U.S. Securities and Exchange Commission
                             Washington, D.C. 20549

                                   FORM 10-KSB

     [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)OF THE SECURITIES EXCHANGE
ACT OF 1934

      For fiscal year ended December 31, 1996

     [ ] TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES  EXCHANGE
ACT OF 1934

      Commission File No.:  0-23038


                        CORRECTIONAL SERVICES CORPORATION
                 (Name of small business issuer in its charter)

                               Delaware 11-3182580
                (State of other jurisdiction of (I.R.S. Employee
               incorporation or organization) Identification No.)

                    1819 Main Street, Sarasota, Florida 34236
               (Address of principal executive offices) (Zip Code)

Issuer's telephone number:  (941) 953-9199



Securities registered under Section 12(b) of the Exchange Act:  None.



Securities registered under Section 12(g) of the Exchange Act:


                     Common Stock, par value $.01 per share
                        Warrants to Purchase Common Stock
                                (Title of Class)

     Check  whether  the issuer (1) filed all  reports  required  to be filed by
Section 13 or 15(d) of the  Exchange  Act during the past 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 [ ]

     Check if there is no disclosure  of  delinquent  filers in response to Item
405 of Regulation S-B is not contained in this form,  and no disclosure  will be
contained,  to the  best of  registrant's  knowledge,  in  definitive  proxy  or
information statements incorporated by reference in Part III of this Form 10-KSB
or any amendment to this Form 10-KSB. [x]


     Issuer's revenues for its most recent fiscal year are $31,501,658.



     The aggregate  market value of the 5,279,504 shares of Common Stock held by
non-affiliates of the Company as of March 14, 1997 is $56,754,668.



     The number of shares of Common Stock, par value $.01 per share, outstanding
as of March 14, 1997 is

                                       2
<PAGE>



7,670,879.


     Transitional Small Business Disclosure Format. Yes [ ] No [x]

                                     PART I

Item 1.  Description of Business.



Corporate Structure

     Correctional  Services  Corporation  (the  "Company") was  incorporated  in
Delaware on October 28, 1993 to acquire all of the outstanding  capital stock of
a number of affiliated  corporations engaged in the operation of corrections and
detention facilities.  All references to the Company include the Company and all
wholly-owned subsidiaries on a consolidated basis.


Description

     The Company is a leading  developer and manager of privatized  correctional
and detention  facilities  in the United  States.  Through its three  divisions,
Adult, Juvenile and Community Corrections,  the Company provides a diverse range
of services to local, state, and federal governmental correctional agencies. The
Company  currently  has  agreements  to operate 16  correctional  and  detention
facilities in New York,  Florida,  Arizona,  Texas,  New Mexico and the State of
Washington.  Thirteen  of these  facilities,  with a total of  2,461  beds,  are
currently in operation,  three,  with a total of 900 beds, are anticipated to be
operational in the fourth quarter of 1997. In addition, the Company is currently
operating two facilities on an interim basis, while negotiating contracts,  with
a total of 350 beds each.  See  "Business-Recent  Events."  The  Company is also
aggressively pursuing other privatized correctional projects both at the request
for proposal ("RFP") stage and the pre-RFP development stage.

     The Company  manages both secure and non-secure  facilities.  The Company's
secure facilities  include a detention and processing center for illegal aliens,
an adult prison,  intermediate  sanction  facilities,  driving while intoxicated
("DWI") facilities,  and military-style  boot camps for juvenile offenders.  Its
non-secure   facilities  include   residential   programs,   such  as  community
correctional  facilities  for federal and state  offenders  serving the last six
months of their sentences, and non-residential supervision programs.

     In addition to  providing  fundamental  residential  services for adult and
juvenile  inmates,  the Company has developed a broad range of programs intended
to reduce  recidivism,  including basic and special  education,  substance abuse
treatment  and  counseling,  vocational  training,  life  skills  training,  and
behavioral  modification  counseling.  The  management  services  offered by the
Company range from project consulting to the design,  development and management
of new  correctional and detention  facilities and the redesign,  renovation and
management  of older  facilities.  The Company  believes  its proven  ability to
manage the full  spectrum of  correctional  facilities  and its wide  variety of
programs and services will increase its marketing opportunities.


Growth Strategy

     The  Company's  business  strategy is to enhance its  position as a leading
developer and manager of a diverse range of quality privatized  correctional and
detention facilities, and to expand its operations,  both internally and through
acquisitions,  in order to capitalize on current  growth trends in the industry.
Key elements of the Company's strategy are as follows:



     Maintaining  Quality  Facility  Operations:   The  Company  recognizes  the
importance  of  maintaining  high  quality  management  and  operations  at  its
facilities.  The Company seeks to operate all its facilities in accordance  with
the guidelines of the American Correctional  Association ("ACA"), an independent
organization  comprised of professionals in the corrections  industry,  and uses
compliance  audit  teams to  rigorously  examine  all  aspects of the  Company's
facilities  and  operations.  The Company's  senior level ethics and  compliance
officer, who reports directly to the President and Board of Directors,  provides
additional  oversight and  monitoring of facility  operations.  The Company also
promotes quality performance by its facility administrators and management


                                       3
<PAGE>



     teams and hold  Company-wide  conferences  for facility  administrators  to
exchange information and enhance performance at all its facilities.  The Company
encourages  tours  of its  facilities  for  governmental  representatives  as it
believes the quality of its operations can best be demonstrated  through on-site
visits.



     Capitalizing  on  Diversity  of  Services.  The  diversified   correctional
services  provided  by the Company  include  housing  adult  inmates or detained
persons in secure facilities,  providing  non-secure  residential and management
services  in  community  correctional  facilities  and  managing  and  operating
juvenile   offender   facilities,   both   secure  and   non-secure,   including
military-style  boot camps.  The  Company  believes  that its proven  ability to
manage the full spectrum of privatized correctional facilities will increase its
marketing  opportunities  and will be beneficial where  particular  governmental
policies favor certain types of programs or services over others.



     Enhancing Proven Programs.  In awarding management  contracts,  contracting
governmental  agencies  frequently  give  significant  weight  to the  potential
effectiveness  of the  programs  to be provided  by the  bidder.  The  Company's
programs  include basic and special  education,  substance  abuse  treatment and
counseling,  vocational  training,  job  placement,  life  skills  training  and
behavioral  modification  counseling,  all  of  which  are  intended  to  reduce
recidivism. The Company's staff of professionals seek to continually enhance and
improve these programs,  monitor resident  offender  performance and develop new
programs to address perceived needs.



     Developing  New Business  Opportunities.  The growing demand for privatized
correctional  facilities at all levels of government  has enabled the Company to
pursue more projects meeting its criteria. The Company pursues projects based on
the probability of success,  geographic location, size, potential profitability,
and political and community acceptability. This approach is intended to optimize
resource  allocation,  profitability  and  financial  return.  The  Company  (i)
currently owns a 400 bed correctional  facility in Arizona, (ii) in January 1997
signed a contract to finance,  construct, own and operate a 600 bed adult prison
in Arizona,  (iii) has agreed to fund approximately $650,000 of construction and
related costs for a juvenile boot camp in Texas and (iv) has used its capital to
renovate and improve other  facilities  which it operates.  The Company believes
its  willingness  to commit its capital to  facility  ownership  and  renovation
enhances its growth opportunities.



     Strategic  Acquisitions.   Historically,  the  Company's  growth  has  been
generated  internally,  primarily through the competitive bid process.  However,
the Company continues to evaluate strategic acquisitions,  particularly where an
acquisition  would enhance the Company's  capabilities or add to the services it
offers in the correctional  services industry.  At present,  the Company has not
entered into any agreements or commitments for an acquisition.


Market

     The  continuing  pressure to control  costs and address  increasing  inmate
populations  has generated  strong growth in the  privatization  of correctional
services.  According to the Private Adult  Correctional  Facility Census,  Ninth
Edition,  prepared by the  Private  Corrections  Project,  Center for Studies in
Criminology  & Law,  University  of  Florida,  dated March 15,  1996,  the rated
capacity of international  privatized adult secure correctional  facilities grew
from 2,620 beds in 1986 to 63,595 beds at year-end  1995 and, in a June 16, 1996
forecast  prepared  by the  Project,  is  projected  to grow to 197,503  beds by
year-end  2000.  This  population  does not  include  any  projected  growth for
privatized  juvenile  offender and community  correctional  facilities,  both of
which, the Company believes,  are also growing rapidly.  According to the United
States  Department  of  Justice,  Office of  Juvenile  Justice  and  Delinquency
Prevention,  between 1988 and 1994 juvenile  arrests for violent  crimes grew by
more than 50%.



     The Company  believes the growth in demand for privatized  correctional and
detention  facilities is being fueled by a number of factors.  First, the United
States continues to experience a shortage of correctional beds. According to the
United States Department of Justice, Bureau of Justice Statistics, the number of
adult inmates housed in federal and state  facilities  increased from 487,593 at
December 31, 1985, to 1,104,074 at June 30, 1995.


                                       4
<PAGE>



     Second,  inmates convicted of violent crimes generally serve only one-third
of their  sentences,  and the public is demanding that a longer portion of their
sentences  be  served.  Third,  courts and  various  governmental  agencies  are
requiring  overcrowded  conditions  to be remedied,  outdated  facilities  to be
replaced,  and  services  to be  expanded.  As a  result  of  increasing  fiscal
pressures,  many  governmental  agencies  are turning to the  private  sector to
deliver cost-effective correctional services to address these needs.


Recent Events

     The Company,  in November 1996, took over the management of the Frio County
Jail and  Detention  facility  in  Pearsall,  Texas.  The  Company is  currently
managing  the  facility on an interim  basis and has the option to purchase  the
right to operate the facility,  under the terms of the existing  Management  and
Operations Agreement,  from the former operator. This option expires the earlier
of May 24, 1997 or 30 days after the current  outstanding  debt  associated with
the facility has been refinanced. The facility has recently received 250 inmates
from the State of Idaho under a one (1) year agreement.



     In February  1997 the Company took over the  management  of the Judge Roger
Hashem  Juvenile  Justice  Center in  Rockdale,  Texas.  The  Company  currently
operates the facility on an interim basis and has entered into negotiations with
the Milam,  Robertson and Falls  Counties  regarding a Management and Operations
Agreement. The facility has a capacity of 60 beds.



     Due to substantially  reduced  occupancy levels and operating losses at the
Company's state contracted  community-based halfway houses in New York, New York
and Fort  Worth,  Texas,  the  Company is in the  process of winding  down those
operations.


Operational Divisions


     In January 1996, the Company organized its operations into three divisions:
Adult, Juvenile and Community Corrections.



     Adult.  The Adult  Division  operates  five  secure  facilities  located in
Seattle,  Washington;  Houston,  Del Valle and  Mansfield,  Texas;  and Phoenix,
Arizona, with a total of 1,216 beds. In addition, this Division will operate the
600-bed prison to be constructed and owned by the Company in Florence,  Arizona,
anticipated to become  operational in the fourth quarter of 1997 and the 200 bed
jail located in Gallup, New Mexico.  Currently,  the Division is operating on an
interim  basis a 295 bed facility in Pearsall,  Texas.  In addition to providing
housing for adult inmates,  the Company provides a variety of rehabilitation and
educational  services intended to reduce  recidivism.  The Company also provides
health care,  transportation,  food services and work and recreational  programs
for adult inmates.



     Juvenile.  The  Juvenile  Division  operates  (or  upon  completion  of the
facility  will  operate)  seven  facilities  located (or to be  constructed)  in
Bartow, Polk City and Pahokee, Florida; and Canadian,  Mansfield, Eagle Lake and
Killeen,  Texas, for convicted youths aged 12 to 24, with a total of 1,150 beds.
The Eagle Lake facility is  anticipated  to be operational in the fourth quarter
of 1997.  In addition,  the Division is operating on an interim basis the 60-bed
Judge Roger Hashem Juvenile  Justice  Facility in Rockdale,  Texas.  The Company
manages secure and non-secure  juvenile offender facilities for low, medium, and
high risk youths in highly structured  programs,  including  military-style boot
camps, wilderness programs, secure education and training centers, and detention
facilities.  The Company believes these programs, by instilling the qualities of
self-respect, respect for others and their property, personal responsibility and
family values, can help reduce the recidivism rate of its program participants.



                                       5

<PAGE>



     Community   Corrections.   The  Community   Corrections  Division  operates
facilities,  located in Brooklyn, Manhattan and the Bronx, New York with a total
of 195 beds.  These are  non-secure  residential  facilities  for adult male and
female  offenders   transitioning  from  institutional  to  independent  living.
Offenders  are  eligible  for  these  programs  based  upon the type of  offense
committed and behavior while incarcerated in prison. If qualified, offenders may
generally spend the last six months of their sentence in a community corrections
program,  whose mission is to reduce the  likelihood of an inmate  committing an
offense after release by assisting in the reunification  process with family and
the community.  Normally,  in order to remain in the program,  offenders must be
employed,  participate in substance  abuse  programs,  submit to frequent random
drug  testing,  and pay a  predetermined  percentage  of their  earnings  to the
government  to offset the cost of the  program.  The  Company  supervises  these
activities  and also  provides  life  skills  training,  case  management,  home
confinement  supervision and family reunification  programs at these facilities.
The  Company  believes  that  community  correctional   facilities  help  reduce
recidivism,  result in prison beds being  available  for more violent  offenders
and, in appropriate cases, represent cost-effective alternatives to prisons.


Contract Award Process

     Most governmental  procurement and purchasing  activities are controlled by
procurement  regulations  take the form of RFPs,  and most of the  Company's new
business  results from responding to these requests.  Interested  parties submit
proposals  in response to an RFP within a time period of 15 to 120 days from the
time the RFP is issued.  A typical  RFP  requires  a bidder to provide  detailed
information,  including the services to be provided by the bidder,  the bidder's
experience  and  qualifications  and the price at which the bidder is willing to
provide the services.  The Company engages independent  consultants to assist in
responding  to the RFPs.  Approximately  six to  eighteen  months  is  generally
required from the issuance of the RFP to the contract award. In some cases,  the
Company has been asked to assist governmental agencies in developing their RFPs.



     Before  responding to an RFP, the Company  researches and evaluates,  among
other  factors:  (i) the current size and growth  projections  of the  available
correctional  and detention  population;  (ii) whether or not a minimum capacity
level is guaranteed; (iii) the willingness of the contracting authority to allow
the Company to house populations of similar  classification  within the proposed
facility  for  other  governmental  agencies;  and (iv) the  willingness  of the
contracting  authority  to allow the Company to make  adjustments  in  operating
activities,  such as work force reductions in the event the actual population is
less than the contracted capacity.

     Under the RFP,  the bidder may be  required  to design and  construct a new
facility or to redesign  and renovate an existing  facility at its own cost.  In
such event, the Company's ability to obtain the contract award is dependent upon
its ability to obtain the necessary financing or fund such costs internally.



     In  addition  to  issuing  formal  RFPs,  governmental  agencies  may use a
procedure known as Purchase of Services or Requests for  Qualification  ("RFQ").
In the case of an RFQ, the requesting  agency selects a firm it believes is most
qualified to provide the necessary services and then negotiates the terms of the
contract, including the price at which the services are to be provided.


                                       6
<PAGE>



Facilities

     The Company operates both pre-disposition and  post-disposition  secure and
non-secure  correctional  and  detention  facilities  and  non-secure  community
correctional  facilities  for federal,  state and local  correctional  agencies.
Pre-disposition secure detention facilities provide secure residential detention
for individuals awaiting trial and/or the outcome of judicial  proceedings,  and
for aliens  awaiting  deportation or the  disposition  of deportation  hearings.
Post-disposition  secure facilities provide secure incarceration for individuals
who have been found  guilty of a crime by a court of law.  The Company  operates
three  types  of  post-disposition  facilities:   secure  prisons,  intermediate
sanction   facilities  and  military-style   boot  camps.   Secure  prisons  and
intermediate  sanction  facilities  provide  secure  correctional  services  for
individuals who have been found guilty of one or more offenses. Offenders placed
in intermediate  sanction  facilities are typically persons who have committed a
technical  violation of their parole  conditions,  but whose offense  history or
current  offense  does not  warrant  incarceration  in a prison.  Both  types of
facilities  offer  vocational  training,  substance  abuse treatment and offense
specific  treatment.  Boot camps provide  intensely  structured  and  regimented
residential correctional services which emphasize disciplined activities modeled
after the  training  principles  of  military  boot  camps and  stress  physical
challenges, fitness, discipline and personal appearance.



     The  Company  also  operates  non-secure  residential  and  non-residential
community  corrections programs.  Non-secure  residential  facilities,  known as
half-way houses, provide residential correctional services for offenders in need
of less  supervision and monitoring  than are provided in a secure  environment.
Offenders in community corrections facilities are typically allowed to leave the
facility   to  work  in  the   immediate   community   and/or   participate   in
community-based  educational  and vocational  training  programs  during daytime
hours.  Generally,  persons in community correctional facilities are serving the
last six months of their sentence.  Non-residential programs permit the offender
to  reside at home or in some  other  approved  setting  under  supervision  and
monitoring by the Company. Supervision may take the form of either requiring the
offender to report to a correctional  facility a specified  number of times each
week and/or having Company  employees  monitor the offender on a case management
basis at his/her work site and home.





                                       7
<PAGE>



     The following  information  is provided with respect to the  facilities for
which the Company has  management  contracts or has been selected to negotiate a
management contract:


<TABLE>
<CAPTION>

Facility Name, Location and Year                                                                  Contracting              Owned,
Operations Commenced                                                        Type of              Governmental            Leased, or
                                                 Contracted Beds            Facility                Agency              Managed (2)
                                                       (1)

<S>                                                    <C>                    <C>                     <C>                   <C>

Adult Division
     Seattle INS Detention Center                      150              Secure Detention              INS                  Managed
        Seattle, Washington (1989)                                          Facility
     South Texas Intermediate                          400            Secure Intermediate            State                 Managed
        Sanction Facility                                              Sanction Facility
          Houston, Texas (1993)
     Tarrant County Community                          190            Secure Intermediate            County                Managed
        Correctional Facility(3)                                       Sanction Facility
          Mansfield, Texas (1992)
     Travis County Substance                            76            Secure Intermediate            County                Managed
        Abuse Treatment Facility                                       Sanction Facility
          Del Valle, Texas (1994)
     Arizona State Prison, Phoenix West                400                State Prison               State                  Owned
        Phoenix, Arizona (1996 )
     Arizona State Prison, Florence                    600                State Prison               State                  Owned
        Florence, Arizona (est. 1997)
     Gallup, New Mexico (est. 1997)                    200                    Jail                   County                Managed


Juvenile Division
     Tarrant County Community                          120              Secure Boot Camp             County                Managed
        Correctional Center(3)                                              Facility
          Mansfield, Texas (1992)
     Hemphill County Juvenile Detention Center          60              Secure Boot Camp             County                 Leased
          Canadian Texas (1994)                                             Facility
     Bartow Youth Training Center                       74            Secure & Residential           State                 Managed
          Bartow, Florida (1995)                                     Correctional Facility
     Pahokee Youth Training Center                     350            Secure Correctional            State                 Managed
          Pahokee, Florida  (1997)                                          Facility
     Polk City Youth Training Center                   350            Secure Correctional            State                 Managed
          Polk City, Florida  (1997)                                        Facility
     Colorado County Juvenile Residential Facility     100              Secure Boot Camp             County                Managed
          Eagle Lake, Texas (est. 1997)                                     Facility
     Bell County Youth Training Center(4)               96            Secure Correctional            County                Managed
          Killeen, Texas (1997)                                             Facility



Community Corrections Division
     Brooklyn Community Correctional Center             95                Residential            Federal Bureau             Leased
          Brooklyn, New York (1989)                                  Correctional Facility         of Prisons
     Manhattan Community Corrections Center             60                Residential            Federal Bureau             Leased
          New York, New York (1990)                                  Correctional Facility         of Prisons
     Bronx Community Corrections Center                 40                Residential            Federal Bureau             Leased
          Bronx,  New York (1996)                                    Correctional Facility         of Prisons
     New York State Community Corrections              150                Residential                State                  Leased
          Center (5) Brooklyn, New York (1992)                       Correctional Facility
     Fort Worth Community Corrections Center(5)        200                Residential                State                  Leased
          Fort Worth, Texas (1994)                                   Correctional Facility

</TABLE>


     (1) The number of beds  under  contract  generally  is an  estimate  in the
contract  by the  contracting  government  agency  of the  number  of  offenders
expected  to be  assigned to the  facility  and not a guarantee  of a minimum or
maximum  number of  offenders  to be so assigned.  Certain  facilities  have bed
capacity in excess of the number of beds under  contract  and  therefore  may be
occupied by a greater  number of  offenders  than is  estimated  pursuant to the
contract.

     (2) A  managed  facility  is a  facility  for which  the  Company  provides
management  services  pursuant  to a  management  contract  with the  applicable
governmental  agency but, unlike a leased or owned facility,  the Company has no
property interest in the facility.  The Company has granted  NationsBank a first
priority  security  interest  in all its  assets,  including a first real estate
mortgage on the land and building of the Phoenix, Arizona facility.

     (3) This  facility is listed both as part of the Company's  Adult  Division
and its  Juvenile  Division  as the  facility  houses  both  adult and  juvenile
offenders.

     (4) Initially 64 beds; to be expanded to 96 beds.

     (5) See "Recent Events" for a discussion on the status of this facility.




                                       8
<PAGE>



Facility Management Contracts

     Each facility is managed under an agreement with a federal,  state or local
corrections agency which provides for fixed per diem payments to the Company for
each offender  assigned to the facility or a fixed monthly payment  irrespective
of the number of offenders so assigned.  Some contracts also provide for minimum
revenue guarantees to the Company. As is standard in the industry, the Company's
contracts are  short-term,  generally one to three years,  and contain  multiple
renewal options in favor of the contracting governmental agency.





Operating Procedures

     The Company is responsible for the overall operation of each facility under
its  management,  including staff  recruitment,  general  administration  of the
facility,  security of inmates and  employees,  supervision of the offenders and
facility maintenance.  The Company,  either directly or through  subcontractors,
also provides health care (including medical,  dental and psychiatric  services)
and food  service.  Certain  facilities  also offer special  rehabilitation  and
educational  programs,  such as academic or vocational  education,  job and life
skills training, counseling, substance abuse programs, and work and recreational
programs.



     The  Company's  contracts  generally  require the  Company to operate  each
facility in accordance with all applicable local,  state and federal laws, rules
and  regulations and the standards and guidelines of the ACA The ACA establishes
guidelines  and standards by which an adult  correctional  institution  may gain
accreditation.   The  Company  believes  that  the  ACA,  which  currently  only
recommends operating guidelines for but does not accredit juvenile  correctional
facilities,  will  eventually  accredit  these  kinds  of  facilities.  The  ACA
standards,  designed to safeguard  the life,  health and safety of offenders and
personnel,   describe  specific   objectives  with  respect  to  administration,
personnel and staff training,  security,  medical and health care, food service,
inmate  supervision and physical plant  requirements.  The Company  believes the
benefits of operating its  facilities in accordance  with ACA standards  include
improved  management,  better  defense  against  lawsuits by offenders  alleging
violations  of  civil  rights,  a more  humane  environment  for  personnel  and
offenders  and  measurable  criteria for upgrading  programs,  personnel and the
physical plant on a continuous basis. The Company's Seattle INS Detention Center
and Tarrant County Community  Correctional  Facility are fully accredited by the
ACA and certain other facilities currently are being reviewed for accreditation.
The Company's  goal is to obtain and maintain ACA  accreditation  for all of its
facilities.  Mr.  Richard P. Staley,  the  Company's  Senior Vice  President and
director,  is a member of the ACA and a certified ACA standards auditor for jail
and detention facilities.


Employees

     At March 17, 1997, the Company had approximately 1,265 full-time employees,
consisting of clerical and administrative  personnel,  security personnel,  food
service  personnel  and  facility  administrators.   The  Company  believes  its
relationship with its employees is good.



     Each of the  Company's  facilities  is managed  as a separate  entity by an
experienced   facility   administrator.   Other   facility   personnel   include
administrative,  security, medical, food service, counseling, classification and
educational and vocational training  personnel.  The Company conducts background
screening checks and drug testing on potential facility  employees.  Some of the
services rendered at certain facilities,  such as medical services and education
or training, are provided by third-party contractors.


                                       9
<PAGE>



Employee Training

     All  jurisdictions  require  corrections  officers  to complete a specified
amount of training prior to employment.  In most cases,  Company  employees must
undergo  at least  160  hours of  training  before  being  allowed  to work in a
position  that will bring them in contact  with  offenders  or  detainees.  This
training  consists  of  approximately  40 hours  relating  to Company  policies,
operational  procedures  and  management  philosophy,  and 120 hours relating to
legal issues, rights of offenders and detainees, techniques of communication and
supervision,  improvement of interpersonal  skills and job training  relating to
the  specific  tasks to be held.  Each  Company  employee  having  contact  with
offenders  receives a minimum of 40 hours of additional  training each year, and
each management employee receives a minimum of 24 hours of training each year.


Insurance

     Each management contract with a governmental agency requires the Company to
maintain certain levels of insurance  coverage for general  liability,  workers'
compensation, vehicle liability and property loss or damage and to indemnify the
contracting agency for claims and costs arising out of the Company's operations.
The Company maintains  general  liability  insurance in the amount of $5,000,000
and  two  umbrella  policies  in  the  amount  of  $5,000,000  and  $20,000,000,
respectively, for itself and each of its subsidiaries. There can be no assurance
that the aggregate  amount and kinds of the Company's  insurance are adequate to
cover all risks it may incur or that  insurance will be available in the future.
In addition,  the Company is unable to secure insurance for some unique business
risks including,  but not limited to, riot and civil commotion or the acts of an
escaped offender.


Regulation

     The industry in which the Company operates is subject to federal, state and
local regulations which are administered by a variety of regulatory authorities.
Generally,  providers  of  correctional  services  must comply with a variety of
applicable federal,  state and local regulations,  including  education,  health
care and safety regulations.  Management  contracts frequently include extensive
reporting requirements.  In addition, many federal , state and local governments
are  required  to  follow  competitive  bidding  procedures  before  awarding  a
contract.  Certain jurisdictions may also require the successful bidder to award
subcontracts  on a competitive  bid basis and to subcontract to varying  degrees
with businesses owned by women or minorities.


Litigation

     The  nature  of the  Company's  business  results  in  numerous  claims  or
litigation  against  the Company  for  damages  arising  from the conduct of its
employees or others.  Under the rules of the Securities and Exchange Commission,
the Company is obligated to disclose  lawsuits which involve a claim for damages
in excess of 10% of its current assets  notwithstanding  the Company's belief as
to the merit of the lawsuit and the existence of adequate insurance coverage.



     In May 1993,  a former  employee  of the  Company  filed suit in the United
States  District  Court,   Southern  District  of  New  York,  claiming  he  was
intentionally  assaulted by employees of the Company and claiming  $5,000,000 in
damages on each of six causes of action.  In January  1996,  a lawsuit was filed
with the  Supreme  Court of New  York,  County of  Kings,  by a former  employee
alleging  sexual  harassment  and  discrimination,  physical  assault,  rape and
negligent  screening  of  employees  and  claiming  damages of  $4,000,000  plus
attorney fees.


     In March 1996, former inmates at one of the Company's facilities filed suit
in the  Supreme  Court of the  State of New  York,  County of Bronx on behalf of
themselves  and  others  similarly  situated,  alleging  personal  injuries  and
property damage  purportedly  caused by negligence and  intentional  acts of the
Company and claiming  $500,000,000  each for compensatory and punitive  damages,
which  suit was  transferred  to the  United  States  District  Court,  Southern
District of New York, in April 1996. In July 1996, seven detainees at one of the
Company's  facilities  (and certain of their spouses) filed suit in the Superior
Court of New Jersey, County of Union, seeking


                                       10
<PAGE>



$10,000,000  each in  damages  arising  from  alleged  mistreatment  of the
detainees,  which suit was  transferred  to the United  States  District  Court,
District of New Jersey, in August 1996.



     The Company believes the claims made in each of the foregoing actions to be
without  merit and will  vigorously  defend such  actions.  The Company  further
believes the outcome of these actions and all other current legal proceedings to
which it is a party will not have a material  adverse effect upon its results of
operations, financial condition or liquidity. However, there is an inherent risk
in any litigation and a decision adverse to the Company could be rendered.


Risks Associated with Company's Business

     Risks Associated with Internal Expansion

     The  Company's  growth is  generally  dependent  upon its ability to obtain
contracts to develop and manage new correctional and detention  facilities.  The
rate of such development  depends on a number of factors,  including crime rates
and sentencing  patterns in various  jurisdictions  and the Company's ability to
integrate new facilities into its management  structure.  Certain  jurisdictions
recently have  required the  successful  bidders to make a  significant  capital
investment in connection  with the  financing of a particular  project,  a trend
which will require the Company to have sufficient  capital resources in order to
compete effectively.  In some cases, the Company may decide to construct and own
a  facility  without a  contract  award when it  believes  there is  significant
shortage of beds and a strong likelihood it will be awarded a contract; however,
there can be no assurance that any contract will, in fact, be awarded.  Further,
there can be no assurance  that the Company will be able to obtain  contracts to
construct  and/or manage new facilities or retain existing  contracts upon their
expiration.

     Risks Associated with Acquisitions

     The  Company  intends  to  grow  through  internal  expansion  and  through
selective acquisitions.  There can be no assurance that the Company will be able
to identify, acquire or profitably manage acquired operations or that operations
acquired will be profitable or achieve levels of profitability  that justify the
related investment.  Acquisitions  involve a number of special risks,  including
possible  adverse  short-term  effects  on  the  Company's   operating  results,
diversion of  management's  attention  from  existing  business,  dependence  on
retaining,   hiring  and  training  key   personnel,   risks   associated   with
unanticipated  problems  or legal  liabilities,  and  amortization  of  acquired
intangible  assets,  any of which  could have a material  adverse  effect on the
Company's financial condition, results of operations and liquidity.

     Resistance to Privatization of Correctional and Detention Facilities

     Management of correctional and detention  facilities by private entities is
a relatively  new concept and has not  achieved  complete  acceptance  by either
governments or the public. The movement toward privatization of correctional and
detention  facilities has also encountered  resistance from certain groups, such
as labor  unions,  local  sheriff's  departments,  and groups that  believe that
correctional  and  detention  facility  operations  should only be  conducted by
governmental  agencies. In addition,  changes in the dominant political party in
any market in which the Company operates could result in significant  changes to
the previous acceptance of privatization in such market.  Further,  some sectors
of the federal  government and some state and local  governments are not legally
permitted  to  delegate  their  traditional   management   responsibilities  for
correctional and detention facilities to private companies.


                                       11
<PAGE>






     Contracts Subject to Governmental Funding

     The Company's facility management contracts are subject to either annual or
bi-annual  governmental  appropriations.  A failure by a governmental  agency to
receive such appropriations  could result in termination of the contract by such
agency or a reduction of the management fee payable to the Company. In addition,
even if funds are appropriated,  delays in payments may occur which could have a
material  adverse  effect  on the  Company's  financial  condition,  results  of
operations and liquidity. See "Business - Facility Management Contracts."


     Uncertain Occupancy Levels

     The Company is dependent upon the  governmental  agency with which it has a
management contract to provide inmates for, and maintain the occupancy level of,
the  managed  facility.  A  substantial  portion of the  Company's  revenues  is
generated  under facility  management  contracts that specify a net rate per day
per inmate ("per diem rate"), with no minimum guaranteed occupancy levels, while
most of the Company's  facilities  cost structures are relatively  fixed.  Under
such a per diem rate  structure,  a  decrease  in  occupancy  levels  may have a
material  adverse  effect  on the  Company's  financial  condition,  results  of
operations  and  liquidity.  See "Business  Facility  Management  Contracts" and
"Business-Recent Events."


Regulation

     The  industry  in which the  Company  operates  is  subject to a variety of
federal,  state and local  regulations,  including  education,  health  care and
safety  regulations,  which are administered by various regulatory  authorities.
The Company's contracts typically include extensive reporting requirements,  and
supervision  and  on-site  monitoring  by  representatives  of  the  contracting
governmental  agencies.  Corrections  officers  customarily are required to meet
certain  training  standards  and, in some  instances,  facility  personnel  are
required  to be  licensed  and  subject  to  background  investigation.  Certain
jurisdictions  also require the Company to award  subcontracts  on a competitive
basis or to subcontract with businesses owned by members of minority groups. The
failure to comply with any applicable laws, rules or regulations and the loss of
any  required  license  could have a material  adverse  effect on the  Company's
financial condition,  results of operations and liquidity.  Further, current and
future  operations of the Company may be subject to  additional  regulation as a
result of new statues and regulations or changes in the manner in which existing
statutes and regulations are or may be interpreted or applied,  which could have
a material  adverse  effect on the  Company's  financial  condition,  results of
operations and liquidity.


Competition

     The Company  competes  on the basis of cost,  quality and range of services
offered, its experience in managing facilities,  the reputation of its personnel
and its ability to design,  finance and  construct new  facilities.  Some of the
Company's  competitors  have greater  resources than the Company.  There are few
barriers for companies  seeking to enter into the management of  correctional or
detention  facilities.  The Company  also  competes in some  markets  with local
companies that may have a better  understanding of local conditions and a better
ability to gain  political  and public  acceptance.  In addition,  the Company's
Community  Corrections  and Juvenile  Divisions  compete with  governmental  and
not-for-profit entities.


Item 2.  Description of Property.


Brooklyn, New York Lease

     The Company leases this building,  located at 988 Myrtle Avenue,  Brooklyn,
New York, from Myrtle Avenue Family Center,  Inc.  ("MAFC")  pursuant to a lease
which commenced January 1, 1994 and expires


                                       12
<PAGE>



December 31, 1998.  The lease  establishes a monthly  rental of $40,000 and
contains  three  five-year  renewal  options.  The monthly  rental for the first
option  period,  which runs from January 1, 1999 through  December 31, 2003,  is
$40,000.  The  monthly  rental for the  second  option  period,  which runs from
January 1, 2004 through  December 31, 2008, is $45,000,  and the monthly  rental
for the third option  period,  which runs from January 1, 2009 through  December
31, 2013, is $50,000. In addition,  the Company pays taxes,  insurance,  repairs
and  maintenance  on the building.  MAFC is a  corporation  owned by Esther Horn
(27.5%),  James  F.  Slattery  (8%)  and  Aaron  Speisman  (27.5%),  significant
stockholders of the Company.  The terms of the lease were not negotiated at arms
length due to their relationship with both the Company and MAFC.

Bronx, New York Lease

     The Company leases a building  located at 2534 Creston Avenue,  Bronx,  New
York from Creston Realty Associates,  L.P. ("CRA"), which is owned 10% by Esther
Horn, a significant  stockholder  of the  Company..  The lease term is two years
commencing October 1, 1996 and has three additional one year option periods. The
Company  also pays a base rent of  $180,000  per year which will  escalate  five
percent per year for each of the three year options if they are  exercised.  The
Company pays taxes,  insurance,  repairs and  maintenance on this building which
will be used to house a community  correctional  center. The terms of this lease
were not negotiated at arms length due to the relationship  between the Company,
Ms.  Horn and  CRA.  However,  pursuant  to the  terms  of a Board of  Directors
resolution adopted in connection with the Company's initial public offering, all
transactions  between  the  Company  and  any  of  its  officers,  directors  or
affiliates (except for wholly-owned subsidiaries) must be approved by a majority
of the  unaffiliated  members of the Board of Directors  and be on terms no less
favorable to the Company than could be obtained from unaffiliated  third parties
and be in connection with bona fide business purposes of the Company.

Manhattan, New York Lease

     The Company  subleases the building located at 12-16 East 31st Street,  New
York, New York as well as an annex located at 11 East 30th Street, New York, New
York from LeMarquis  Operating Corp.  ("LMOC").  The Company currently  utilizes
approximately  fifty  percent of the  building  for the  LeMarquis  Correctional
Center  and  for  the  New  York  Community  Correctional  Program.  LMOC  is  a
corporation  owned 25% by Ms.  Horn and 8% by Mr.  Slattery.  LMOC  leases  this
building  from an  unaffiliated  party  at a  current  base  monthly  rental  of
approximately  $15,456 (the "Base  Rent"),  plus taxes and other  charges in the
approximate   current   amount  of  $17,346  for  a  total  monthly   rental  of
approximately  $32,802. The Company has the right to use as much of the building
as it requires  for its  business  subject to the rights of certain  residential
subtenants to remain in the building.  These rights include the right to housing
at a predetermined  rental for an indefinite period of time pursuant to New York
State rent stabilization laws.

     The  Company  pays rent of $18,000 per month above the rent paid by LMOC to
the  building's  owner for a total monthly rent of  approximately  $50,802.  The
Company has, to date, invested $690,000 in leasehold  improvements.  The Company
will not receive any credit,  in terms of a reduction in rent or otherwise,  for
these improvements. The initial term of the Company's sublease expired April 30,
1995 and is in its first  renewal  period  which  expires  April 30,  2000.  The
sublease  contains two additional  five-year  renewal  options  beginning May 1,
2000. The monthly rent above the rent paid by LMOC to the building's  owner will
increase to $22,000 per month during the second  renewal term  beginning  May 1,
2000 and to $26,000 per month  during the third  renewal term  beginning  May 1,
2005. In 1994,  the Company paid $40,000 to LMOC for the renewal  options.  This
option payment was separately  negotiated  between the Board of Directors of the
Company and LMOC. Mr. Slattery participated in such negotiations.


Fort Worth, Texas Lease

     The Company leases the facility located at 600 North Henderson Street, Fort
Worth,  Texas from an unaffiliated  party at a monthly rental of $10,200 for the
period May 16, 1994  through May 15,  1996;  $10,400 for the period May 16, 1996
through May 15,  1997;  $10,815.20  for the period May 16, 1997  through May 15,
1998;  and  $11,252.97  for the period May 16, 1998 through April 15, 1999.  The
lease for these premises  commenced May 16, 1994 and expires April 15, 1999. The
lease  contains three renewal  options.  The term of the first renewal option is
for three years and the second and third renewal options are for two years.  The
Company's rent is to


                                       13
<PAGE>



increase four percent per annum during each year of the renewal term.



Executive Office Leases

     The Company  leases  approximately  6,400 square feet of  executive  office
space located at 1819 Main Street, Sarasota,  Florida from an unaffiliated party
at a base  monthly  rental of $8,278.29  for the period  October 1, 1995 through
September 30, 1996;  $8,812.38 for the period October 1, 1996 through  September
30, 1997;  $9,346.46 for the period October 1, 1997 through  September 30, 1998;
$9,880.54 for the period October 1, 1998 through September 30, 1999;  $10,414.63
for the period  October 1, 1999 through  September 30, 2000.  The lease does not
contain any renewal  options.  On March 1, 1997 the Company entered into a lease
amendment for approximately 1,399 square feet in its existing executive offices.
The lease  amendment  calls for an additional  base rental of $1,924 with annual
increases  of  approximately  $100  per  month on each  October  1st  until  the
expiration of the lease amendment on September 30, 2000.

     The Company also leases an office at 9603 Gayton Road,  Richmond,  Virginia
from an unaffiliated party at a current base monthly rental of $1,661. The lease
for these  premises,  which  commenced June 10, 1995,  expires May 31, 1998. The
base monthly rent  payable by the Company  under this lease is to increase  five
(5) percent per year during the term of the lease.

     The Company also leases an office at 276 Fifth Avenue,  New York,  New York
from an  unaffiliated  party at a monthly rental of $2,231.  The lease for these
premises, which commenced November 1, 1993, expires October 31, 1998.

     Additional  information with respect to this item is incorporated herein by
reference to Item 2-"Business- Facilities."


Item 3.  Legal Proceedings.

         Information  with  respect  to this  item  is  incorporated  herein  by
reference to Item 1 "Business-Litigation."


Item 4.  Submission of Matters to a Vote of Stockholders.

     On July 28, 1996 the Company  shareholders agreed to change the name of the
corporation from "Esmor Correctional  Services,  Inc." to "Correctional Services
Corporation."  The shareholders also agreed to increase the number of authorized
shares of Common Stock from  10,000,000  to  30,000,000  all with a par value of
$.01 per share.




                                       14
<PAGE>





                                     PART II

Item 5.    Market for Common Equity and Related Stockholder Material

     (a)The Company's Common Stock is traded on The Nasdaq National Market under
the symbol "CSCQ." The following table sets forth the high and low closing sales
prices for the calendar  quarters  indicated  from February 2, 1994, the date of
the  Company's  initial  public  offering,  as reported  by the Nasdaq  National
Market:

                                            High                   Low
1995:

First Quarter.....................         16 1/5                 7 7/8
Second Quarter....................         22 1/2                 10 1/2
Third Quarter.....................         15 1/2                 7
Fourth Quarter....................         13 3/4                 7 1/4

1996:

First Quarter.....................         14                     8 1/2
Second Quarter....................         20 1/2                 8 1/2
Third Quarter.....................         17 1/4                 10
Fourth Quarter....................         16 1/2                 10


     (b) As of March 14, 1997,  there were  approximately  2,694  holders of the
Company's  Common Stock,  including  beneficial  owners of shares  registered in
nominee or street name.

     (c) The Company has not paid any cash  dividends  on its capital  stock and
does not anticipate  paying any such dividends in the  foreseeable  future.  The
Company's  bank loan  agreement  precludes  the  payment of  dividends  prior to
December 31, 1996. Thereafter, such dividends are limited to ten percent (10.0%)
of the  Company's  net  earnings  after taxes,  provided  that the Company is in
compliance with the Financial covenants of the bank loan agreement.

     The Company  also has Series A Warrants to purchase  its Common  Stock at a
purchase  price of $7.75 per share which trade on the Nasdaq  Stock market under
the symbol "CSCQW."

Item 6.   Management's Discussion and Analysis or Plan of Operation.

     Revenues  generated  under  federal,  state  and  local  government  agency
contracts for the management of  correctional  and detention  facilities are the
Company's principal source of income. Certain contracts are based on a fixed per
diem rate per offender,  some of which have guaranteed minimum payments;  others
provide  for fixed  monthly  rates  irrespective  of the  number  of  offenders.
Contracts typically are short-term ranging from one to three years, with renewal
options in favor of the governmental  agency,  thereby subjecting the Company to
the attendant risks.

     The Company pays all costs of operating the managed facilities, except rent
in the case of government-owned  facilities.  The Company's primary expenses are
categorized as operating, general,  administrative and interest expenses, net of
interest income. Operating expenses consist of payroll (employee salaries, wages
and fringe  benefits,  and payroll  taxes) and resident  expenses (food service,
medical   services,   supplies  and  maintenance   and  repairs).   General  and
administrative expenses include rent, utilities,  insurance,  professional fees,
travel, lodging depreciation and amortization.



     The Company usually incurs  development costs, which may range from $50,000
to $200,000,  in  responding  to a  governmental  agency RFP. Such costs include
planning  and  developing  the project,  preparing  the bid proposal and travel,
legal and consulting fees. If management  believes the recovery of such costs is
probable, the costs are

                                       15

<PAGE>



deferred until the anticipated contract has been awarded, at which time the
deferred  costs are  amortized  on a  straight-line  basis  over the term of the
contract  (including  option periods not to exceed five (5) years).  Development
costs of  unsuccessful  or  abandoned  bids are  expensed.  The time period from
incurring  initial  development  costs  on a  project  to  the  commencement  of
operations ranges from six to eighteen months.



     After a contract has been awarded,  the Company incurs  start-up costs from
the date of the award until  commencement of operations.  Start-up costs include
recruitment,  training and travel of personnel and certain legal costs,  and are
capitalized until operations commence, at which time such costs are amortized on
a straight-line  basis over the term of the contract  (including  option periods
not to exceed five (5) years).  Revenues  generated  during this initial  period
under per diem contracts increase as the offender population increases.


Results of Operations

     The following  table sets forth certain  operating  data as a percentage of
total revenues:

                                       Percentage of Total Revenues
                                         Years Ended December 31,

                                    1995                         1996
                                    ----                         ----
Revenues:
   Resident Fees                    96.8%                       98.0%
   Other Income                      3.2                         2.0
                                    -----                       -----
      Total Revenues                100.0                       100.0
                                    -----                       -----
Expenses:
   Operating                         62.7                        69.6
   General and Administrative        31.5                        27.5
   Ft. Worth & NYCC Closure
    Costs                             -                          10.6
   New Jersey Facility Closure
    Costs                            12.4                          -
                                     ----                         ---
      Total Expenses                106.6                       107.7
                                    -----                       -----
Operating (Loss)                   (  6.6)                     (  7.7)
   Interest Expense, Net              2.2                         1.5
                                    -----                       -----
   Loss Before Income Taxes        (  8.8)                     (  9.2)
   Income Tax Benefit               ( 3.3)                       (3.3)
                                   -------                     -------
      Net Loss                     (  5.5%)                      (5.9%)
                                   --------                    -------


Year ended December 31, 1996 Compared to Year ended December 31, 1995

     Revenue increased slightly from $31,490,026 for the year ended December 31,
1995 to $31,501,658 for the year ended December 31, 1996. A full year's revenues
in 1996  generated by the Canadian,  Texas  facility  which began  operations in
April,  1995 and the Bartow,  Florida  facility  which began  operations in July
1995, as well as revenues generated by the Phoenix, Arizona facility which began
operation  in  April  1996,  were  offset  by  the  loss  in  revenues  stemming
principally  from  the  discontinuance  of  the  Company's   operations  at  its
Elizabeth, New Jersey INS facility on June 18, 1995 and lower occupancy rates at
the  Company's  Fort  Worth,  Houston,   Texas  and  New  York  State  Community
Corrections facilities.

     Operating  expenses  increased  11.1% from  $19,731,797  for the year ended
December 31, 1995 to $21,928,329  for the year ended December 31, 1996 primarily
due to increases in payroll which increased  $1,839,967 or 15.1%.  These changes
resulted  primarily  from the opening of the  facilities  noted  above,  and the
addition of  management  personnel in the corporate  office.  As a percentage of
revenues,  operating  expenses  increased from 62.7% for the year ended December
31, 1995 to 69.6% for the year ended December 31, 1996.

     General and administrative expenses decreased 12.9% from $9,938,344 for the
year ended December 31, 1995 to $8,655,628 for the year ended December 31, 1996.
The decline in general and administrative expenses was primarily attributable to
the  closure of the  Elizabeth,  New Jersey INS  facility  in June,  1995.  As a
percentage


                                       16
<PAGE>



of revenues,  general and administrative  expenses were 31.6% and 27.5% for
the years  ended  December  31,  1995 and 1996  respectively.  In  addition,  at
December 31, 1995 and 1996,  the Company  wrote-off  $3,909,700  and  $3,329,000
respectively  in  facility  closure  costs for its  Elizabeth,  New  Jersey  INS
facility  (1995)  and for its Fort  Worth,  Texas and New York  State  Community
Corrections  programs (1996).  In each year, the Company wrote-off fixed assets,
development  and start-up costs and other costs  associated  with the closure of
each program.

     The  operating  losses  for the  1995  and 1996  years  of  $2,089,815  and
$2,411,299  respectively  are  attributable  principally to the above  mentioned
facility closure costs.

     Interest  expense net of interest income  decreased 31.1% from $699,576 for
the year ended  December  31, 1995 to $481,728  for the year ended  December 31,
1996.  This  decrease  resulted  primarily  from  utilizing a portion of the net
proceeds  received  from the September  1996 public  offering of Common Stock to
repay bank indebtedness  which reduced interest expense,  and from investing the
balance of the net proceeds in cash equivalents which increased interest income.

     The income tax benefits of $1,050,000 and $1,025,000  respectively  for the
years 1995 and 1996 result  principally from the utilization of operating losses
sustained in each year.  The  effective  tax rate was 37.6% in 1995 and 35.4% in
1996.

     As a  result  of the  foregoing  factors,  the  Company  had a net  loss of
$1,739,391 or $0.38 per share for the year ended December 31, 1995 compared to a
net loss of $1,868,027 or $0.32 per share for the year ended December 31, 1996.



Liquidity and Capital Resources

     The  Company has  historically  financed  its  operations  through  private
placements and public sales of its  securities,  cash generated from  operations
and borrowings from banks.  The company had working capital at December 31, 1996
of $23,560,360, an increase of $19,020,264 from the Company's working capital at
December 31, 1995, which is principally  attributable to funds received from the
September 1996 public  offering of its Common Stock noted below in the financing
section. The Company's current ratio increased to 5.83 to 1 at December 31, 1996
from 1.95 to 1 at December 31, 1995.

     Approximately $15.8 million of the net proceeds of the public offering have
been allocated to fund construction,  start-up and related costs with respect to
two 350-bed  detention  facilities in Florida ($3.0 million in start-up),  which
became  operational  in  December  1996 and  January  1997,  and two  facilities
scheduled  to become  operational  in the  fourth  quarter of 1997 for which the
projected costs to the Company are estimated at $12.8 million.

     Net cash provided by operating activities was $1,022,759 for the year ended
December  31, 1996 as compared to  $3,226,138  for the year ended  December  31,
1995.  The  decrease  was  attributed  primarily  to  an  increase  in  accounts
receivable  and  other  current  assets.  Net  cash of  $9,585,473  was  used in
investing  activities  during the year ended  December  31,  1996 as a result of
fixed asset  acquisition  costs of $6,018,195,  the majority of which related to
the Phoenix,  Arizona facility and $4,317,276 in additional deferred development
and start-up costs  principally  for Phoenix,  Arizona and the Polk and Pahokee,
Florida  projects,  as  compared  to net cash of  $8,684,961  used in  investing
activities for the year ended  December 31, 1995.  Net cash of  $25,738,276  was
provided by financing activities in the year ended December 31, 1996 as compared
to $8,907,125 in the year ended December 31, 1995. The principal  source of such
funds for the year ended  December  31,  1996 was the public  offering of Common
Stock  and for the year  ended  December  31,  1995  the  private  placement  of
subordinated debt, warrants and Common Stock (see below).



Financing


                                       17

<PAGE>



     On September 12, 1996 the Company  completed a public offering of 2,450,000
shares of Common Stock at $13.625 per share.  Of the 2,450,000  shares of Common
Stock offered,  2,070,000 were sold by the Company and 380,000 shares by certain
stockholders.  The Company did not receive any proceeds  from the shares sold by
the  stockholders.  The net  proceeds  received by the Company  after  deducting
applicable issuance costs and expenses aggregated $25,938,514.  The net proceeds
were used to repay  short-term and long-term bank  indebtedness in the amount of
$7,198,468 and will be used to finance construction,  start-up and related costs
of two Florida facilities,  other facilities and for general corporate purposes,
including  the  financing  of working  capital  needs.  Also,  in October,  1996
pursuant  to the  underwriters'  over-allotment  option,  the  Company  sold  an
addition  367,500  shares  of  Common  Stock,  which  aggregated  an  additional
$4,569,542 in net proceeds.

     Effective  December  31,  1995,  the Company  entered  into an  $11,000,000
Revolving   Credit  and  Term  Loan  Agreement  (the  "Loan   Agreement")   with
NationsBank, N.A. ("NationsBank").  Pursuant to the terms of the Loan Agreement,
the Company,  from time to time,  may borrow up to the lesser of  $6,000,000  or
85.0% of the Company's  eligible  accounts  receivable.  Loan proceeds are to be
used for working capital,  including deferred  development and start-up costs in
connection  with new or existing  facilities.  Interest on the revolving  credit
loan is computed, at the Company's option, at either NationsBank prime rate plus
0.75%  or the  London  International  Bank  rate  plus  3.35%.  Under  the  Loan
Agreement, NationsBank also made a term loan at an interest rate of 8.92% to the
Company in the principal  amount of  $5,000,000,  which was applied to repay the
Company's indebtedness of $5,002,869 to another bank.

     The short-term and long-term bank loans were repaid in September 1996, with
a portion of the proceeds received from the public offering. After September 30,
1996, the interest rate payable under the revolving credit loan will be based on
the Company's financial performance set forth in the Loan Agreement. The Company
may prepay any borrowings  without interest or penalty.  The Company has granted
NationsBank the first priority security interest in all of its assets, including
a first real estate  mortgage on the land and building of the  Phoenix,  Arizona
facility. The Company is required to pay NationsBank 0.25% of the average unused
portion of the revolving credit loan.

     During the year ended  December 31, 1995,  the Company  completed a private
placement of 5,676.6 units at $1,000 per unit, each unit consisting of (i) a ten
percent (10.0%) subordinated  promissory note due July 1, 1998, in the principal
amount of $1,000,  and (ii) four year  warrants to purchase 154 shares of Common
Stock at $7.75 per share. The Company received gross proceeds of $5,676,600 from
the sale of the  units of which  $365,000  was  attributed  to the  value of the
warrants.

     During such period,  the Company also  completed  the private  placement of
496,807 shares of Common Stock at $7.75 per share,  receiving  gross proceeds of
$3,850,254.  Approximately  $8,500,000 of the proceeds of the two placements was
used to finance costs  associated with the Company's  Phoenix,  Arizona facility
and the balance for expenses  related to the private  placements and for working
capital.

     The Company received from the exercise of stock options and warrants during
the years ended December 31, 1996 and 1995 $426,890 and $33,320 respectively.

Item 7.


     The information  required by this Item is contained on Pages F-1 through
F-27 hereof.

Item 8.
         None.


                                    PART III

Item 9.  Directors, Executive Officers, Promoters and Control Persons;
         Compliance with Section 16(a) of the Exchange Act

                                       18
<PAGE>



Executive Officers and Directors

     The  following  table lists the  executive  officers  and  directors of the
Company, together with their respective ages and offices:

<TABLE>
<CAPTION>


Name                              Age             Office

<S>                               <C>               <C>

James F. Slattery                 47              President, Chief Executive Officer and Director

Michael C. Garretson              52              Executive Vice President and Chief Operating Officer

Aaron Speisman                    49              Executive Vice President, Secretary and Director

Ira M. Cotler                     34              Executive Vice President-Finance

Richard P. Staley                 65              Senior Vice President and Director

Lee Levinson                      55              Chief Financial Officer

Melvin T. Stith(1)                50              Director

Raymond S. Evans(1)               60              Director

Stuart M. Gerson(1)               53              Director

Shimmie Horn                      24              Director


</TABLE>


-------------------------

(1)  Member of Audit, Compensation and Stock Option Committees.


     James F. Slattery  co-founded  the Company in October 1987 and has been its
President,  Chief Executive Officer and a director since the Company's inception
and Chairman since August 1994.  Prior to co-founding the Company,  Mr. Slattery
had  been a  managing  partner  of Merco  Properties,  Inc.,  a hotel  operation
company,  Vice President of Coastal  Investment Group, a real estate development
company,  and had held several  management  positions  with the  Sheraton  Hotel
Corporation.

     Michael  C.  Garretson  joined  the  Company  in  August  1994 as its  Vice
President of Business  Development.  In October  1995, he became the Director of
Planning  and Economic  Development  for the City of  Jacksonville,  Florida and
served in such position  until  rejoining  the Company in January  1996,  during
which period he also acted as a consultant  to the Company.  Mr.  Garretson  was
elected Executive Vice President and Chief Operating Officer in March 1996. From
September  1993 to August  1994,  Mr.  Garretson  was Senior Vice  President  of
Wackenhut Corrections Corp., a developer and manager of privatized  correctional
and  detention  facilities,  and from August 1990 to August 1993 was Director of
Area Development for Euro Disney S.C.A., the operator of a European theme park.

     Aaron  Speisman  co-founded  the  Company in October  1987 and has been its
Executive  Vice  President,   Secretary  and  a  director  since  the  Company's
inception.  From October 1987 to March 1994,  Mr.  Speisman also served as Chief
Financial  Officer of the  Company.  Since June 1, 1996,  Mr.  Speisman has been
employed by the Company on a part-time basis.

     Ira M. Cotler was elected the Company's Executive Vice President-Finance in
March 1996.  Prior to joining the Company,  from June 1989 to February 1996, Mr.
Cotler was employed by Janney Montgomery Scott Inc., an investment banking firm,
serving in several  capacities,  most  recently as Vice  President  of Corporate
Finance.

     Richard P.  Staley has served as the  Company's  Senior Vice  President  of
Operations since November 1988


                                       19
<PAGE>



and as a director  since May 1994.  From 1984 to 1987,  Mr.  Staley was the
Evaluation and Compliance  Director for  Corrections  Corporation of America and
from 1953 to 1983, held various  positions with the United States  Department of
Justice,  Immigration  and  Naturalization  Service.  Mr.  Staley is a certified
American  Correctional  Association  standards  auditor  for jail and  detention
facilities.

     Lee  Levinson  became an employee  of the Company in February  1994 and was
elected Chief Financial  Officer in March 1994. From 1989 until December,  1993,
Mr. Levinson was a partner at Fleischman & Company, independent certified public
accountants. Mr. Levinson is a certified public accountant.

     Melvin T. Stith was elected a director  of the  Company in  November  1994.
Since July 1991, Mr. Stith has been Dean of the Florida State University College
of  Business.  From  December  1989 to July 1991,  Mr. Stith was Chairman of the
Marketing  Department of the Florida State University  College of Business where
he was also a  Professor.  Mr.  Stith is also a  director  of Sprint  and United
Telephone of Florida.

     Raymond S. Evans was elected a director in May 1994. For more than the past
five  years,  Mr.  Evans has been a partner of the law firm of  Ruskin,  Moscou,
Evans & Faltischek, P.C.

     Stuart M. Gerson was elected a director in June 1994. Since March 1993, Mr.
Gerson has been a partner of the law firm of Epstein  Becker & Green,  P.C. From
January 1993 to March 1993, he was acting Attorney General of the United States.
From January 1989 to January 1993,  Mr. Gerson was the Assistant  U.S.  Attorney
General for the Civil Division of the Department of Justice.

     Shimmie Horn was elected a director of the Company in June 1996.  Mr. Horn,
received a B.A.  degree in Economics from Yeshiva College in 1993, and graduated
from the  Benjamin  Cardozo  School  of Law in  1996.  He is the son of the late
Morris Horn, the former Chairman and a founder of the Company.


                                       20
<PAGE>




Item 10.    Executive Compensation

     The  following  table sets forth a summary  of the  compensation  earned in
1994, 1995 and 1996 by the Company's  Chief Executive  Officer and by each other
executive  officer  whose  compensation   exceeded  $100,000  in  1996:


<TABLE>
<CAPTION>

                           Summary Compensation Table

                                                                                                                      Long Term
                                                         Annual Compensation                                    Compensation Awards

                                                                                               Number of Shares       ALl Other
Name and Principal Position                                                Other Annual       Underlying Options     Compensation
                                Year         Salary          Bonus        Compensation (1)        Granted                (2)
                                ----         ------          -----        ----------------        -------                ---

<S>                              <C>            <C>            <C>             <C>                   <C>                 <C>      


James F. Slattery               1996        $208,685            0             $19,984                  0               $20,139
                                                                                                                       
  President and                 1995        $189,000            0             $13,010              5,000               $30,263   
                                                                                                                       
  Chief Executive Officer       1994        $180,000        $77,230           $23,063             13,125               $22,376



Lee Levinson                    1996        $112,184        $   507           $ 5,167              5,000                 0

  Chief Financial Officer       1995        $110,615        $ 1,000           $ 5,167              5,000                 0

                                1994        $ 90,269        $ 1,000           $ 7,615(3)          12,813                 0

Michael Garretson               1996        $112,406        $   507           $13,000(4)         100,000                 0
  Executive Vice President                                                                        
                                1995        $ 55,926            0                 0                6,250                 0
                                                                                                              
                                1994        $ 17,525            0                 0                  0

Ira Cotler                      1996        $107,261        $   507            $50,396(5)        100,000                0
  Executive Vice President                                                                                              
                                1995          N/A               N/A               N/A               N/A                 N/A
                                                                                                   
                                1994          N/A               N/A               N/A               N/A                 N/A

</TABLE>


------------------

     (1) Consists of car lease payments.

     (2) Consists of life insurance premiums.

     (3) Consists of $7,615 of  consulting  fees prior to his employment by the
         Company.

     (4) Also includes housing allowance.

     (5) Also includes relocation and related costs.



     In addition to the  compensation  described  above,  for 1995, Mr. Slattery
received S Corporation distributions of $134,400.




                                       21
<PAGE>



     The following table sets forth information concerning stock options granted
executive officers named in the Summary Compensation Table:



                              Option Grants in 1996



                                   Individual
                                Grants Individual
                 ---------------------------------------------
<TABLE>
<CAPTION>


                               Number of        % of Total                                       Potential Realizable Value
                                 Shares          Options                                         at Assumed Annual Rates of
                               Underlying        Granted          Exercise                      Stock Price Appreciation for
                                Options            all             Price         Expiration               Option Term
          Name                   Granted        Employees        per/Share          Date              5%               10%
          ----                   -------        ---------       ------------     ----------        --------         ---------

<S>                               <C>               <C>             <C>              <C>             <C>              <C>

James F. Slattery.........            0              0                   0                0               0                0
Lee Levinson..............        5,000            1.9%            $11.000         1/5/2001        $ 18,944         $ 41,973
Michael Garretson.........      100,000             39%            $11.000         1/5/2001        $244,500         $540,500
Ira Cotler................      100,000             39%            $11.000         1/5/2001        $244,500         $540,500 


</TABLE>




     The following table sets forth information concerning stock options granted
executive officers named in the Summary Compensation Table:

                       Option Values at December 31, 1996


<TABLE>
<CAPTION>

                                              Number of                                 Value of
                                          Shares Underlying                 Unexercised In-The-Money Options
                                         Options at Year End                          at Year End
Name                                     Exercisable/Unexercisable                Exercisable/Unexercisable

<S>                                              <C>                                        <C>                 

James F. Slattery...............              6,563/11,562                          $  6,497/$  6,496           
Lee Levinson....................              6,407/12,656                          $ 15,439/$ 15,435 
Mike Garretson..................             26,458/66,667                          $138,877/$366,669
Ira Cotler......................             33,333/66,667                          $183,332/$366,669

</TABLE>


Employment Agreements

     The Company has entered  into an  employment  agreement  with Mr.  Slattery
which expires  February 9, 1999 and provides for minimum annual  compensation of
$189,000,  cost of living  increases,  use of an  automobile,  reimbursement  of
business expenses, health insurance, related benefits and a bonus equal to 5% of
pre-tax profits in excess of $1,000,000,  such bonus not to exceed $200,000.  As
of June 1, 1996, Mr.  Speisman is employed under an agreement which provides for
Mr. Speisman's employment on a part-time basis at an annual salary of $35,000.

     The  Company has also  entered  into  employment  agreements  with  Messrs.
Garretson and Cotler which expire January 20, 1999 and provide for  compensation
of $115,000 and  $129,000,  respectively,  annual salary  increases,  automobile
allowances,  reimbursement of business expenses, health or disability insurance,
related  benefits,  a  bonus  equal  to 3%  of  pre-tax  profits  in  excess  of
$1,000,000, such bonus not to exceed $50,000 and $75,000,  respectively, and the
grant to each of options to purchase 100,000 shares of Common Stock. See "Stock


                                       22
<PAGE>



Options-Other Options."

     In October  1989, a subsidiary  of the Company,  entered into an employment
agreement with William Banks.  Under this  agreement,  Mr. Banks was responsible
for developing and implementing  community  relations  projects on behalf of the
Company and for acting as a liaison  between the Company and local community and
civic groups who may have concerns about Company's  facilities being established
in their communities,  and with government officials throughout the State of New
York.  As  compensation,  Mr.  Banks  received 3% of the gross  revenue from all
Federal Bureau of Prisons,  state and local correctional agency contracts within
the State of New York with a guaranteed  minimum  monthly  income of $4,500.  In
December  1993,  Mr. Banks agreed to become a consultant to the Company upon the
same terms and conditions in order to accurately reflect the level and nature of
the services he  provided.  In 1995 and 1996,  Mr.  Banks  earned  approximately
$334,000 and $296,000 respectively.

     Stock Options

     1993 Stock Option Plan

     Under the 1993 Stock Option Plan (the "1993 Plan") 500,000 shares of Common
Stock are reserved for issuance  upon  exercise of options  designated as either
(i) incentive stock options ("ISOs") under the Internal Revenue Code of 1986, as
amended (the "Code") or (ii)  non-qualified  options.  Under the 1993 Plan, ISOs
may be granted to  employees  and  officers  of the  Company  and  non-qualified
options  may be  granted  to  consultants,  directors  (whether  or not they are
employees), employees or officers of the Company.

     The 1993 Plan is administered by the Company's Stock Option Committee which
determines the persons to whom options will be granted,  the number of shares to
be covered by each option, whether the options granted are intended to be ISO's,
the rate of exercise of each option,  the option  purchase price per share,  the
manner of exercise,  the form of payment upon exercise, and whether restrictions
such as repurchase  rights are to be imposed on the shares  following  exercise.
Options  granted  under the 1933 Plan  expire five years after the date of grant
and may not be granted at a price less than the fair market  value of the Common
Stock on the date of grant (or 110% of fair market  value in the case of persons
holding 10% or more of the voting  stock of the  Company).  The  aggregate  fair
market value of shares for which ISOs  granted to any  employee are  exercisable
for the first time by such  employee  during any calendar  year (under all stock
option  plans  of the  Company  and any  related  corporation)  may  not  exceed
$100,000.  No options  may be granted  under the 1993 Plan after  October  2003;
however,  options  granted  under the 1993 Plan prior  thereto may extend beyond
that date.  Options granted under the 1993 Plan are not  transferable  during an
optionee's  lifetime  but are  transferable  at  death by will or by the laws of
descent and distribution.

     During fiscal 1994 and 1995, options to purchase 225,313 and 54,375 shares,
respectively,  were granted under the 1993 Plan at exercise  prices ranging from
$4.76 to $20.63 per share.  In 1996,  options to  purchase  50,700  shares  were
granted under the 1993 Plan at exercise prices ranging from $8.875 to $15.25 per
share.



                                       23
<PAGE>





     Item 11. Security Ownership of Certain Beneficial Owners and Management

     The following  table sets forth certain  information  as of March 14, 1997,
based on information  obtained from the persons named below, with respect to the
beneficial  ownership of shares of the Company's Common Stock by (i) each person
known by the Company to beneficially own more than 5% of the outstanding  shares
of Common Stock,  (ii) each executive  officer and director of the Company,  and
(iii) all officers and directors of the Company as a group:

<TABLE>
<CAPTION>


Name and Address                                         Amount and Nature of                     Percentage of
Beneficial Owner(1)                                     Beneficial Ownership                  Beneficial Ownership
<S>                                                              <C>                                   <C>


Esther Horn................................                     659,175                                8.6%
James F. Slattery(2).......................                     788,125                               10.3
Aaron Speisman(3)..........................                     470,763                                6.1
Jennifer Anna Speisman 1992 Trust..........                      83,438                                1.1%
Joshua Israel Speisman 1992 Trust..........                      83,438                                1.1%
Ira M. Cotler (4)..........................                      84,034                                1.1%
Richard P. Staley (5)......................                      76,006
Michael C. Garretson (6)...................                      59,791
Raymond S. Evans(7)........................                      24,044                                 *
Lee Levinson(8)............................                      26,814                                 *
Stuart Gerson (9)..........................                      19,475                                 *
Melvin T. Stith (10).......................                      15,000                                 *
Shimmie Horn (11)..........................                       1,312                                 *
All officers and directors as a group
(ten persons) (2)  (3) (4) (5) (6) (7) (8)
(9) (10) (11)..............................                   1,565,364                               20.4%


</TABLE>


------------------------
* Less than 1%


     (1) All  addresses are c/o  Correctional  Services  Corporation, 1819 Main
Street,  Suite 1000,  Sarasota,  Florida 34236.

     (2) Includes  options to purchase  15,625 shares of Common Stock.  Does not
include options to purchase 2,500 shares of Common Stock not exercisable  within
60 days.

     (3) Director and founder.  Does not include  98,438  shares of Common Stock
owned by the Jennifer Anna Speisman 1992 Trust and 98,438 shares of Common Stock
owned by the Joshua Israel  Speisman  1992 Trust,  trusts for the benefit of Mr.
Speisman's children,  as to which Mr. Speisman disclaims  beneficial  ownership.
Includes  options  to  purchase  15,625  shares of  Common  Stock and a Series A
Warrant to purchase 6,700 shares of Common Stock but does not include options to
purchase  2,500  shares of  Common  Stock not  exercisable  within 60 days.

     (4) Includes  2,612 shares of Common Stock owned by his wife as to which he
disclaims beneficial ownership.  Also includes options to purchase 66,666 shares
of Common Stock, a Series A Warrant to purchase 3,850 shares of Common Stock and
other  warrants  to purchase  10,906  shares of Common  Stock.  Does not include
options to purchase  33,334  shares of Common  Stock not  exercisable  within 60
days.

     (5) Includes  options to purchase  41,081 shares of Common Stock.  Does not
include options to purchase 19,544 shares of Common Stock not exercisable within
60 days.


                                       24
<PAGE>



     (6) Consists of options to purchase 59,791 shares of Common Stock. Does not
include options to purchase 33,334 shares of Common Stock not exercisable within
60 days.

     (7) Includes  options to purchase  15,425 shares of Common Stock.  Does not
include options to purchase 7,500 shares of Common Stock not exercisable  within
60 days.

     (8) Includes 3,282 shares of Common Stock owned by wife and 1,969 shares of
Common  Stock  owned by his minor  child,  as to which he  disclaims  beneficial
ownership. Also includes options to purchase 21,563 shares of Common Stock. Does
not include  options to purchase  3,500 shares of Common  Stock not  exercisable
within 60 days.

     (9)  Consists of options to purchase  15,625  shares of Common  Stock and a
Series A Warrant to  purchase  3,850  shares of Common  Stock.  Does not include
options to purchase  22,500  shares of Common  Stock not  exercisable  within 60
days.

     (10) Consists of options to purchase  15,000  shares of Common Stock.  Does
not include  options to purchase  7,000 shares of Common  Stock not  exercisable
within 60 days. 

     (11) Does not include options to purchase 10,000 shares of Common Stock not
exercisable within 60 days.

     The Company is unaware of any arrangements  which may result in a change in
control of the Company.




                                       25
<PAGE>



     Item 12. Certain Relationships and Related Transactions

     The Company  subleases a building  located at 12-16 East 31st  Street,  New
York, New York from LeMarquis Operating Corp.  ("LMOC"), a corporation owned 25%
by Ester  Horn  and 8% by James F.  Slattery.  The  Company  currently  utilizes
approximately  fifty  percent  of  the  building  for  the  Manhattan  Community
Corrections and the New York Community  Corrections  programs.  LMOC leases this
building  from an  unaffiliated  party  at a  current  base  monthly  rental  of
approximately  $15,456 (the "Base Rent"),  plus taxes,  currently  approximately
$14,000,  and water and sewer charges,  currently  approximately  $3,500,  for a
total monthly rental of approximately  $33,000. The Company has the right to use
as much of the building as it requires for its business subject to the rights of
certain residential  subtenants to remain in the building.  These rights include
the right to housing at a predetermined  rental for an indefinite period of time
pursuant to New York State rent stabilization laws.

     As a result of the lease negotiations, under a sublease dated as of January
1, 1994, since May 1, 1995, the Company has paid rent of $18,000 per month above
the  rent  paid by LMOC to the  building's  owner  for a total  monthly  rent of
approximately  $50,802;  prior to May 1, 1995 and under  the  prior  lease,  the
Company  paid  rent of  $10,000  per  month  above  the rent paid by LMOC to the
building  owner.  The Company  has,  to date,  invested  $690,000  in  leasehold
improvements and will not receive any credit, in terms of a reduction in rent or
otherwise,  for  these  improvements.  The  terms  of  this  sublease  were  not
negotiated at arm's length due to the relationship of Mrs. Horn and Mr. Slattery
with both the Company and LMOC. The  negotiation of the sublease,  including the
renewal terms,  was requested by the  Representative  of the Underwriters of the
Company's  February 2, 1994 initial public offering to  substantially  track the
renewal terms of the Company's  management  contract.  The negotiations were not
subject  to the  board  resolution,  adopted  subsequent  to  the  negotiations,
relating to affiliated transactions,  although the terms were approved by all of
the  directors.  The initial term of the  Company's  sublease  expired April 30,
1995,  and is currently in its first renewal term expiring  April 30, 2000.  The
sublease contains two additional  successive five-year renewal options beginning
May 1, 2000.  The  monthly  rent  above the rent paid by LMOC to the  building's
owner  will  increase  to $22,000  per month  during  the  second  renewal  term
beginning  May 1, 2000 and to $26,000 per month  during the third  renewal  term
beginning May 1, 2005. The Company paid $40,000 to LMOC for the renewal options.
These renewal options were separately  negotiated between the Board of Directors
of the Company and LMOC. Mr. Slattery  participated in such  negotiations.  Mrs.
Horn and Mr. Slattery will receive their proportionate  shares of rents received
by LMOC under the terms of this sublease.

     Previously,  residential and commercial tenants of the building paid annual
rent of approximately $300,000 to LeMarquis Enterprise Corp. ("Enterprises"),  a
company owned 30% by Mrs. Horn, 28% by Mr. Slattery and 25% by Mr. Speisman, and
Enterprises  paid all  expenses of  operating  the  residential  and  commercial
portions of the  building  as well as a portion of the  overall  expenses of the
building.  The  Company  paid any cash  flow  deficiency  to  Enterprises.  This
arrangement  terminated in February 1994,  and all of the  building's  revenues,
including rent from the residential and commercial tenants, are now received and
expenses paid by the Company.  The revenue from this portion of the building was
approximately  $210,000 in 1994 and  $205,000 in 1995.  The Company  anticipates
that  operating  the  portion  of  the  building  occupied  by  residential  and
commercial  tenants will result in a net expense to the Company of approximately
$25,000  per month.  Due to New York rent  stabilization  laws,  the  Company is
unable to increase the rent paid by the residential  tenants in this building in
response to increased rent or expenses incurred by the Company.

     The  Company  leases the  entire  building  located  at 988 Myrtle  Avenue,
Brooklyn, New York from Myrtle Avenue Family Center, Inc. ("MAFC") pursuant to a
lease which commenced  January 1, 1994 and expires  December 31, 1998. The lease
establishes a monthly  rental of $40,000 and contains  three  five-year  renewal
options. The monthly rental for the first option period, which runs from January
1, 1999 through December 31, 2003, is $40,000. The monthly rental for the second
option  period,  which runs from January 1, 2004 through  December 31, 2008,  is
$45,000,  and the monthly  rental for the third option  period,  which runs from
January 1, 2009 through December 31, 2013, is $50,000. In addition,  the Company
pays taxes,  insurance,  repairs and  maintenance  on this  building.  MAFC is a
corporation  owned by Mrs.  Horn (27.5%) and Messrs.  Slattery (8%) and Speisman
(27.5%). The terms of the lease were not negotiated at arm's length due to their
relationship  with  MAFC  and  the  Company.   Messrs.   Slattery  and  Speisman
participated in such negotiations.



                                       26
<PAGE>



     The Company leases a building  located at 2534 Creston Avenue,  Bronx,  New
York from Creston Realty Associates,  L.P. ("CRA"), the corporation owned 10% by
Ester Horn. The lease term is two years commencing October 1, 1996 and has three
additional  one year  option  periods.  The  Company  also  pays a base  rent of
$180,000  per year which will  escalate  five  percent  per year for each of the
three year options if they are  exercised.  The Company  pays taxes,  insurance,
repairs and maintenance on this building which will be used to house a community
correctional  center. The terms of this lease were not negotiated at arms length
due to the relationship between the Company, Ms. Horn and CRA.

     Pursuant  to the  terms  of a Board  of  Directors  resolution  adopted  in
connection with the Company's initial public offering,  all transactions between
the  Company  and any of its  officers,  directors  or  affiliates  (except  for
wholly-owned  subsidiaries)  must be approved by a majority of the  unaffiliated
members  of the  Board of  Directors  and be on terms no less  favorable  to the
Company  than  could be  obtained  from  unaffiliated  third  parties  and be in
connection  with bona fide  business  purposes of the Company.  In the event the
Company makes a loan to an individual affiliate (other than a short-term advance
for  travel,   business  expense,   relocation  or  similar  ordinary  operating
expenditure),  such loan must be  approved  by a  majority  of the  unaffiliated
directors.

     Stuart M. Gerson, a director of the Company,  is a member of Epstein Becker
& Green,  P.C., a law firm which  represented the Company on certain matters and
which is  representing  the Company in connection  with this offering.  In April
1996, in consideration for certain consulting services,  the Company granted Mr.
Gerson  options  to  purchase  a total of 15,000  shares  of Common  Stock at an
exercise  price of $8.75 per share,  the fair market  value of the shares on the
date of grant.  The options,  which were not granted pursuant to either the 1993
Plan or the Directors Plan are  non-qualified  options under the Code,  vest 50%
one year from the date of grant and the remaining 50% two years from the date of
grant. See "Legal Matters."

     ITEM 13. EXHIBITS AND REPORTS

     (a) Exhibits

     *2.1 Stock Transfer  Agreements between the Company and the stockholders of
each of Esmor Management,  Inc., Esmor (Brooklyn),  Inc., Esmor Manhattan, Inc.,
Esmor  (Seattle),  Inc.,  Esmor New Jersey,  Inc.,  Esmor Texas,  Inc. and Esmor
Houston, Inc.

     *3.1 Certificate of Incorporation dated October 28, 1993

     3.1.1 Copy of Certificate of Amendment of Certificate of  Incorporation  of
Esmor Correctional Services, Inc. dated July 29, 1996

     *3.2 By-Laws

     *4.2  Form  of  Underwriter's   Warrant  between  the  Company  and  Janney
Montgomery Scott Inc. *10.1 Stock Option Plan *10.5 Employment Agreement between
the Company and James F. Slattery *10.6 Employment Agreement between the Company
and Aaron Speisman

     10.6.1  Modification  to the Employment  Agreement  between the Company and
Aaron Speisman, dated June 13, 1996

     *10.9.2  Exercise of third option year of the  contract for  operation of a
facility in Brooklyn, New York

     #10.9.3 Extension of contract for operation of a facility in Brooklyn,  New
York through March 31, 1995

     *10.10  Bridge  Contract  between the Company  and the U.S.  Department  of
Justice,  Immigration  and  Naturalization  Service for operation of the Seattle
Processing Center, dated September 28, 1993



                                       27
<PAGE>



     10.10.1 Contract Amendment between the Company and the U.S. Immigration and
Naturalization  service for operation of the Seattle  Processing  Center,  dated
10/1/96

     *10.11  Contract  between the Company and the Judicial  District  Community
Supervision  and Corrections  Department of Tarrant  County,  dated September 1,
1993

     #10.11.1  Renewal and  Amendment of  Agreement  between the Company and the
Judicial District  Community  Supervision and Corrections  Department of Tarrant
County, dated October 5, 1994

     **10.11.2  Contract between the Company and the Judicial District Community
Supervision  and Corrections  Department of Tarrant County,  dated September 26,
1995 for the operation of the Tarrant County Community Corrections Facility

     *10.12  Contract  between the Company and the New York State  Department of
Corrections, dated July 17, 1992

     **10.12.1  Extension of Contract between the Company and the New York State
Department of Corrections

     *10.13  Contract  between the Company and the Texas  Department of Criminal
Justice, Pardons and Paroles Division

     #10.13.1  Extension  to the  contract  between  the  Company  and the Texas
Department of Criminal  Justice,  Pardons and Paroles  Division for operation of
the South Texas Intermediate Sanction Facility

     **10.13.2 Contract between the Company and the Texas Department of Criminal
Justice for operation of the South Texas Intermediate Sanction Facility

     *10.15 Agreement  between the Company and William Banks,  dated October 31,
1989

     *10.16 Form of Sub-Lease between the Company and LeMarquis Operating Corp.

     *10.17 Form of Lease between the Company and Myrtle  Avenue Family  Center,
Inc.

     *10.18 Lease between the Company and T. NY (USA)

     #10.19  Contract  by and  between  Esmor  Canadian,  Inc.  and the Board of
Trustees for the Hemphill County Juvenile  Detention Center for operation of the
Hemphill County Juvenile Detention Center

     #10.20 Contract between Esmor Fort Worth,  Inc. and the Texas Department of
22 of  Criminal  Justice,  Pardons  and  Paroles  Division  for the  Fort  Worth
Community

     #10.21  Contract dated  September 1, 1994 by the Community  Supervision and
Corrections  Department of Travis County,  Texas for the Travis County Substance
Abuse Treatment Facility

     **10.21.1  Contract dated October 1, 1995 by the Community  Supervision and
Corrections  Department of Travis County,  Texas for the Travis County Substance
Abuse Treatment Facility

     #10.22  Contract  between the Company and the U.S.  Department  of Justice,
Immigration and  Naturalization  Service for operation of the Seattle Processing
Center, effective August 1, 1994

     **10.22.1  Exercise of second  option of the contract for  operation of the
Seattle Processing Center #10.23 Lease between Esmor Fort Worth, Inc. and Region
Enterprises, Inc.

     #10.24  Revolving  Credit and Term Loan  Agreement with Marine Midland Bank
dated as of July 28, 1994

     **10.25 1994 Non-Employee Director Stock Option Plan


                                       28
<PAGE>




     **10.26 Loan and Security Agreement with NationsBank, N.A. (South) dated as
of December 31, 1995

     **10.27  Lease  between  the  Company  and  Zell/Merrill  Lynch Real Estate
Opportunity Partners Limited Partnership dated as of June 30, 1995

     10.27.1  Amendment  to the Lease  Agreement  between  the  Company and Zell
Merill Lynch Real Estate Opportunity Partners Limited Partnership dated November
15, 1996

     **10.28 Lease between the Company and Gayton  Crossing  dated as of May 26,
1995

     **10.29 Contract between the Company and the State of Florida, Correctional
Privatization  Commission  dated  October 6, 1995 for  operation  of the Pahokee
Youth Facility

     **10.30 Contract between the Company and the State of Florida, Correctional
Privatization  Commission  dated  October 6, 1995 for operation of the Polk City
Youth Facility

     **10.31 Contract  between the Company and the State of Arizona,  Department
of Corrections for operation of the Arizona DWI Facility

     **10.32 Contract  between the Company and the State of Florida,  Department
of Juvenile Justice for operation of the Bartow Youth Facility

     **10.34 Asset Purchase  Agreement dated as of December 15, 1995 between the
Company and Corrections Corporation of America

     **10.35  Construction  Contract  dated as of December  28, 1995 between the
Company and Bison  Industries,  Inc. for  construction of the Pahokee  (Florida)
Youth Facility

     **10.36  Design and  Construction  Contract dated as of December 1, 1995 by
and between the Company,  the Florida  Correctional  Finance Corporation and the
State of  Florida,  Correctional  Privatization  Commission  for the  design and
construction of the Polk City (Florida) Youth Facility

     **10.37  Contract  dated July 1, 1995,  between  the  Company  and the U.S.
Department of Justice,  Federal Bureau of Prisons for operation of a facility in
New York, New York

     **10.38  Contract  between the Company and the U.S.  Department of Justice,
Federal Bureau of Prisons for operation of a facility in Brooklyn, New York

     10.40  Contract  between  the  Company  and the U.S.  Bureau of Prisons for
operation of the Bronx Community Corrections Center, dated October, 1, 1996

     10.41  Contract  between the Company and the State of Arizona for operation
of the DWI Secure Prison, dated November 7, 1996.

     10.42  Contract  between  the Company  and  McKinley  County New Mexico for
operation of the McKinley  County,  New Mexico Adult Detention  Facility,  dated
October 3, 1996

     10.43  Contract  between  the Company and  Colorado  County,  Texas for the
operation of the Colorado County, Texas Juvenile Residential Facility

     10.44 Lease  Agreement  between the Company and Creston Realty  Associates,
L.P., dated October 1, 1996

     *10.45 Lease between the Company and Elberon Development Company

     10.45.1  Assignment  of Lease  between the Company and Elberon  Development
Company


                                       29
<PAGE>




     10.46  Contract  between the Company and Bell County Texas for operation of
the Bell County Juvenile Residential Facility

     *10.47 Employment  Agreement  between the Company and Ira M. Cotler,  dated
January 21, 1996.

     *10.48  Employment  Agreement between the Company and Michael C. Garretson,
dated January 21, 1996.

     **22.1 List of Significant Subsidiaries

     **23.1 Consent of Grant Thornton LLP


------------------------

     *Incorporated by reference to the Company's  Registration Statement on Form
SB-2 (File No. 33-71314-NY).

     #Incorporated  by reference to the Company's  Annual Report on  Form-10-KSB
for the year ended December 31, 1994.

     **Incorporated  by reference to the initial filing of the Company's  Annual
Report on Form 10-KSB for the year ended December 31, 1995.

     (b) Reports on Form 8-K

     The Company did not file any reports on Form 8-K for its last quarter in
fiscal 1996.









                                       30



<PAGE>



                                   SIGNATURES

     In accordance  with Section 13 or 15(d) of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.

                                  CORRECTIONAL SERVICES CORPORATION
                                  Registrant


                                 By: /s/James F. Slattery, President
                                    ---------------------------------
                                    James F. Slattery, President


Dated: March 31, 1997


     In  accordance  with the Exchange Act, this report has been signed below by
the following  persons on behalf of the  Registrant and in the capacities and on
the dates indicated.


<TABLE>
<CAPTION>

               Signature                                  Title                                           Date

<S>                                                        <C>                                             <C>


/s/James F. Slattery                     President (Principal Executive Officer) and                 March 31, 1997
--------------------------------
James. F. Slattery                       Director

/s/Aaron Speisman                        Vice President, Secretary and Director                      March 31, 1997
--------------------------------
Aaron Speisman

/s/Lee Levinson                          Chief Financial Officer (Principal Financial                 March 31, 1997
--------------------------------
Lee Levinson                             Officer)

/s/Raymond S. Evans
--------------------------------         Director                                                    March 31, 1997
Raymond S. Evans

/s/Stuart Gerson
--------------------------------         Director                                                    March 31, 1997
Stuart Gerson

/s/Melvin Stith
--------------------------------         Director                                                    March 31, 1997
Melvin Stith

/s/Shimmie Horn       
--------------------------------         Director                                                    March 31, 1997
Shimmie Horn

/s/Richard Staley               
--------------------------------         Vice President and Director                                 March 31, 1997
Richard Staley


</TABLE>


                                       31

     
        
                     


CONSOLIDATED FINANCIAL STATEMENTS
AND REPORT OF INDEPENDENT CERTIFIED
PUBLIC ACCOUNTANTS

CORRECTIONAL SERVICES CORPORATION
AND SUBSIDIARIES

December 31, 1996 and 1995



<PAGE>



                                 C O N T E N T S

<TABLE>
<CAPTION>

                                                                                                               Page
<S>                                                                                                             <C>

Report of Independent Certified Public Accountants                                                               1

    Consolidated Balance Sheets as of December 31, 1995 and 1996                                                 2

    Consolidated Statements of Operations for the years ended December 31, 1995
      and 1996                                                                                                   3

    Consolidated Statement of Stockholders' Equity for the years ended
      December 31, 1995 and 1996                                                                                 4

    Consolidated Statements of Cash Flows for the years ended
      December 31, 1995 and 1996                                                                                5-6

    Notes to Consolidated Financial Statements                                                                   7



</TABLE>


















<PAGE>






               REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS



Board of Directors
Correction Services Corporation


     We  have  audited  the   accompanying   consolidated   balance   sheets  of
Correctional  Services  Corporation and Subsidiaries as of December 31, 1996 and
1995,  and the related  consolidated  statements  of  operations,  stockholders'
equity and cash flows for the years then ended.  These financial  statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audits.

     We conducted  our audits in accordance  with  generally  accepted  auditing
standards.  Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement.  An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements.  An audit also includes
assessing the  accounting  principles  used and  significant  estimates  made by
management,  as well as evaluating the overall financial statement presentation.
We believe  that our audits of the  financial  statements  provide a  reasonable
basis for our opinion.

     In our opinion,  the financial statements referred to above present fairly,
in all material  respects,  the consolidated  financial position of Correctional
Services  Corporation and Subsidiaries as of December 31, 1996 and 1995, and the
consolidated  results of their operations and their  consolidated cash flows for
the  years  then  ended,  in  conformity  with  generally  accepted   accounting
principles.


GRANT THORNTON LLP


New York, New York
March 7, 1997





<PAGE>



               CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES
                           CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>

                                                                                                   December 31,
                          ASSETS                                                              1996               1995
<S>                                                                                           <C>                <C>

CURRENT ASSETS
  Cash and cash equivalents                                                                $20,932,309     $   3,756,748

  Restricted cash                                                                                    -           750,000
  Accounts receivable                                                                        4,023,620         3,374,229
  Receivable from sale of equipment and leasehold improvements                               1,476,000                 -
  Prepaid expenses and other                                                                 2,001,973         1,415,306
     Total current assets                                                                   28,433,902         9,296,283

BUILDING, EQUIPMENT AND LEASEHOLD IMPROVEMENTS -
  AT COST, NET                                                                              12,040,149         7,226,323

  LONG-TERM RECEIVABLE FROM SALE OF EQUIPMENT AND

  LEASEHOLD IMPROVEMENTS                                                                     2,031,882         3,207,882

OTHER ASSETS
  Deferred development and start-up costs, net                                               5,817,959         1,729,270
  Deferred income taxes                                                                      1,495,000         1,120,000
  Other                                                                                         485,157          760,769

                                                                                           $50,304,049       $23,340,527

                      LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES

  Accounts payable and accrued liabilities                                                $4,873,542           3,535,165

  Current portion of long-term debt                                                              --            1,221,022

     Total current liabilities                                                             4,873,542           4,756,187

LONG-TERM DEBT                                                                                   --            4,000,000
LONG-TERM PORTION OF ACCRUED CLOSURE EXPENSES                                              1,606,000                  --
SUBORDINATED PROMISSORY NOTES                                                              3,899,841           5,362,295

COMMITMENTS AND CONTINGENCIES                                                                    --                   --

STOCKHOLDERS' EQUITY
  Preferred stock, $.01 par value, 1,000,000 shares authorized,
    none issued and outstanding                                                                  --                   --
  Common stock, $.01 par value, 30,000,000 shares authorized,
   7,660,779 and 4,911,688 shares issued and outstanding
    as of 1996 and 1995, respectively.                                                       76,608               49,117
  Additional paid-in capital                                                             42,022,593            9,479,436
  Accumulated deficit                                                                    (2,174,535)           (306,508)
                                                                                         39,924,666            9,222,045

                                                                                        $50,304,049          $23,340,527

</TABLE>

     The accompanying notes are an integral part of these statements.

                                       F-2


<PAGE>



               CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>

                                                                                             Years Ended December 31,

                                                                                          1996                    1995
<S>                                                                                         <C>                    <C>

Revenues
    Resident fees                                                                       $30,866,162           $30,482,683
    Other income                                                                            635,496             1,007,343

                                                                                         31,501,658            31,490,026

Expenses
    Operating                                                                            21,928,329            19,731,797
    General and administrative                                                            8,655,628             9,938,344
    Fort Worth and New York Community Corrections
      closure costs                                                                       3,329,000                    --
    New Jersey facility closure costs                                                              -            3,909,700

                                                                                         33,912,957            33,579,841


Operating Loss                                                                           (2,411,299)           (2,089,815)

Interest expense                                                                            481,728               699,576

Loss before income taxes                                                                 (2,893,027)           (2,789,391)
Income tax (benefit)                                                                     (1,025,000)           (1,050,000)

         NET LOSS                                                                     $  (1,868,027)         $ (1,739,391)


Net per common share                                                                          $(.32)               $(.38)


Weighted average shares outstanding                                                       5,781,853            4,552,707






</TABLE>





     The accompanying notes are an integral part of these statements.

                                       F-3


<PAGE>



               CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES
                 CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY

                     Years ended December 31, 1996 and 1995
<TABLE>
<CAPTION>


                                                                         Additional           Retained
                                                        Common            paid-in             earnings
                                                         stock            capital             (deficit)             Total
<S>                                                        <C>              <C>                <C>                   <C>

Balance at January 1, 1995                             44,079            $5,616,456         $ 1,432,883         $  7,093,418

Exercise of stock options                                  70               33,250                  -               33,320
Common stock issuance                                   4,968            3,464,730                  -            3,469,698
Issuance of warrants with
  subordinated promissory notes                            -               365,000                  -              365,000
Net loss                                                   -                  -              (1,739,391)        (1,739,391)

Balance at December 31, 1995                           49,117            9,479,436            (306,508)            9,222,045


Common stock issuance through
   public offering                                     24,375           30,483,681                   -            30,508,056
Exercise of stock options                                 649              411,338                   -               411,987
Exercise of warrants                                    2,467            1,648,138                   -             1,650,605
Net loss                                                   -                    -           (1,868,027)           (1,868,027)



Balance at December 31, 1996                          $76,608           $42,022,593        $(2,174,535)          $39,924,666



</TABLE>














     The accompanying notes are an integral part of this statement.

                                      F-4


<PAGE>



               CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES
                      CONSOLIDATED STATEMENTS OF CASH FLOWS
                             Year ended December 31,
<TABLE>
<CAPTION>


<S>                                                                                      <C>                <C>
                                                                                      1996                  1995
Cash flows from operating activities:
  Net loss                                                                        $(1,868,027)          $(1,739,391)
  Adjustments to reconcile net loss to net cash
    provided by operating activities:
      Depreciation and amortization                                                   778,462             1,168,850
      Amortization of subordinated note discount                                      173,247                50,695
      New Jersey facility asset impairment                                                  -             2,771,424
      New Jersey deferred development costs writedown                                       -               416,201
      Ft. Worth deferred development cost writedown                                    98,446                     -
      Ft. Worth and NYCC facilities asset impairment                                  564,050                     -
      Amortization of deferred loan costs                                             243,258               127,568
      Deferred income tax benefit                                                    (375,000)           (1,120,000)
      Changes in operating assets and liabilities:
        Accounts receivable                                                          (649,391)            1,429,785
        Refundable taxes                                                             (650,000)                    -
        Prepaid expenses and other current assets                                      63,333              (774,644)
        Accounts payable and accrued liabilities                                      377,877               895,650
        Reserve for Ft. Worth and NYCC facilities carrying costs                    2,566,504                     -
        Reserve for New Jersey facility carrying costs                               (300,000)                    -

                Net cash provided by operating activities                           1,022,759            3,226,138

Cash flows from investing activities:
  Capital expenditures                                                             (6,018,195)           (6,110,693)
  Development and start-up costs                                                   (4,317,276)           (1,824,268)
  (Increase) decrease in restricted cash - unexpended construction
    funds                                                                             750,000              (750,000)

                Net cash used in investing activities                              (9,585,471)           (8,684,961)

Cash flows from financing activities:
  Proceeds from issuance of common stock                                           30,508,056             3,469,698
  Proceeds from long-term borrowing                                                        -              1,500,000
  Payments on long-term borrowings                                                 (4,000,000)           (1,282,715)
  Proceeds (payments) on short-term debt, net                                      (1,221,022)              218,333
  Issuance of subordinated notes and warrants                                              -              5,676,600
  Debt issuance costs                                                                      -               (652,101)
  Net proceeds from exercise of stock options and warrants                            426,890                33,320
  Other assets                                                                         24,349               (56,010)

                Net cash provided by financing activities                          25,738,273             8,907,125



</TABLE>


     The accompanying notes are an integral part of these statements.

                                       F-5


<PAGE>



               CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES
                CONSOLIDATED STATEMENTS OF CASH FLOWS - CONTINUED
                            Years ended December 31,
<TABLE>
<CAPTION>


                                                                                        1996                   1995
<S>                                                                                    <C>                      <C>

NET INCREASE IN CASH AND CASH
  EQUIVALENTS                                                                          $17,175,561        $ 3,448,302


Cash and cash equivalents at beginning of period                                         3,756,748            308,446

Cash and cash equivalents at end of period                                            $ 20,932,309        $ 3,756,748
                                                                                       ===========        ===========

Supplemental disclosures of cash flows information:  Cash paid during the period
  for:
    Interest                                                                          $    883,900        $   602,700
                                                                                       ===========        ============
    Income taxes                                                                      $    (2,200)        $   789,500
                                                                                       ===========        ============

</TABLE>
































     The accompanying notes are an integral part of these statements.

                                      F-6


<PAGE>



               CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                           December 31, 1996 and 1995


     NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

     Correctional   Services   Corporation  and  Subsidiaries   (formerly  Esmor
Correctional  Services,  Inc.)  operate and manage  detention  and  correctional
facilities for Federal,  state and local government agencies. On August 1, 1996,
the Company's Certificate of Incorporation was amended which changed the name of
the Company to  Correctional  Services  Corporation  and increased the number of
authorized shares of Common Stock from 10,000,000 to 30,000,000 shares.

1.       Principles of Consolidation

     The consolidated  financial statements include the accounts of Correctional
Services   Corporation  and  its   wholly-owned   subsidiaries,   Esmor,   Inc.,
Correctional  Services  Management,  Inc., Esmor Brooklyn,  Inc., Esmor Seattle,
Inc., Esmor Manhattan,  Inc., Esmor Mansfield,  Inc., Esmor Houston, Inc., Esmor
New Jersey, Inc., Esmor Ft. Worth, Inc., Esmor Canadian,  Inc. and Esmor Travis,
Inc.  (collectively  the  "Company"  or  the  "  companies").   All  significant
intercompany balances and transactions have been eliminated.  As of December 31,
1996 all of the  aforementioned  subsidiaries  (except Esmor, Inc. and Esmor New
Jersey, Inc.) were merged into the parent company.

2.       Revenue Recognition

     Revenue is  recognized  at the time the service is  provided.  Revenues are
principally derived from government agencies.  The Company's accounts receivable
balance is  considered  fully  collectible  based on historical  experience  and
management's current evaluation. Accordingly, no allowance for doubtful accounts
has been provided in the accompanying financial statements.

3.       Building, Equipment and Leasehold Improvements

     Building,  equipment  and  leasehold  improvements  are  carried  at  cost.
Depreciation  of buildings  are  computed  under the  straight-line  method over
twenty and thirty year periods.  Depreciation of equipment is computed under the
straight-line method over a five-year period.  Leasehold  improvements are being
amortized over the shorter of the life of the asset or the applicable lease term
(ranging from five to ten years).







                                       F-7


<PAGE>



               CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                           December 31, 1996 and 1995


     NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (Continued)

4.       Deferred Development and Start-up Costs

     Deferred development costs consist of costs that can be directly associated
with a  specific  anticipated  contract  and,  if the  recoverability  from that
contract is probable,  they are deferred until the anticipated contract has been
awarded.  At the  commencement  of  operations  of the  facility,  the  deferred
development costs are amortized over the life of the contract  (including option
periods) as development expense but not to exceed 5 years. Costs of unsuccessful
or  abandoned  contracts  are  charged to expense  when  their  recovery  is not
considered  probable.  Facility start-up costs are incurred (after a contract is
awarded) in connection  with the opening of new  facilities  under the contract.
These costs,  which are required  under the  contract,  are  capitalized  to the
extent recoverable from the date of award until  commencement of operations,  at
which time they are amortized on a straight-line  basis over the term (including
option periods) of the government contracts not to exceed five years.

5.       Income Taxes

     The  Company  utilizes  an  asset  and  liability  approach  for  financial
accounting and reporting for income taxes. The primary  objectives of accounting
for income taxes are to (a)  recognize the amount of tax payable for the current
year and (b)  recognize  the amount of deferred tax  liability or asset based on
management's  assessment  of the tax  consequences  of  events  that  have  been
reflected in the Company's consolidated financial statements.

6.       Loss Per Share

     The  computation  of net loss per common  share is based upon the  weighted
average  number of common  shares  outstanding  during  the year.  Common  stock
equivalents  (stock  options and warrants) were not included for the years ended
December 31, 1995 and 1996, as their effect would be anti-dilutive.

7.       Cash and Cash Equivalents

     The Company  considers all highly liquid debt  instruments  purchased  with
original maturities of three months or less to be cash equivalents.

     Restricted cash of $750,000 at December 31, 1995 represented  payments made
in 1996 to the contractor for the completion of the Phoenix, Arizona facility.




                                       F-8


<PAGE>



               CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                           December 31, 1996 and 1995


     NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (Continued)

8.       Reclassifications

     Certain reclassifications have been made to the 1995 balances to conform to
the  1996  presentation.  In  addition,  certain  construction  costs  initially
classified as deferred  development  costs have been  reclassified to buildings,
equipment and leasehold improvements as of December 31, 1995.

9.       Use of Estimates in Consolidated Financial Statements

     In preparing consolidated financial statements in conformity with generally
accepted accounting principles,  management makes estimates and assumptions that
affect the  reported  amounts  of assets  and  liabilities  and  disclosures  of
contingent  assets and  liabilities  at the date of the  consolidated  financial
statements,  as well as the reported amounts of revenues and expenses during the
reporting  period.  Actual  results  could  differ  from  those  estimates.  For
discussion of the realization of Receivable from Sale of Equipment and Leasehold
Improvements and costs  pertaining to the New York and Fort Worth closures.  see
Note L.

10.      Accounting for the Impairment of Long-Lived Assets and for Long-Lived
         Assets to be Disposed Of

     On January 1, 1996, the Company adopted  Statement of Financial  Accounting
Standards No. 121  "Accounting  for the Impairment of Long-Lived  Assets and for
Long-Lived  Assets to be Disposed Of" ("SFAS No.  121").  The standards for SFAS
No. 121 require  that the Company  recognize  and measure  impairment  losses of
long-lived assets and certain  identifiable  intangibles and to value long-lived
assets to be disposed of. The primary  objectives  under SFAS No. 121 are to (a)
recognize  an  impairment  loss  of an  asset  whenever  events  or  changes  in
circumstances indicate that its carrying amount may not be recoverable or (b) if
planning to dispose of long-lived  assets or certain  identifiable  intangibles,
such  assets  have  been  reflected  in  the  Company's  consolidated  financial
statements at the net asset value less cost to sell. The effect of adopting SFAS
121 was not considered material to the consolidated financial statements.







                                       F-9


<PAGE>



               CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                           December 31, 1996 and 1995


     NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (Continued)

11.      Stock Based Compensation

     In October 1995, the Financial  Accounting  Standards Board issued SFAS No.
123,  "Accounting  for Stock-Based  Compensation.  With respect to stock options
granted to  employees,  SFAS No. 123 permits  companies  to  continue  using the
accounting method promulgated by the Accounting  Principles Board Opinion No. 25
("APB  No.  25"),  "Accounting  for  Stock  Issued  to  Employees,"  to  measure
compensation or to adopt the fair value based method prescribed by SFAS No. 123.
Management  has not adopted SFAS No.  123's  accounting  recognition  provisions
related to stock  options  granted to employees and  accordingly,  will continue
following APB No. 25's accounting provisions. All other requirements of SFAS No.
123 were implemented on January 1, 1996.

     NOTE B - CONTRACTUAL AGREEMENTS WITH GOVERNMENT AGENCIES

     The Company currently operates fifteen secure and non-secure corrections or
detention  programs  in the  states of  Arizona,  Florida,  New York,  Texas and
Washington for Federal,  state and local  government  agencies  exclusive of two
programs which are expected to close in 1997 and for which a write-down has been
provided for the year ended December 31, 1996 (see Note K). The Company's secure
facilities  include a  detention  and  processing  center  for  illegal  aliens,
intermediate  sanction facilities for parole violators and a shock incarceration
facility,  which  is a  military  style  "boot  camp"  for  youthful  offenders.
Non-secure facilities include residential programs such as community corrections
facilities for federal and state offenders  serving the last six months of their
sentences and non-residential programs such as home confinement supervision.

     The Company is  compensated on the basis of the number of offenders held in
each of its facilities.  The Company's  contracts may provide for fixed per diem
rates  or  monthly  fixed  rates.   Some  contracts  also  provide  for  minimum
guarantees.

     The  terms  of  each  contract  vary  and can be  from  one to five  years.
Contracts  for  more  than  one year  have  renewal  options  which  either  are
exercisable on mutual agreement between the Company and the government agency or
are exercisable by the government agency alone.








                                      F-10


<PAGE>



               CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                           December 31, 1996 and 1995


     NOTE C - FAIR VALUE OF FINANCIAL INSTRUMENTS

     For the Company, financial instruments consist principally of cash and cash
equivalents, subordinated promissory notes and long-term debt.

     The following  methods and assumptions were used to estimate the fair value
of each class of financial  instruments  for which it is practicable to estimate
that value:

1.       Cash and Cash Equivalents

     The carrying amount reasonably approximates fair value because of the short
maturity of those instruments.

2.       Subordinated Promissory Notes and Long-Term Debt

     The fair value of the Company's subordinated promissory notes and long-term
debt is estimated  based upon the quoted  market  prices for the same or similar
issues or on the  current  rates  offered  to the  Company  for debt of the same
remaining maturities.


<TABLE>
<CAPTION>

                                                                                 Year Ended December 31,


                                                                 1996                                     1995
                                                                 ----                                     ----

                                                       Carrying           Fair                 Carrying           Fair
                                                       Amount             Amount                Amount           Amount
<S>                                                      <C>               <C>                    <C>               <C>

            Cash and cash equivalents                $20,932,00           $20,932,00          $3,757,000       $3,757,000

            Long-term debt                                    0                    0          $5,221,000       $5,221,000
            Subordinated promissory
            notes                                    $3,900,000           $3,900,000          $5,362,000       $5,362,000

</TABLE>



     3. Receivable from Sale of Equipment and Leasehold Improvements

     The carrying value of the  Receivable  from Sale of Equipment and Leasehold
at December 31, 1995 and 1996 is $3,207,882  and  $3,507,882  respectively.  The
Company  believes the fair value of the  Receivable  from Sale of Equipment  and
Leasehold Improvements is not practicable to estimate (See Note L-1(b)).






                                      F-11


<PAGE>



               CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                           December 31, 1996 and 1995


     NOTE D - PREPAID EXPENSES AND OTHER CURRENT ASSETS

     Prepaid expenses and other current assets consist of the following:


                                                  1996          1995

Prepaid insurance                             $  214,231   $   190,754
Prepaid real estate                              165,061       122,473
Prepaid and refundable income taxes              819,199       665,878
Other                                            803,482       436,201
                                              $2,001,973    $1,415,306
                                              ==========    ==========


     NOTE E - BUILDING, EQUIPMENT AND LEASEHOLD IMPROVEMENTS

     Building,  equipment and leasehold  improvements,  at cost,  consist of the
following:

                                                  1996          1995

Building and land                            $10,072,687    $5,742,749
Equipment                                      2,221,427     1,138,276
Leasehold improvements                           645,341     1,000,678
                                              ----------     ---------
                                              12,939,455     7,881,703

Less accumulated depreciation                  (899,306)      (655,380)
                                              ---------      ---------
                                             $12,040,149    $7,226,323
                                             ===========    ==========


     Depreciation  expense  for the years ended  December  31, 1996 and 1995 was
approximately $640,000 and $1,040,000, respectively.







                                      F-12


<PAGE>



               CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                           December 31, 1996 and 1995


     NOTE F - OTHER ASSETS

     Deferred development and start-up costs are comprised of the following:

                                             1996                1995
                                             ----                ----

Development costs                        $3,158,242           $1,663,804
Start-up costs                            3,079,272              354,880
                                         ----------           ----------
                                          6,237,514            2,018,684

 Less accumulated amortization             (419,555)            (289,414)
                                         ----------           ----------
                                         $5,817,959           $1,729,270
                                         ==========           ==========


     The  December  31,  1996 and 1995  balance  of  $5,817,959  and  $1,729,270
includes development costs of approximately $306,300 and $48,500,  respectively,
related to unawarded  contracts.  Included in deferred  development  is $637,500
paid to  Colorado  County,  Texas which  represents  the  Company's  contractual
commitment to finance 25% of the facility's construction cost with the county to
fund the balance.

Other assets consist of the following:


                                            1996                 1995
                                            ----                 ----

Deferred refinancing costs, net          $344,167              $587,424
Deposits                                  106,820               125,773
Deferred lease option costs                26,660                34,664
Other                                       7,510                12,908
                                          -------              --------
                                         $485,157              $760,769
                                         ========              ========




                                      F-13


<PAGE>



               CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                           December 31, 1996 and 1995


     NOTE G - ACCOUNTS PAYABLE AND ACCRUED LIABILITIES

     Accounts payable and accrued liabilities consist of the following:


                                                     1996              1995
                                                     ----              ----

Accounts payable                                 $1,900,867         $1,324,963
Accrued expenses                                  1,193,348          1,722,848
Payroll and related taxes                           691,540            284,633
Construction costs (including retainage)             10,950            120,120
Income taxes                                        116,333             82,601
Accrued closure costs of Fort Worth and
 New York Community Corrections                     960,504                  -
                                                 ----------         ----------
                                                 $4,873,542         $3,535,165
                                                 ==========         ==========


     NOTE H - DEBT

     Effective December 31, 1995, the Company and NationsBank, N.A. entered into
a loan and security  agreement  totaling  $11.0 million  expiring on January 15,
1998.  The agreement  consists of $5 million term loan at a fixed rate of 8.92%,
which  refinanced  previous debt with another bank,  and a $6 million  revolving
line of credit  for  working  capital  purposes.  On  September  17,  1996,  the
outstanding  balances of both the term loan  ($4,333,360) and the revolving line
($2,865,108) were repaid in full with interest from the net proceeds raised from
the public  offering (see Note K).  Borrowings  under the revolver are based, at
the  Company's  option,  on .75%  over  the  bank's  prime  rate  or the  London
International  Bank Rate  (LIBOR)  plus  3.35%.  After  September  30,  1996 the
interest  rate  charged  under  either  method  will be based  on the  Company's
financial  performance  as specified in the agreement.  Further,  the Company is
required to pay an annual  commitment  fee of .25% of the average unused portion
of the  facility.  The Company  may prepay any  borrowings  without  interest or
penalty.  The Company's  subsidiaries  have guaranteed the Company's  obligation
under the agreement.  The Company has granted the bank a first priority security
interest  in all of its assets,  including  a first real estate  mortgage on the
land and building  being used for its  Phoenix,  Arizona  facility.  The lending
agreement contains certain financial covenants including a debt service coverage
ratio and a senior  liabilities  to  tangible  net worth and  subordinated  debt
ratio. The agreement  precludes the payment of dividends and stock repurchase or
redemptions prior to December 31, 1996. Thereafter, such dividends,  purchase or
redemptions is limited to 10% of the Company's net earnings after taxes provided
that the Company is in compliance with the above- noted financial covenants.


                                      F-14


<PAGE>



               CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                           December 31, 1996 and 1995


     NOTE H - DEBT - (Continued)

     Through a series of transactions  that closed in July, August and September
1995,  the  Company  issued  5,676.6  units at  $1,000  per  unit,  in a private
placement of its securities  ("1995 Private  Placement").  Each unit consists of
(i) a 10% subordinated promissory note due July 31, 1998 in the principal amount
of $1,000,  interest payable  quarterly and (ii) a four year warrant to purchase
154 shares of common stock at $7.75 per share. The Company received  proceeds of
$5,676,600 in connection with the 1995 Private Placement and recorded the market
value of the warrants,  $365,000,  as promissory  note discount  amortized  over
three years.  The net proceeds  from such  issuance  were used to construct  and
renovate the Phoenix, Arizona facility.

     The Company's prior revolving credit and term loan agreement dated July 18,
1994, with a bank,  provided the Company with maximum  borrowings of $5,000,000,
at the bank's  prime rate plus 1% per  annum,  in the form of: (i) a  $1,000,000
revolving  credit  agreement  expiring July 28, 1996 and (ii) a $4,000,000  term
loan agreement with the outstanding  principal  payable in monthly  installments
through August 31, 1999. The Company had granted the prior bank a first priority
security  interest in all of its assets.  On March 24, 1995, the Company entered
into a $1,500,000  project loan and term loan  agreement  with a bank.  Proceeds
from the loan were used to finance  the cost of  construction  of the  Company's
Canadian,  Texas facility.  As noted above, these loans have been repaid in full
by the loan and security agreement with NationsBank, N.A.

     On July 28, 1995, the Company entered into an agreement with the bank under
which this bank (i) waived its right to declare  the  revolving  credit and term
loan agreement  dated July 28, 1994 and the project loan and term loan agreement
dated March 24, 1995 in default in the event of the  expiration of the Company's
Elizabeth,  New Jersey  contract with the United  States  Department of Justice,
Immigration  and  Naturalization  Services  ("INS"),  and (ii)  consented to the
Company's 1995 Private  Placement,  see above. In addition,  the Company granted
the prior bank a first priority deed of trust,  assignment of rents and security
interest on its Phoenix, Arizona facility and the assignment of leases and rents
on its Elizabeth,  New Jersey facility.  Pursuant to the agreement, the maturity
date of the term  loan  agreements  became  July 1,  1997,  payable  in  monthly
installments of $92,000 with the balance due July 1, 1997.  Under the agreement,
the Company prepaid  $250,000 of the term loans in September 1995. In connection
with the  agreement,  the President and Executive  Vice  President  gave limited
personal  guarantees,  not to exceed  $1,200,000 each. On December 31, 1995, the
term loan,  revolving  line of credit and project loan  agreements  were paid in
full by the loan and security agreement with NationsBank, N.A.



                                      F-15


<PAGE>



               CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                           December 31, 1996 and 1996


     NOTE H - DEBT - (Continued)

     There were no bank  borrowings  at the end of 1996.  Borrowings at December
1995  under the bank  long-term  debt and  revolving  line of credit  agreements
consist of the following:

                                                                 1995
                                                                 ----

            Term loans                                        $5,000,000
            Revolving line of credit                             221,022
                                                               ---------
                                                               5,221,022
            Less
             Current maturities                                1,221,022
                                                               ---------
                                                              $4,000,000
                                                              ==========


     NOTE I - RENTAL AGREEMENTS

     Minimum rental commitments under  non-cancelable  leases as of December 31,
1996, are as follows:

                                                                 Related
                                              Total              Companies
                                              -----              ---------
  Year ending December 31,
       1997                                $1,850,000          $1,277,000
       1998                                 1,870,000           1,254,000
       1999                                 1,210,000             630,000
       2000                                   540,000             212,000
       2001                                   110,000                   -
       Thereafter                                   -                   -
                                           ----------          ----------
                                           $5,580,000          $3,373,000
                                           ==========          ==========


     The  Company  leases one  facility  from a related  party  under a sublease
arrangement, which expires April 30, 2000. The Company has a five-year option to
renew  this  sublease  arrangement.  A portion  of this  building  and annex are
occupied by residential and commercial tenants.



                                      F-16


<PAGE>



               CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                           December 31, 1996 and 1996


     NOTE I - RENTAL AGREEMENTS - Continued

     The  Company  leases a second  facility  from a  related  party.  The lease
commenced January 1, 1994 and expires December 31, 1998. Thereafter, the Company
has three successive  five-year  options to renew. In addition to the base rent,
the Company pays taxes, insurance, repairs and maintenance on this facility.

     The  Company  leases a third  facility  from a  related  party.  The  lease
commenced  October 1, 1996 and  expires  September  30,  1998.  Thereafter,  the
Company has three successive  one-year options to renew. In addition to the base
rent,  the  Company  pays taxes,  insurance,  repairs  and  maintenance  on this
facility.

     Rental  expense for the years ended  December 31, 1996 and 1995  aggregated
$1,410,000  and  $1,510,000,  respectively,  and  is  included  in  general  and
administrative expenses. Rent expense to related companies aggregated $1,090,000
and $1,038,000 for the years ended December 31, 1996 and 1995, respectively.


     NOTE J - INCOME TAXES

     The income tax expense (benefit) consists of the following:


                                              1996              1995
                                              ----              ----
Current:
   Federal                              $  (695,000)         $   (42,000)
   State and local                           45,000              112,000

   Deferred
    Federal, state and local               (375,000)          (1,120,000)
                                        -----------          -----------
                                        $(1,025,000)         $(1,050,000)
                                        ===========          ===========


                                      F-17


<PAGE>



               CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                           December 31, 1996 and 1995


     NOTE J - INCOME TAXES - (Continued)

     The following is a  reconciliation  of the federal  income tax rate and the
effective tax rate as a percentage of pre-tax income:

                                                     December 31,

                                               1996              1995
                                               ----              ----

 Statutory federal rate                       (34.0)%           (34.0)%
 State taxes, net of federal tax benefit        1.4               5.0
 Non-deductible items                           1.5               1.2
 Other                                         (4.3)             (9.8)
                                              (35.4)%           (37.6)%
                                              =======           =======


     Deferred  income  taxes  reflect  the tax  effected  impact  of  "temporary
differences"  between  the  amounts  of assets  and  liabilities  for  financial
reporting purposes and such amounts as measured by tax laws and regulations. The
components of the Company's deferred tax assets are summarized as follows:


                                               1996                1995
                                               ----                ----

Ft. Worth and NYCC closure costs           $  969,000                   -
New Jersey facility closure costs                   -          $  986,000
Vacation accrual                               70,000              52,000
Development costs                             111,000              42,000
Accrued expenses                               33,000              70,000
Other                                               -             (30,000)
Net operating loss carryfoward                242,000                   -
Alternative minimum tax credit                 70,000                   -
                                             --------             -------
                                            1,495,000           1,120,000
Valuation allowance                                 -                   -
                                            ---------           ---------
                                           $1,495,000          $1,120,000
                                           ==========          ==========


     The  Company,  after  considering  its previous  pattern of  profitability,
excluding the New Jersey, Ft. Worth, and NYCC facility closure charges,  and its
anticipated future taxable income,  believes it is more likely than not that the
deferred tax assets will be realized.


                                      F-18


<PAGE>



               CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                           December 31, 1996 and 1995


     NOTE K - STOCKHOLDERS' EQUITY

     On  March  8,  1995,  the  Company's   Board  of  Directors   authorized  a
five-for-four  stock split in the form of a 25% stock dividend  payable on April
5, 1995 to  stockholders  of record on March 23,  1995.  All  references  in the
financial statements to average number of shares outstanding,  per share amounts
and stock option data for prior periods  presented have been restated to reflect
the 5% stock dividend and five-for-four stock split.

     During  September  1995,  the Company  completed  the private  placement of
496,807  shares of common stock at $7.75 per share.  The Company  received gross
proceeds of $3,850,254, net of issuance costs of $380,556. The net proceeds were
used for its Phoenix, Arizona facility.

     In connection with the 1995 Private  Placement,  warrants issued with units
totaled 874,198 which are exercisable at $7.75 per share.  During the year ended
December 31, 1996, 216,703 of such warrants were exercised  simultaneously  with
the tendering of  subordinated  notes.  At December 31, 1995 and 1996,  warrants
outstanding totaled 874,198 and 657,495, respectively. (See Note H).

     On February 2, 1994,  the  Company  completed a public  offering of 833,333
shares of common stock. The net proceeds received by the Company after deducting
applicable issuance costs and expenses aggregated $4,105,020. In connection with
the public offering, the Company sold to the representative of the underwriters,
for a nominal  sum,  warrants to purchase  from the  Company  109,375  shares of
common stock. The warrants are exercisable for a period of four years commencing
February 2, 1995 at an exercise  price of 107% of the  initial  public  offering
price  ($4.76),  increasing  to 114% of the  initial  public  offering  price on
February 2, 1996,  121% of the initial public offering price on February 2, 1997
and 128% of the initial public  offering  price on February 2, 1998.  During the
year ended  December  31, 1996,  30,000 of such  warrants  were  exercised at an
exercise price of $5.43 per share.

     On September 12, 1996, the Company completed a public offering of 2,070,000
shares of Common  Stock at $13.625  per share.  The net  proceeds  of the public
offering  after  deducting  applicable  issuance  costs and expenses  aggregated
approximately  $25,790,000.  In October,  1996,  pursuant  to the  underwriters'
over-allotment  option,  the Company sold an additional 367,500 shares of Common
Stock at $13.625 per share.  The net proceeds  received from the exercise of the
over-allotment option aggregated approximately  $4,716,000.  The net proceeds of
the public offering and the over- allotment option were used to repay bank loans
of  $7,198,468  (See Note H) and are being used for  construction,  start-up and
related costs of the Florence,  Arizona and Eagle Lake, Texas facilities and for
start-up  costs of the Polk and  Pahokee,  Florida  facilities  and for  general
corporate purposes.




                                      F-19


<PAGE>



               CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                           December 31, 1996 and 1995


NOTE L - COMMITMENTS AND CONTINGENCIES

     1(a). Fort Worth and New York Closures

     During the fourth quarter of 1996, due to substantially  reduced  occupancy
levels  and   operating   losses  being   sustained  at  two  of  the  Company's
community-based  halfway  houses,  the Company has  decided to  discontinue  the
operations of two programs;  one in Fort Worth, Texas and the other in New York,
New York.  Operations  at each  facility are  anticipated  to cease early in the
second quarter of 1997. As a result, the Company has accrued certain expenses at
December 31, 1996, and has written down certain assets related to each program.

     In Fort Worth,  the Company has  notified  the  contracting  agency  (Texas
Department  of Criminal  Justice) that the entire  facility will be closed.  All
incremental  closure  related costs,  from April 1, 1997 until the expiration of
the facility's  operating lease in May, 1999, have been charged to operations at
December 31, 1996. Such expenses include the write-off of fixed assets, deferred
development  and start-up costs,  and a provision for rent expense,  real estate
taxes, insurance and closure costs.

     At the Company's Brooklyn and Manhattan,  New York facilities,  the Company
has written-  off a portion of fixed assets and expenses  related to the program
it manages  for the New York State  Department  of  Corrections.  Such  expenses
include rents and related costs of operating each  facility,  real estate taxes,
insurance  and closure  costs from April 1, 1997 through the  expiration  of the
facilities'   operating  leases  on  December  31,  1998  and  April  30,  2000,
respectively.  Costs and expenses associated with the Company's ongoing programs
in New York with the Federal Bureau of Prisons have not been written down except
for certain costs  anticipated  at the  Manhattan  facility  resulting  from the
closure of the New York program.

     The December 31, 1996 write-down of $3,329,000 represents actual charges to
operations  incurred for each program at December 31, 1996 and the present value
of those  expenses  subsequent to April 1, 1997  attributable  to the closure of
each program which total $3,600,000  discounted using an interest rate of 9% per
annum.

     The composition of the writedown is as follows:

Fixed assets, net                                           $  564,050
Deferred development and start-up costs, net                    98,446
Accrued closure costs                                        2,566,504
Closure related costs incurred in 1996                         100,000
                                                            ----------
                                                            $3,329,000
                                                            ==========
Accrued closure costs                                       $2,566,504
Less current portion                                           960,504
                                                            ----------
Long-term portion of accrued closure costs                  $1,606,000
                                                            ==========

                                      F-20




<PAGE>



               CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                           December 31, 1996 and 1995


     NOTE L - COMMITMENTS AND CONTINGENCIES - Continued

     For each of the  aforementioned  programs,  the operating  losses  incurred
until the  facilities  are closed will be reflected in the financial  statements
applicable to those periods.

     1. New Jersey Facility Closure

     Due to a disturbance  at the Company's  Elizabeth,  New Jersey  facility on
June 18, 1995,  the facility was closed and all detainees  located  therein were
moved by the INS to other  facilities.  On December 15, 1995,  the company and a
publicly-traded company (the "Buyer"), which also operates and manages detention
and correctional  facilities,  entered into an asset purchase agreement pursuant
to which the Buyer  purchased the  equipment,  inventory and supplies,  contract
rights and records,  leasehold and land improvements of the Company's New Jersey
facility for $6,223,000.  The purchase price is payable in non-interest  bearing
monthly  installments of $123,000  (through August 1999) effective January 1997,
the month the Buyer commenced  operations of the facility.  If the INS re-awards
the contract to the Buyer, the unpaid balance is payable in monthly non-interest
bearing  installments  of $123,000  beginning in the first month of the re-award
term and the Company will record as income the unpaid balance.  On June 13, 1996
the  Company,  the Buyer and the INS executed a novation  agreement  whereby the
Buyer  became  the  successor-in-interest  to the  contract  with  the  INS.  In
addition,  the Company's  lease for the New Jersey  facility was assigned to the
Buyer.  The Company has no continuing  obligation with respect to the Elizabeth,
New Jersey facility.

     The  receivable  from  sale of the  equipment  and  leasehold  improvements
reflected  in the balance  sheet at December  31, 1995 and  December  31,  1996,
represents the present value of the  consideration to be received through August
1999 of $3,207,882 and $3,507,882, respectively, ($4,428,000 discounted using an
interest rate of 11.5% per annum) reduced by the estimated  closing costs (legal
and consulting) and the facility's estimated carrying costs through December 31,
1996.  The  statement of operations  for 1995 reflects a provision,  "New Jersey
facility  closure  costs," of  $3,909,700  which  represents  $416,201  from the
write-off of deferred  development  costs related to the facility and $3,493,499
resulting  from the  adjustment  of the  carrying  value of the  related  assets
discussed  above.  During the year ended  December 31, 1996,  the entire reserve
established  at December 31, 1995 for carrying and closing  costs was reduced by
approximately  $300,000  of  payments  for rent and other  carrying  and closing
costs.




                                      F-21


<PAGE>



               CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                           December 31, 1996 and 1995

     NOTE L - COMMITMENTS AND CONTINGENCIES - (CONTINUED)

2.       Legal Matters

     In May 1993,  a former  employee  of the  Company  filed suit in the United
States  District  Court,   Southern  District  of  New  York,  claiming  he  was
intentionally  assaulted by employees of the Company and claiming  $5,000,000 in
damages on each of six causes of action.  In January  1996,  a lawsuit was filed
with the  Supreme  Court of New  York,  County of  Kings,  by a former  employee
alleging  sexual  harassment  and  discrimination,  physical  assault,  rape and
negligent  screening  of  employees  and  claiming  damages of  $4,000,000  plus
attorney fees. In March 1996, former inmates at one of the Company's  facilities
filed  suit in the  Supreme  Court of the State of New York,  County of Bronx on
behalf of themselves and other similarly  situated,  alleging  personal injuries
and property damage purportedly caused by negligence and intentional acts of the
Company and claiming  $500,000,000  each for compensatory and punitive  damages,
which  suit was  transferred  to the  United  States  District  Court,  Southern
District of New York, in April 1996. In July 1996, seven detainees at one of the
Company's  facilities  (and certain of their spouses) filed suit in the Superior
Court of New Jersey,  County of Union,  seeking unspecified damages arising from
alleged mistreatment of the detainees,  which suit was transferred to the United
States District Court, District of New Jersey, in August 1996.

     The Company believes the claims made in each of the foregoing actions to be
without  merit and will  vigorously  defend such  actions.  The Company  further
believes the outcome of these actions and all other current legal proceedings to
which it is a party will not have a material  adverse effect upon its results of
operations, financial condition or liquidity.

3.       Contracts

     Renewal of government contracts (Note B) is subject to, among other things,
appropriations of funds by the various levels of government  involved  (Federal,
state or local).  Also, several contracts contain provisions whereby the Company
may be subject to audit by the government  agencies  involved.  These  contracts
also generally  contain  "termination for the convenience of the government" and
"stop work order"  clauses which  generally  allow the government to terminate a
contract  without cause. In the event one of the Company's  larger  contracts is
terminated, it may have a material adverse effect on the Company's operations.

4.       Officers' Compensation

     Effective  February  9,  1994,  the  President  entered  into  a  five-year
employment  agreement  with the Company that  provides  annual  compensation  of
$189,000, annual cost of living increases and an annual bonus of five percent of
pre-tax earnings greater than $1,000,000, not to exceed $200,000.

     In January 1996, the Company entered into three-year  employment agreements
with its Chief  Operating  Officer and Executive Vice  President-Finance,  which
provide annual compensation of $115,000 and $129,000,  respectively, and a bonus
equal to 3% of pre-tax profits in excess F-22


<PAGE>


               CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                           December 31, 1996 and 1995

     NOTE L - COMMITMENTS AND CONTINGENCIES - (CONTINUED)

of $1,000,000 not to exceed $50,000 and $75,000,  respectively.  Pursuant to the
terms of the  employment  agreement,  each  executive  was  granted an option to
purchase  100,000  shares of common  stock.  The option was  granted at the fair
market  value of the stock on the date of grant which was $8.875 per share.  The
options are  exercisable as follows:  one-third on the date of grant,  one-third
one year from the date of grant and the  remaining  one-third two years from the
date of grant.

5.       Other

     Approximately  96.6% and 98.0% and of the Company's  revenues for the years
ended  December 31, 1995 and 1996,  respectively,  relate to amounts earned from
Federal,  state and local  contracts.  The Company's  contracts in 1995 and 1996
with  government  agencies  where revenues  exceeded 10% of the Company's  total
consolidated  revenues  were with the U. S. Bureau of Prisons,  the INS, the New
York State  Department  of  Corrections,  and the Texas  Department  of Criminal
Justice, and in 1996 also included the Arizona Department of Corrections.

6.       Fiduciary Funds

     The  Company  has  acted as a  fiduciary  disbursing  agent on  behalf of a
governmental entity whereby certain  governmental entity funds are maintained in
a separate  bank account.  These funds have been paid to the general  contractor
which  constructed the government owned  facilities.  The company is responsible
for managing the  construction  process.  The Company has no legal rights to the
funds nor the constructed facility, and accordingly, such funds do not appear in
the accompanying financial statements.

7.       Construction Commitments

     The Company has a  construction  contract  to build the  Florence,  Arizona
facility at a cost of $9,985,000 and another construction  agreement to renovate
the Frio, Texas facility for $300,000.

8.       Letter of Credit

     In connection with the Company's workmen's  compensation insurance coverage
requirements, the Company has obtained a $170,000 Letter of Credit from its bank
in favor of the insurance carrier.



                                       23


<PAGE>



               CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                           December 31, 1996 and 1995


     NOTE M - STOCK OPTIONS

     In October 1993, the Company adopted a stock option plan (the "Stock Option
Plan"). This plan provides for the granting of both: (i) incentive stock options
to employees  and/or officers of the Company and (ii)  non-qualified  options to
consultants,  directors,  employees or officers of the Company. The total number
of shares which may be sold  pursuant to options  granted under the stock option
plan is 500,000.  The Company,  in June 1994,  adopted a Non-employee  Directors
Stock Option Plan,  which  provides  for the grant of  non-qualified  options to
purchase up to 196,875 shares of the Company's common stock.

     Options  granted  under  both plans may not be granted at a price less than
the fair market  value of the Common Stock on the date of grant (or 110% of fair
market  value in the case of persons  holding 10% or more of the voting stock of
the Company).  Options  granted under the Stock Option Plan will expire not more
than five years from the date of grant.

     In 1996,  the Company  granted  215,000  options to two key employees and a
director of the Company.  The exercise price of the options is equal to the fair
market  value of the common stock at the date of the grant.  These  options vest
over a two year period and expire five years from the date of grant.

     The  Company  has  adopted  only the  disclosure  provisions  of  Financial
Accounting  Standard No. 123, Accounting for Stock Based Compensation (FAS 123).
It applies APB Opinion No. 25,  Accounting  for Stock Issued to  Employees,  and
related  interpretations  in  accounting  for its plans  and does not  recognize
compensation  expense  for its stock  based  compensation  plans  other than for
restricted stock. If the Company had elected to recognize  compensation  expense
based  upon the fair  value at the  grant  date for  awards  under  these  plans
consistent  with the  methodology  prescribed by FAS 123, the Company's net loss
and loss per share would be increased to the pro forma amounts indicated below:

                                          Year Ended December 31,

                                         1996                  1995
                                         ----                  ----
 Net (loss)
   As reported                       $(1,868,027)          $(1,739,391)
   Pro forma                         $(2,716,910)          $(1,972,438)

 Loss earnings per common share
   As reported                       $      (.32)          $      (.38)
   Pro forma                         $      (.47)          $      (.43)




                                      F-25


<PAGE>



               CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                           December 31, 1996 and 1995


     NOTE M - STOCK OPTIONS - Continued

     These pro forma  amounts may not be  representative  of future  disclosures
because they do not take into effect pro forma  compensation  expense related to
grants made before 1995.  The fair value of these  options was  estimated at the
date of grant  using  Black-Scholes  option-pricing  model  with  the  following
weighted-average assumption for the years ended December 31, 1996 and 1995.


                                             1996             1995
                                             ----             ----

            Volatility                        72%              72%
            Risk free rate                  5.64%            6.38%
            Expected life              3.32 years          4 years


     The weighted average fair value of options granted during 1996 and 1995 for
which the exercise price equals the market price on the grant date was $5.71 and
$8.81,  respectively,  and the weighted  average exercise prices were $10.56 and
$15.04,  respectively.  The weighted  average  fair value and  weighted  average
exercise price of options  granted in 1995 for which the exercise price exceeded
the market price on the grant date were $10.5 and $20.63, respectively.

     The  Black-Scholes   option  valuation  model  was  developed  for  use  in
estimating the fair value of traded  options which have no vesting  restrictions
and are fully  transferable.  In addition,  option  valuation models require the
input of highly  subjective  assumptions  including  the  expected  stock  price
volatility.  Because the Company's  employee stock options have  characteristics
significantly different from those of traded options, and because changes in the
subjective input asusmptions can materially  affect the fair value estimate,  in
management's  opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options.

     Stock option activity during 1996 and 1995 is summarized below:

                                                          Weighted-Average
                                       Options            Exercise Price
                                       -------            ----------------

  Balance, January 31, 1995            290,313             $  6.19
  Granted                               81,875               15.73
  Exercised                             (7,000)               4.76
  Canceled                                   -                   -
                                       -------             -------
  Balance, January 1, 1996             365,188                8.35
  Granted                              293,700               10.56
  Exercised                            (64,888)               6.37
  Canceled                             (43,750)              12.67
  Balance, December 31, 1996           550,250                9.40
                                       =======             =======



                                      F-26


<PAGE>


               CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES
             NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
                           December 31, 1996 and 1995


NOTE M - STOCK OPTIONS - Continued

     The following table summarizes information concerning currently outstanding
and exercisable stock options:


<TABLE>
<CAPTION>

                                                                                
                                                                                Weighted-Average
                                                                                   Remaining
                        Range of                         Number                 Contractual Life             Weighted-Average
                        Exercise                         Outstanding                (Years)                  Exercise Price
                        --------                         -----------            ----------------             ----------------

<S>                       <C>                             <C>                       <C>                              <C>

                          $4-8                           214,676                     2.34                           $6.21
                          $8-12                          240,374                     4.0                            $9.07
                         $12-18                           60,200                     4.46                          $16.32
                         $18-21                           35,000                     3.46                          $19.29
                                                         -------
                                                         550,250
                                                         =======

                       Range of                         Number                  Weighted-Average
                       Exercise Prices                Exercisable               Exercise Price
                       ---------------                -----------               ---------------- 

                          $4-8                           214,676                     $6.21
                          $8-12                           67,604                     $9.22
                         $18-21                           17,500                    $19.29
                                                         -------
                                                         299,780
                                                         =======


</TABLE>





     NOTE N - EMPLOYEE BENEFIT PLAN

     On July 1, 1996, the Company  adopted a contributory  retirement plan under
Section  401(k) of the Internal  Revenue Code,  for the benefit of all employees
meeting certain minimum service requirements.  Eligible employees can contribute
up to 15% of their  salary  but not in excess of $9,500 in 1996.  The  Company's
contribution  under the plan amounts to 20% of the employees'  contribution.  In
1996, the Company contributed $15,886 to the plan.

     NOTE O - SELF INSURANCE

     During 1996, the Company  decided to self insure for workers'  compensation
insurance.  The Company has obtained an aggregate excess policy which limits the
Company's  exposure to a maximum of $600,000.  The  December 31, 1996  estimated
insurance liability totaling $120,000 is based upon review by the Company and an
independent  insurance  broker  of  claims  filed and  claims  incurred  but not
reported.



                                      F-27