amount of debt outstanding under the Amended Credit Facility from $58.1
million at December 31, 2001 to $41.6 million at September 30, 2002.

At September 30, 2002, the Companys debt consisted of a revolving credit
facility, which was amended on March 15, 2002 (the Amended Credit Facility),
with borrowings outstanding of $41.6 million and $7.5 million available for
future borrowings. The Amended Credit Facility was executed with a syndicate
of four banks with Bank of America, N.A. acting as the lead bank and
administrative agent. The Amended Credit Facility was terminated on October 31,
2002, at which time the Company wrote-off approximately $750,000 of deferred
loan costs related to the Amended Credit Facility.

On October 31, 2002, the Company entered into a new credit facility with
CapitalSource Finance LLC (the CapitalSource Credit Facility). The
CapitalSource Credit Facility matures on October 31, 2005 and includes both a
revolving credit facility (the Revolver) and a $5.0 million term loan (the
Term Loan). Proceeds from the CapitalSource Credit Facility were used to
repay the borrowings outstanding pursuant to the Amended Credit Facility. The
CapitalSource Credit Facility is secured by substantially all assets of the
Company and its operating subsidiaries. On November 8, 2002, the Company had
borrowings outstanding under the Revolver totaling $35.3 million and $6.1
million available for future borrowing. Included in the borrowings outstanding
on November 8, 2002, was $6.2 million of restricted cash being used to
collateralize outstanding letters of credit.

Borrowings under the Revolver are limited to the lesser of (1) 85% of
eligible receivables (as defined) or (2) $45.0 million (the Revolver
Capacity). Under the terms of the CapitalSource Credit Facility, the Revolver
Capacity will be increased from $45.0 million to $55.0 million upon the
addition of an additional lending participant. Interest under the Revolver is
payable monthly at the greater of 5.75% or the Citibank N.A. prime rate plus
1.0%. The Company is also required to pay a monthly letter of credit fee equal
to an annual rate of 3.5% on the outstanding balance of letters of credit. The
Company is also required to pay a monthly collateral management fee equal to an
annual rate of 1.38% on average borrowings outstanding under the Revolver.

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

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All amounts outstanding under the Revolver will be due and payable on
October 31, 2005. If the Revolver is extinguished prior to July 1, 2005, the
Company will be required to pay an early termination fee equal to 1.0% of the
Revolver Capacity. In connection with the Revolver, the CapitalSource Credit
Facility requires a lockbox agreement which provides for all receipts to be
swept daily to reduce borrowings outstanding. This agreement, combined with the
existence of a Material Adverse Effect (MAE) clause in the Capital Source
Credit Facility, will cause the Revolver to be classified as a current
liability, per guidance in the FASBs Emerging Issues Task Force 95-22,
Balance Sheet Classification of Borrowings Outstanding under Revolving Credit
Agreements that Include Both a Subjective Acceleration Clause and a Lock-Box
Arrangement. The MAE clause, which is a typical requirement in commercial
credit agreements, allows the lender to require the loan to become due if it
determines there has been a material adverse effect on the Companys
operations, business, properties, assets, liabilities, condition or prospects.
The classification of the Revolver as a current liability is a result only of
the combination of the two aforementioned factors: the lockbox agreements and
the MAE clause. As discussed above, the Revolver does not expire or have a
maturity date within one year. The Revolver has a final expiration date of
October 31, 2005.

The Term Loan requires monthly principal payments of $138,889 through its
maturity on October 31, 2005. Interest under the Term Loan is payable monthly
at the greater of 8.5% or the Citibank, N.A. prime rate plus 3.5%. Upon
expiration of the Term Loan, the Company will be required to pay a fee of
$100,000.

Beginning, November 30, 2002, the CapitalSource Credit Facility will
require the Company to achieve a minimum level of EBIDTA on a rolling three
month measurement period as outlined below. The CapitalSource Credit Facility
defines EBITDA as net income plus interest expense, income taxes, depreciation
expense, amortization expense, any other non-cash non-recurring expense and
loss from asset sales outside of the normal course of business, minus gains on
asset sales outside the normal course of business, non-recurring gains, and
charges against the Companys loss contract reserve.

|                                                  |  |                |           | 
|------------------------------------------------- |  | -------------- | --------- | 
|Period                                            |  | Minimum EBITDA
|Three month periods ending prior to March 1, 2003 |  | $              | 2,750,000 | 
|Three month periods ending after March 1, 2003    |  | $              | 3,000,000 | 

Also beginning November 30, 2002, the CapitalSource Credit Facility will
require the Company to maintain a minimum fixed charge coverage ratio. The
CapitalSource Credit Facility defines the fixed charge coverage ratio as EBITDA
divided by the sum of principal payments on outstanding debt, cash interest
expense on outstanding debt, capital expenditures, cash income taxes paid or
accrued, and cash dividends paid or accrued or declared. For the month ended
November 30, 2002, the Company will be required to maintain a minimum fixed
charge ratio of 1.0. Beginning December 31, 2002 and continuing for each month
thereafter, the Company will be required to maintain a minimum monthly fixed
charge coverage ratio of 1.5. In addition, beginning on June 30, 2003 and
continuing for each quarter thereafter, the Company will be required to
maintain a minimum fixed charge ratio of 1.75 calculated using the most recent
twelve month period.

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

The Company is dependent on the availability of borrowings pursuant to the
CapitalSource Credit Facility to meet its working capital needs, capital
expenditure requirements and other cash flow requirements during the remainder
of 2002 and through 2003. Management believes that the Company can comply with
the terms of the CapitalSource Credit Facility and meet its expected
obligations throughout 2002 and through 2003. However, should the Company fail
to meet its projected results, it may be forced to seek additional sources of
financing in order to fund its working capital needs.

At September 30, 2002, the Company had standby letters of credit
outstanding totaling $6.6 million. The letters of credit were issued pursuant
to the Amended Credit Facility. On October 31, 2002, there were $6.2 million
of letters of credit outstanding, which became collateralized by borrowings
under the CapitalSource Credit Facility.

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

On October 21, 2002, the Company completed a private placement of 480,000
shares of newly issued common stock at $9.50 per share realizing proceeds of
approximately $4.0 million, net of issuance costs. The net proceeds were used
to repay borrowings under the Companys Amended Credit Facility.
The Company subsequently registered the resale of all of the shares
on a Form S-3 registration statement (No. 333-98355), filed with the
SEC on August 19, 2002 and declared effective on October 18, 2002.

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Inflation

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

Recently Issued Accounting Pronouncements

In June 1998, the FASB issued SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities(SFAS 133), as amended in June 2000 by
SFAS No. 138, Accounting for Certain Derivative Instruments and Certain Hedging
Activities(SFAS 138), which requires the Company to recognize all
derivatives as assets or liabilities measured at fair value. Changes in fair
value are recognized through either earnings or other comprehensive income
dependent on the effectiveness of the hedge instrument. At September 30, 2002,
the Company maintained an interest collar agreement with a bank for a notional
amount of $6.0 million and an expiration date of March 2003. On October 31,
2002, the Company terminated this collar agreement at a cost of $164,575.

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

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

The Company adopted SFAS 141 on July 1, 2001. Such adoption had no effect
on the Companys financial position or results of operations. The Company
adopted SFAS 142 effective January 1, 2002, at which time the amortization of
the Companys existing goodwill ceased. Other than the effect on net income of
not amortizing goodwill, the adoption of SFAS 142 had no effect on the
Companys results of operations or financial position. Amortization expense
related to goodwill during the quarter and nine month period ended June 30,
2001 was approximately $627,000 and $2.2 million, respectively.

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

In April 2002, the FASB issued SFAS No. 145, Rescission of FASB
Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections (SFAS 145). SFAS 145 rescinds Statement of Financial Accounting
Standards No. 4, Reporting Gains and Losses from Extinguishment of Debt,
which required all gains and losses from extinguishment of debt to be
aggregated and, if material, classified as an extraordinary item, net of the
related income tax effect. As a result, the criteria in APB 30 will now be used
to classify those gains and losses. SFAS 145 amends SFAS 13, Accounting for
Leases, to require that certain lease modifications that have economic effects
similar to sale-leaseback transactions be accounted for in the same manner as
sale-leaseback transactions. SFAS 145 also makes technical corrections to
existing pronouncements. While those corrections are not substantive in nature,
in some instances, they may change accounting practice. The provisions of SFAS
145 are effective for financial statements issued for fiscal years beginning
after May 15, 2002, and interim periods within those fiscal years, however,
early adoption is encouraged.

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As discussed above, on October 31, 2002, the Company replaced its existing
credit facility with a new credit facility issued by CapitalSource Finance
LLC. As a result of the transaction, the Company wrote off the deferred loan
costs associated with its existing credit facility. The Company expects to
adopt the provisions of SFAS 145 in the fourth quarter of 2002. Under the
provisions of SFAS 145, the expense resulting from the early termination of the
Companys existing credit facility, primarily consisting of the write off of
the associated deferred loan costs, will be classified as a component of
pre-tax income for the fourth quarter of 2002 versus the extraordinary item
classification that would have been required prior to SFAS 145.

In June 2002, the FASB issued SFAS No. 146, Accounting for Costs
Associated with Exit or Disposal Activities (SFAS 146). SFAS 146 addresses
financial accounting and reporting for costs associated with exit or disposal
activities and nullifies EITF Issue No. 94-3, Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring) (Issue 94-3). SFAS
146 requires that a liability for a cost associated with an exit or disposal
activity be recognized when the liability is incurred. Under Issue 94-3, a
liability for an exit cost as generally defined in Issue 94-3 was recognized at
the date of an entitys commitment to an exit plan. The provisions of SFAS 146
are effective for exit or disposal activities that are initiated after December
31, 2002, with early application encouraged. Adoption of SFAS 146 is not
expected to have a material impact on the Companys financial statements.




ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market risk represents the risk of loss that may impact the consolidated
financial statements of the Company due to adverse changes in financial market
prices and rates. Prior to October 31, 2002, the Companys exposure to market
risk was primarily related to changes in the variable interest rate under the
Amended Credit Facility. The Amended Credit Facility carried an interest rate
based on the Bank of America, N.A. prime rate. Beginning October 31, 2002, the
Companys exposure to market risk will be primarily related to changes in the
variable interest rate under the CapitalSource Credit Facility. The
CapitalSource Credit Facility carries an interest rate based on the Citibank
N.A. prime rate, therefore the Companys cash flow may be affected by changes
in the prime rate. For example, a hypothetical 10% change in interest rates
would have increased or decreased interest expense paid under the Amended
Credit Facility by approximately $270,000 during the nine months ended
September 30, 2002. As of September 30, 2002, the Company had approximately
$41.6 million outstanding under the Amended Credit Facility, which represented
26.1% of the Companys total liabilities and stockholders equity.




ITEM 4. CONTROLS AND PROCEDURES

As required by SEC rules, the Company has evaluated the effectiveness of
the design and operation of its disclosure controls and procedures within 90
days of the filing of this quarterly report. This evaluation was carried out
under the supervision and with the participation of the Companys management,
including its principal executive officer and principal financial officer.
Based on this evaluation, these officers have concluded that the design and
operation of the Companys disclosure controls and procedures are effective.
There were no significant changes to the Companys internal controls or in
other factors that could significantly affect internal controls subsequent to
the date of their evaluation.

Disclosure controls and procedures are the Companys controls and other
procedures that are designed to ensure that information required to be
disclosed by the Company in the reports that it files or submits under the
Securities Exchange Act of 1934 is recorded, processed, summarized and
reported, within the time periods specified in the SECs rules and forms.
Disclosure controls and procedures include, without limitation, controls and
procedures designed to ensure that information required to be disclosed by the
Company in the reports that the Company files under the Exchange Act is
accumulated and communicated to the Companys management, including its
principal executive officer and principal financial officer, as appropriate, to
allow timely decisions regarding required disclosure.

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PART II:




OTHER INFORMATION




ITEM 1. LEGAL PROCEEDINGS

The Company is appealing a $1.7 million judgment against it. In December
1995, the Florida Association of Counties Trust (FACT), as the insurer for
the Polk County Sheriffs Office, and the Sheriff of Polk County, Florida,
brought an action against Prison Health Services in the Circuit Court, 10th
Judicial Circuit, Polk County, Florida seeking indemnification for $1.0 million
paid on behalf of the plaintiffs for settlement of a lawsuit brought against
the Sheriffs Office. The recovery is sought for amounts paid in settlement of
a wrongful death claim brought by the estate of an inmate who died as a result
of injuries sustained from a beating from several corrections officers
employed by the Sheriffs Office. The plaintiffs contend that an
indemnification provision in the contract between Prison Health Services and
the Sheriffs Office obligates the Company to indemnify the Sheriffs Office
against losses caused by its own wrongful acts. The Company was represented by
counsel provided by Reliance Insurance Company, the Companys insurer. In
April 2001, FACTs motion for summary judgment on the question of liability for
indemnity was denied, but on rehearing in July 2001 the prior denial was
reversed and summary judgment was granted. In October 2001, Reliance filed for
receivership. In January 2002, the court entered final judgment in favor of
FACT for approximately $1.7 million at a hearing at which the Company was not
represented, as counsel provided by Reliance had simultaneously filed a motion
to withdraw. The Company retained new counsel in February 2002 and has filed a
notice of appeal on the judgment. The Company expects a decision on the appeal
in early 2003. The Company has posted an appeal bond in the amount of $2.0
million, which has been classified as a deposit and included in prepaid
expenses and other current assets on its consolidated balance sheet. As of
September 30, 2002, the Company has reserved $522,000 related to costs
associated with this proceeding. The Company believes that it will be
successful on appeal. The Company has numerous defenses to FACTs claim,
including the Companys belief that the court that granted summary judgment in
favor of FACT upon rehearing made an error of law when it ruled that the
Companys contract with the Sheriffs Office obligated the Company to indemnify
the Sheriffs Office against its own wrongful acts. In addition, the Sheriffs
Office released the Company from liability for this claim subsequent to filing
the lawsuit. In the event that the Company is not successful on appeal, the
Company does not believe that the adverse judgment will have a material adverse
effect on its financial position, although it may affect its quarterly or
annual results of operations.

In addition to the matter discussed above, the Company is a party to
various legal proceedings incidental to its business. Certain claims, suits and
complaints arising in the ordinary course of business have been filed or are
pending against the Company. An estimate of the amounts payable on existing
claims for which the liability of the Company is probable is included in
accrued expenses at September 30, 2002 and December 31, 2001. The Company is
not aware of any material unasserted claims and, based on its past experience,
would not anticipate that potential future claims would have a material adverse
effect on its consolidated financial position or results of operations.




ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS

On October 21, 2002, the Company closed on the sale of 480,000 shares of
Common Stock to institutional and accredited investors at a price of $9.50 per
share. Net proceeds to the Company, after fees and expenses, were
approximately $4 million. Jefferies & Company, Inc. acted as placement agent
in the sale and received a fee of $250,000. The sale was a privately
negotiated sale to selected institutional investors and other accredited
investors. The shares were exempt from registration under the Securities Act
of 1933 pursuant to Section 4(2) thereof and Rule 506 of Regulation D
promulgated thereunder. The Company used the proceeds to repay indebtedness.
The Company subsequently registered the resale of all of the shares on a Form
S-3 registration statement (No. 333-98355), filed with the SEC on August 19,
2002 and declared effective on October 18, 2002.

27



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##### Table of Contents






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

(A)  Exhibits

|     |  |   |  |                                                                                                                                                                                                                           
|---- |  | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|3.1  |  |  |  | Amended and Restated Certificate of Incorporation of America Service
Group Inc. (incorporated herein by reference to Exhibit 3.1 to the
Companys Quarterly Report on 10-Q for the three month period ended June
30, 2002)
|     |  |   |  |                                                                                                                                                                                                                           
|3.2  |  |  |  | Amended and Restated Bylaws of America Service Group, Inc.
(incorporated herein by reference to Exhibit 3.2 to the Companys
Quarterly Report on 10-Q for the three month period ended June 30, 2002)                     
|     |  |   |  |                                                                                                                                                                                                                           
|4.1  |  |  |  | Specimen Common Stock Certificate (incorporated herein by reference to
Exhibit 4.1 to the Companys Quarterly Report on 10-Q for the three month
period ended June 30, 2002)                                              
|     |  |   |  |                                                                                                                                                                                                                           
|10.1 |  |  |  | Revolving Credit, Term Loan and Security Agreement, dated as of October
31, 2002, between the Company and CapitalSource Finance LLC.                                                                                      
|     |  |   |  |                                                                                                                                                                                                                           
|11   |  |  |  | Computation of Per Share Earnings.*                                                                                                                                                                                       
|     |  |   |  |                                                                                                                                                                                                                           
|99.1 |  |  |  | Certification of the Chief Executive Officer Pursuant to 18 U.S.C.
Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.                                                                    
|     |  |   |  |                                                                                                                                                                                                                           
|99.2 |  |  |  | Certification of the Chief Financial Officer Pursuant to 18 U.S.C.
Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.                                                                    



---

|* |  | Data required by SFAS No. 128, Earnings Per Share, is provided in note 15
to the condensed consolidated financial statements in this report.
|- |  | ----------------------------------------------------------------------------------------------------------------------------------------------

(B)  Reports on Form 8-K

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

28



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##### Table of Contents






SIGNATURES

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

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

Dated:  November 14, 2002

29



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##### Table of Contents






CERTIFICATIONS

I, Michael Catalano, certify that



|1. |  | I have reviewed this quarterly report on Form 10-Q of
America Service Group Inc.;                                                                                                                                                                                                                                             
|-- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  
|2. |  | Based on my knowledge, this quarterly report does not
contain any untrue statement of a material fact or omit to state
a material fact necessary to make the statements made, in light
of the circumstances under which such statements were made, not
misleading with respect to the period covered by this quarterly
report;
|  
|3. |  | Based on my knowledge, the financial statements and
other financial information included in this quarterly report,
fairly present in all material respects the financial condition,
results of operations and cash flows of the registrant as of,
and for, the periods presented in this quarterly report;                    
|  
|4. |  | The registrants other certifying officers and I are
responsible for establishing and maintaining disclosure controls
and procedures (as defined in Exchange Act Rules 13a-14 and
15d-14) for the registrant and we have:                                                                                                     



| | a) |  | designed such disclosure controls and
procedures to ensure that material information relating to
the registrant, including its consolidated subsidiaries, is
made known to us by others within those entities,
particularly during the period in which this quarterly report
is being prepared;
| | -- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |    |  |                                                                                                                                                                                                                                                                                                
| | b) |  | evaluated the effectiveness of the registrants
disclosure controls and procedures as of a date within 90
days prior to the filing date of this quarterly report (the
Evaluation Date); and                                                                                                  
|
| | c) |  | presented in this quarterly report our
conclusions about the effectiveness of the disclosure
controls and procedures based on our evaluation as of the
Evaluation Date;                                                                                                                        



|5. |  | The registrants other certifying officers and I have
disclosed, based on our most recent evaluation, to the
registrants auditors and the audit committee of registrants
board of directors (or persons performing the equivalent
function):
|-- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | a) |  | all significant deficiencies in the design or
operation of internal controls which could adversely affect
the registrants ability to record, process, summarize and
report financial data and have identified for the
registrants auditors any material weaknesses in internal
controls; and
| | -- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | b) |  | any fraud, whether or not material, that
involves management or other employees who have a significant
role in the registrants internal controls; and                                                                                                                                        



|6. |  | The registrants other certifying officers and I have
indicated in this quarterly report whether or not there were
significant changes in internal controls or in other factors
that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material
weaknesses.
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                         |  |                                                                              
|------------------------ |  | -----------------------------------------------------------------------------
|Date:  November 14, 2002 |  | /s/ Michael Catalano                                                         
|                         |  |                                                                              
|                         |  | Name: Michael Catalano
Title: Chairman, President and
Chief Executive Officer

30



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##### Table of Contents



I, Michael W. Taylor, certify that



|1. |  | I have reviewed this quarterly report on Form 10-Q of
America Service Group Inc.;                                                                                                                                                                                                                                             
|-- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|  
|2. |  | Based on my knowledge, this quarterly report does not
contain any untrue statement of a material fact or omit to state
a material fact necessary to make the statements made, in light
of the circumstances under which such statements were made, not
misleading with respect to the period covered by this quarterly
report;
|  
|3. |  | Based on my knowledge, the financial statements and
other financial information included in this quarterly report,
fairly present in all material respects the financial condition,
results of operations and cash flows of the registrant as of,
and for, the periods presented in this quarterly report;                    
|  
|4. |  | The registrants other certifying officers and I are
responsible for establishing and maintaining disclosure controls
and procedures (as defined in Exchange Act Rules 13a-14 and
15d-14) for the registrant and we have:                                                                                                     



| | a) |  | designed such disclosure controls and
procedures to ensure that material information relating to
the registrant, including its consolidated subsidiaries, is
made known to us by others within those entities,
particularly during the period in which this quarterly report
is being prepared;
| | -- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | b) |  | evaluated the effectiveness of the registrants
disclosure controls and procedures as of a date within 90
days prior to the filing date of this quarterly report (the
Evaluation Date); and                                                                                                  
|
| | c) |  | presented in this quarterly report our
conclusions about the effectiveness of the disclosure
controls and procedures based on our evaluation as of the
Evaluation Date;                                                                                                                        



|5. |  | The registrants other certifying officers and I have
disclosed, based on our most recent evaluation, to the
registrants auditors and the audit committee of registrants
board of directors (or persons performing the equivalent
function):
|-- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | a) |  | all significant deficiencies in the design or
operation of internal controls which could adversely affect
the registrants ability to record, process, summarize and
report financial data and have identified for the
registrants auditors any material weaknesses in internal
controls; and
| | -- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|
| | b) |  | any fraud, whether or not material, that
involves management or other employees who have a significant
role in the registrants internal controls; and                                                                                                                                        



|6. |  | The registrants other certifying officers and I have
indicated in this quarterly report whether or not there were
significant changes in internal controls or in other factors
that could significantly affect internal controls subsequent to
the date of our most recent evaluation, including any corrective
actions with regard to significant deficiencies and material
weaknesses.
|-- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|                         |  |                                                                                 
|------------------------ |  | --------------------------------------------------------------------------------
|Date:  November 14, 2002 |  |                                                                                 
|                         |  | /s/ Michael W. Taylor                                                           
|                         |  |                                                                                 
|                         |  | Name: Michael W. Taylor
Title: Senior Vice President and
Chief Financial Officer

31