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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549



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FORM 10-K



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|x | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ------------------------------------------------------------------------------------



For the Fiscal Year Ended December 31, 2004



OR



| ̈ | Transition Report to Section 13 or 15(d) of the Securities Exchange Act of 1934
|- | -------------------------------------------------------------------------------



For the transition period from  to
.



Commission File No.: 0-23038



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CORRECTIONAL SERVICES CORPORATION

(Exact name of registrant as specified in its charter)



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|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|DELAWARE                                                       |  | 11-3182580                          
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)



|                                        |  |           
|--------------------------------------- |  | ----------
|1819 Main Street, Sarasota, Florida     |  | 34236     
|(Address of principal executive office) |  | (Zip Code)



Registrants
telephone number, including area code: (941) 953-9199



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Securities registered pursuant to Section 12(b) of the Act:



None



Securities registered pursuant to Section 12(g) of the Act:



|                                       |  |                                          
|-------------------------------------- |  | -----------------------------------------
|Title of each class                    |  | Name of each exchange on which registered
|Common Stock, par value $.01 per share |  | Nasdaq National Market                   



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Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 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 ̈



Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not 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-K or any amendment to this Form 10-K.  x



Indicate by check mark whether the registrant is an accelerated filer. (as
defined by Exchange Act Rule 12b-2).    Yes ̈No  x



At June 30, 2004, the aggregate market value of
the voting and non-voting common equity held by non-affiliates of the registrant was $24,538,000.



At March 15, 2005, there were 10,166,940 outstanding shares of the Common Stock of the Registrant.



DOCUMENTS INCORPORATED BY REFERENCE



Parts of the Registrants Proxy Statement for its 2005 Annual Meeting of

Shareholders are incorporated by reference in Part III of this report.



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##### Table of Contents

TABLE OF CONTENTS



|                        |  |                                                                                                              |  |     
|----------------------- |  | ------------------------------------------------------------------------------------------------------------ |  | ----
|                        |  |                                                                                                              |  | Page
|                        |  | PART I                                                                                                       |  |     
|                        |  |                                                                                                             
|Item 1                  |  | Business                                                                                                     |  | 4   
|                        |  |                                                                                                             
|Item 2                  |  | Properties                                                                                                   |  | 14  
|                        |  |                                                                                                             
|Item 3                  |  | Legal Proceedings                                                                                            |  | 15  
|                        |  |                                                                                                             
|Item 4                  |  | Submission of Matters to a Vote of Security Holders                                                          |  | 19  
|                        |  |                                                                                                             
|                        |  | PART II                                                                                                      |  |     
|                        |  |                                                                                                             
|Item 5                  |  | Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities |  | 19  
|                        |  |                                                                                                             
|Item 6                  |  | Selected Financial Data                                                                                      |  | 21  
|                        |  |                                                                                                             
|Item 7                  |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                        |  | 21  
|                        |  |                                                                                                             
|Item 7A                 |  | Quantitative and Qualitative Disclosures About Market Risk                                                   |  | 34  
|                        |  |                                                                                                             
|Item 8                  |  | Financial Statements and Supplementary Data                                                                  |  | 34  
|                        |  |                                                                                                             
|Item 9                  |  | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure                         |  | 34  
|                        |  |                                                                                                             
|Item 9A                 |  | Controls and Procedures                                                                                      |  | 34  
|                        |  |                                                                                                             
|Item 9B                 |  | Other Information                                                                                            |  | 35  
|                        |  |                                                                                                             
|                        |  | PART III                                                                                                     |  |     
|                        | 
|Items 10, 11, 12 and 13 |  | 35                                                                                                          
|                        |  |                                                                                                             
|                        |  | PART IV                                                                                                      |  |     
|                        |  |                                                                                                             
|Item 14                 |  | Principal Accountant Fees and Services                                                                       |  | 35  
|                        |  |                                                                                                             
|Item 15                 |  | Exhibits and Financial Statement Schedules                                                                   |  | 36  
|                        |  |                                                                                                             
|                        |  | Signature Page                                                                                               |  | 38  



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SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995



This document contains forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933, as amended, and 21E of the Securities Exchange Act of 1934, as amended, which are not historical facts and involve risks and uncertainties. These include statements regarding the expectations, beliefs, intentions or
strategies regarding the future. The Company intends that all forward-looking statements be subject to the safe-harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements reflect the Companys
views as of the date they are made with respect to future events and financial performance, but are subject to many uncertainties and risks which could cause the actual results of the Company to differ materially from any future results expressed or
implied by such forward-looking statements. Examples of such uncertainties and risks include, but are not limited to: fluctuations in occupancy levels and labor costs; the ability to secure both new contracts and the renewal of existing contracts;
the ability to obtain financing when a contract requires that the Company construct a new facility in order to meet the needs of the contract; the ability to meet financial covenants; the ability to reduce various operating costs; and public
resistance to privatization. Additional risk factors include those discussed in reports filed by the Company from time to time on Forms 10-K, 10-Q and 8-K. The Company does not undertake any obligation to update any forward-looking statements.



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PART I



Item 1. Business



General Development of Business



Correctional Services
Corporation (hereinafter referred to CSC) was incorporated under the laws of the State of Delaware on October 28, 1993 to acquire all of the outstanding capital stock of a number of affiliated corporations engaged in the operation of
correctional and detention facilities. In 1999, CSC acquired Youth Services International (hereinafter referred to as YSI), a leading national provider of private educational, developmental and rehabilitative programs for at risk,
delinquent and adjudicated juveniles, through a merger accounted for as a pooling of interests. On September 22, 2004, the Company acquired a variable interest in a variable interest entity, South Texas Detention Complex Local Development
Corporation (hereinafter referred to as the South Texas Development Corporation), in connection with the financing of the construction of the South Texas Detention Complex (which is described in greater detail below). Pursuant to FIN 46
(revised), the accounts of the South Texas Development Corporation have been consolidated with the accounts of CSC, YSI and their respective wholly owned subsidiaries. CSC, YSI and the South Texas Development Corporation, together with the other
wholly-owned subsidiaries of CSC and YSI, are referred to hereinafter collectively as the Company.



The Company is a leading developer and operator of correctional and detention facilities for adult offenders and one of the largest and most comprehensive providers of educational, developmental and rehabilitative
programs for at risk, delinquent and adjudicated juveniles. As of year end, the Company operated and managed 14 residential facilities for adult offenders in 6 states having a capacity to house approximately 5,500 offenders, operated and managed 17
residential facilities in 7 states for at risk, delinquent and adjudicated juveniles having a capacity to provide services for approximately 1,300 juveniles, and provided aftercare services for approximately 500 juveniles in the juvenile justice
system of the State of Georgia. (As explained below, the Companys contract for the provision of aftercare services in the State of Georgia will terminate effective as of March 31, 2005.)



The Company is also a leading provider of design and construction services for juvenile and
adult correctional facilities, including project consulting, design, development and construction of new correctional and detention facilities and the redesign and renovation of existing facilities. These services usually are provided in conjunction
with an agreement for the Company to operate the facility upon completion of the construction or renovation.



The following are highlights of the material developments in the Companys business during calendar year 2004:



Northwest Regional Detention Center Opened in April:



In April 2004, the Company completed the construction of and opened a new 890-bed regional detention center located in Tacoma, Washington, known as the Northwest
Regional Detention Center, which currently houses approximately 500 detainees in the custody of the United States Department of Homeland Security, Bureau of Immigration and Customs Enforcement, Office of Detention and Removal (which assumed
the responsibilities of the former United States Immigration and Naturalization Service in connection with the formation of the Department of Homeland Security) (hereinafter referred to as ICE). The Company developed and constructed the
Northwest Regional Detention Center in furtherance of a contract awarded by ICE to the Company in 2003 under which the Company has undertaken to house up to 500 detainees awaiting deportation in the Northwest Regional Detention Center.



The Company secured financing for the construction of the Northwest Regional Detention
Center on June 30, 2003 through a financing transaction in which the Washington Economic Development Finance Authority (WEDFA), an instrumentality of the State of Washington, issued revenue bonds to finance the project, and subsequently
loaned the proceeds of the bond issuance to a newly formed limited liability company, CSC of Tacoma LLC, for the purposes of constructing the Northwest Regional Detention Center. In connection with this financing, the Company formed a limited
liability company, known as CSC of Tacoma, LLC, for the sole purpose of owning the real property on which this facility was constructed. This LLC owns this real property, as well as all of the improvements constructed thereon, and leases
the same to the Company pursuant to long-term lease arrangement. Although the Company is the sole member of CSC of Tacoma, LLC, the LLC is managed by an independent group of managers and the Company has limited rights with respect to the business
and operations of the LLC. However, in accordance with generally accepted accounting principles, the assets and liabilities and results of operations of CSC of Tacoma LLC are consolidated with the assets and liabilities and results of operations of
the Company. The bonds issued by WEDFA to finance the project and the loan from WEDFA to CSC of Tacoma, LLC are non-recourse to the Company.



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South Texas Detention Complex Under Construction:



On January 26, 2004, ICE awarded the Company another contract to provide housing for up to
1,020 detainees in a facility to be located in Frio County, Texas (Frio County). In furtherance of that contract, the Company entered into an agreement with Frio County, whereby Frio County created the South Texas Development
Corporation, a non-profit, local development corporation pursuant to Chapter 431 Texas Transportation Code. On September 22, 2004, this corporation issued $49.5 million of taxable revenue bonds, net of a $88,000 discount, to finance the construction
of a new 1,020-bed regional detention center located in Pearsall, Frio County, Texas, to be known as the South Texas Detention Complex (the South Texas Detention Complex). The bonds are non-recourse to the Company. The
Company is currently developing the South Texas Detention Complex for the South Texas Development Corporation. The South Texas Development Corporation, as the owner of the South Texas Detention Complex, simultaneously entered into an operating
agreement with the Company, giving the Company the sole and exclusive right to use, occupy, operate and manage the South Texas Detention Complex for a period of 20 years after its completion. The South Texas Development Corporation also granted the
Company an option to purchase the South Texas Detention Complex at any time for a purchase price equivalent to the amount necessary, if any, to repay the principal and interest on any outstanding bonds or for $1.00 upon the bonds being paid in full.
The Company is currently in the final stages of construction of this project, and anticipates completing construction and to begin accepting detainees into this facility on or about May 1, 2005.



New Management Contracts:



During 2004, the Company also entered into contracts and began operations at the following
facilities:



| | 1) | Bill Clayton Detention Center, located in Littlefield, Texas, a facility capable of housing up to 214 minimum and medium security adult offenders, which is currently fully utilized
by the Wyoming Department of Corrections;
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | 2) | Crisp County Youth Development Center, a 64-bed residential facility for juveniles located in Cordele, Georgia, which the Company manages for the Georgia Department of Juvenile
Justice;
| | -- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | 3) | Lufkin Detention Center, a 300-bed residential facility for adult offenders located in Lufkin, Texas;
| | -- | -----------------------------------------------------------------------------------------------------



| | 4) | Marion Youth Development Center, a 96-bed residential facility for male juveniles located in Ocala, Florida, which the Company manages for the Florida Department of Juvenile
Justice;
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | 5) | Sawmill Academy for Girls, a 27-bed residential facility for female juveniles located in Tallahassee, Florida, which the Company manages for the Florida Department of Juvenile
Justice;
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | 6) | Thompson Juvenile Residential Facility, a 112-bed residential facility for male juveniles, located in Pembroke Pines, Florida, which the Company manages for the Florida Department
of Juvenile Justice; and
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| | 7) | Tri-County Jail and Detention Jail Facility, a 226-bed facility for adult offenders located in Ullin, Illinois, which the Company manages for Pulaski County, Illinois, which is
currently utilized by the United States Marshals Service, the United States Bureau of Immigration and Customs Enforcement and surrounding counties.
| | -- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Expired or Terminated Management Contracts:



During 2004, the Company terminated its management contract for the Lufkin Detention Center, following a determination by management of the
Company that the anticipated utilization and daily occupancy of the facility would be insufficient in the foreseeable future to make the operation of the facility viable financially.



Additionally, during 2004, the Companys management agreements for The Charles H. Hickey, Jr. School (hereafter referred to as
CHHJS) in Baltimore, Maryland and the Dallas Youth Academy in Dallas, Texas expired by their terms. The Company elected not to participate in the re-bid for the operation and management of CHHJS in light of a determination by management
that the facility could not be operated profitably under the terms outlined in the request for proposals for that facility. The State of Maryland subsequently withdrew its request for proposals with respect to CHHJS and currently operates CHHJS
directly. Dallas County, Texas closed the Dallas Youth Academy program after the Companys contract expired.



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Discontinued Operations:



In 2004, the Company discontinued its operation and management of the Hemphill County Juvenile Facility in Canadian, Texas, following a
decision by the Texas Youth Commission (hereinafter referred to as TYC), the primary user of that facility, to transfer substantially all of the juveniles housed by TYC in privately operated facilities to TYC-owned and operated
facilities. The Company also discontinued operations at the Tarkio Academy in Tarkio, Missouri effective as of October 31, 2004 due to continuing financial losses at that facility. The results of operations from the Hemphill County Juvenile Facility
and the Tarkio Academy are reflected in the accompanying financial statements as discontinued operations, together with the results of operations from other facilities and programs previously classified as discontinued operations.



Other Developments:



Settlement Pending in Elizabeth Class Action Lawsuit:



On February 17, 2005, the United States District Court for the District of New Jersey gave
preliminary approval to the terms of a settlement negotiated by the Companys liability insurance carrier and the counsel for the plaintiffs in the class action lawsuit that has been pending against the Company since March, 1996. The suit was
filed in March 1996 in the Supreme Court of the State of New York, County of Bronx by several former detainees in the INS Detention Center that the Company formerly operated for the INS in Elizabeth, New Jersey, on behalf of themselves and others
similarly situated, in which the plaintiffs in the suit claimed $500,000,000 in compensatory and punitive damages on a variety of legal theories. This suit was removed to the United States District Court, Southern District of New York, in April
1996, and subsequently transferred to the United States District Court for the District of New Jersey. The plaintiffs in this case obtained certification from the Court to try their case as a class action on behalf of themselves and all other
persons who were detained in the Elizabeth INS Detention Center while the Company operated it. As noted above, on February 17, 2005, the District Court approved the terms of a settlement in this case that was negotiated by the Companys
liability insurance carrier and the plaintiffs case in order to resolve this case. The Company has no obligation to contribute to this settlement, which will be funded in full by the Companys liability insurance carrier. The
Companys defense counsel and the plaintiffs counsel are currently preparing the settlement documentation. The Company expects that the settlement documentation will be completed and that the Court will formally approve the settlement in
the near future.



Contract for Georgia Aftercare Services to Terminate on
March 31, 2005:



Additionally, on or about March 3, 2005, the State of
Georgia, Department of Juvenile Services notified the Company that it would be terminating the Companys contract for the provision of aftercare services for approximately 500 juveniles in the State of Georgia effective as of March 31, 2005 due
to a lack of appropriations necessary for the continuation of these services. Accordingly, the Companys contract for these services with the State of Georgia will terminate on March 31, 2005.



Description of the Companys Business:



The Company is a leading developer and operator of correctional and detention facilities for
adult offenders and one of the largest and most comprehensive providers of educational, developmental and rehabilitative programs for at risk, delinquent and adjudicated juveniles.



Operational Divisions



The Company operates a wide range of correctional, educational, developmental and rehabilitative facilities and programs targeted toward solving the specialized needs of
governmental agencies, and has organized its operations into two divisions: Adult/Community Corrections and Juvenile.



Adult/Community Corrections:



The Companys Adult/Community Corrections Division primarily operates secure, residential correctional and detention facilities that house and service, among other
populations:



| |  |  | substance abuse offenders;
| | - |  | --------------------------



| |  |  | parole violators;
| | - |  | -----------------



| |  |  | pre-trial detainees;
| | - |  | --------------------



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| |  |  | aliens pending deportation;
| | - |  | ---------------------------



| |  |  | federal detainees and inmates awaiting permanent commitments or court appearances;
| | - |  | ----------------------------------------------------------------------------------



| |  |  | sex offenders; and
| | - |  | ------------------



| |  |  | inmates transitioning from incarceration to community living.
| | - |  | -------------------------------------------------------------



In its secure adult facilities, the Company not only provides adult inmates with housing but also with other basic services, including health care and food service. The
Division also provides transportation services for governmental agencies and remote post security and supervision for inmates and detainees making court appearances or who require hospitalization or off-site medical care. In addition, the Company
provides a variety of rehabilitative and educational services in its facilities, including substance abuse counseling, community service and recreational programs for adult inmates where appropriate.



The Companys three Community Corrections facilities are non-secure residential
facilities for adult male and female offenders transitioning from institutional to independent living. Qualified offenders may spend the last three to six months of their sentence in a community corrections program. These programs assist the
offender in the reunification process with family and the community. Independent research has indicated that successful reunification can play a key role in recidivism reduction, which is the primary goal of any corrections operation. To that end,
the Company provides life skills training, case management, home confinement supervision and family reunification programs from these facilities. The Company believes that community corrections facilities help reduce recidivism, resulting in prison
beds being available for more violent offenders and, in appropriate cases, represent cost-effective alternatives to prisons for many jurisdictions.



At year-end 2004, the Adult/Community Corrections Division operated 14 correctional and detention facilities in six states, containing approximately 5,500 beds.



During the year 2004, revenues from the Adult/Community Corrections programs
comprised 59.7% of the Companys consolidated revenue, and 92.2% of the consolidated contribution margin. During the year 2004, 31.1% and 20.1% of the Companys consolidated revenues in its Adult/Community Corrections division were earned
from various agencies of the United States Government and the State of Arizona, respectively.



Juvenile Division:



The Companys
Juvenile Division operates largely under the YSI brand name and primarily operates secure and non-secure facilities for low, medium, and high risk youths in highly structured programs, including wilderness programs, secure education and
training centers, academy programs, high impact programs servicing lower level or first time offenders, and detention facilities. In addition, the Juvenile Division also provides non-residential aftercare programs for juveniles who have completed
residential programs throughout the Companys system.



The Companys
juvenile facilities provides educational, rehabilitative and development services for juveniles using the YSI Continuum of Care, a proprietary rehabilitative system that strives to reduce the recidivism rate of program participants and
hopefully help to prevent adult incarceration. Specific YSI Continuum of Care programs and services for juveniles include:



| |  |  | The Discovery Network, addressing education, prevention, and intervention for delinquent sexual misconduct;
| | - |  | -----------------------------------------------------------------------------------------------------------



| |  |  | The Choices Network, focusing on education, prevention and intervention surrounding substance abuse and sales;
| | - |  | --------------------------------------------------------------------------------------------------------------



| |  |  | The Bridges Program, dealing with trust and emotional stability issues for youth experiencing continued out-of-home placements due to temporary or permanent severing of parental
custody;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The Futures Network, teaching specialized coping skills and intervention services to pre-adolescent delinquent youth;
| | - |  | ---------------------------------------------------------------------------------------------------------------------



| |  |  | The Athena Program, addressing gender identity development, sex role stereotyping, surviving sexual abuse, and juvenile prostitution among high-risk delinquent girls;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The Florian Program, providing specialized education, intervention and prevention services for pre-adolescent fire setter and arson actions of emotionally disturbed delinquent
youth; and
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Youthful Offender Programs, which are designed specifically for young adults aged 18-25, who are under the continuing jurisdiction of juvenile courts.
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------



The Companys innovative programs address the root causes and issues behind adult and
juvenile anti-social behavior. The Company believes its programs, by instilling the qualities of self-respect, respect for others and their property, personal responsibility, and family values, can help change the thinking and behavior of program
participants. The Companys juvenile programs are comprised of four major components: education, vocational training, socialization, and



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recreation. Behavioral management principles intended to dramatically change the thinking and behavior of program participants are consistently applied
throughout each segment of programming to teach participants basic life skills, while reinforcing the principle that success begins with appropriate, acceptable behavior.



At year-end 2004, the Juvenile Division operated 17 facilities in seven states approximating 1,300 beds, exclusive of aftercare. During the
year 2004, revenues from the Juvenile Division comprised 40.3% of the Companys consolidated revenues, and 7.8% of the consolidated contribution margin. During the year 2004, 8.5% and 7.3% of the Companys consolidated revenues were earned
from the Florida and Georgia Departments of Juvenile Justice, respectively. Included in the 7.3% of revenue attributed to Georgia Department of Juvenile Justice is 1.0% associated with the Dublin Aftercare program, which will be closing at the end
of the first quarter of 2005.



In addition to providing fundamental residential
services for adult and juvenile offenders, the Company has developed a broad range of programs intended to reduce recidivism, including: basic, special, and vocational education; substance abuse treatment and counseling; life skills training;
behavioral modification counseling; and comprehensive aftercare programs. In all of its facilities, the Company strives to provide the highest quality services designed to reduce recidivism and continually evaluates and audits its programs and
believes the reputation of its programs will lead to continued business opportunities.



Marketing and Business Development



The Company engages in
extensive marketing and business development on a national basis. Marketing efforts are spearheaded by the Companys business development team in conjunction with the Companys executive officers and outside consultants. Additional
marketing efforts are conducted locally by the Facility Administrators to fill empty beds on an as-needed basis, and in anticipation of future vacancies.



The Company receives frequent inquiries from or on behalf of governmental agencies. Upon receiving such an inquiry, the Company determines whether there is an existing or
future need for the Companys services, whether the legal and political climate is conducive to privatized correctional operations, and whether or not the project is commercially viable.



Contract Award Process



Most governmental procurement and purchasing activities are controlled by procurement regulations that take the form of a Request for
Proposal (RFP), and to date most of the Companys new business has resulted from responding to these requests. Interested parties submit proposals in response to an RFP within a time period of usually 15 to 120 days from the time
that 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. From time to time, the Company engages independent consultants to assist in responding to the RFPs. Approximately six to eighteen months is generally required from the issuance of an RFP to the contract award.



Before responding to an RFP, the Company researches and evaluates, among other factors:



| |  |  | the current size and growth projections of the available correctional and detention population;
| | - |  | -----------------------------------------------------------------------------------------------



| |  |  | whether or not a minimum capacity level is guaranteed;
| | - |  | ------------------------------------------------------



| |  |  | 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
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | 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
RFPs, 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.



Market



The Company believes there is a growing acceptance of privatization of governmental services. Correctional and detention functions traditionally performed by federal, state and local governments have faced continuing
pressure to



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control costs and reduce the number of governmental employees. Since incarceration costs generally grow faster than many other parts of budget items, in an
attempt to address these budgetary pressures, governmental agencies responsible for correctional and detention facilities are privatizing facilities. As of year-end 2003 (the most recent available data), privately operated adult prison facilities
held 95,522 prisoners, up 1.7% from 2002. This accounted for 6.5% of all Federal and State adult inmates as of year-end 2003 and 2002.



An estimated 2.1 million adult inmates are held in Federal and State prisons, and local jails as of December 31, 2003. On December 31, 2003, State adult prisons were
operating between full capacity and 16% above capacity, while Federal adult prisons were operating at 39% above capacity.



The services in which the juvenile justice system has seen the greatest growth are residential services for children committing crimes who have serious emotional and
behavioral problems. The public and private sector have had to adjust to providing services for children who are dually diagnosed, have drug and alcohol addictions and/or sex offending and fire setting histories. The Company has developed treatment
programs to address these growing needs, and has focused their efforts to capture a share of this growing market. The Companys Florida facilities began receiving Medicaid funds in 2001 for reimbursement of behavioral health services, as the
provision of these additional services qualified for reimbursement under Medicaid. The Company plans to seek this certification at other applicable juvenile facilities.



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. 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 operations compete with governmental and not-for-profit entities. The Companys main competitors in the adult
division include but are not limited to Corrections Corporation of America, the Geo Group (formerly Wackenhut Corrections Corporation), and Cornell Corrections. The Companys primary competitors in the Juvenile Division are Premier Behavioral
Solutions (formerly Ramsay Youth Services), Securicor, and Sunshine Youth Services.



Facilities



The Company operates adult and juvenile
pre-adjudication and post-adjudication secure and non-secure correctional and detention facilities, and non-secure adult community corrections facilities for federal, state, and local correctional agencies. Pre-adjudication 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-adjudication secure facilities provide
secure incarceration for individuals who have been found guilty of a crime by a court of law. The Company operates six types of post-adjudication facilities: 1) secure prisons (adult); 2) intermediate sanction facilities (adult); 3) high impact
programs (juvenile); 4) academies (juvenile); 5) secure treatment and training facilities (adult and juvenile); and 6) sexually delinquent juvenile programs (juvenile).



Secure prisons and intermediate sanction facilities provide a secure correctional environment 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. High impact programs provide residential placement for juveniles who are either first time offenders or who were unable to meet the
terms of a non-residential placement. High impact programs are generally short term with stays of 30 to 90 days, but involve all of the rehabilitative elements of an academy program. Academies are secure facilities that range from hardware secure to
staff secure. These facilities typically service juveniles who are repeat offenders and/or violent crime offenders. The academies emphasize rehabilitative programming, including individual and group treatment, education, recreation and vocational
training. Secure treatment and training facilities provide numerous services designed to reduce recidivism including educational and vocational training, life skills, anger control management, and substance abuse counseling and treatment. Juvenile
sex offender programs are generally locked secure and involve a length of stay from 12 to 24 months.



The Company also operates non-secure residential and non-residential community corrections programs. Non-secure residential facilities, known as halfway houses, provide a residential correctional environment 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 three to 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



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form of either requiring the offender to report to a correctional facility a specified number of times each week and/or having the Company employees monitor
the offender on a case management basis at his/her work site and home. In the juvenile division, the non-residential programs take the form of aftercare programs. Unlike the adult division where a non-residential supervision program may replace the
last part of an adults residential supervision, the juvenile division counterpart, the aftercare program, is strictly post release. The goal of these programs, like adult community corrections, is to assist the juvenile in effecting a positive
return to their families and communities. Aftercare programs provide the contact, supervision and support that is needed to further instill the principles learned by the juvenile during the longer residential program.



The following information is provided with respect to the facilities that the Company
operated as of March 15, 2005:



Adult Division



|                                                                  |  |                        |  |                                            |  |                                             |  |                             
|----------------------------------------------------------------- |  | ---------------------- |  | ------------------------------------------ |  | ------------------------------------------- |  | ----------------------------
|Facility Name, Location and Year Operations
Commenced             |  | DesignCapacity Beds(1) |  | Type of Facility                           |  | Contracting Governmental Agency             |  | Owned, Leased, or Managed(2)
|Arizona State Prison, Florence WestFlorence, Arizona (1997)       |  | 750                    |  | Prison                                     |  | State                                       |  | Leased                      
|                                                                  |  |                        |  |                                           
|Arizona State Prison, Phoenix WestPhoenix, Arizona (1996)         |  | 450                    |  | Prison                                     |  | State                                       |  | Leased (3)                  
|                                                                  |  |                        |  |                                           
|Bill Clayton Detention CenterLittlefield, Texas (2004)            |  | 214                    |  | Long TermDetention                         |  | State                                       |  | Managed                     
|                                                                  |  |                        |  |                                           
|Bronx Community Corrections CenterBronx, New York (1996)          |  | 111                    |  | Residential CommunityCorrectional Facility |  | Federal Bureauof Prisons                    |  | Leased                      
|                                                                  |  |                        |  |                                           
|Brooklyn Community Correctional CenterBrooklyn, New York (1989)   |  | 164                    |  | Residential CommunityCorrectional Facility |  | Federal Bureauof Prisons                    |  | Leased                      
|                                                                  |  |                        |  |                                           
|Dickens County Correctional CenterSpur, Texas (1998)              |  | 489                    |  | Jail/Long TermDetention                    |  | Federal/County                              |  | Managed                     
|                                                                  |  |                        |  |                                           
|Fort Worth Community Corrections CenterFort Worth, Texas (1994)   |  | 200                    |  | ResidentialCorrectional Facility           |  | State                                       |  | Leased                      
|                                                                  |  |                        |  |                                           
|Frio County JailPearsall, Texas (1997)                            |  | 391                    |  | Jail/Long TermDetention                    |  | County/State/Federal                        |  | Part-Leased/Part-Owned      
|                                                                  |  |                        |  |                                           
|Grenada County JailGrenada, Mississippi (1998)                    |  | 160                    |  | Jail                                       |  | County                                      |  | Managed                     
|                                                                  |  |                        |  |                                           
|Jefferson County Downtown JailBeaumont, Texas (1998)              |  | 500                    |  | Jail/Long TermDetention                    |  | County/Federal                              |  | Managed                     
|                                                                  |  |                        |  |                                           
|Newton County Correctional FacilityNewton, Texas (1998)           |  | 872                    |  | Prison/Jail/Long TermDetention             |  | County/MultiState/Federal                   |  | Managed                     
|                                                                  |  |                        |  |                                           
|Northwest Detention CenterTacoma, Washington (2004)               |  | 890                    |  | Secure DetentionFacility                   |  | Bureau of Immigrationand CustomsEnforcement |  | Owned                       
|                                                                  |  |                        |  |                                           
|South Texas Intermediate SanctionFacility Houston, Texas (1993)   |  | 450                    |  | Secure IntermediateSanction Facility       |  | State                                       |  | Managed                     
|                                                                  |  |                        |  |                                           
|Tri-County Jail and Detention Jail FacilityULLIN, Illinois (2004) |  | 226                    |  | Jail/Long TermDetention                    |  | County/Federal                              |  | Managed                     

---

|(1) | Design capacity is based on the physical space available presently, or licensure for offender or residential beds in compliance with relevant regulations and contract requirements.
In certain cases, the management contract for a facility provides for a lower number of beds.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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|(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.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | See Part I, Item 2, Properties and Part II, Item 7, Managements Discussion and Analysis of Financial Condition and Results of Operations  Liquidity and
Capital Resources for a discussion of the sale of this facility by the Company.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Juvenile Division



|                                                                    |  |                         |  |                                   |  |                                 |  |                             
|------------------------------------------------------------------- |  | ----------------------- |  | --------------------------------- |  | ------------------------------- |  | ----------------------------
|Facility Name, Location and Year Operations
Commenced               |  | Design Capacity Beds(1) |  | Type of Facility                  |  | Contracting Governmental Agency |  | Owned, Leased, or Managed(2)
|Blackwater STOP CampMilton, Florida (2003)                          |  | 18                      |  | Non SecureTreatment Facility      |  | State                           |  | Managed                     
|                                                                    |  |                         |  |                                  
|Chamberlain AcademyChamberlain, South Dakota (1993)                 |  | 78                      |  | Non SecureAcademy Facility        |  | Multi-State/Federal             |  | Owned                       
|                                                                    |  |                         |  |                                  
|Colorado County Juvenile FacilityEagle Lake, Texas (1998)           |  | 156                     |  | Secure ResidentialFacility        |  | State/County                    |  | Managed                     
|                                                                    |  |                         |  |                                  
|Crisp County Youth Development CenterCordele, Georgia (2004)        |  | 64                      |  | Secure TreatmentFacility          |  | State                           |  | Managed                     
|                                                                    |  |                         |  |                                  
|Dallas County Secure Post Adjudication FacilityDallas, Texas (1998) |  | 96                      |  | Secure TreatmentFacility          |  | County                          |  | Managed                     
|                                                                    |  |                         |  |                                  
|Elmore AcademyElmore, Minnesota (1998)                              |  | 126                     |  | Non Secure AcademyFacility        |  | Multi-State                     |  | Owned                       
|                                                                    |  |                         |  |                                  
|Forest Ridge Youth ServicesWallingford, Iowa (1993)                 |  | 140                     |  | Non Secure FemaleAcademy Facility |  | Multi-State                     |  | Owned                       
|                                                                    |  |                         |  |                                  
|Hillsborough AcademyTampa, Florida (1997)                           |  | 25                      |  | Secure Sexual OffenderFacility    |  | State                           |  | Managed                     
|                                                                    |  |                         |  |                                  
|JoAnn Bridges AcademyGreenville, Florida (1998)                     |  | 30                      |  | Secure FemaleAcademy Facility     |  | State                           |  | Managed                     
|                                                                    |  |                         |  |                                  
|Marion Youth Development CenterOcala, Fla (2004)                    |  | 96                      |  | Secure TreatmentFacility          |  | State                           |  | Managed                     



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|                                                                      |  |     |  |                                |  |               |  |        
|--------------------------------------------------------------------- |  | --- |  | ------------------------------ |  | ------------- |  | -------
|Okaloosa County Juvenile Residential FacilityOkaloosa, Florida (1998) |  | 65  |  | Secure TreatmentFacility       |  | State         |  | Managed
|                                                                      |  |     |  |                               
|Paulding Regional Youth Detention CenterDallas, Georgia (1999)        |  | 100 |  | Secure DetentionFacility       |  | State         |  | Managed
|                                                                      |  |     |  |                               
|Reflections Treatment AgencyKnoxville, Tennessee (1992)               |  | 52  |  | Secure Sexual OffenderFacility |  | State         |  | Leased 
|                                                                      |  |     |  |                               
|Santa Rosa Youth Development CenterSanta Rosa, Florida (2003)         |  | 25  |  | Secure TreatmentFacility       |  | State         |  | Managed
|                                                                      |  |     |  |                               
|Sawmill Academy for GirlsTallahassee, Florida (2004)                  |  | 27  |  | Secure TreatmentFacility       |  | State         |  | Managed
|                                                                      |  |     |  |                               
|Springfield AcademySpringfield, South Dakota (1993)                   |  | 84  |  | Non Secure AcademyFacility     |  | State/Federal |  | Owned  
|                                                                      |  |     |  |                               
|Thompson AcademyPembroke, Florida (2004)                              |  | 112 |  | Secure TreatmentFacility       |  | State         |  | Leased 

---

|(1) | Design capacity is based on the physical space available presently, or licensure for offender or residential beds in compliance with relevant regulations and contract requirements.
In certain cases, the management contract for a facility provides for a lower number of beds.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(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.
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Facility Management Contracts



The Company is primarily
compensated on the basis of the population in each of its facilities on a fixed rate per inmate per day; however, some contracts have a minimum revenue guarantee, or the Company may also be paid a lesser per diem paid for unoccupied beds.
Additionally, some facilities are compensated on a per diem basis, in addition to the normal per diem, for treatment provided to residents with behavioral and/or mental health diagnoses, as well as resident requiring substance abuse counseling.
Invoices are generally sent on a monthly basis detailing the population for the prior month. Occupancy rates for facilities tend to be low when initially opened or when expansions are initially available. However, after a facility passes the
start-up period, typically three months, the occupancy rate tends to stabilize.



The Company is required by its contracts to maintain certain levels of insurance coverage for general liability, workers compensation, vehicle liability and property loss or damage. The Company is also required to indemnify the
contracting agencies for claims and costs arising out of the Companys operations and in certain cases, to maintain performance bonds.



As is standard in the industry, the Companys contracts are short term in nature, generally ranging from one to three years and containing multiple renewal options.
Most facility contracts also generally contain clauses that allow the governmental agency to terminate a contract with or without cause, and are subject to legislative appropriation of funds.



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.



The Companys contracts generally require the
Company to operate each facility in accordance with all applicable local, state and federal laws, and rules and regulations. In addition, all facilities are generally required to adhere to the guidelines of the American Correctional Association
(ACA). 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



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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. Several of our facilities are fully
accredited by the ACA and certain other facilities currently are being reviewed for accreditation. It is the Companys goal to obtain and maintain ACA accreditation for all of its facilities, when applicable.



Facility Design and Construction



In addition to its facility management services, the Company also consults with various
governmental entities to design and construct new correctional and detention facilities and renovate older facilities to provide enhanced services to the population. Pursuant to the Companys design, construction and management contracts, it is
responsible for overall project development and completion. Typically, the Company develops the conceptual design for a project, then hires architects, engineers and construction companies to complete the development. When designing a particular
facility, the Company utilizes, with appropriate modifications, prototype designs the Company has used in developing other projects. Management of the Company believes that the use of such prototype designs allows it to reduce cost overruns and
construction delays. The Company designed and built the 890-bed Northwest Regional Detention Center in Tacoma, Washington facility, which opened in April 2004. This facility was built within the time frame planned and under budget. The Company also
is in the construction phase of the 1,020-bed South Texas Detention Complex that is expected to open late in the second quarter of 2005.



Employees



At December 31, 2004, the Company had approximately 2,200 employees, consisting of corporate and facility employees. Each of the Companys facilities is led by an experienced facility administrator, warden, or
executive director. 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, education or food service, are provided by third-party contractors.



Employee Training



All jurisdictions require corrections officers and youth workers to complete a specified amount of training. Generally, the Company employees are required to participate
in at least 160 hours of paid training during their first year of service, with 120 hours coming prior to their direct contact with offenders or detainees, unless otherwise specified by contract. Training is requisite for all new hires, regardless
of classification, is outcome based, and requires observable or measurable levels of performance competency. Training consists of approximately 40 hours relating to the Company policies, operational procedures, management philosophy, ethics and
compliance training, and 120 hours relating to legal issues, rights of offenders and detainees, techniques of communication and supervision, improvement of interpersonal skills, life safety and emergency procedures, training to promote the security
and health and welfare of the residents, and job training relating to the specific tasks to be held. All the Company training programs meet or exceed applicable American Correctional Association (ACA) licensing requirements.



In addition to comprehensive pre-service training, all Company personnel are required to
complete 40 hours of in-service training annually, unless otherwise specified by contract. Mandatory annual training plans are interfaced between state and federal laws, policies, ACA Standards for Adult and Juvenile Facilities, and course lesson
plans. Some of the topics include: use of force or behavioral management programs, security procedures, suicide precautions, interpersonal communications, cultural sensitivity, first aid and CPR, and safety procedures. The Companys training
matrix is designed to provide the flexibility needed to incorporate specialized training mandated by the contracting agency, such as an overview of the criminal justice or juvenile justice system.



Furthermore, the Company reimburses employees for specialized training programs to ensure
retention of licensure or certification as required by the appropriate professional standards.



The Company places dignity, professionalism and respect for all, as its benchmark, and is committed to providing quality training programs for newly hired employees to prepare them for a challenging and rewarding
career in the corrections field. The Company also provides scheduled annual refresher training to veteran employees to maintain their proficiencies and adherence to the Companys commitment to provide quality service to its contracting
agencies.



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The Company is committed to providing quality training programs for newly hired employees to prepare them for a
challenging and rewarding career in the Criminal Justice or Juvenile Justice field and to reinforce adherence to the Companys commitment to provide quality service to its contracting agencies.



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 currently maintains primary general liability insurance in the amount of
$3,000,000 and a primary excess liability policy in the amount of $2,000,000, and an excess umbrella policy in the amount of $25,000,000, covering itself and each of its subsidiaries, as well as automobile liability insurance, employment practices
liability insurance, workers compensation insurance, and property and casualty insurance, in addition to other special forms of insurance. There can be no assurance that the aggregate amount and kinds of the Companys insurance are
adequate to cover all occurrences or that insurance will be available in the future. In addition, the Company is unable to secure insurance for some unique business risks, which may include, but not be limited to, some types of punitive damages in
states where it is prohibited by law.



Regulation



Generally, providers of correctional services must comply with a variety of applicable
federal, state and local regulations, including educational, health care and safety regulations administered by a variety of regulatory authorities. 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.



The failure to comply
with any applicable laws, rules or regulations or the loss of any required license could have a material adverse effect on the Companys business, financial condition and results of operations. Furthermore, the current and future operations of
the Company may be subject to additional regulations as a result of, among other factors, new statutes and regulations and changes in the manner in which existing statutes and regulations are or may be interpreted or applied. Any such additional
regulations could have a material adverse effect on the Companys business, financial condition and results of operations.



Item 2. Properties



Leased Properties:



The Company leases office space for its corporate headquarters in
Sarasota, Florida. The Company also leases the space for the following facilities: Reflections Treatment Agency, Frio County Jail, Brooklyn Community Correctional Center, Bronx Community Correctional Center, Thompson Academy, and Fort Worth
Community Corrections Center.



In accordance with generally accepted accounting
principles, the Company also reflects its management agreement for the Arizona State Prison-Florence West as a capitalized lease on its balance sheet. In 2002, the Company engaged in a transaction in which (a) The Industrial Development Authority of
the County of Pinal, Arizona issued taxable revenue bonds in order to finance the purchase of this facility from the Company by an unrelated, not-for-profit entity; and (b) the Company sold and conveyed legal title to this facility to the
not-for-profit entity for $10,000,000, subject to an option in favor of the State of Arizona to purchase the facility from the not-for-profit entity. In connection with this transaction, the Company simultaneously entered into a management agreement
with the not-for-profit entity, under which the Company has the exclusive right to use and occupy the facility in order to provide services for the Arizona Department of Corrections. In accordance with generally accepted accounting principles, the
Company recorded this transaction as a sale on its financial statements in 2002. However, although (a) this transaction was conducted at arms length between the Company and the not-for profit entity, (b) the Company does not own or hold legal
title to the facility, and (c) the not-for-profit entity is under no obligation to convey the property back to the Company at any time under any circumstance, generally accepted accounting principles further required that the Company reflect its
management agreement for the facility as a capitalized lease obligation. Accordingly, this asset and the related capitalized lease obligations are reflected as such on the Companys financial statements.



14



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Owned Properties:



The Company owns its facilities located in Chamberlain, South Dakota; Springfield, South Dakota; Elmore, Minnesota; and Forest Ridge, Iowa, and an undeveloped expansion
parcel adjacent to the Frio County Jail.



In addition, in connection with the
financing of the construction of the Northwest Regional Detention Center in Tacoma, Washington, the Company formed a limited liability company, known as CSC of Tacoma, LLC, for the sole purpose of owning the real property on which this
facility was constructed. This LLC owns this real property as well as all of the improvements constructed thereon, and leases the same to the Company pursuant to long-term lease arrangement. Although the Company is the sole member of CSC of Tacoma,
LLC, the LLC is managed by an independent group of managers and the Company has limited rights with respect to the business and operations of the LLC. However, under the consolidation principles utilized by the Company under generally accepted
accounting principles, this real property and related liabilities are recorded on the financial statements of the Company.



In addition, in connection with the financing of the construction of the South Texas Detention Center, the Company entered into an agreement with Frio County, whereby
Frio County created the South Texas Development Corporation, a non-profit, local development corporation pursuant to Chapter 431 Texas Transportation Code for the sole purpose of owning the real property on which this facility was constructed. The
South Texas Development Corporation owns this real property as well as all of the improvements constructed thereon. As previously indicated above, pursuant to FIN 46 (revised), the Company has a variable interest in the South Texas Development
Corporation and it has been consolidated with the accounts of the Company.



The
Company also owns two parcels of real property, which were acquired by the Company in anticipation of future development projects, but were never developed, and are now being marketed for sale. These properties are located in Mangonia Park, Florida
and Belle Glade, Florida, and are classified on the balance sheet under assets held for sale.



The Company also owns real property and improvements located in Newport News, Virginia from which the Company formerly operated its Genesis Treatment Agency program. This program terminated operations in October 2003.
The property is currently being marketed for sale, and is classified on the balance sheet under assets held for sale.



Additionally, the Companys balance sheet reflects that the Arizona State Prison  Phoenix West as an asset of the Company, despite the fact that, in 2002, the
Company sold this facility to an unrelated, not-for-profit entity. During the year ended December 31, 2002, the Company sold this facility to a not-for-profit entity, subject to an option in favor of the State of Arizona to purchase the facility
from the not-for-profit entity, and received proceeds of approximately $8.5 million, which was used to reduce existing bank debt. The not-for-profit entity used proceeds from contract revenue bonds issued through the Industrial Development Authority
of Maricopa County to purchase the facility from the Company. In connection with this transaction, the Company simultaneously entered into a management agreement with the not-for-profit entity, under which the Company has the exclusive right to use
and occupy the facility in order to provide services for the Arizona Department of Corrections. In addition, the Company was required to post a letter of credit in this transaction in order to ensure that, if the State exercises its option to
purchase the facility from the not-for-profit entity, the not-for-profit entity and the Industrial Development Authority will have sufficient funds available to them in order to pay off the outstanding balance of the revenue bonds. Accordingly, in
light of the continuing financial interest of the Company in this facility, the Company was unable to record this transaction as a sale on its financial statements in accordance with generally accepted accounting principles. Legal title to the
property is held by the not-for-profit entity. The ownership of the facility will eventually be passed to the State of Arizona over the passage of time, or when the State of Arizona exercises its option to purchase the facility. The Companys
non-recourse liability with respect to the debt service payments is $7.8 million as of December 31, 2003, and matures in 2022, or upon the State of Arizonas exercise of its option to purchase the facility. On either of those occurrences a sale
shall be deemed to have occurred, and the Company will recognize a $1.9 million gain.



Item 3. Legal Proceedings



Settlement Pending in Class Action Suit



As noted above in Item 1, on February 17, 2005, the United States District Court for the District of New Jersey approved preliminarily the terms of a settlement negotiated by the Companys liability insurance carrier and the
plaintiffs counsel with respect to the following matter:



Brown, Samson, et al., v. Esmor Correctional Services, Inc., Esmor, Inc., Esmor New York State Correctional Facilities, Inc., Esmor Management, Inc., Esmor Manhattan, Inc, Esmor Brooklyn, Inc., Esmor New Jersey, Inc., James Slattery and
Aaron Speisman, Superior Court of the State of New York, No. 8654/96; removed to US District Court for the Southern District of New York; transferred to the US District Court for the District of New Jersey



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This suit was filed in March 1996 in the Supreme Court of the State of New York, County of Bronx by several former
detainees in the INS Detention Center that the Company formerly operated for the INS in Elizabeth, New Jersey, on behalf of themselves and others similarly situated, in which the plaintiffs in the suit claimed $500,000,000 in compensatory and
punitive damages on a variety of legal theories. This suit was removed to the United States District Court, Southern District of New York, in April 1996, and subsequently transferred to the United States District Court for the District of New
Jersey. The plaintiffs in this case obtained certification from the Court to try their case as a class action on behalf of themselves and all other persons who were detained in the Elizabeth INS Detention Center while the Company operated it.



On February 17, 2005, the District Court approved a settlement negotiated by
the Companys liability insurance carrier and the plaintiffs counsel whereby the Companys liability insurance carrier would deposit a lump sum of $2.5 million in escrow to be administered and distributed by the plaintiffs
counsel to class participants in accordance with a payment formula currently being developed for presentation to the Court. The Company has no obligation to contribute to this settlement, which will be funded in full by the Companys liability
insurance carrier. The Companys defense counsel and the plaintiffs counsel are currently preparing the settlement documentation. The Company expects that the settlement documentation will be completed and that the Court will formally
approve the settlement in the near future.



Other Legal Proceedings:



The nature of the Companys business results in numerous claims
against the Company for damages allegedly arising from the conduct of its employees and others. The Company believes that most of these claims and suits lack legal merit and/or that the Company has meritorious defenses to the claims, and vigorously
defends against these types of actions. The Company also has procured liability insurance to protect the Company against most of the types of claims that reasonably could be expected to be asserted against the Company based upon the Companys
past experience and an assessment of the risks of the Companys business, including workers compensation, employment-related, negligence and other types of tort and civil rights claims and suits.



The Company believes, based upon the Companys past experience, that, except as noted
below, the insurance coverage maintained by the Company for the claims and suits currently pending against the Company or which reasonably can be expected to be asserted against the Company, should be adequate to protect the Company from any
material exposure in any given matter, even if the outcome of the matter is unfavorable to the Company. However, the dollar amount of certain of the claims currently pending against the Company exceed the amount of insurance coverage available to
the Company, and, therefore, if the Company is unsuccessful in defending against such claims, the insurance coverage available to the Company may not be sufficient to satisfy those claims, and such a result could have a material adverse effect on
the Companys results of operations, financial condition and liquidity. In addition, if all, or a substantial number of, the claims and suits currently pending against the Company are resolved unfavorably to the Company, the insurance coverage
available to the Company may not be sufficient to satisfy all such claims, and such a result could have a material adverse effect on the Companys results of operations, financial condition and liquidity. Notwithstanding the foregoing, however,
the Company currently believes that no material adverse effect on its financial condition, liquidity or results of operations will result from the outcome of any of the claims and suits currently pending against the Company.



Notwithstanding the foregoing, the Company has determined that the following matters should
be deemed material to the Company under applicable SEC rules and regulations, because either: (a) the claims asserted against the Company in the following cases depart from those asserted in the normal course of the Companys business; or (b)
the claims asserted against the Company in these matters involve amounts that exceed 10% of the Companys current assets on a consolidated basis as of December 31, 2004 and the Company does not maintain insurance coverage for the claims
asserted in the case or does not maintain insurance coverage sufficient to cover the amounts sought from the Company in the case:



|1. | Alexander, Rickey, et al. v. Correctional Services Corporation, Unidentified CSC Employees, Knyvette Reyes, R.N., Dr. Samuel Lee, D.O., & Tony Schaffer, Esq., in the 236thJudicial District Court, Tarrant County, Cause No. 236-187481-01.
|-- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



In September, 2003, following a trial related to the death of a trainee in the boot camp
program at the Tarrant County Community Correctional Center, which was being operated by the Company at the time of the trainees death, a Tarrant County, Texas trial court entered a judgment against the Company for a total of $37.5 million in
compensatory damages and $750,000 in punitive damages. The Company has filed a notice of appeal in this case, notifying the trial court of its intention to appeal the judgment to the Second Court of Appeals of Texas. The Company had originally
expected to file



16



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its initial brief in this appeal during the first half of 2004; however, due to delays attributable solely to the failure of the court reporter to file
certified copies of the transcript from the trial with the appellate court, the Company was unable to prepare and file its initial brief for the appeal at that time. In addition, in November, 2004, the co-defendant in this case, Knyvette Reyes, who
was employed by the Company as a nurse at the facility, filed a petition for personal bankruptcy, which placed an automatic stay on all further proceedings in this case. Accordingly, the Company has been unable to file its brief in support of its
appeal. In light of this development, the Company is currently evaluating the options available to it in order to pursue its appeal notwithstanding the bankruptcy filing by the co-defendant. Accordingly, at this time, it is not possible to provide
any estimate as to when this matter will be resolved and when the Second Court of Appeals will hear the Companys appeal. Nevertheless, based upon the advice of defense counsel, the Company believes that there is substantial likelihood that, on
appeal, the Company will obtain relief from the judgment entered against it by the trial court.



In the meantime, on or about December 28, 2003, the Companys general liability insurance carrier posted with the trial court bonds in the aggregate amount of $25 million in order to secure the judgment pending
the outcome of the Companys appeal. (Although the judgment in this case exceeds $25 million, Texas law required that only $25 million in bonds be posted in this case in order to secure the judgment.) Consequently, the plaintiffs are precluded
by Texas law from executing upon the judgment pending the outcome of the appeal.



The primary general and excess liability insurance policies of the Company in effect at the time of the trainees death provided $35 million of coverage, which, less amounts paid on other claims under the policies, should be available
for these purposes. (As of the date hereof, a total of $415,000 has been paid by the Companys insurers on other claims covered by the applicable policies.) However, as previously announced by the Company, Northland Insurance Company, the
Companys primary general liability insurance carrier at the time of the death of the trainee, filed a declaratory judgment action in federal court against the Company seeking to disclaim any obligation to defend or indemnify the Company or its
former employee with respect to this case. On July 28, 2004, the federal district court in which this action had been filed denied Northlands motion for summary judgment in its action, and entered a memorandum order in the case which contained
an explicit finding by the court that the Companys insurers were obligated to defend and indemnify the Company and its employees against the claims made in this case. In light of this ruling, the Company recently has filed a petition with the
Court seeking a final judgment from the Court that Northland and the Companys excess liability insurance carrier are obligated to indemnify the Company against the judgment entered against it in the underlying suit and to pay on behalf of the
Company all pre-judgment and post-judgment interest that has or will accrue on the amounts awarded in the judgment. This petition is currently pending with the Court. The Company believes, based upon the advice of its counsel, that the Court will
enter a final judgment in this case that hold that Northland and the Companys excess liability insurance carrier are obligated to indemnify the Company to the extent of their respective policy limits against the judgment in the underlying suit
and to pay on behalf of the Company, in addition to its policy limits, all pre-judgment and post-judgment interest that has or will accrue on the amounts awarded in the judgment.



Nevertheless, because the amount of the judgment in this case exceeds the total amount of insurance available to the Company by
approximately $2.5 million, the Company has an uninsured exposure in this case of approximately $2.5 million. However, based upon the advice of counsel, the Company at this time does not believe that the ultimate settlement or final judgment in this
case will exceed the amount of the bonds posted to secure the judgment or that it is probable that the Company will incur any material loss in this case. Accordingly, no loss has been recognized in connection with this litigation. The Company will
continue to assess this matter with its legal counsel in accordance with SFAS No. 5, Accounting for Contingencies, and, if and when deemed appropriate, will reflect the potential impact of the case on its financial statements.



The Company also notes that, because it maintained the primary and excess liability policies
that provide coverage for the foregoing case on an occurrence basis, to the extent that the Companys insurers make any payments to the plaintiffs in the foregoing case under the policies, such payments will serve to reduce the
amount of insurance coverage available to the Company for other claims made against the Company that are covered by the same policies. Likewise, to the extent that the Companys insurers make any payments to any other plaintiffs or claimants in
order to settle any other claims covered under these policies, such payments will serve to reduce the amount of insurance coverage available to the Company for the settlement of or payment of the judgment in the Alexander case described above. As
noted above, as of the date hereof, a total of $415,000 has been paid by the Companys insurers on other claims covered by the applicable policies.



17



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##### Table of Contents

At present, there is currently only one lawsuit pending against the Company that relates to an occurrence
that occurred during the policy period covered by these policies, which is described below:



|2. | Layman, Ryan v. Jennifer Burkley, Youth Services International, Inc., The State of Nevada, Department of Human Resources, Division of Child and Family Services, Roes I  X,
Does I  X, Case No. CV-S-03-0086-KJD-LRL, in the United States District Court for the District of Nevada.
|-- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



The Plaintiff in this case is a former resident of the Summit View Youth Correctional Facility (which was formerly operated by the Company) who has brought civil rights,
intentional infliction of emotional distress, assault and battery and negligence claims against the Company arising out of allegations that, between November, 2000 and January, 2001, the Plaintiff was subjected to repeated sexual
assaults by co-Defendant Jennifer Burkley, a former employee of the Company. Plaintiff alleges that the alleged encounters with co-defendant Burkley were the cause of his current mental and psychological problems and seeks compensatory damages
in the amount of $2,000,000 and unspecified punitive damages. The Company has not disputed that co-Defendant Burkley engaged in sexual activities with the Plaintiff while he was incarcerated at the Summit View Correctional Facility, but has denied
the Plaintiff was sexually assaulted and that the Company has any liability for these activities. The Company also has asserted that none of the alleged sexual encounters with co-defendant Burkley were the proximate cause of his mental
and psychological problems. The State of Nevada has been dismissed from this case on governmental immunity grounds. The Company is not providing a defense to co-defendant Burkley and Burkley has not sought coverage or a defense from the Company or
its insurance carrier.



At the conclusion of discovery in this case, the
Company filed a motion to exclude the purported expert testimony proffered by the Plaintiff to support his claims that the Companys or Burkleys actions were the proximate cause of the Plaintiffs alleged damages under
the above-referenced theories of liability, and also filed a motion for summary judgment on all claims asserted in this case. On January 24, 2005, the District Court entered an order that granted the Companys motion to exclude the purported
experts testimony and an order that granted summary judgment to the Company on the civil rights, intentional infliction of emotional distress and negligence claims that had been asserted against the Company, but that denied the Companys
motion with respect to the assault and battery claims. Accordingly, the assault and battery claim is the only claim remaining in this case and defense counsel is preparing this claim for trial.



The basis of the Courts decision to grant summary judgment to the Company on the civil
rights, intentional infliction of emotional distress and negligence claims was that, in light of the exclusion of the proffered experts testimony, the Plaintiff did not develop sufficient facts to support his claims that the Companys or
Burkleys actions or inaction were the proximate cause of the Plaintiffs alleged damages under these theories. The Court did not address any of the Companys other arguments for summary judgment on these claims in its decision to
grant summary judgment, finding that the lack of evidence to support proximate causation was fatal to each of these causes of action, which obviated the need to address these alternative grounds. In the Companys summary judgment motion on the
assault and battery claim, the Company argued that the Plaintiff consented to each of the alleged sexual encounters with Burkley and that, in any event, Burkley was acting outside the course and scope of her employment in engaging in the alleged
encounters with Plaintiff. The basis of the Courts decision to deny the Companys motion for summary judgment on the assault and battery claims was that, in light of the testimony developed during discovery, the Plaintiff is entitled to
have a jury determine whether he actually consented to the sexual encounters with co-defendant Burkley and whether Burkley was acting within the scope of her employment when she engaged in the sexual encounters with Plaintiff.



Nevertheless, in light of the facts that (a) the assault and battery claim is the only claim
remaining in this case; (b) the District Courts recent order prohibits the Plaintiff from presenting at trial any expert testimony to support his claims that his current mental and psychological problems resulted from his encounters with
Burkley; and (c) Plaintiff did not suffer any physical injuries as a result of the alleged encounters, the Company does not believe that is probable that the Company will incur any material loss in connection with this case, and therefore, no loss
has been recognized in connection with this litigation. However, as noted above, if, and to the extent that, the Companys liability insurers make any payments to the plaintiff in this case for settlement or otherwise, the amount of any such
payment will reduce the amount of insurance coverage available to the Company for the settlement of or payment of the judgment in the Alexander case described above.



|3. | Jama, Hawa Abdi, et al. v. Esmor Correctional Services, Inc., et al., Case No. 973093 in the United States District Court for the District of New Jersey.
|-- | ---------------------------------------------------------------------------------------------------------------------------------------------------------



The Jama case was initiated in July 1997 by group of former
detainees in the INS Detention Center that the Company formerly operated in Elizabeth, New Jersey. The suit asserts that the Company is liable for personal injuries and property damage allegedly caused by the negligent and intentional acts of the
Company, certain of the current and former officers of the Company and a number of former employees of the Company who served as guards at the detention facility. The Complaint filed in this case asserts numerous legal theories. No monetary damages
have been stated. The Plaintiffs in this case are represented by the Rutgers University Law School Constitutional Law Clinic. The Company believes that it has meritorious legal and factual defenses to the claims asserted by the plaintiffs in this
case, and is vigorously pursuing its defense of those claims.



18



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##### Table of Contents

This case is currently in the latter stages of discovery. During the course of discovery, the trial court has dismissed
and/or granted summary judgment to the Company on a number of the claims initially asserted by the plaintiffs in this case. Accordingly, at the present time, the Companys defense counsel is preparing the remaining claims for trial. The Company
also has filed an interlocutory appeal from the District Court asserting that the District Court erred in ruling that the nine (9) remaining plaintiffs properly opt-out of the Brown, Samson class action, discussed below. This appeal is
currently pending before the Third Circuit Court of Appeals. (As discussed below, the District Court approved a settlement in the Brown, Samson class action on February 17, 2005.) In any event, the Company believes that it should have
more than adequate insurance coverage available to it to cover any adverse outcome in this case. Therefore, at this time, the Company does not believe that it is probable that the Company will incur any material loss in connection with this case,
and therefore, no loss has been recognized in connection with this litigation.



|4. | City of Tallulah v. Trans-American Development Assoc. and Correctional Services Corporation, 6th Judicial District Court Madison Parish, LA, Case No. 2001 000146.
|-- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------



In June, 2001, the City of Tallulah filed suit against
Trans-American Development Assoc. & Correctional Services Corporation, alleging that either or both parties are obligated to continue to pay to the City an annual management fee of $150,000 related to the Tallulah Correctional Center
for Youth, despite the fact that neither party is currently operating the facility. The Complaint filed by the City in this matter does not specify the amount of damages that the City is seeking, but, based on the theory outlined in the Citys
complaint, the Company has estimated that the City likely will seek approximately $3,250,000 in this case. The Company believes that the Citys case against the Company is wholly without merit and is vigorously defending against this claim.
However, in light of the fact that this matter is not covered by any form of insurance available to the Company, and given the inherent uncertainties associated with litigation, no assurance can be given that this litigation will be resolved
favorably to the Company.



|5. | Scianetti, Adorno, Womble and Johnson v. Correctional Services Corporation, Case. No. 01 CV 9170 in the United States District Court for the Southern District of New York.
|-- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------



This suit was served upon the Company in November, 2001 by four
(4) female former residents of the LeMarquis Community Correctional Center that the Company formerly operated in New York, each of whom alleges that Miguel Corriera, who was formerly employed by the Company as a prisoner advocate at
LeMarquis, sexually assaulted and battered them while they were housed at LeMarquis. Plaintiff Johnson further alleges that Mr. Corriera raped her while she was housed at LeMarquis. Each Plaintiff asserted causes of action for negligence against the
Company. Each Plaintiff sought $50,000,000 in compensatory damages from the Company. In 2003, the Companys general liability insurance carrier settled the claims of Plaintiffs Scianetti and Adorno for a total of $25,000, leaving only the
claims of Plaintiffs Womble and Johnson remaining in the suit. The Company believes that it has meritorious defenses to the claims made by the remaining plaintiffs in this case and is vigorously pursuing its defenses to those claims. However, given
the inherent uncertainties associated with litigation and the fact that the damages sought by the plaintiffs in this case substantially exceeds the amount of insurance coverage available to the Company, no assurance can be given that the outcome of
this litigation will not have a materially adverse effect on the Company. A trial on the remaining Plaintiffs claims commenced on February 7, 2005, but, the next day, the trial judge had a family emergency and declared a mistrial. The Court
recently reset this case for trial on April 11, 2005.



Item 4. Submission of Matters to a Vote of Security Holders



No matters were submitted to the stockholders during the fourth quarter of 2004.



PART II



Item 5. Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities



The common stock of the Company is traded on the Nasdaq National Market under the trading symbol CSCQ. The following table sets
forth, for the calendar quarters indicated, the high and low closing sale prices per share on the Nasdaq National Market, based on published financial sources (such quotations represent inter-dealer prices without retail markup, markdown or
commission, and may not necessarily represent actual transactions) .



19



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##### Table of Contents

|               |  |                                |  |     
|-------------- |  | ------------------------------ |  | ----
|               |  | CSC CommonStock Sale Price ($)
|               |  | High                           |  | Low 
|2003           |  |                                |  |     
|First Quarter  |  | 3.05                           |  | 2.26
|Second Quarter |  | 2.95                           |  | 2.40
|Third Quarter  |  | 3.10                           |  | 2.30
|Fourth Quarter |  | 2.93                           |  | 2.08
|               |  |                               
|2004           |  |                                |  |     
|First Quarter  |  | 4.02                           |  | 2.38
|Second Quarter |  | 3.62                           |  | 2.40
|Third Quarter  |  | 3.36                           |  | 2.22
|Fourth Quarter |  | 3.09                           |  | 2.17



On March 14, 2005, there were 219 holders of record and approximately 2,143 beneficial shareholders registered in nominee and street name. The Company paid
no cash dividends during the years ended December 31, 2004 and 2003.



The following table sets forth securities authorized for issuance under equity compensation plans of the Company as of December 31, 2004.



|                                                       |  |                                                                     |  |                                                                    |      |                                                                                          |          
|------------------------------------------------------ |  | ------------------------------------------------------------------- |  | ------------------------------------------------------------------ | ---- | ---------------------------------------------------------------------------------------- | ---------
|                                                       |  | Number of securitiesto be issued uponexercise ofoutstanding options |  | Weighted-averageexercise price ofoutstanding stockoption ($/share) |      | Number of securitiesremaining availablefor future issuanceunder equitycompensation plans
|Equity compensation plans approved by stockholders     |  | 624,334                                                             |  | $                                                                  | 6.68 |                                                                                          | 1,625,000
|Equity compensation plans not approved by stockholders |  |                                                                    |  |                                                                    |     |                                                                                          |         



The Company has not issued or sold any
securities during the past three years that were not registered pursuant to the Securities Act of 1933, as amended, and has not issued or sold any securities registered thereunder during the past three years otherwise than pursuant to the exercise
of options pursuant to the equity compensation plans of the Company. The proceeds of all securities sold by the Company pursuant to the exercise of such options were used by the Company for general working capital purposes.



Neither the Company nor any affiliated purchaser purchased any shares of the Companys
equity securities during 2004.



20



---

##### Table of Contents

Item 6. Selected Financial Data



The information below is only a summary and should be read in conjunction with the Companys historical financial statements and related notes (in thousands, except per share data).



|                                                             |  |                         |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|------------------------------------------------------------ |  | ----------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | - |  | ---- | ------- | - |  | - | ------- | -
|                                                             |  | Year Ended December 31, |        
|                                                             |  | 2004                    |         |   | 2003 |   |         | 2002 |  |   | 2001    |   |  | 2000 |        
|Revenues                                                     |  | $                       | 133,719 |   |      | $ | 126,531 |      |  | $ | 144,502 |   |  | $    | 157,061 |   |  | $ | 190,488 |  
|                                                             |  |                         |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Operating expenses (1)                                       |  |                         | 114,949 |   |      |   | 112,378 |      |  |   | 128,784 |   |  |      | 144,552 |   |  |   | 168,140 |  
|Startup costs                                                |  |                         | 3,276   |   |      |   | 378     |      |  |   |        |   |  |      | 399     |   |  |   | 155     |  
|General and administrative (1)                               |  |                         | 8,452   |   |      |   | 9,211   |      |  |   | 9,117   |   |  |      | 12,832  |   |  |   | 13,666  |  
|Restructuring and Long-lived Asset Impairment                |  |                         | 1,496   |   |      |   |        |      |  |   |        |   |  |      | 4,356   |   |  |   |        |  
|Loss contract costs                                          |  |                         |        |   |      |   |        |      |  |   | 220     |   |  |      | 1,150   |   |  |   |        |  
|Other operating expenses (income)                            |  |                         | 618     |   |      |   | (53     | )    |  |   | (1,525  | ) |  |      | 1,312   |   |  |   | (1,116  | )
|                                                             |  |                         |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Operating income (loss)                                      |  |                         | 4,928   |   |      |   | 4,617   |      |  |   | 7,906   |   |  |      | (7,540  | ) |  |   | 9,643   |  
|Interest expense, net (1)                                    |  |                         | 4,644   |   |      |   | 2,203   |      |  |   | 2,326   |   |  |      | 2,182   |   |  |   | 3,154   |  
|                                                             |  |                         |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Income (loss) from continuing operations before income taxes |  |                         | 284     |   |      |   | 2,414   |      |  |   | 5,580   |   |  |      | (9,722  | ) |  |   | 6,489   |  
|Income tax provision (benefit)                               |  |                         | 381     |   |      |   | 1,208   |      |  |   | 1,086   |   |  |      | (3,452  | ) |  |   | 2,535   |  
|                                                             |  |                         |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Income (loss) from continuing operations                     |  |                         | (97     | ) |      |   | 1,206   |      |  |   | 4,494   |   |  |      | (6,270  | ) |  |   | 3,954   |  
|Income (loss) from discontinued operations                   |  |                         | (3,151  | ) |      |   | 128     |      |  |   | (2,131  | ) |  |      | 390     |   |  |   | 1,836   |  
|                                                             |  |                         |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Net income (loss)                                            |  | $                       | (3,248  | ) |      | $ | 1,334   |      |  | $ | 2,363   |   |  | $    | (5,880  | ) |  | $ | 5,790   |  
|                                                             |  |                         |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Net income (loss) per share:                                 |  |                         |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Basic                                                        |  | $                       | (0.32   | ) |      | $ | 0.13    |      |  | $ | 0.23    |   |  | $    | (0.58   | ) |  | $ | 0.51    |  
|Diluted                                                      |  | $                       | (0.32   | ) |      | $ | 0.13    |      |  | $ | 0.23    |   |  | $    | (0.58   | ) |  | $ | 0.51    |  
|Balance sheet data:                                          |  |                         |         |   |      |   |         |      |  |   |         |   |  |      |         |   |  |   |         |  
|Working capital (deficit)                                    |  | $                       | 11,686  |   |      | $ | 13,602  |      |  | $ | 17,171  |   |  | $    | (7,855  | ) |  | $ | 18,831  |  
|Total assets                                                 |  |                         | 199,990 |   |      |   | 147,304 |      |  |   | 88,088  |   |  |      | 86,083  |   |  |   | 96,775  |  
|Long-term liabilities, net of current portion                |  |                         | 120,957 |   |      |   | 75,974  |      |  |   | 20,258  |   |  |      | 314     |   |  |   | 16,338  |  
|Shareholders equity                                         |  |                         | 48,113  |   |      |   | 51,348  |      |  |   | 50,008  |   |  |      | 47,645  |   |  |   | 53,738  |  

---

|(1) | Certain reclassifications have been made to prior year amounts to conform to the 2004 presentation including the effects of discontinued operations.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------



Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations



The consolidated financial statements of the Company are prepared in conformity with accounting principles generally accepted in the United States of America. As such, we
are required to make certain estimates, judgments and assumptions that we believe are reasonable based upon the information available. These estimates and assumptions affect the reported amounts of assets and liabilities at the date of the financial
statements and the reported amounts of revenue and expenses during the reporting period. The Company routinely evaluates its estimates based on historical experience and on various other assumptions that management believes are reasonable under the
circumstances. Actual results may differ from these estimates under different assumptions or conditions. A summary of our significant accounting policies is set forth below and in Note A to our financial statements included herein.



The following discussion and analysis of the Companys financial condition and results
of operations should be read in conjunction with the accompanying financial statements and the discussion of the Companys significant accounting policies which is set forth below and in Note A to the financial statements.



Overview



During 2004, the Companys contribution from operations, consisting of revenues less operating expenses and start up costs was $15.5
million. The Company incurred a loss from continuing operations in 2004 of $97,000 and a net loss $3.2 million or $(0.32) per diluted share in 2004, when losses for discontinued operations are included. During the year



21



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##### Table of Contents

2004, revenues from the Adult/Community Corrections programs comprised 59.7% of the Companys consolidated revenue, and 92.2% of the consolidated
contribution margin. During the year 2004, revenues from the Juvenile Division comprised 40.3% of the Companys consolidated revenues, and 7.8% of the consolidated contribution margin.



Results of Operations



The following table sets forth the Companys results of operations as a percentage of total revenues for the fiscal
years indicated:



|                                                       |  |                                                      |    |  |       |    |  |       |   
|------------------------------------------------------ |  | ---------------------------------------------------- | -- |  | ----- | -- |  | ----- | --
|                                                       |  | Percentage of Total RevenuesYears Ended December 31, |   
|                                                       |  | 2004                                                 |    |  | 2003  |    |  | 2002  |   
|Revenues                                               |  | 100.0                                                | %  |  | 100.0 | %  |  | 100.0 | % 
|                                                       |  |                                                      |    |  |       |    |  |       |   
|Facility expenses:                                     |  |                                                      |    |  |       |    |  |       |   
|Operating                                              |  | 86.0                                                 | %  |  | 88.8  | %  |  | 89.1  | % 
|Startup costs                                          |  | 2.4                                                  | %  |  | .3    | %  |  |      |   
|                                                       |  |                                                      |    |  |       |    |  |       |   
|                                                       |  | 88.4                                                 | %  |  | 89.1  | %  |  | 89.1  | % 
|                                                       |  |                                                      |    |  |       |    |  |       |   
|Contribution from operations                           |  | 11.6                                                 | %  |  | 10.9  | %  |  | 10.9  | % 
|                                                       |  |                                                      |    |  |       |    |  |       |   
|Other operating expenses:                              |  |                                                      |    |  |       |    |  |       |   
|General and administrative                             |  | 6.3                                                  | %  |  | 7.3   | %  |  | 6.3   | % 
|Long-lived Asset Impairment                            |  | 1.1                                                  | %  |  |      |    |  |      |   
|Loss contract costs                                    |  |                                                     |    |  |      |    |  | 0.2   | % 
|Loss (gain) on disposal of assets                      |  | 0.5                                                  | %  |  | (0.0  | )% |  | (1.1  | )%
|                                                       |  |                                                      |    |  |       |    |  |       |   
|                                                       |  | 7.9                                                  | %  |  | 7.3   | %  |  | 5.4   | % 
|                                                       |  |                                                      |    |  |       |    |  |       |   
|Operating income                                       |  | 3.7                                                  | %  |  | 3.6   | %  |  | 5.5   | % 
|Interest expense, net                                  |  | 3.5                                                  | %  |  | 1.7   | %  |  | 1.6   | % 
|                                                       |  |                                                      |    |  |       |    |  |       |   
|Income from continuing operations before income taxes  |  | 0.2                                                  | %  |  | 1.9   | %  |  | 3.9   | % 
|Income tax provision                                   |  | 0.3                                                  | %  |  | 0.9   | %  |  | 0.8   | % 
|                                                       |  |                                                      |    |  |       |    |  |       |   
|Income from continuing operations                      |  | (0.1                                                 | )% |  | 1.0   | %  |  | 3.1   | % 
|Income (loss) from discontinued operations, net of tax |  | (2.3                                                 | )% |  | 0.1   | %  |  | (1.5  | )%
|                                                       |  |                                                      |    |  |       |    |  |       |   
|Net income (loss)                                      |  | (2.4                                                 | )% |  | 1.1   | %  |  | 1.6   | % 
|                                                       |  |                                                      |    |  |       |    |  |       |   



Year Ended December 31, 2004
Compared to Year Ended December 31, 2003



Revenue increased by $7.2
million or 5.7% for the year ended December 31, 2004 to $133.7 million compared to the same period in 2003. The increase in annual revenue from 2003 to 2004 was primarily due to:



| |  | an increase of $28.0 million from revenues generated by eight new programs (1,350 beds) where contracts were awarded during 2004; plus
|- |  | --------------------------------------------------------------------------------------------------------------------------------------



| |  | an increase of $363,000 generated from changes in net occupancy levels and per diem rates at existing facilities; net of
|- |  | ------------------------------------------------------------------------------------------------------------------------



| |  | the decrease of $21.1 million in revenue from 9 facilities and programs closed or discontinued in 2004 and 6 facilities closed or discontinued in 2003.
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------



Operating expenses increased $2.6 million or 2.3% for the year ended December 31, 2004 to
$114.9 million compared to the same period in 2003. However, as a percentage of revenues, operating expenses decreased to 86.0% for the twelve months ended December 31, 2004 from 88.8% for the twelve months ended December 31, 2003. The decrease in
operating expense as a percentage of revenue is due in part to the discontinuation of operations by the Company in 2004 of certain unprofitable facilities and an increase in 2004 in the ratio of adult facilities operated by the Company, which
traditionally operate at lower costs and higher margins than juvenile facilities. During 2004, the overall decrease in operating expense as a percentage of revenue was offset by increases in certain operating expenses, such as medical/dental
services and business insurance.



22



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##### Table of Contents

Startup costs were $3.3 million for the twelve months ended December 31, 2004, related primarily to the startup of the
eight new facilities that opened during 2004. This compares to $378,000 in start-up costs for 2003, which related to the openings of the Northwest Regional Detention Center and two new juvenile facilities that opened in the 2004. The Company incurs
costs as it relates to the start up of new facilities. Such costs are principally comprised of expenses associated with the recruitment, hiring and training of staff, travel of personnel, certain legal costs and other costs incurred after a contract
has been awarded. The Company expenses start up costs as they are incurred. Start up costs are usually incurred through the population ramp up period, but generally within the first three full months of operations. Also, to the extent that other
operating expenses exceed revenue during the ramp up period, they are recognized as start up expenses. This is due to the need to incur a significant portion of the facilitys operating expenses while the facility is in the process of attaining
full occupancy.



General and administrative expenses decreased to $8.5 million
for the twelve months ended December 31, 2004, compared to $9.2 million for the twelve months ended December 31, 2003. As a percentage of revenues, general and administrative expenses decreased to 6.3% for the twelve months ended December 31, 2004
from 7.3% for the same period in 2003. The decrease in 2004 was primarily due to decreases in corporate payroll as a result of position elimination and vacancies.



During the fourth quarter of 2004, the Company determined that the carrying amount of the net assets identifiable with its Colorado County
Juvenile Facility located in Eagle Lake, Texas was not recoverable and exceeded its fair value. Based on FASB 144, Accounting for the Impairment or Disposal of Long-lived Assets, the Company recognized an impairment of $1.5 million on
these net assets.



During the twelve months ended December 31, 2004, the
Company recorded a loss on the disposal of assets of $618,000 compared to a gain of $53,000 recorded during the same period 2003. The current period loss is related to the Companys settlement of claims related to the operation of the facility
in Bayamon, Puerto Rico, which the Company ceased to operate in January, 2003. During 2003, the Company initiated legal action against the Puerto Rican government to recover unpaid revenues and receive reimbursement for certain costs and to recover
breach of contract damages. The Puerto Rican government initiated a counter suit seeking a similar amount for the cost of repairs that it alleged were necessary to restore the Bayamon facility. The Company had approximately $2.0 million in
receivables and approximately $560,000 in deferred charges related to assets purchased by the Company for use at the facility as of December 31, 2003, pending resolution of the aforementioned lawsuit. During the year ended December 31, 2004, the
Company settled its dispute with the government, whereby the Company received $2.0 million in settlement of all claims the Company had asserted against the government, and paid the Puerto Rican Government $600,000 in order to settle the claims
asserted by the Government against the Company. The $600,000 amount was accrued as of December 31, 2003. As a result of this settlement, the Company wrote off $560,000 in deferred charges, which is included in the accompanying financial statements
as loss on disposal of assets.



Interest expense, net of interest income, was
$4.6 million for the twelve months ended December 31, 2004 compared to $2.2 million for the twelve months ended December 31, 2003, a net increase in interest expense of approximately $2.4 million. The Companys interest expense for 2004 relates
to interest paid by the Company with respect to borrowings under its working capital line of credit, interest deemed payable under the Companys capitalized lease obligations with respect to the Arizona State Prison  Phoenix West, Arizona
State Prison  Florence West and interest payable with respect to the financings of the Northwest Regional Detention Center and the South Texas Detention Complex.



During 2004, the Company capitalized interest of $803,000 and recognized $2.0 million in interest expense with respect to the note payable
related to the construction of the Northwest Regional Detention Center. In connection with the financing of the Northwest Regional Detention Center, CSC of Tacoma LLC issued a note payable to WEDFA with respect to the proceeds of the bond issuance
that were loaned by WEDFA to the LLC. Interest incurred on the note payable by CSC of Tacoma, LLC to WEDFA was capitalized with respect to qualified expenditures during the construction phase of that project and otherwise expensed as incurred.
Construction of the Northwest Regional Detention Center was completed in April, 2004. Accordingly, since that time, interest incurred on the foregoing note payable has been expensed. Interest of $1.3 million related to the Northwest Regional
Detention Center was capitalized during 2003.



In 2004, the Company capitalized
$279,000 in interest related to qualified expenditures in connection with the construction of the South Texas Detention Complex and incurred an additional $334,000 in interest expense related to this project.



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For the twelve months ended December 31, 2004, the Company recognized an income tax benefit of $1.6 million compared to
an income tax provision of $1.3 million for the twelve months ended December 31, 2003. Of the 2004 amount, income taxes of $381,000 and $2.0 million were allocated to continuing operations and discontinued operations, respectively. In 2003, income
taxes of $1.2 million and $82,000 were allocated to continuing operations and discontinued operations, respectively. During 2004 the tax provision exceeded income before taxes due principally to non-deductible items and the relatively low amount of
income before income tax. To calculate the tax provision (benefit) the Company uses an estimated effective tax rate. This effective rate is based on the federal and state statutory rates as adjusted by various non-deductible items, which caused the
income tax from continuing operations to exceed the statutory rate.



In 2004,
the Company recorded a loss from discontinued operations of $3.2 million, net of a $2.0 million tax benefit, compared to income from discontinued operations of $128,000, net of an $82,000 tax expense in 2003. The losses incurred by the Company in
2004 from discontinued operations arose from the closing of the Tarkio Academy in Missouri and the Hemphill County Juvenile Facility in Canadian, Texas in 2004, and continuing costs associated with the Keweenaw Academy facility in Michigan, and the
Genesis Treatment Agency program in Newport News, Virginia, which were closed in prior periods. The Company recorded charges for the impairment of assets during the year ended December 31, 2004 related to the closing of the Tarkio Academy and
Hemphill County Juvenile Facility, in the amount of $2.9 million, which are included in the loss from discontinued operations for 2004. Revenue included in discontinued operations amounted to $4.1 million and $13.7 million in 2004 and 2003,
respectively.



Year Ended December 31, 2003 Compared to Year Ended December
31, 2002



Revenue decreased by $18.0 million or 12.5% for the year ended
December 31, 2003 to $126.5 million compared to the same period in 2002. The change was primarily due to:



| |  | a decrease of $25.1 million from the closure of eleven programs consisting of 942 beds in six facilities where contracts were terminated in 2003 and 498 beds in five facilities
where contracts were terminated in 2002; and
|- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  | an increase of $6.8 million generated from net occupancy level and per diem rate changes at existing facilities; and
|- |  | --------------------------------------------------------------------------------------------------------------------



| |  | an increase of $300,000 from revenues generated by two new programs (43 beds) where contracts were awarded during 2003.
|- |  | -----------------------------------------------------------------------------------------------------------------------



Operating expenses decreased $16.4 million or 12.7% for the year ended December 31, 2003 to
$112.4 million compared to the same period in 2002 primarily due to the closing of the eleven facilities mentioned above. This decrease was partially offset by legal costs of $1.6 million incurred during the year ended December 31, 2003.
Approximately $1.1 million of costs are related primarily to certain outstanding legal matters from closed facilities. The Companys legal reserve balance is approximately $1.7 million as of December 31, 2003.



As a percentage of revenues, operating expenses decreased to 88.8% for the twelve months
ended December 31, 2003 from 89.1% for the twelve months ended December 31, 2002. The Company made significant improvements in cost control initiatives, such as payroll target initiatives and changes in the structure of the Companys health
benefit plan. Those improvements were partially offset by the increased cost of workers compensation insurance and general liability insurance and the increase in the Companys legal settlement costs discussed above.



Start-up costs were $378,000 for the twelve months ended December 31, 2003 and were related
to the openings of the Northwest Regional Detention Center in Tacoma, Washington and two new juvenile facilities that opened in 2004. These costs consisted primarily of payroll expenses associated with transitioning the operations of the Seattle,
Washington ICE facility to the new Tacoma facility. There were no start up costs incurred during 2002.



General and administrative expenses increased to $9.2 million for the twelve months ended December 31, 2003, compared to $9.1 million for the twelve months ended December 31, 2002. As a percentage of revenues, general
and administrative expenses increased to 7.3% for the twelve months ended December 31, 2003 from 6.3% for the same period in 2002. The increase in 2003 was primarily due to increases in directors and officers liability insurance costs,
professional and consulting fees, corporate payroll, and workers compensation costs, compared to the same period in 2002.



The Company recorded a $220,000 loss reserve for the year ended December 31, 2002, for estimated contract losses through the contract termination at the Bayamon, Puerto
Rico juvenile facility, which ended January 31, 2003.



During the twelve months
ended December 31, 2002, the Company recorded a gain on the disposal of assets of $1.5 million primarily related to the sale of the Salinas, Puerto Rico facility to the Puerto Rican government for $15.0 million. The facility was constructed by the
Company, and was completed in 2001, but had never been operational, due to the Puerto Rican governments inability to fulfill its contract with the Company, and provide inmates for the facility.



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Interest expense, net of interest income, was $2.2 million for the twelve months ended December 31, 2003 compared to $2.3
million for the twelve months ended December 31, 2002, a net decrease in interest expense of approximately $123,000. The Company incurred interest charges during 2003 primarily related to the 2002 sale of its Phoenix and Florence, Arizona facilities
which, under applicable accounting principles, resulted in the recognition of a long-term liability and a capital lease obligation with higher imputed interest rates than the bank debt to which the Company was subject prior to the sale of those
facilities, interest on the note payable, the amortization of deferred loan costs, borrowings under the Companys line of credit, and interest on outstanding letters of credit. Interest incurred during the comparable period in 2002 was related
primarily to borrowings under the Companys line of credit, and the amortization of deferred loan costs. During the twelve months ended December 31, 2003, the Company capitalized interest of approximately $1.3 million related to the
construction of its Tacoma, Washington facility. No interest was capitalized during the same period in 2002.



For the twelve months ended December 31, 2003, the Company recognized an income tax provision of $1.3 million compared to an income tax benefit of $277,000 for the twelve months ended December 31, 2002. Of the 2003
amount, $1.2 million and $82,000 were allocated to continuing operations and discontinued operations, respectively. Of the 2002 amount, $1.1 million expense and $1.4 million benefit were allocated to continuing operations and discontinued
operations, respectively. To calculate the tax provision (benefit) the Company uses an estimated effective tax rate. This rate is based on the federal and state statutory rates as adjusted by various non-deductible items, which caused the income tax
from continuing operations to exceed the statutory rate for 2003. Income tax from continuing operations for 2002 was also affected by the Company recognizing a $1.4 million tax benefit principally attributable to a change in estimate of the
recoverability of deferred tax assets associated with exiting Puerto Rico operations. The effective rate associated with discontinued operations is not affected by non-deductible items.



The Company recorded income from discontinued operations of $128,000, net of an $82,000 tax expense in 2003 compared to loss from
discontinued operations of $2.1 million, net of a $1.4 million tax benefit, in 2002. These losses relate to its Keweenaw, Michigan; Newport News, Virginia; Tarkio Academy, Missouri; and Canadian, Texas facilities, which were closed due to low
utilization. The Company recognized a $1.3 million loss on facility contracts for the year ended December 31, 2002 related to the Companys Keweenaw, Michigan juvenile facility, which is included in the loss from discontinued operations for the
year ended December 31, 2002, as a result of low utilization by the contracting agencies. However, the Company reached an agreement with its landlord to terminate the lease effective December 2003, at which time the Company began terminating
facility contracts. The Company recorded a loss contract recovery credit of $896,000, representing a change in estimate of contract losses. No reserve remains at December 31, 2003. The Company recorded a charge for the impairment of assets during
the year ended December 31, 2002, related to the Keweenaw, Michigan facility, in the amount of $1.9 million, which is included in the loss from discontinued operations for 2002. No impairment reserve was recorded related to the closure of the
Newport News facility, as the Company believes the net book values of facility assets are recoverable. Revenue included in discontinued operations amounted to $13.7 million and $15.9 million in 2003 and 2002, respectively.



During the year ended December 31, 2002, the Company sold its Phoenix, Arizona facility to a
not-for-profit entity and received proceeds of approximately $8.5 million, which was used to reduce existing bank debt. The not-for-profit entity used proceeds from contract revenue bonds issued through the Industrial Development Authority of
Maricopa County to purchase the facility from the Company. Neither the Company nor the State of Arizona is obligated to repay the bonds. The bond payments are payable exclusively from the revenue generated by the facilitys operations, or from
the disposition of the facility. However, due to certain guarantee obligations of the Company with respect to the purchase of the facility by the State from the not-for-profit entity, and applicable generally accepted accounting principles, the
Company was not permitted to record the transaction as a sale for accounting purposes. Therefore, the assets and associated liabilities remain on the financial statements of the Company. Legal title to the property is held by the not-for-profit
entity. The ownership of the Phoenix, Arizona facility will eventually be passed to the State of Arizona over the passage of time, or when the State of Arizona exercises its option to purchase the facility. The Companys non-recourse liability
with respect to the debt service payments is $7.8 million as of December 31, 2003, and matures in 2022, or upon the State of Arizonas exercise of its option to purchase the facility. On either of those occurrences a sale shall be deemed to
have occurred, and the Company will recognize a $1.9 million gain.



Liquidity and Capital Resources



Cash, Cash Equivalents
and Working Capital



At December 31, 2004, the Company had $725,000 in
cash, $10.9 million in current restricted cash and equivalents, and $11.7 million of working capital, as compared to December 31, 2003, when the Company had $3.8 million in cash, $4.5 million in current restricted cash and $13.6 million of working
capital. The current restricted cash consists primarily of (a) the proceeds of the bonds issued by the South Texas Development Corporation to finance the construction of the South Texas Detention Complex, which are currently held in escrow for use
in completing the construction of the facility



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and to fund certain reserve requirements under the indenture for the bonds, and (b) the debt service and other reserve funds established under the loan
agreement between WEDFA and CSC of Tacoma, LLC related to the financing of the Northwest Regional Detention Center.



The Company expects to continue to have cash needs as it relates to financing start-up costs in connection with new contracts that would improve the profitability of the
Company. There can be no assurance that the Companys operations together with amounts available under the revolving line of credit, which expires in 2005, will continue to be sufficient to finance its existing level of operations, fund
start-up costs and meet its debt service obligations.



In October 2002, the
Company entered into a financing agreement with General Electric Capital Corporation (hereinafter referred to as the Credit Agreement), which has been amended various times since inception. The Credit Agreement imposes various financial
covenants on the Company, which, among other things, obligate the Company to maintain a minimum net worth, minimum monthly cash flow levels, minimum EBITDA levels, and establishes certain borrowing base criteria. The Company is in compliance with or
has received waivers of compliance with all covenants as of December 31, 2004. Additionally, the Credit Agreement prohibits the payment of any dividends. In connection with the establishment of the Credit Agreement, the Company incurred $995,000 in
loan fees, which are being amortized as interest expense over the term of the Credit Agreement. The Companys borrowing base under the Credit Agreement is primarily a function of the balance of eligible accounts receivable held by the Company
at any given time. The Credit Agreement is secured by all of the assets of the Company, except real property, and consists of a $19 million revolving line of credit which accrues interest at the lesser of LIBOR plus 4.0%, or prime plus 2.0%. The
Company also incurs a monthly fee based on 0.5% of its unused line of credit, with an annual fee of $75,000. The line of credit is used primarily to fund the working capital requirements of the Company.



As of December 31, 2004, there was no outstanding balance under this revolving line of credit
and the Company had approximately $7.0 million in borrowing availability thereunder, after taking into account outstanding letters of credit of $9.3 million, the principal amount of which are charged against the line of credit, and borrowing base
limitations of $2.7 million.



The Credit Agreement matures on September 25,
2005. The Company expects to enter into a new long-term financing agreement under similar terms and conditions; however, there can be no assurances that the Company will be successful in obtaining this new agreement.



Sources and Uses of Cash During 2004



Net cash of $295,000 was provided by operating activities during the year ended December 31,
2004, as compared to $7.1 million provided by operations for the year ended December 31, 2003. The increase utilization of cash in 2004 was primarily attributable to the increased expenses associated with the startup of the eight new facilities and
to the timing of receipts on accounts receivable.



Net cash of $42.3 million
was provided by financing activities for the year ended December 31, 2004, as compared to $50.9 million provided by financing activities for the year ended December 31, 2003. During 2004, funds from financing activities were primarily provided by
proceeds, net of issuance costs, from the bonds issued by the South Texas Development Corporation related to the construction of the South Texas Detention Complex. During the 2003 period, funds were borrowed under the Companys line of credit
and from WEDFA to provide capital necessary to cover the capital expenditures related to the Northwest Regional Detention Center.



As explained in Note I - Restricted cash equivalents, investments and notes payable in the accompanying financial statements, on September 22, 2004, the South Texas
Development Corporation, a consolidated variable interest entity, issued $49.4 million of taxable revenue bonds, net of a $88,000 discount, to finance the construction of the South Texas Detention Complex. The proceeds of these bonds, net of the
discount, were disbursed into escrow accounts held in trust as follows:



|                                |  |   |       
|------------------------------- |  | - | ------
|Issuance costs fund             |  | $ | 6,154 
|Project fund                    |  |   | 35,406
|Debt service and other reserves |  |   | 7,825 
|                                |  |   |       
|                                |  | $ | 49,385
|                                |  |   |       



The amount deposited to the issuance
costs funds, which are classified on the Companys balance sheet as deferred loan costs, will be amortized using the effective interest method over the term of the bonds.



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The proceeds of the bonds deposited in the project fund are being used to complete the construction of the South Texas
Detention Complex. The total construction costs of the project are expected to be $39.3 million, including $3.9 million, which was funded by the Company in current and prior periods. The Company is required by the bond indenture to fund an
additional $1.1 million when the facility is substantially complete, which is expected to be used to fund certain additional reserve funds established under the bond indenture. Amounts deposited in the project fund and in the debt service and other
reserves from the proceeds of the bonds are reflected on the Companys balance sheet as non-current restricted cash, equivalents and investments.



Construction of the South Texas Detention Complex is expected to be completed by May 2005. The bonds are secured by the facility and payments will be primarily from the
revenues of the facility, which will be used to make the debt service payments on the bonds. The effective interest rate on the bonds, including the amortization of the discount and issuance costs, is approximately 6.8% and the bonds mature in
February 2016.



Also included in non-current restricted cash equivalents and
investments as of December 31, 2004 are funds held in trust related to the financing of the South Texas Regional Detention Complex as follows (in thousands):



|                                |  |   |       
|------------------------------- |  | - | ------
|Project fund                    |  | $ | 20,287
|Debt service and other reserves |  |   | 7,332 
|                                |  |   |       
|                                |  | $ | 27,619
|                                |  |   |       



As described elsewhere herein, on June
30, 2003, CSC of Tacoma, LLC issued a $57.2 million note payable, net of a $175,000 discount, to WEDFA, which issued revenue bonds and subsequently loaned the proceeds of the bond issuance to CSC of Tacoma LLC, a wholly owned subsidiary of the
Company. The bonds are non-recourse to CSC of Tacoma LLC and the Company. The proceeds of the note were disbursed into escrow accounts held in trust as follows (in thousands):



|                                |  |   |       
|------------------------------- |  | - | ------
|Issuance costs reserve          |  | $ | 6,268 
|Construction fund reserve       |  |   | 41,400
|Debt service and other reserves |  |   | 9,572 
|                                |  |   |       
|                                |  | $ | 57,240
|                                |  |   |       



The proceeds of the note deposited in
the construction fund reserve were used to build the Northwest Regional Detention Center. The total construction costs of the project were approximately $42.9 million, including $8.0 million that was funded by the Company. Construction on the
facility was complete in early 2004. The note is secured by the facility, and payments will be made exclusively from the revenues of the facility, which will be used to make the debt service payments on the bonds. The annual blended interest rate
ranges between 3.3% and 4.1% during the term of the note. The effective rate of the note, net of the estimated interest earned on the debt service reserve fund and amortization of the note discount and loan issuance costs, is approximately 5.0%, and
the note matures in October 2014.



Net cash of $45.7 million was used in
investing activities during the year ending December 31, 2004, as compared to $58.6 million used in investing activities during the year ended December 31, 2003. During the 2004 period, the Companys uses of cash for investing activities
included $25.9 million used for the payment of construction costs related to the South Texas Detention Complex and the Northwest Regional Detention Center and capital improvements at other new facilities. Uses also included the capitalization of
interest in the amount of $1.1 million, and $3.0 million for the purchase of property and equipment at existing facilities. Additional cash provided by the bond issuance related to the South Texas Detention Complex project was invested, and held as
non-current restricted cash and will be used to fund construction costs of the project. In the comparable period for 2003, $59.5 million in cash was used to purchase the land and make payments for construction and design costs relating to the
Northwest Regional Detention Center, to make investments of restricted cash and to purchase of property and equipment at existing facilities. The funds held in 2003 as long-term restricted cash were used for the construction costs of the Northwest
Regional Detention Center.



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Tabular Disclosure of Contractual Obligations



Registrants known contractual obligations as of December 31, 2004 (in thousands):



|                            |  |                        |         |                 |   |           |  |           |        |                  |   |        |  |   |       
|--------------------------- |  | ---------------------- | ------- | --------------- | - | --------- |  | --------- | ------ | ---------------- | - | ------ |  | - | ------
|                            |  | Payments due by period
|Contractual Obligations     |  | Total                  |         | Less than1 year |   | 1-3 years |  | 4-5 years |        | More than5 years
|Long-term debt obligations  |  | $                      | 115,383 |                 | $ | 5,021     |  | $         | 14,858 |                  | $ | 20,508 |  | $ | 74,996
|Capital lease obligations*  |  |                        | 11,098  |                 |   | 606       |  |           | 1,272  |                  |   | 849    |  |   | 8,371 
|Operating lease obligations |  |                        | 13,476  |                 |   | 2,865     |  |           | 4,697  |                  |   | 3,553  |  |   | 2,361 

---

|* | Amounts are net of imputed interest calculated at 7.9%.
|- | -------------------------------------------------------



Treasury Stock



On October 20, 2000, the Company announced that its Board of Directors had authorized a share repurchase program of up to $10.0 million. No shares were repurchased in 2004, 2003 or 2002.



Critical Accounting Policies



The consolidated financial statements are prepared in conformity with accounting principles
generally accepted in the United States of America. As such, we are required to make certain estimates, judgments and assumptions that we believe are reasonable based upon the information available. These estimates and assumptions affect the
reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. The Company routinely evaluates its estimates based on historical experience and on
various other assumptions that management believes are reasonable under the circumstances. Actual results may differ from these estimates under different assumptions or conditions. A summary of our significant accounting policies is described in
Note A to our financial statements included herein. The significant accounting policies and estimates, which we believe are the most critical to aid in fully understanding and evaluating our reported financial results, include the following:



Revenue Recognition and Accounts Receivable



Facility management revenues are recognized as services are provided based on a net rate per
day per inmate or on a fixed monthly rate. Certain revenues are accrued, based on population levels or other pertinent available data. Subsequent adjustments to revenue are recorded when actual levels are known or can be reasonably estimated.



The Company extends credit to the government agencies with which it contracts
and other parties in the normal course of business. Further, the Company regularly reviews outstanding receivables, and provides estimated losses through an allowance for doubtful accounts. In evaluating the level of established reserves, the
Company makes judgments regarding its customers ability to make required payments, economic events and other factors. As the financial condition of these parties change, circumstances develop or additional information becomes available,
adjustments to the allowance for doubtful accounts may be required. As of December 31, 2004 accounts in dispute with two agencies total approximately $2.5 million, of which no reserves have been recognized. While the Company expects to collect fully
on these accounts, the ultimate outcome could vary from this estimate.



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Asset Impairments



As of December 31, 2004, the Company had approximately $92.3 million in long-lived property and equipment, assets under capital leases, and construction in progress.
Additionally, the Company has assets held for sale of approximately $6.7 million. The Company evaluates the recoverability of the carrying values of its long-lived assets, other than intangibles, when events suggest that impairment may have
occurred. In these circumstances, the Company utilizes estimates of undiscounted cash flows or other measures of fair value, to determine if impairment exists. If impairment exists, it is measured as the amount by which the carrying amount of the
asset exceeds the estimated fair value of the asset. During the year ended December 31, 2004, the Company recorded and included in discontinued operations impairment charges of $2.9 million associated with the assets of its discontinued Tarkio,
Missouri and Canadian, Texas facilities. Included in continuing operations in 2004 is an impairment charge of $1.5 million associated with the assets of the Colorado County Juvenile Facility in Eagle Lake, Texas. No impairment of assets was
recognized during 2003.



Property, Equipment and Leasehold Improvements



Property, equipment and leasehold improvements are carried at cost.
Depreciation of buildings is computed using the straight-line method over twenty and thirty year periods. Depreciation of equipment is computed using the straight-line method over a five-year period. Leasehold improvements are amortized over the
life of the asset or the applicable lease term. Amortization of certain improvements to managed facilities may exceed the term of the management contract, including renewal options, based on managements estimate of expected contract renewals.
For tax purposes accelerated methods of depreciation are utilized. Repairs and maintenance costs are expensed as incurred.



Workers Compensation Insurance Reserves



The Company maintains insurance policies to indemnify the Company for excessive individual and aggregate workers compensation costs. However, these policies include
large individual and aggregate deductibles for which the Company is liable. As a result of workers compensation risks inherent in our industry, we have incurred significant workers compensations costs. We estimate our total liability on
an undiscounted basis as the total probable ultimate outcome that will be incurred by the Company and paid to, or on behalf of, the claimant over their life expectancy. We base this estimate upon the advice of our insurer/third party administrator
and upon our review of claimant file information maintained by our insurer/third party administrator. While we estimate claims reserves based on their probable outcome, we have experienced changes in estimated claims during 2004 and 2003, resulting
in workers compensation costs of approximately $1.2 million and $1.3 million that were not included in our estimated reserves prior to the beginning of those periods. As a result of these changes in estimate and increasing costs in general, we
have instituted additional safety and back to work programs that we believe will reduce our ultimate costs incurred. As of December 31, 2004 and 2003, we recognized $2.8 million for both years of workers compensation claims liabilities for
claims not yet paid. Under our insurance contracts currently in place, the maximum amount of incurred but unpaid claims for which we could be responsible amounts to $10.3 million as of December 31, 2004.



We use input from our insurance carriers, insurance brokers, and third party administrators
to develop, monitor, and improve our insurance programs and assess our insurance coverage and costs, safety, incentive, and back to work type programs, and assist with our overall adequacy of the individual and aggregate claim reserves. In 2005, we
anticipate that we would involve an independent actuary to further assist us in our ongoing assessment of the adequacy of our insurance coverage and review of our claim history for, among other things, trends, impacts of cost controlling measures,
and the sufficiency of our insurance reserves. The results of the actuarys review, among other things, could suggest that our reserves require further refinement, either an increase or a decrease, of the reserve amounts, which would be
reflected in 2005s results of operations as a change in estimate.



Income Taxes



Deferred tax assets and liabilities are
recognized as the difference between the book basis and tax basis of assets and liabilities. In providing for allowances for deferred taxes, the Company considers current tax regulations, estimates of future taxable income and available tax planning
strategies. If tax regulations, operating results or the ability to implement tax-planning strategies vary, adjustments to the carrying value of deferred tax assets and liabilities may be required. The Company estimates that it will have sufficient
taxable income during the next five years to fully utilize its net deferred tax assets. To calculate the tax provision (benefit) the Company uses an estimated effective tax rate. This effective rate is based on the federal and state statutory rates
as adjusted by various non-deductible items, which may cause the income tax from continuing operations to vary from the statutory rate. During 2004, the tax provision exceeded income before taxes due principally to non-deductible items and the
relatively low amount of income before income tax.



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Loss Contracts



The Company evaluates the future profitability of its contracts when events suggest that the contract may not be profitable over its remaining term. The Company measures
the estimated future losses at the present value of the estimated net cash flows over the remainder of the contract from the time of measurement, with consideration first given to asset impairments as discussed above. For 2004 and 2003, the Company
did not recognize any loss contract costs. However, in December 2003 the Company recorded a loss contract recovery of $896,000, which represented an excess of reserve over actual costs, and is included in the loss from discontinued operations for
2003. No reserve remained at December 31, 2003.



Discontinued Operations



In accordance with SFAS No. 144, Accounting for the Impairment
or Disposal of Long-Lived Assets, the Company has recorded the results of operations of components that have either been disposed of or are classified as held for sale under discontinued operations on the income statement. The Company defines
components that have been disposed of as facilities not operating under a management agreement where the Company has unilaterally terminated its various contracts with sending agencies or has otherwise ceased operations. In these disposal
situations, the Company typically has a significant facility investment or on-going lease obligations. In situations where management agreements with a principal agency are terminated in accordance with the contract provisions, whether or not
subject to renewal or proposal and the Company has no significant facility investment or material exit costs, the results of operations of these facilities continue to be recorded in continuing operations. In the event that a termination of a
management agreement involves material exit costs or where a significant asset is owned or leased, discontinued operations may be reported based on managements assessment of the transaction. (See Note N  Discontinued Operations in the
accompanying financial statements)



Commitments and Contingencies



As more fully discussed under Legal Proceedings in Item
3, the nature of the Companys business results in numerous claims against the Company for damages allegedly arising from the conduct of its employees and others. Additionally, the Company is subject to audits of contracting agencies and other
contingencies. Commitments and contingencies are evaluated and assessed individually to determine whether a liability has been incurred or whether disclosure is otherwise required.



The Company recognizes legal costs related to the defense or assertion of legal claims when the related services have been rendered. Legal
costs that are associated with specific facility operations are recognized in facility operating expenses. Other legal costs are recognized in general and administrative expense.



During 2004, the Company expensed $1.0 million for estimated current and future legal settlements compared to $1.6 million accrued for
during 2003. The legal settlement reserve balance is $1.5 million as of December 31, 2004 and December 31, 2003. Changes in estimates associated with the final resolution of these claims could significantly affect our results of operations in future
periods. (See Note Q  Commitments and Contingencies in the accompanying financial statements)



New Accounting Pronouncements



In
December 2004, the Financial Accounting Standards Board issued Statement 123 (revised 2004), Share-Based Payment (Statement 123(R)). Statement 123(R) requires that the compensation cost relating to share-based payment transactions be recognized in
financial statements. The cost will be measured based on the fair value of the instruments issued. Statement 123(R) covers a wide range of share-based compensation arrangements including share options, restricted share plans, performance-based
awards, share appreciation rights and employee share purchase plans. Statement 123(R) replaces statement 123, Accounting for Stock-Based Compensation and supersedes Opinion 25, Accounting for Stock Issued to Employees. As originally issued in 1995,
Statement 123 established as preferable the fair-value-based method of accounting for share based payment transactions with employees. However, that Statement permitted entities the option of continuing to apply the guidance in Opinion 25 as long as
the footnotes to the financial statements disclosed what net income would have been had the preferable fair-value-based method been used. The Company will be required to apply Statement 123(R) as of the first interim reporting period that begins
after June 15, 2005, and the Company plans on using the modified prospective method, effective July 1, 2005. The Company is currently evaluating the impact of Statement 123(R). An illustration of the impact on our net income and earning per share is
presented in Note A - item 13 Stock Based Compensation of this section, assuming, the Company elects to account for its employee stock compensation plans using the fair value based method of accounting defined in SFAS No. 123, using the
Black-Scholes methodology. We have not yet determined whether we will use the Black-Scholes method in our adoption of Statement 123(R).



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In November 2004, the FASB Emerging Issues Task Force (EITF) released Issue No. 03-13, Applying the Conditions in
Paragraph 42 of FASB Statement No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, in Determining Whether to Report Discontinued Operations. To qualify as a discontinued operation, paragraph 42 of Statement 144 requires
that the cash flows of the disposed component be eliminated from the operations of the ongoing entity and that the ongoing entity not have any significant continuing involvement in the operations of the disposed component after the disposal
transaction. EITF 03-13 provides guidance on how to interpret and apply the criteria in paragraph 42A (elimination of cash flows) and paragraph 42B (no significant continuing involvement) of Statement 144. EITF 03-13 is effective for all periods
beginning after December 15, 2004. Previously reported operating results related to disposal transactions initiated within an enterprises fiscal year that includes November 30, 2004 (date that the consensus was ratified) may be reclassified to
reflect the consensus. The Company does not believe that the adoption of EITF 03-13 will have a significant effect on its financial statements.



RISK FACTORS



Investors should carefully consider the following factors that may affect future results, together with the other information contained in this Annual Report on Form
10-K, in evaluating the Company before purchasing its securities. In particular, prospective investors should note that this Annual Report on Form 10-K contains forward-looking statements within the meaning of the Private Securities Litigation
Reform Act of 1995 and that actual results could differ materially from those contemplated by such statements. See Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995 on page 3 of this Annual Report on Form
10-K. The factors listed below represent certain important risks the Company believes could cause such results to differ and are not intended to represent a complete list of the general or specific risks that may affect the Company. It should be
recognized that other risks may be significant, presently or in the future, and the risks set forth below may affect the Company to a greater extent than indicated.



DECREASES IN OCCUPANCY LEVELS AT OUR
FACILITIES OR RISING COSTS MAY HAVE A MATERIAL ADVERSE EFFECT ON OUR
BUSINESS.



While the non-personnel cost structures of the
facilities we operate are relatively fixed, a substantial portion of our revenues are generated under facility management contracts with government agencies that specify a net rate per day per inmate or a per diem rate, with no minimum guaranteed
occupancy levels. Under this per diem rate structure, a decrease in occupancy levels may have a material adverse effect on our financial condition, results of operations and liquidity. We are dependent upon the governmental agencies with which we
have management contracts to provide inmates for, and maintain the occupancy level of, our managed facilities. We cannot control those occupancy levels. In addition, our ability to estimate and control our costs with respect to all of these
contracts is critical to our profitability.



THE
NON-RENEWAL OR TERMINATION OF OUR FACILITY MANAGEMENT CONTRACTS, WHICH GENERALLY
RANGE FROM ONE TO THREE YEARS, COULD HAVE A MATERIAL ADVERSE EFFECT
ON OUR BUSINESS.



As is
typical in our industry, our facility management contracts are short-term, generally ranging from one to three years, with renewal or extension options as well as termination for convenience clauses in favor of the contracting governmental agency.
Many YSI contracts renew annually. Additionally, the Company received approximately 36.7% of its 2004 consolidated revenue from three agencies: Florida and Georgia Department of Juvenile Justice and Arizona Department of Corrections. Our facility
management contracts may not be renewed or our customers may terminate such contracts in accordance with their right to do so. The non-renewal or termination of any of these contracts could materially adversely affect our financial condition,
results of operations and liquidity, including our ability to secure new facility management contracts from others.



A contracting governmental agency often has a right to terminate a facility contract with or without cause by giving us adequate notice. At times a contracting government
agency may notify us that we are not in compliance with certain provisions of a facility contract. Our failure to cure any such noncompliance could result in termination of the facility contract, which could materially adversely affect our financial
condition, results of operations and liquidity. If a governmental agency does not receive necessary appropriations, it could terminate its contract or reduce the management fee payable to us. Even if funds are appropriated, delays in payments may
occur which could have a material adverse



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effect on our financial condition, results of operations and liquidity. We currently lease many of the facilities that we manage. If a management contract
for a leased facility were terminated, we would continue to be obligated to make lease payments until the lease expires.



OUR ABILITY TO SECURE NEW CONTRACTS TO DEVELOP
AND MANAGE CORRECTIONAL DETENTION FACILITIES DEPENDS ON MANY FACTORS WE CANNOT
CONTROL.



Our growth is generally dependent upon our
ability to obtain new contracts to develop and manage new correctional and detention facilities. This depends on a number of factors we cannot control, including crime rates and sentencing patterns in various jurisdictions and acceptance of
privatization. Certain jurisdictions recently have required successful bidders to make a significant capital investment in connection with the financing of a particular project, a trend which will require the combined company to have sufficient
capital resources to compete effectively. We may not be able to obtain these capital resources when needed.



FUTURE ACQUISITIONS MAY INVOLVE SPECIAL RISKS, INCLUDING POSSIBLE ADVERSE
SHORT-TERM EFFECTS ON OUR OPERATING RESULTS, DIVERSION OF MANAGEMENTS
ATTENTION FROM EXISTING BUSINESS, DEPENDENCE ON KEY PERSONNEL, UNANTICIPATED LIABILITIES
AND COSTS OF AMORTIZATION OF INTANGIBLE ASSETS. ANY OF THESE RISKS
COULD MATERIALLY ADVERSELY AFFECT US.



The Company also intends to grow through selective acquisitions of companies and individual facilities although there are no current plans or agreements to acquire any
other companies. We may not be able to identify or acquire any new companies or facilities and we may not be able to profitably manage acquired operations. Acquisitions involve a number of special risks, including possible adverse short-term effects
on our operating results, diversion of managements attention from existing business, dependence on retaining, hiring and training key personnel, risks associated with unanticipated liabilities, and the costs of amortization of acquired
intangible assets, any of which could have a material adverse effect on our financial condition, results of operations and liquidity.



OUR ABILITY TO OBTAIN FINANCING WHEN A CONTRACT
REQUIRES THAT THE COMPANY CONSTRUCT A NEW FACILITY IN ORDER TO MEET
THE NEEDS OF THE CONTRACT AND CONSTRUCT THE FACILITY WITHIN THE
ESTABLISHED CONSTRUCTION BUDGET



Certain new contracts awarded to the Company require that the Company construct a new facility to meet the needs of the contract. In the past, the Company has relied upon bank financing and arrangements with government entities to finance
the construction of new facilities. However, the Company may be unable to obtain this financing, due to borrowing limitations, or changes in governmental policies that have allowed certain types of financing in the past. The result of any of these
events might compel the awarding agency to look for an alternative provider. Additionally, if the Company were not able to construct the facility within the established construction budget, the cost overruns could cause the Company to use cash on
hand to fund the cost overruns, which may have a material adverse affect on the Companys cash flows.



PUBLIC RESISTANCE TO PRIVATIZATION OF CORRECTIONAL AND DETENTION FACILITIES
COULD RESULT IN OUR INABILITY TO OBTAIN NEW CONTRACTS OR THE LOSS
OF EXISTING CONTRACTS.



The
movement toward privatization of correctional and detention facilities has encountered resistance from certain groups, such as labor unions and others that believe that correctional and detention facility operations should only be conducted by
governmental agencies. Political changes or changes in attitudes toward private correctional and detention facilities management in any market in which we will operate could result in significant changes to the previous acceptance of privatization
in such market and the subsequent loss of facility management contracts. Further, some sectors of the federal government and some state and local governments are not legally permitted to delegate their traditional operating responsibilities for
correctional and detention facilities to private companies.



OPPOSITION TO FACILITY LOCATION MAY ADVERSELY IMPACT THE COMPANYS
ABILITY TO DEVELOP SITES FOR NEW FACILITY LOCATIONS.



The Companys success in opening new facilities is dependent in part upon its ability to obtain facility sites that can be leased or
acquired on economically favorable terms. Some locations may be in or near populous areas and, therefore,



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may generate legal action or other forms of opposition from residents in areas surrounding a proposed site. Certain facilities are already located in or
adjacent to such areas and, in one instance, the Company abandoned its plan to expand a facility after consulting with community leaders who raised concerns about the expansion. There can be no assurance the Company will be able to open new
facilities or expand existing facilities in any particular location.



OUR FAILURE TO COMPLY WITH UNIQUE GOVERNMENTAL REGULATION COULD RESULT
IN MATERIAL PENALTIES OR NON-RENEWAL OR TERMINATION OF OUR FACILITY
MANAGEMENT CONTRACTS.



The industry in which
we operate is subject to extensive federal, state and local regulations, including education, health care and safety regulations, which are administered by many regulatory authorities. Some of the regulations are unique to our industry, and the
combination of regulations we face is unique. We may not always successfully comply with these regulations, and failure to comply can result in material penalties or non-renewal or termination of our facility management contracts. Our contracts
typically include extensive reporting requirements, and supervision and on-site monitoring by representatives of the contracting governmental agencies. Corrections officers and youth care workers are customarily 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 us to award subcontracts on a competitive basis or to subcontract with businesses owned by
members of minority groups. Our businesses also are subject to operational and financial audits by the governmental agencies with which we have contracts. The outcomes of these audits could have a material adverse effect on our business, financial
condition or results of operations.



DISTURBANCES
AT ONE OR MORE OF OUR FACILITIES COULD RESULT IN CLOSURE OF
THESE FACILITIES BY THE RELEVANT GOVERNMENTAL ENTITIES AND A LOSS OF
OUR CONTRACTS TO MANAGE THESE FACILITIES.



An escape, riot or other disturbance at one of our facilities could have a material adverse effect on our financial condition, results of operations and liquidity. Among
other things, the adverse publicity generated as a result of any such event could have a material adverse effect on our ability to retain an existing contract or obtain future ones. In addition, if such an event occurs, there is a possibility that
the facility where the event occurred may be shut down by the relevant governmental entity. A closure of any of our facilities could have a material adverse effect on our financial condition, results of operations and liquidity.



INSURANCE COVERAGE MAY BECOME
INADEQUATE OR UNAVAILABLE TO COVER POTENTIAL LIABILITY RELATED TO MANAGEMENT OF
CORRECTIONAL AND DETENTION FACILITIES OR ITS COSTS MAY ADVERSELY AFFECT RESULTS
OF OPERATIONS.



Our management of
correctional and detention facilities exposes us to potential third-party claims or litigation by prisoners or other persons for personal injury or other damages, including damages resulting from contact with our facilities, programs, personnel or
students (including students who leave our facilities without our authorization and cause bodily injury or property damage). Currently, we are subject to actions initiated by former employees, inmates and detainees alleging assault, sexual
harassment, personal injury, property damage, and other injuries. In addition, our management contracts generally require us to indemnify the governmental agency against any damages to which the governmental agency may be subject in connection with
such claims or litigation. We maintain insurance programs that provide coverage for certain liability risks faced by us, including personal injury, bodily injury, death or property damage to a third party where we are found to be negligent. There is
no assurance, however, that our insurance will be adequate to cover potential third-party claims. In addition, we are unable to secure insurance for some unique business risks, which may include, but not be limited to, some types of punitive damages
in states where it is prohibited by law.



Committed offenders often seek
redress in federal courts pursuant to federal civil rights statutes for alleged violations of their constitutional rights caused by the overall condition of their confinement or by specific conditions or incidents. We may be subject to liability if
any such claim or proceeding is made or instituted against us or the state with which we contract or subcontract.



The Company continues to incur increased costs for insurance. Workers compensation and general liability insurance represent significant costs to the Company.



STAFF RECRUITMENT DIFFICULTIES
MAY IMPACT OPERATIONS.



Many
of our facilities are located in areas where there are smaller populations and/or where there are more jobs than available workers. Our choice of employees is further limited by our drug free workplace status, and licensure and other policy
prohibitions against hiring individuals with past criminal histories. However, many of our contracts require the



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##### Table of Contents

Company to have certain numbers and certain types of employees on duty at the facility at all times. Although the Company makes rigorous efforts to recruit
and retain a sufficient work force, it is sometimes unable to achieve adequate staffing without significant overtime expense. This additional expense may adversely effect the Companys results.



Item 7A. Quantitative and Qualitative Disclosures About Market Risk



The Company does not hold any investments or financial instruments that are subject to market risk. As discussed above in Item 7, Liquidity and Capital Resources, borrowings under the Companys
current line of credit established under the Credit Agreement are repayable at variable rates of interest and are therefore exposed to fluctuations in interest rates. There are no outstanding borrowings under the Companys line of credit. The
Companys note payable with respect to the Northwest Regional Detention Center and its other note payable accrue interest at fixed rates of interest.



The table below presents the principal amounts, weighted average interest rates, fair value and other terms, by year of expected maturity, required to evaluate the
expected cash flows and sensitivity to interest rate changes. Actual maturities may differ because of prepayment rights.



|                                                    |  |      |   |  |                         |       |      |   |       |  |      |       |      |   |             |  |       |        |            |   |        |  |   |         |  |   |        
|--------------------------------------------------- |  | ---- | - |  | ----------------------- | ----- | ---- | - | ----- |  | ---- | ----- | ---- | - | ----------- |  | ----- | ------ | ---------- | - | ------ |  | - | ------- |  | - | -------
|                                                    |  |      |   |  | Expected Maturity Dates
|                                                    |  |      |   |  | 2005                    |       | 2006 |   | 2007  |  | 2008 |       | 2009 |   | There after |  | Total |        | Fair Value
|Fixed rate debt (in thousands)                      |  |      |   |  |                         |       |      |   |       |  |      |       |      |   |             |  |       |        |            |   |        |  |   |         |  |   |        
|Loan payable                                        |  |      |   |  | $                       | 3     |      | $ | 302   |  | $    |      |      | $ |            |  | $     |       |            | $ |       |  | $ | 305     |  | $ | 305    
|                                                    |  |      |   |  |                         |       |      |   |       |  |      |       |      |   |             |  |       |        |            |   |        |  |   |         |  |   |        
|Note payable                                        |  |      |   |  | $                       | 4,705 |      | $ | 4,905 |  | $    | 9,260 |      | $ | 9,650       |  | $     | 10,085 |            | $ | 68,062 |  | $ | 106,667 |  | $ | 106,667
|                                                    |  |      |   |  |                         |       |      |   |       |  |      |       |      |   |             |  |       |        |            |   |        |  |   |         |  |   |        
|Weighted average interest Rate at December 31, 2004 |  | 5.27 | % |  |                         |       |      |   |       |  |      |       |      |   |             |  |       |        |            |   |        |  |   |         |  |   |        
|                                                    |  |      |   |  |                         |       |      |   |       |  |      |       |      |   |             |  |       |        |            |   |        |  |   |         |  |   |        
|Variable rate debt                                  |  |      |   |  | $                       |      |      | $ |      |  | $    |      |      | $ |            |  | $     |       |            | $ |       |  | $ |        |  | $ |       
|                                                    |  |      |   |  |                         |       |      |   |       |  |      |       |      |   |             |  |       |        |            |   |        |  |   |         |  |   |        
|Weighted average interest rate at December 31, 2003 |  | N/A  |   |  |                         |       |      |   |       |  |      |       |      |   |             |  |       |        |            |   |        |  |   |         |  |   |        
|                                                    |  |      |   |  |                         |       |      |   |       |  |      |       |      |   |             |  |       |        |            |   |        |  |   |         |  |   |        



Item 8. Financial
Statements and Supplementary Data



The information
required by this item is contained on Pages F-1 thru F31- hereof.



Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure



Not applicable



Item 9A. Controls and Procedures



Under the supervision and with the participation of our management, we have evaluated the effectiveness of the design and operation of our disclosure controls and procedures. Based on that evaluation, we concluded that our disclosure
controls and procedures are effective in timely alerting them to material information required to be included in our filings with the SEC.



We have also evaluated our internal controls for financial reporting, and there have been no changes that occurred during the Companys most recent fiscal quarter
that have materially affected, or are reasonably likely to materially affect, the Companys internal controls over financial reporting.



Any system of disclosure controls and internal controls, even if well-conceived, is inherently limited in detecting and preventing all errors and fraud and provides
reasonable, not absolute, assurance that its objectives are met. The design of a control system must reflect resource constraints. Inherent limitations include the potential for faulty judgments in decision-making, breakdowns because of simple error
or mistakes, and circumvention of controls by individual acts, collusion of two or more people, or management override of controls.



We included certifications of our Chief Executive Officer and our Chief Financial Officer as exhibits to this report as required by Section 302 of the Sarbanes-Oxley Act
of 2002. The foregoing information concerning our evaluation of disclosure controls referenced in the Section 302 certifications should be read with the Section 302 certifications to more completely understand them.



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Item 9B. Other Information



In
December 2004, the Company determined that the carrying amount of the net assets identifiable with its Colorado County Juvenile Facility located in Eagle Lake, Texas was not recoverable and exceeded its fair value. Based on FASB 144,
Accounting for the Impairment or Disposal of Long-lived Assets, the Company recognized an impairment of $1.5 million on these net assets.



PART III



The information required by Items 10,
11, 12, and 13 of Form 10-K will be contained in, and is incorporated by reference from, the proxy statement for the Companys 2005 Annual Meeting of Shareholders, which will be filed with the Securities and Exchange Commission pursuant to
Regulation 14A within 120 days after the end of the fiscal year covered by this Annual Report.



Item 14. Principal Accountant Fees and Services



| | (1) | Audit Fees
| | --- | ----------



The aggregate fees billed or billable by Grant Thornton, LLP for professional services in connection with the audit of the Companys 2004 and 2003
annual financial statements and review of the Companys 2004 and 2003 quarterly financial statements were approximately $270,000 for 2004 and $205,000 for 2003.



| | (2) | Audit-Related Fees
| | --- | ------------------



The aggregate fees billed by Grant Thornton, LLP for assurance and related services in 2004 and 2003 that were reasonably related to the performance of
the audit or review of the Companys financial statements and are not reported under Audit Fees above were approximately $45,000 and $46,000, respectively. The fees billed in 2004 and 2003 consisted primarily of an audit of
financial data as required under an operating agreement, and the audits of the Companys 401(k) plans.



| | (3) | Tax Fees
| | --- | --------



The aggregate fees billed by Grant Thornton, LLP in 2004 and 2003 for tax compliance, tax advice and tax planning were approximately $60,000 and $84,000,
respectively.



| | (4) | All Other Fees
| | --- | --------------



The aggregate fees billed during 2004 and 2003 for services rendered by Grant Thornton, LLP, other than the services described in the preceding
paragraphs, were approximately $0 for 2004 and 2003.



| | (5) | Audit Committee Administration of the Engagement
| | --- | ------------------------------------------------



In accordance with Section 10A(i) of the Securities Exchange Act of 1934, before Grant Thornton LLP is engaged by the Company, the engagement is approved
by the Companys audit committee. With respect to the provision of services other than audit, review, or attest services, pre-approval of the audit committee of the Company is required prior to the start of field work.



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##### Table of Contents

PART IV



Item 15. Exhibits and Financial Statement Schedules



The following documents are filed as part of this report:



The consolidated financial statements of the Company as at December 31, 2004 and for the year period then ended are included on pages F-1 through F-31 of this Form 10-K.



Exhibits: The following exhibits are incorporated by reference into this Form 10-K or filed
with this Form 10-K:



|         |  |                                                                                                                                                                                
|-------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|3.1      |  | Certificate of Incorporation of CSC dated October 28, 1993.(1)                                                                                                                 
|         | 
|3.1.1    |  | Copy of Certificate of Amendment of Certificate of Incorporation of CSC dated July 29, 1996.(3)                                                                                
|         | 
|3.1.2    |  | Copy of Certificate of Correction to CSCs Certificate of Incorporation.(1)                                                                                                    
|         | 
|3.1.3    |  | Copy of Certification of Correction to CSCs Certificate of Amendment to CSCs Certificate of Incorporation. (1)                                                               
|         | 
|3.2      |  | CSCs By-Laws.(6)                                                                                                                                                              
|         | 
|* 10.1   |  | CSCs 1993 Stock Option Plan, as amended.(6)                                                                                                                                   
|         | 
|* 10.1.1 |  | 2004 Stock Option Plan of Correctional Services Corporation                                                                                                                    
|         | 
|10.17    |  | Form of Lease between CSC and Myrtle Avenue Family Center, Inc.(1)                                                                                                             
|         | 
|* 10.25  |  | 1994 Non-Employee Director Stock Option Plan.(2)                                                                                                                               
|         | 
|* 10.1.2 |  | Amended and Restated Non-Employee Director Stock Option Plan of Correctional Services Corporation                                                                              
|         | 
|10.44    |  | Lease Agreement between CSC and Creston Realty Associates, L.P., dated October 1, 1996.(3)                                                                                     
|         | 
|* 10.74  |  | Employment Agreement dated September 29, 1999 between CSC and James F. Slattery.(5)                                                                                            
|         | 
|10.74.1  |  | Loan and Security Agreement, dated October 30, 2002, between CSC and General Electric Capital Corporation. (7)                                                                 
|         | 
|10.74.2  |  | Amendment No. 1 to Loan and Security Agreement, dated May 15, 2003, between CSC and General Electric Capital Corporation. (8)                                                  
|         | 
|10.74.3  |  | Letter Agreement dated June 27, 2003, incorporated into the Loan and Security Agreement dated October 30, 2002, between CSC and General Electric Capital Corporation. (9)      
|         | 
|10.74.4  |  | Amendment No. 2 to the Loan and Security Agreement dated November 14, 2003, between CSC and General Electric Capital Corporation. (10)                                         
|         | 
|10.74.5  |  | Trust Indenture between the South Texas Detention Complex Development Corporation and U.S. Bank National Association, as trustee.(11)                                          
|         | 
|10.74.6  |  | Design and Development Agreement between the South Texas Detention Complex Development Corporation and Correctional Services Corporation. (11)                                 
|         | 
|10.74.7  |  | Operating Agreement between the South Texas Detention Complex Local Development Corporation and Correctional Services Corporation. (11)                                        
|         | 
|* 10.75  |  | Change in Control Agreement dated September 29, 1999 between CSC and James F. Slattery.(5)                                                                                     
|         | 
|11       |  | Statement of Computation of Per Share Earning is set forth in Note S to the accompanying financial statements                                                                  
|         | 
|12       |  | Statements re Computation of Ratios  Not Applicable                                                                                                                           
|         | 
|13       |  | Annual Report to Security Holders, Form 10-Q or 10-QSB  Not Applicable                                                                                                        
|         | 
|14       |  | Code of Ethics  Incorporated by reference from the Registrants Proxy Statement for its 2005 Annual Meeting of Shareholders                                                   
|         | 
|16       |  | Not applicable                                                                                                                                                                 
|         | 
|18       |  | Not applicable                                                                                                                                                                 
|         | 
|21       |  | List of Subsidiaries is set forth in Note A to the accompanying financial statements                                                                                           
|         | 
|22       |  | Not applicable                                                                                                                                                                 
|         | 
|23.1     |  | Consent of Grant Thornton L.L.P., CSCs Independent Registered Public Accounting Firm                                                                                          
|         | 
|31.1     |  | Certification required by Rule 13a-14(a) (17 CFR 240.13a-14(a)) or Rule 15d-14(a) (17 CFR 240.15d-14(a)), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.



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|     |  |                                                                                                                                                                                
|---- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|31.2 |  | Certification required by Rule 13a-14(a) (17 CFR 240.13a-14(a)) or Rule 15d-14(a) (17 CFR 240.15d-14(a)), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.
|     | 
|32.1 |  | Certification pursuant to 18 U.S.C Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                         
|     | 
|32.2 |  | Certification pursuant to 18 U.S.C Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.                                                         

---

|(1) | Incorporated by reference to exhibit of same number filed with CSCs Registration Statement on Form SB-2 (Registration No. 33-71314-NY).
|--- | ----------------------------------------------------------------------------------------------------------------------------------------

|(2) | Incorporated by reference to exhibit of same number filed with the initial filing of CSCs Annual Report on Form 10-KSB for the year ended December 31, 1995.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | Incorporated by reference to exhibit of same number filed with CSCs Annual Report on Form-10-KSB for the year ended December 31, 1996.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------

|(4) | Incorporated by reference to exhibit of same number filed with CSCs Form 10-Q for the three months ended March 31, 1998.
|--- | -------------------------------------------------------------------------------------------------------------------------

|(5) | Incorporated by reference to exhibit of same number filed with CSCs Form 10-Q for the nine months ended September 30, 1999.
|--- | ----------------------------------------------------------------------------------------------------------------------------

|(6) | Incorporated by reference to exhibit of same number filed with CSCs Registration Statement on Form S-1 (Registration Number 333-6457).
|--- | ---------------------------------------------------------------------------------------------------------------------------------------

|(7) | Incorporated by reference to exhibit of the same number filed with CSCs Form 10-Q for the nine months ended September 30, 2002.
|--- | --------------------------------------------------------------------------------------------------------------------------------

|(8) | Incorporated by reference to exhibit of same number filed with CSCs Form 10-Q for the three months ended March 31, 2003.
|--- | -------------------------------------------------------------------------------------------------------------------------

|(9) | Incorporated by reference to exhibit of same number filed with CSCs Form 10-Q for the six months ended June 30, 2003.
|--- | ----------------------------------------------------------------------------------------------------------------------

|(10) | Incorporated by reference to exhibit of same number filed with CSCs Form 10-Q for the nine months ended September 30, 2003.
|---- | ----------------------------------------------------------------------------------------------------------------------------

|(11) | Incorporated by reference to exhibit of same number filed with CSCs Form 10-Q for the nine months ended September 30, 2004.
|---- | ----------------------------------------------------------------------------------------------------------------------------

|* | Management Contract or Compensatory Plan or Arrangement.
|- | --------------------------------------------------------



37



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SIGNATURES



Pursuant to the requirements of Section 13
or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.



CORRECTIONAL SERVICES CORPORATIONRegistrantBy:

/s/ James F. SlatteryJames F. Slattery, President




Dated: March 31, 2005



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.



|                      |  |                                                                                 |  |               
|--------------------- |  | ------------------------------------------------------------------------------- |  | --------------
|Signature             |  | Title                                                                           |  | Date          
|/s/ James F. Slattery |  | President and Chief Executive Officer (Principal Executive Officer), Director   |  | March 31, 2005
|James F. Slattery     |  |                                                                                
|                      |  |                                                                                
|/s/ Bernard A. Wagner |  | Senior Vice President and Chief Financial Officer (Principal Financial Officer) |  | March 31, 2005
|Bernard A. Wagner     |  |                                                                                
|                      |  |                                                                                
|/s/ Aaron Speisman    |  | Executive Vice President and Director                                           |  | March 31, 2005
|Aaron Speisman        |  |                                                                                
|                      |  |                                                                                
|/s/ Stuart Gerson     |  | Chairman of the Board                                                           |  | March 31, 2005
|Stuart Gerson         |  |                                                                                
|                      |  |                                                                                
|/s/ Chet Borgida      |  | Director                                                                        |  | March 31, 2005
|Chet Borgida          |  |                                                                                
|                      |  |                                                                                
|/s/ John H. Shuey     |  | Director                                                                        |  | March 31, 2005
|John H. Shuey         |  |                                                                                
|                      |  |                                                                                
|/s/ Bobbie L. Huskey  |  | Director                                                                        |  | March 31, 2005
|Bobbie L. Huskey      |  |                                                                                
|                      |  |                                                                                
|/s/ Melvin T. Stith   |  | Director                                                                        |  | March 31, 2005
|Melvin T. Stith       |  |                                                                                



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C O N T E N T S



|                                                                                                     |  |     
|---------------------------------------------------------------------------------------------------- |  | ----
|                                                                                                     |  | Page
|Report of Independent Registered Public Accounting Firm                                              |  | F-2 
|                                                                                                     | 
|Consolidated Balance Sheets as of December 31, 2004 and 2003                                         |  | F-3 
|                                                                                                     | 
|Consolidated Statements of Operations for the years ended December 31, 2004, 2003, and 2002          |  | F-4 
|                                                                                                     | 
|Consolidated Statement of Stockholders Equity for the years ended December 31, 2004, 2003, and 2002 |  | F-5 
|                                                                                                     | 
|Consolidated Statements of Cash Flows for the years ended December 31, 2004, 2003, and 2002          |  | F-6 
|                                                                                                     | 
|Notes to Consolidated Financial Statements                                                           |  | F-7 



F-1



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##### Table of Contents

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM



Board of Directors

Correctional Services Corporation



We have audited the accompanying consolidated balance sheets of Correctional Services Corporation and Subsidiaries as of December 31, 2004 and 2003, and the related
consolidated statements of operations, stockholders equity and cash flows for each of the three years in the period ended December 31, 2004. 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 the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. The Company is not required to have, nor were we engaged to perform an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a
basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Companys internal control over financial reporting. Accordingly, we express no such
opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, 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 provide a reasonable basis for our opinion.



In our opinion, the consolidated 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, 2004 and 2003, and the consolidated results of their operations and consolidated cash flows for each of the three years in the period ended December 31, 2004, in conformity with accounting
principles generally accepted in the United States of America.



/s/ GRANT THORNTON LLP



Tampa, Florida

March 8, 2005



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##### Table of Contents

CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(in thousands)



|                                                                                                                                                                                |  |              |         |   |      |   |         |  
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------ | ------- | - | ---- | - | ------- | -
|                                                                                                                                                                                |  | December 31, |        
|                                                                                                                                                                                |  | 2004         |         |   | 2003 |  
|ASSETS                                                                                                                                                                          |  |              |         |   |      |   |         |  
|CURRENT ASSETS                                                                                                                                                                  |  |              |         |   |      |   |         |  
|Cash and cash equivalents                                                                                                                                                       |  | $            | 725     |   |      | $ | 3,755   |  
|Restricted cash and cash equivalents                                                                                                                                            |  |              | 10,905  |   |      |   | 4,517   |  
|Accounts receivable, net                                                                                                                                                        |  |              | 25,986  |   |      |   | 21,146  |  
|Deferred tax asset                                                                                                                                                              |  |              | 2,850   |   |      |   | 2,200   |  
|Prepaid expenses and other current assets                                                                                                                                       |  |              | 2,140   |   |      |   | 1,966   |  
|                                                                                                                                                                                |  |              |         |   |      |   |         |  
|Total current assets                                                                                                                                                            |  |              | 42,606  |   |      |   | 33,584  |  
|                                                                                                                                                                                |  |             
|PROPERTY, EQUIPMENT AND LEASEHOLD IMPROVEMENTS, NET                                                                                                                             |  |              | 92,345  |   |      |   | 71,141  |  
|PROPERTY HELD FOR SALE                                                                                                                                                          |  |              | 6,670   |   |      |   | 6,951   |  
|                                                                                                                                                                                |  |             
|OTHER ASSETS                                                                                                                                                                    |  |              |         |   |      |   |         |  
|Long term restricted cash equivalents and investments                                                                                                                           |  |              | 34,843  |   |      |   | 17,777  |  
|Deferred tax asset, net                                                                                                                                                         |  |              | 8,631   |   |      |   | 7,598   |  
|Goodwill                                                                                                                                                                        |  |              | 679     |   |      |   | 679     |  
|Deferred loan costs, net                                                                                                                                                        |  |              | 11,183  |   |      |   | 6,637   |  
|Other                                                                                                                                                                           |  |              | 3,033   |   |      |   | 2,937   |  
|                                                                                                                                                                                |  |              |         |   |      |   |         |  
|TOTAL ASSETS                                                                                                                                                                    |  | $            | 199,990 |   |      | $ | 147,304 |  
|                                                                                                                                                                                |  |              |         |   |      |   |         |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                                            |  |              |         |   |      |   |         |  
|CURRENT LIABILITIES                                                                                                                                                             |  |              |         |   |      |   |         |  
|Accounts payable                                                                                                                                                                |  | $            | 817     |   |      | $ | 498     |  
|Accrued liabilities                                                                                                                                                             |  |              | 24,582  |   |      |   | 18,941  |  
|Current portion of capital lease obligations                                                                                                                                    |  |              | 500     |   |      |   | 247     |  
|Current portion of long term liabilities                                                                                                                                        |  |              | 5,021   |   |      |   | 296     |  
|                                                                                                                                                                                |  |              |         |   |      |   |         |  
|Total current liabilities                                                                                                                                                       |  |              | 30,920  |   |      |   | 19,982  |  
|                                                                                                                                                                                |  |             
|LONG TERM LIABILITIES                                                                                                                                                           |  |              |         |   |      |   |         |  
|Bond and note payable                                                                                                                                                           |  |              | 101,962 |   |      |   | 57,332  |  
|Capital lease obligations                                                                                                                                                       |  |              | 10,598  |   |      |   | 9,939   |  
|Other long-term liabilities                                                                                                                                                     |  |              | 8,095   |   |      |   | 8,398   |  
|Loans payable                                                                                                                                                                   |  |              | 302     |   |      |   | 305     |  
|                                                                                                                                                                                |  |             
|COMMITMENTS AND CONTINGENCIES                                                                                                                                                   |  |              |        |   |      |   |        |  
|                                                                                                                                                                                |  |             
|STOCKHOLDERS EQUITY                                                                                                                                                            |  |              |         |   |      |   |         |  
|Preferred stock, $.01 par value, 1,000 shares authorized, none issued and outstanding                                                                                           |  |              |        |   |      |   |        |  
|Common Stock, $.01 par value, 30,000 shares authorized,11,385 shares issued and 10,167 shares outstanding in 2004 and11,377 shares
issued and 10,159 shares outstanding in 2003 |  |              | 114     |   |      |   | 114     |  
|Additional paid-in capital                                                                                                                                                      |  |              | 82,816  |   |      |   | 82,803  |  
|Accumulated deficit                                                                                                                                                             |  |              | (31,826 | ) |      |   | (28,578 | )
|Treasury stock, at cost                                                                                                                                                         |  |              | (2,991  | ) |      |   | (2,991  | )
|                                                                                                                                                                                |  |              |         |   |      |   |         |  
|                                                                                                                                                                                |  |              | 48,113  |   |      |   | 51,348  |  
|                                                                                                                                                                                |  |              |         |   |      |   |         |  
|TOTAL LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                                                      |  | $            | 199,990 |   |      | $ | 147,304 |  
|                                                                                                                                                                                |  |              |         |   |      |   |         |  



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



F-3



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##### Table of Contents

CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per share data)



|                                                                                                       |  |                          |         |   |      |   |         |      |  |   |         |  
|------------------------------------------------------------------------------------------------------ |  | ------------------------ | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                                                                       |  | Years Ended December 31, |        
|                                                                                                       |  | 2004                     |         |   | 2003 |   |         | 2002 | 
|                                                                                                       |  |                          |        
|Revenues                                                                                               |  | $                        | 133,719 |   |      | $ | 126,531 |      |  | $ | 144,502 |  
|                                                                                                       |  |                          |         |   |      |   |         |      |  |   |         |  
|Facility expenses:                                                                                     |  |                          |         |   |      |   |         |      |  |   |         |  
|Operating                                                                                              |  |                          | 114,949 |   |      |   | 112,378 |      |  |   | 128,784 |  
|Startup costs                                                                                          |  |                          | 3,276   |   |      |   | 378     |      |  |   |        |  
|                                                                                                       |  |                          |         |   |      |   |         |      |  |   |         |  
|                                                                                                       |  |                          | 118,225 |   |      |   | 112,756 |      |  |   | 128,784 |  
|                                                                                                       |  |                          |         |   |      |   |         |      |  |   |         |  
|Contribution from operations                                                                           |  |                          | 15,494  |   |      |   | 13,775  |      |  |   | 15,718  |  
|                                                                                                       |  |                          |         |   |      |   |         |      |  |   |         |  
|Other operating expenses:                                                                              |  |                          |         |   |      |   |         |      |  |   |         |  
|General and administrative                                                                             |  |                          | 8,452   |   |      |   | 9,211   |      |  |   | 9,117   |  
|Long-lived asset impairment                                                                            |  |                          | 1,496   |   |      |   |        |      |  |   |        |  
|Loss contract costs                                                                                    |  |                          |        |   |      |   |        |      |  |   | 220     |  
|Loss (gain) on disposal of assets                                                                      |  |                          | 618     |   |      |   | (53     | )    |  |   | (1,525  | )
|                                                                                                       |  |                          |         |   |      |   |         |      |  |   |         |  
|                                                                                                       |  |                          | 10,566  |   |      |   | 9,158   |      |  |   | 7,812   |  
|                                                                                                       |  |                          |         |   |      |   |         |      |  |   |         |  
|Operating income                                                                                       |  |                          | 4,928   |   |      |   | 4,617   |      |  |   | 7,906   |  
|Interest expense, net                                                                                  |  |                          | 4,644   |   |      |   | 2,203   |      |  |   | 2,326   |  
|                                                                                                       |  |                          |         |   |      |   |         |      |  |   |         |  
|Income from continuing operations before income taxes                                                  |  |                          | 284     |   |      |   | 2,414   |      |  |   | 5,580   |  
|Income tax provision                                                                                   |  |                          | 381     |   |      |   | 1,208   |      |  |   | 1,086   |  
|                                                                                                       |  |                          |         |   |      |   |         |      |  |   |         |  
|Income (loss) from continuing operations                                                               |  |                          | (97     | ) |      |   | 1,206   |      |  |   | 4,494   |  
|Income (loss) from discontinued operations, net of tax (benefit) expense of $(2,016), $82,and $(1,363) |  |                          | (3,151  | ) |      |   | 128     |      |  |   | (2,131  | )
|                                                                                                       |  |                          |         |   |      |   |         |      |  |   |         |  
|Net income (loss)                                                                                      |  | $                        | (3,248  | ) |      | $ | 1,334   |      |  | $ | 2,363   |  
|                                                                                                       |  |                          |         |   |      |   |         |      |  |   |         |  
|Basic income (loss) per share:                                                                         |  |                          |         |   |      |   |         |      |  |   |         |  
|Income per share from continuing operations                                                            |  | $                        | (0.01   | ) |      | $ | 0.12    |      |  | $ | 0.44    |  
|Income (loss) per share from discontinued operations                                                   |  |                          | (0.31   | ) |      |   | 0.01    |      |  |   | (0.21   | )
|                                                                                                       |  |                          |         |   |      |   |         |      |  |   |         |  
|Net income (loss) per share                                                                            |  | $                        | (0.32   | ) |      | $ | 0.13    |      |  | $ | 0.23    |  
|                                                                                                       |  |                          |         |   |      |   |         |      |  |   |         |  
|Diluted income (loss) per share:                                                                       |  |                          |         |   |      |   |         |      |  |   |         |  
|Income per share from continuing operations                                                            |  | $                        | (0.01   | ) |      | $ | 0.12    |      |  | $ | 0.44    |  
|Income (loss) per share from discontinued operations                                                   |  |                          | (0.31   | ) |      |   | 0.01    |      |  |   | (0.21   | )
|                                                                                                       |  |                          |         |   |      |   |         |      |  |   |         |  
|Net income (loss) per share                                                                            |  | $                        | (0.32   | ) |      | $ | 0.13    |      |  | $ | 0.23    |  
|                                                                                                       |  |                          |         |   |      |   |         |      |  |   |         |  
|Number of shares used to compute income (loss) per share:                                              |  |                          |         |   |      |   |         |      |  |   |         |  
|Basic                                                                                                  |  |                          | 10,165  |   |      |   | 10,157  |      |  |   | 10,155  |  
|Diluted                                                                                                |  |                          | 10,165  |   |      |   | 10,237  |      |  |   | 10,195  |  



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





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##### Table of Contents

CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF STOCKHOLDERS EQUITY

(in thousands)



|                             |  |             |     |                          |   |                      |  |   |               |   |  |       |        |   |  |   |        |  
|---------------------------- |  | ----------- | --- | ------------------------ | - | -------------------- |  | - | ------------- | - |  | ----- | ------ | - |  | - | ------ | -
|                             |  | CommonStock |     | AdditionalPaid-inCapital |   | Accumulated(Deficit) |  |   | TreasuryStock |   |  | Total |       
|Balance at December 31, 2001 |  | $           | 114 |                          | $ | 82,797               |  | $ | (32,275       | ) |  | $     | (2,991 | ) |  | $ | 47,645 |  
|                             |  |             |     |                          |  
|Net income                   |  |             |    |                          |   |                     |  |   | 2,363         |   |  |       |       |   |  |   | 2,363  |  
|                             |  |             |     |                          |   |                      |  |   |               |   |  |       |        |   |  |   |        |  
|Balance at December 31, 2002 |  |             | 114 |                          |   | 82,797               |  |   | (29,912       | ) |  |       | (2,991 | ) |  |   | 50,008 |  
|                             |  |             |     |                          |  
|Stock options exercised      |  |             |    |                          |   | 6                    |  |   |              |   |  |       |       |   |  |   | 6      |  
|                             |  |             |     |                          |  
|Net income                   |  |             |    |                          |   |                     |  |   | 1,334         |   |  |       |       |   |  |   | 1,334  |  
|                             |  |             |     |                          |   |                      |  |   |               |   |  |       |        |   |  |   |        |  
|Balance at December 31, 2003 |  |             | 114 |                          |   | 82,803               |  |   | (28,578       | ) |  |       | (2,991 | ) |  |   | 51,348 |  
|                             |  |             |     |                          |  
|Stock options exercised      |  |             |    |                          |   | 13                   |  |   |              |   |  |       |       |   |  |   | 13     |  
|                             |  |             |     |                          |  
|Net loss                     |  |             |    |                          |   |                     |  |   | (3,248        | ) |  |       |       |   |  |   | (3,248 | )
|                             |  |             |     |                          |   |                      |  |   |               |   |  |       |        |   |  |   |        |  
|Balance at December 31, 2004 |  | $           | 114 |                          | $ | 82,816               |  | $ | (31,826       | ) |  | $     | (2,991 | ) |  | $ | 48,113 |  
|                             |  |             |     |                          |   |                      |  |   |               |   |  |       |        |   |  |   |        |  



The accompanying notes
are an integral part of this financial statement.



F-5



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##### Table of Contents

CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)



|                                                                                                               |  |                          |         |   |      |   |         |      |  |   |         |  
|-------------------------------------------------------------------------------------------------------------- |  | ------------------------ | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                                                                               |  | Years Ended December 31, |        
|                                                                                                               |  | 2004                     |         |   | 2003 |   |         | 2002 | 
|Cash flows from operating activities:                                                                          |  |                          |         |   |      |   |         |      |  |   |         |  
|Net income (loss)                                                                                              |  | $                        | (3,248  | ) |      | $ | 1,334   |      |  | $ | 2,363   |  
|Adjustments to reconcile net income (loss) to net cash provided by operating activities:                       |  |                          |         |   |      |   |         |      |  |   |         |  
|Depreciation and amortization                                                                                  |  |                          | 5,699   |   |      |   | 3,410   |      |  |   | 4,353   |  
|Provision for bad debt                                                                                         |  |                          | 512     |   |      |   | 203     |      |  |   | 330     |  
|Deferred income tax expense (benefit)                                                                          |  |                          | (1,683  | ) |      |   | 1,332   |      |  |   | (468    | )
|Restructuring, impairment and loss contract reserves                                                           |  |                          | 4,352   |   |      |   | (1,544  | )    |  |   | 1,287   |  
|Loss (gain) on disposal of fixed assets, net                                                                   |  |                          | 618     |   |      |   | (58     | )    |  |   | (1,526  | )
|Changes in operating assets and liabilities:                                                                   |  |                          |         |   |      |   |         |      |  |   |         |  
|Restricted cash                                                                                                |  |                          | (6,386  | ) |      |   | (2,656  | )    |  |   | (1,828  | )
|Accounts receivable                                                                                            |  |                          | (5,353  | ) |      |   | 3,119   |      |  |   | 963     |  
|Prepaid expenses and other current assets                                                                      |  |                          | (174    | ) |      |   | (456    | )    |  |   | 177     |  
|Accounts payable and accrued liabilities                                                                       |  |                          | 5,958   |   |      |   | 2,406   |      |  |   | (2,800  | )
|                                                                                                               |  |                          |         |   |      |   |         |      |  |   |         |  
|Net cash provided by operating activities:                                                                     |  |                          | 295     |   |      |   | 7,090   |      |  |   | 2,851   |  
|                                                                                                               |  |                          |         |   |      |   |         |      |  |   |         |  
|Cash flows from investing activities:                                                                          |  |                          |         |   |      |   |         |      |  |   |         |  
|Capital expenditures including use of restricted cash                                                          |  |                          | (28,631 | ) |      |   | (41,707 | )    |  |   | (2,800  | )
|Proceeds from the sale of property, equipment and leasehold improvements                                       |  |                          | 254     |   |      |   | 18      |      |  |   | 24,725  |  
|Note proceeds invested in non-current restricted cash                                                          |  |                          | (17,067 | ) |      |   | (17,777 | )    |  |   |        |  
|Other assets                                                                                                   |  |                          | (214    | ) |      |   | 915     |      |  |   | (461    | )
|                                                                                                               |  |                          |         |   |      |   |         |      |  |   |         |  
|Net cash provided by (used in) investing activities:                                                           |  |                          | (45,658 | ) |      |   | (58,551 | )    |  |   | 21,464  |  
|                                                                                                               |  |                          |         |   |      |   |         |      |  |   |         |  
|Cash flows from financing activities:                                                                          |  |                          |         |   |      |   |         |      |  |   |         |  
|Payments on loans payable                                                                                      |  |                          | (3      | ) |      |   | (3      | )    |  |   | (17,186 | )
|Proceeds from note payable                                                                                     |  |                          | 43,012  |   |      |   | 51,344  |      |  |   |        |  
|Payments on term note                                                                                          |  |                          |        |   |      |   |        |      |  |   | (12,000 | )
|Payments on capital lease obligation                                                                           |  |                          | (409    | ) |      |   | (217    | )    |  |   |        |  
|Proceeds (payments) on other long-term obligation                                                              |  |                          | (280    | ) |      |   | (241    | )    |  |   | 8,276   |  
|Payment of subordinated debt                                                                                   |  |                          |        |   |      |   |        |      |  |   | (10     | )
|Stock options exercised                                                                                        |  |                          | 13      |   |      |   | 6       |      |  |   |        |  
|                                                                                                               |  |                          |         |   |      |   |         |      |  |   |         |  
|Net cash provided by (used in) financing activities:                                                           |  |                          | 42,333  |   |      |   | 50,889  |      |  |   | (20,920 | )
|                                                                                                               |  |                          |         |   |      |   |         |      |  |   |         |  
|Net increase (decrease) in cash and cash equivalents                                                           |  |                          | (3,030  | ) |      |   | (572    | )    |  |   | 3,395   |  
|Cash and cash equivalents at beginning of period                                                               |  |                          | 3,755   |   |      |   | 4,327   |      |  |   | 932     |  
|                                                                                                               |  |                          |         |   |      |   |         |      |  |   |         |  
|Cash and cash equivalents at end of period                                                                     |  | $                        | 725     |   |      | $ | 3,755   |      |  | $ | 4,327   |  
|                                                                                                               |  |                          |         |   |      |   |         |      |  |   |         |  
|Non-cash investing activities                                                                                  |  |                          |         |   |      |   |         |      |  |   |         |  
|Property exchanged for a note receivable                                                                       |  | $                        |        |   |      | $ |        |      |  | $ | 414     |  
|                                                                                                               |  |                          |         |   |      |   |         |      |  |   |         |  
|Property sold pursuant to a sale-leaseback transaction, recognized as a capital lease                          |  | $                        |        |   |      | $ |        |      |  | $ | 10,403  |  
|                                                                                                               |  |                          |         |   |      |   |         |      |  |   |         |  
|Property previously held under the operating lease-financing facility, financed by senior debt credit facility |  | $                        |        |   |      | $ |        |      |  | $ | 13,184  |  
|                                                                                                               |  |                          |         |   |      |   |         |      |  |   |         |  
|Equipment purchase financed by capital lease                                                                   |  | $                        | 1,320   |   |      | $ |        |      |  | $ |        |  
|                                                                                                               |  |                          |         |   |      |   |         |      |  |   |         |  
|Assets written off against restructuring reserve                                                               |  | $                        |        |   |      | $ |        |      |  | $ | 2,204   |  
|                                                                                                               |  |                          |         |   |      |   |         |      |  |   |         |  
|Supplemental disclosures of cash flows information:                                                            |  |                          |         |   |      |   |         |      |  |   |         |  
|Cash paid (refunded) during the period for:                                                                    |  |                          |         |   |      |   |         |      |  |   |         |  
|Interest                                                                                                       |  | $                        | 5,882   |   |      | $ | 2,120   |      |  | $ | 1,286   |  
|                                                                                                               |  |                          |         |   |      |   |         |      |  |   |         |  
|Income taxes                                                                                                   |  | $                        | 297     |   |      | $ | 103     |      |  | $ | (65     | )
|                                                                                                               |  |                          |         |   |      |   |         |      |  |   |         |  



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





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##### Table of Contents

CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)



NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES



Correctional Services Corporation and its subsidiaries (the Company) are organized to
privately operate and manage detention and correctional facilities as well as educational, developmental and rehabilitative programs for federal, state and local government agencies.



| | 1. | Principles of Consolidation
| | -- | ---------------------------



The consolidated financial statements as of December 31, 2004 include the accounts of Correctional Services Corporation, its wholly owned subsidiaries
(see below), and a variable interest entity: South Texas Detention Complex Local Development Corporation. Pursuant to FIN 46 (revised), the accounts of South Texas Detention Complex Local Development Corporation have been consolidated with the
accounts of Correctional Services Corporation and the following wholly owned subsidiaries in these financial statements. The following represents the subsidiaries of the company and the consolidated variable interest entity:



| |  |  | Esmor, Inc.
| | - |  | -----------

| |  |  | CSC Management de Puerto Rico, Inc.
| | - |  | -----------------------------------

| |  |  | Youth Services International Holdings, Inc.
| | - |  | -------------------------------------------

| |  |  | Youth Services International Real Property Partnership, LLP
| | - |  | -----------------------------------------------------------

| |  |  | FF & E, Inc.
| | - |  | ------------

| |  |  | Youth Services International, Inc.
| | - |  | ----------------------------------

| |  |  | Youth Services International of Iowa, Inc.
| | - |  | ------------------------------------------

| |  |  | Youth Services International of Northern Iowa, Inc.
| | - |  | ---------------------------------------------------

| |  |  | Youth Services International of South Dakota, Inc.
| | - |  | --------------------------------------------------

| |  |  | Youth Services International of Missouri, Inc.
| | - |  | ----------------------------------------------

| |  |  | Youth Services International of Central Iowa, Inc.
| | - |  | --------------------------------------------------

| |  |  | Youth Services International of Texas, Inc.
| | - |  | -------------------------------------------

| |  |  | Youth Services International of Illinois, Inc.
| | - |  | ----------------------------------------------

| |  |  | Youth Services International of Michigan, Inc.
| | - |  | ----------------------------------------------

| |  |  | CSC of Tacoma LLC
| | - |  | -----------------

| |  |  | South Texas Detention Complex Local Development Corporation (a variable interest entity)
| | - |  | ----------------------------------------------------------------------------------------



All significant intercompany balances and transactions have been eliminated.



| | 2. | Use of Estimates in Consolidated Financial Statements
| | -- | -----------------------------------------------------



In preparing consolidated financial statements in conformity with accounting principles generally accepted in the United States of America, 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.



| | 3. | New Accounting Pronouncements
| | -- | -----------------------------



In December 2004, the Financial Accounting Standards Board issued Statement 123 (revised 2004), Share-Based Payment (Statement 123(R)). Statement 123(R)
requires that the compensation cost relating to share-based payment transactions be recognized in financial statements. The cost will be measured based on the fair value of the instruments issued. Statement 123(R) covers a wide range of share-based
compensation arrangements including share options, restricted share plans, performance-based awards, share appreciation rights and employee share purchase plans. Statement 123(R) replaces statement 123, Accounting for Stock-Based Compensation and
supersedes Opinion 25, Accounting for Stock Issued to Employees. As originally issued in 1995, Statement 123 established as preferable the fair-value-based method of accounting for share based payment transactions with employees. However, that
Statement permitted entities the option of continuing to apply the guidance in Opinion 25 as long as the footnotes to the financial statements disclosed what net income would have been had the preferable fair-value-based method been used. The
Company will be required to apply Statement 123(R) as of the first interim reporting period that begins after June 15, 2005, and



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CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)



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



the Company plans on using the modified prospective method, effective July
1, 2005. The Company is currently evaluating the impact of Statement 123(R). An illustration of the impact on our net income and earning per share is presented in item 13 Stock Based Compensation of this section, assuming, the Company
elects to account for its employee stock compensation plans using the fair value based method of accounting defined in SFAS No. 123, using the Black-Scholes methodology. We have not yet determined whether we will use the Black-Scholes method in our
adoption of Statement 123(R).



In November 2004, the FASB
Emerging Issues Task Force (EITF) released Issue No. 03-13, Applying the Conditions in Paragraph 42 of FASB Statement No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, in Determining Whether to Report Discontinued
Operations. To qualify as a discontinued operation, paragraph 42 of Statement 144 requires that the cash flows of the disposed component be eliminated from the operations of the ongoing entity and that the ongoing entity not have any
significant continuing involvement in the operations of the disposed component after the disposal transaction. EITF 03-13 provides guidance on how to interpret and apply the criteria in paragraph 42A (elimination of cash flows) and paragraph 42B (no
significant continuing involvement) of Statement 144. EITF 03-13 is effective for all periods beginning after December 15, 2004. Previously reported operating results related to disposal transactions initiated within an enterprises fiscal year
that includes November 30, 2004 (date that the consensus was ratified) may be reclassified to reflect the consensus. The Company does not believe that the adoption of EITF 03-13 will have a significant effect on its financial statements.



| | 4. | Revenue Recognition and Contract Provisions
| | -- | -------------------------------------------



Facility management revenues are recognized as services are provided based on a net rate per day per inmate or on a fixed monthly rate. Revenues are
principally derived pursuant to contracts with federal, state and local government agencies. These contracts generally provide for fixed per diem payments based upon program occupancy. Contract terms with government entities generally range from one
to five years in duration and expire at various dates. Most of these contracts are subject to termination for convenience by the governmental entity. Certain contracts are renewable at the option of the customer for up to 20 years.



Certain revenues are accrued based on population levels or other pertinent
available data. Subsequent adjustments to revenue are recorded when actual levels are known. Included in accounts receivables at December 31, 2004 and 2003 is approximately $895,000 and $905,000, respectively, of unbilled receivables.



As of March 31, 2004, the Company ceased operation at one of the programs
which operated under a contract whereby revenues recognized as reimbursable costs are incurred through a gross maximum price cost reimbursement arrangement. This contract had costs, including indirect costs, subject to audit and adjustment by
negotiations with government representatives. Contract revenues subject to audit relating to this contract of approximately $3.9 million, $15.6 million, and $15.8 million have been recorded for the years ended December 31, 2004, 2003 and 2002,
respectively, at amounts which are considered to be earned. Subsequent adjustments, if any, resulting from the audit process are recorded when the Company concurs with the adjustments or the final adjustment amount can be reasonably estimated
(NOTE R  COMMITMENTS AND CONTINGENCIES).



The
Companys receivables are due principally from federal, state, and local government agencies. Payment terms vary based on the particular institutions. The Company performs periodic evaluations of the collectability of its receivables and does
not require collateral on its accounts receivable. The Company determines its allowance by considering a number of factors, including the length of time trade accounts receivable are past due, the Companys previous loss history, and the
customers current ability to pay its obligation to the Company. The Company writes-off accounts receivable when they become uncollectable.



Accounts receivables are presented net of an allowance for doubtful accounts of $946,000 and $617,000 at December 31, 2004 and 2003, respectively. The
Company recognized a provision for doubtful accounts of $512,000, $203,000, and $330,000 for the years ended December 31, 2004, 2003 and 2002, respectively. The Company evaluates the future profitability of its contracts when events suggest that the
contract may not be profitable over the remaining term of the contract. The Company measures the estimated future losses as the present value of the estimated net cash flows over the remainder of the contract from the time of measurement.



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CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)



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



| | 5. | Cash and Cash Equivalents
| | -- | -------------------------



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



Included in the current portion of restricted cash and cash equivalents at
December 31, 2004 is $8.7 million related to amounts payable on the construction of the South Texas Detention Complex, $1.8 million related to amounts payable on the note related to the Northwest Regional Detention Center, and approximately $405,000
in an escrow account set aside as collateral on the Companys facilities maintenance funds. At December 31, 2003 current restricted cash included approximately $400,000 in an escrow account, set aside as collateral on the Companys
facilities maintenance funds, and $4.1 million related to amounts payable on the construction of the Northwest Regional Detention Center. Included in long term cash equivalents and investments at December 31, 2004 is $27.6 million related to
amount payable on the construction and required debt service reserves of the South Texas Detention Complex, and $6.8 million related to the required debt service reserve on the note of the Northwest Regional Detention Center, and approximately
$400,000 in an escrow account set aside as collateral on the Companys loan payable. At December 31, 2003 long term restricted cash included $17.4 million related to the amount payable on the construction and the required debt service reserves
of the Northwest Regional Detention Center, and approximately $400,000 in an escrow accounts set aside as collateral on the Companys loan payable.



| | 6. | Property, Equipment and Leasehold Improvements
| | -- | ----------------------------------------------



Property, equipment and leasehold improvements are carried at cost. Depreciation of buildings is computed using the straight-line method over twenty and
thirty year periods. Depreciation of equipment is computed using the straight-line method over a five-year period. Leasehold improvements are amortized over the shorter of the life of the asset or the applicable lease term. Amortization of certain
improvements to managed facilities may exceed the term of the management contract, including renewal options based on managements estimate of expected contract renewals. For tax purposes accelerated methods of depreciation are utilized.
Repairs and maintenance costs are expensed as incurred.



| | 7. | Assets Held Under Capital Leases
| | -- | --------------------------------



Assets held under capital leases are recorded at the lower of the net present value of the minimum lease payments or the fair value of the leased asset at
the inception of the lease. Amortization expense is recognized using the straight-line method over the shorter of the estimated useful life of the asset or the term of the related lease.



| | 8. | Goodwill
| | -- | --------



Goodwill represents the cost in excess of the net assets of businesses acquired. Prior to January 1, 2002, goodwill was amortized into amortization
expense over 10 years using the straight-line method. Beginning January 1, 2002 the Company adopted the provisions of SFAS No. 142, Goodwill and Other Intangible Assets,and accordingly discontinued the amortization of goodwill. Based on the
Companys evaluations of goodwill in accordance with the provisions of SFAS No. 142, there is no impairment associated with goodwill as of January 1, 2002, or during the periods ended December 31, 2002, 2003 or 2004.



| | 9. | Accounting for the Impairment of Long-Lived Assets
| | -- | --------------------------------------------------



The Company reviews long-lived assets to be held and used or disposed of for impairment whenever events or changes in circumstances indicate that the
carrying amount of an asset may not be recoverable. The Company uses an estimate of the undiscounted cash flows over the remaining life of its long-lived assets in measuring whether the assets to be held and used will be realizable. An impairment
loss is recognized to the extent that the sum of discounted estimated future cash flows (using the Companys incremental borrowing rate over a period



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CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)



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



of less than 30 years) that is expected to result from the use of the asset
is less than the carrying value. Assets held for sale are recognized at the lower of their carrying value or fair market value less costs to sell, which ever is lower. During the year ended December 31, 2004, the Company recorded and included in
discontinued operations impairment charges of $2.9 million associated with the assets of its discontinued Tarkio, Missouri and Canadian, Texas facilities. Included in continuing operations is an impairment charge of $1.5 million associated with the
assets of its Colorado, Texas facility. No impairment of assets was recognized during 2003. The Company recognized an impairment of approximately $1.9 million during the year ended December 31, 2002.



| | 10. | Discontinued Operations
| | --- | -----------------------



In accordance with SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, the Company has recorded the results of operations
of components that have either been disposed of or are classified as held for sale under discontinued operations on the income statement. The Company defines components that have been disposed of as facilities not operating under a management
agreement where the Company has unilaterally terminated its various contracts with sending agencies or has otherwise ceased operations. In these disposal situations, the Company typically has a significant facility investment or on-going lease
obligation. In situations where management agreements with a principal agency are terminated in accordance with the contract provisions, whether or not subject to renewal or proposal, and the Company has no significant facility investment or
on-going financial obligation, the results of operations of these facilities continue to be recorded in continuing operations. In the event that a termination of a management agreement involves a significant penalty or where a significant asset is
owned or leased, discontinued operations may be reported based on managements assessment of the transaction (see NOTE N  DISCONTINUED OPERATIONS).



| | 11. | Income Taxes
| | --- | ------------



Deferred tax assets and liabilities are recognized as the difference between the book basis and tax basis of assets and liabilities. In providing for
allowances for deferred taxes, the Company considers current tax regulations, estimates of future taxable income and available tax planning strategies. If tax regulations, operating results or the ability to implement tax-planning strategies vary,
adjustments to the carrying value of deferred tax assets and liabilities may be required. To calculate the tax provision (benefit) the Company uses an estimated effective tax rate. This rate is based on the federal and state statutory rates as
adjusted by various non-deductible items, which may cause the income tax from continuing operations to vary from the statutory rate.



| | 12. | Earnings Per Share
| | --- | ------------------



Basic earnings per share is computed by dividing net income (loss) by the weighted-average number of common shares outstanding. In the computation of
diluted earnings per share, the weighted-average number of common shares outstanding is adjusted, when the effect is not anti-dilutive, for the effect of all common stock equivalents. The average quarterly share price for the period is used in all
cases when applying the treasury stock method to potentially dilutive outstanding options.



| | 13. | Stock Based Compensation
| | --- | ------------------------



The Company follows SFAS No. 123, which establishes a fair value based method of accounting for stock-based employee compensation plans; however, the
Company has elected to account for its employee stock compensation plans using the intrinsic value method under Accounting Principles Board Opinion No. 25 with pro forma disclosures of net earnings and earnings per share, as if the fair value based
method of accounting defined in SFAS No. 123 had been applied.



Had compensation cost for the Companys stock option plan been determined on the fair value at the grant dates for stock-based employee compensation arrangements consistent with the method required by SFAS No. 123, the Companys
net income (loss) and net income (loss) per common share would have been the pro forma amounts indicated below (in thousands, except for per share data) (see also NOTE T  STOCK OPTIONS):



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CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)



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



|                                                                                                                                    |  |                          |        |   |      |   |       |      |  |   |       |  
|----------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------ | ------ | - | ---- | - | ----- | ---- |  | - | ----- | -
|                                                                                                                                    |  | Years Ended December 31, |       
|                                                                                                                                    |  | 2004                     |        |   | 2003 |   |       | 2002 | 
|Net income (loss), as reported                                                                                                      |  | $                        | (3,248 | ) |      | $ | 1,334 |      |  | $ | 2,363 |  
|Deduct: Total stock-based compensation expense determined under fair value based methods for all awards, net of related tax
effects |  |                          | (82    | ) |      |   | (98   | )    |  |   | (212  | )
|                                                                                                                                    |  |                          |        |   |      |   |       |      |  |   |       |  
|Pro forma net income (loss)                                                                                                         |  | $                        | (3,330 | ) |      | $ | 1,236 |      |  | $ | 2,151 |  
|                                                                                                                                    |  |                          |        |   |      |   |       |      |  |   |       |  
|Basic and diluted income (loss) per common share                                                                                    |  |                          |        |   |      |   |       |      |  |   |       |  
|As reported                                                                                                                         |  | $                        | (0.33  | ) |      | $ | 0.12  |      |  | $ | 0.21  |  
|Pro forma                                                                                                                           |  | $                        | (0.33  | ) |      | $ | 0.12  |      |  | $ | 0.21  |  



| | 14. | Comprehensive Income
| | --- | --------------------



The Companys comprehensive income (loss) is equivalent to net income (loss) for the years ended December 31, 2004, 2003, and 2002.



| | 15. | Treasury Stock
| | --- | --------------



On October 20, 2000, the Company announced that its Board of Directors had authorized a share repurchase program of up to $10.0 million. The Company
repurchased no shares during the years ended December 31, 2004, 2003, or 2002. (see NOTE K  LOANS PAYABLE).



| | 16. | Legal Costs and Settlement Reserve
| | --- | ----------------------------------



The Company recognizes legal costs related to the defense or assertion of legal claims when the related services have been rendered. Legal costs that are
associated with specific facility operations are recognized in facility operating expenses. Other legal costs are recognized in general and administrative expense.



During 2004, the Company expensed $1.0 million for estimated current and future legal settlements compared to $1.6 million
accrued for during 2003. The legal settlement reserve balance is $1.5 million as of December 31, 2004 and December 31, 2003. (see NOTE Q  COMMITMENTS AND CONTINGENCIES)



| | 17. | Start Up Costs
| | --- | --------------



The Company incurs costs as it relates to the start up of new facilities. Such cost are principally comprised of expenses associated with the recruitment,
hiring and training of staff, travel of personnel, certain legal costs and other costs incurred after a contract has been awarded. The Company expenses start up costs as they are incurred. Start-up costs are usually incurred through the population
ramp up period, but generally within the first three full months of operations. Also, to the extent that other operating expenses exceed revenue during the ramp up period, they are recognized as start up expenses. This is due to the need to incur a
significant portion of the facilitys operating expenses while the facility is in the process of attaining full occupancy. The Company recorded start up costs of $3.3 million for year ended December 31, 2004, and $378,000 for year ended
December 31, 2003. No start up costs were recorded for year ended December 31, 2002.



| | 18. | Workers Compensation Insurance Reserves
| | --- | ----------------------------------------



The Company maintains insurance policies to indemnify the Company for excessive individual and aggregate workers compensation costs. However, these
policies include large individual and aggregate deductibles for which the Company is liable. As a result of workers compensation risks inherent in the Companys industry, the Company has incurred significant workers compensations
costs. The Company estimates its total liability on an undiscounted basis as the total probable ultimate outcome that will be incurred by the Company



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CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)



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



and paid to, or on behalf of, the claimant over its life expectancy. The
Company bases this estimate upon the advice of its insurer/third party administrator and upon its review of claimant file information maintained by its insurer/third party administrator. While the Company estimates claims reserves based on its
probable outcome, the Company has experienced changes in estimated claims during 2004 and 2003, resulting in workers compensation costs of approximately $1.2 million and $1.3 million that were not included in its estimated reserves prior to
the beginning of those periods. As a result of these changes in estimate and increasing costs in general, the Company has instituted additional safety and back to work programs that it believes will reduce its ultimate costs incurred. As of December
31, 2003 and 2004, the Company recognized $2.8 million for both years of workers compensation claims liabilities for claims not yet paid. Under its insurance contracts currently in place, the maximum amount of incurred but unpaid claims for
which the Company could be responsible amounts to $10.3 million as of December 31, 2004.



The Company uses input from its insurance carriers, insurance brokers, and third party administrators to develop, monitor, and improve its insurance programs and assess its insurance coverage and costs, safety,
incentive, and back to work type programs, and assist with its overall adequacy of the individual and aggregate claim reserves. In 2005, the Company anticipates that it would involve an independent actuary to further assist it, in its ongoing
assessment of the adequacy of its insurance coverage and review of its claim history for, among other things, trends, impacts of cost controlling measures, and the sufficiency of its insurance reserves. The results of the actuarys review,
among other things, could suggest that the Companys reserves require further refinement either an increase or a decrease to the reserve amounts, which would be reflected in 2005s results of operations as a change in estimate.



| | 19. | Loss Contracts
| | --- | --------------



The Company evaluates the future profitability of its contracts when events suggest that the contract may not be profitable over its remaining term. The
Company measures the estimated future losses at the present value of the estimated net cash flows over the remainder of the contract from the time of measurement, with consideration first given to asset impairments as discussed above. For 2004 and
2003, the Company did not recognize any loss contract costs. However, in December 2003 the Company recorded a loss contract recovery of $896,000, which represented an excess of reserve over actual costs, and is included in loss from discontinued
operations for 2003. No reserve remained at December 31, 2003.



| | 20. | Reclassifications
| | --- | -----------------



Certain amounts in the 2003 and 2002 consolidated financial statements and notes to the consolidated financial statements have been reclassified to
conform to the 2004 presentation, including the effects of discontinued operations.



NOTE B - FAIR VALUE OF FINANCIAL INSTRUMENTS



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 and Restricted Cash
|-- | ---------------------------------------------



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



|2. | Long Term Restricted Cash Equivalents and Investments
|-- | -----------------------------------------------------



The fair value of long term restricted cash equivalents and investments are estimated based on quoted market prices for these or similar investments.



|3. | Accounts and Notes Receivable, Accounts Payable and Accrued Expenses
|-- | --------------------------------------------------------------------



The carrying amount reasonably approximates fair value because of the short-term maturities of these items.



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CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)



NOTE B - FAIR VALUE OF FINANCIAL INSTRUMENTS (continued)



|4. | Subordinated Promissory Notes and Long-Term Debt
|-- | ------------------------------------------------



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



NOTE C - PREPAID
EXPENSES AND OTHER CURRENT ASSETS



Prepaid expenses and other current
assets consist of the following (in thousands):



|                                              |  |              |       |      |   |       |  
|--------------------------------------------- |  | ------------ | ----- | ---- | - | ----- | -
|                                              |  | December 31, |      
|                                              |  | 2004         |       | 2003 |  
|Prepaid insurance                             |  | $            | 688   |      | $ | 452   |  
|Prepaid real estate taxes                     |  |              | 53    |      |   | 70    |  
|Prepaid and refundable (payable) income taxes |  |              | 184   |      |   | (50   | )
|Prepaid rent  current portion                |  |              | 398   |      |   | 389   |  
|Prepaid expenses                              |  |              | 579   |      |   | 519   |  
|                                              |  |              |       |      |   |       |  
|Total prepaid expenses                        |  |              | 1,902 |      |   | 1,380 |  
|Short term investment                         |  |              | 235   |      |   | 181   |  
|Other                                         |  |              | 3     |      |   | 405   |  
|                                              |  |              |       |      |   |       |  
|                                              |  | $            | 2,140 |      | $ | 1,966 |  
|                                              |  |              |       |      |   |       |  



NOTE D - PROPERTY, EQUIPMENT AND
LEASEHOLD IMPROVEMENTS



Property, equipment and leasehold improvements, at
cost, consist of the following (in thousands):



|                                               |  |              |         |   |      |   |         |  
|---------------------------------------------- |  | ------------ | ------- | - | ---- | - | ------- | -
|                                               |  | December 31, |        
|                                               |  | 2004         |         |   | 2003 |  
|Buildings and land                             |  | $            | 59,385  |   |      | $ | 24,467  |  
|Construction in progress, excluding land       |  |              | 19,986  |   |      |   | 36,623  |  
|Equipment                                      |  |              | 12,471  |   |      |   | 7,942   |  
|Capital lease assets                           |  |              | 11,699  |   |      |   | 10,403  |  
|Leasehold improvements                         |  |              | 4,502   |   |      |   | 10,699  |  
|                                               |  |              |         |   |      |   |         |  
|                                               |  |              | 108,043 |   |      |   | 90,134  |  
|Less accumulated depreciation and amortization |  |              | (15,698 | ) |      |   | (18,993 | )
|                                               |  |              |         |   |      |   |         |  
|                                               |  | $            | 92,345  |   |      | $ | 71,141  |  
|                                               |  |              |         |   |      |   |         |  



Depreciation expense for the years
ended December 31, 2004, 2003, and 2002 was approximately $3.0 million, $2.3 million, and $3.0 million, respectively. Amortization expense for the years ended December 31, 2004 and 2003 was $742,000 and $554,000, respectively. There was no
amortization expense in 2002.



During December 2002, the Company sold its
Florence, Arizona facility to an unrelated not-for-profit entity for approximately $10.4 million. The Company leased back the property under an agreement that is classified as a capital lease and recognized capital lease assets of $10.4 million. The
capital lease assets are amortized over the 20-year lease period. Accumulated amortization of the capital lease assets as of December 31, 2004 and 2003 was $1.3 million and $554,000, respectively.



During the twelve months ended December 31, 2004, the Company incurred interest costs of
approximately $5.7 million, of which the Company capitalized approximately $1.1 million included in property, equipment, and construction in progress, associated with the construction of the Northwest Regional Detention Center, and South Texas
Detention Complex.



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CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)



NOTE E  PROPERTY HELD FOR SALE



The Company has idle property currently being marketed for sale consisting of the following (in thousands):



|                              |  |              |       |   |      |   |       |  
|----------------------------- |  | ------------ | ----- | - | ---- | - | ----- | -
|                              |  | December 31, |      
|                              |  | 2004         |       |   | 2003 |  
|Land and buildings            |  | $            | 6,947 |   |      | $ | 7,228 |  
|Equipment                     |  |              | 230   |   |      |   | 230   |  
|                              |  |              |       |   |      |   |       |  
|                              |  |              | 7,177 |   |      |   | 7,458 |  
|Less accumulated depreciation |  |              | (507  | ) |      |   | (507  | )
|                              |  |              |       |   |      |   |       |  
|                              |  | $            | 6,670 |   |      | $ | 6,951 |  
|                              |  |              |       |   |      |   |       |  



Approximately $738,000 of the balance
at December 31, 2004 relates to property purchased for development, where those plans have been abandoned, and approximately $5.9 million relates to the building and assets associated with a program formerly operated by the Company, where operations
were discontinued effective October 2003.



NOTE F  DEFERRED LOAN COSTS



Deferred loan costs at December 31, 2004 consists of $314,000 of costs
associated with the Companys Credit Agreement (see NOTE K  LOANS PAYABLE), net of amortization of $755,000; $5.1 million of issuance costs associated with the financing of the construction of the Northwest Regional Detention Center, net
of amortization of $1.4 million; and $5.8 million of issuance costs associated with the financing of the construction of the South Texas Detention Complex, net of amortization of $223,000. (See NOTE I  RESTRICTED AND CASH NOTE PAYABLE)
Amortization of deferred loan costs associated with the Companys Credit Agreement is included in interest expense. Amortization of deferred loan costs associated with the Northwest Regional Detention Center, and South Texas Detention Complex
projects are amortized using the effective interest method and are considered in the weighted average interest rate used to capitalize interest on qualified expenditures. Amortization of deferred loan costs are included in interest expense.



NOTE G - OTHER ASSETS



Other assets consist of the following (in thousands):



|                                      |  |              |       |      |   |      
|------------------------------------- |  | ------------ | ----- | ---- | - | -----
|                                      |  | December 31,
|                                      |  | 2004         |       | 2003
|Deposits                              |  | $            | 752   |      | $ | 400  
|Prepaid rent  net of current portion |  |              | 2,281 |      |   | 2,537
|                                      |  |              |       |      |   |      
|                                      |  | $            | 3,033 |      | $ | 2,937
|                                      |  |              |       |      |   |      



NOTE H - ACCRUED LIABILITIES



Accrued liabilities consist of the following (in thousands):



|                                                  |  |              |        |      |   |       
|------------------------------------------------- |  | ------------ | ------ | ---- | - | ------
|                                                  |  | December 31,
|                                                  |  | 2004         |        | 2003
|Accrued expenses                                  |  | $            | 4,162  |      | $ | 4,291 
|Accrued construction payable                      |  |              | 7,794  |      |   | 3,640 
|Accrued interest                                  |  |              | 1,098  |      |   | 482   
|Accrued medical claims and premiums               |  |              | 894    |      |   | 1,079 
|Accrued workers compensation claims and premiums |  |              | 2,960  |      |   | 3,147 
|Accrued payroll                                   |  |              | 4,142  |      |   | 3,883 
|Other                                             |  |              | 3,532  |      |   | 2,419 
|                                                  |  |              |        |      |   |       
|                                                  |  | $            | 24,582 |      | $ | 18,941
|                                                  |  |              |        |      |   |       



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CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)



NOTE I  RESTRICTED CASH EQUIVALENTS AND INVESTMENTS, AND BOND AND NOTE PAYABLE



At December 31, 2004, the Company had $10.9 million in current restricted cash and cash
equivalents and $34.8 million in long-term restricted cash equivalents and investments. The balances in those accounts are attributable primarily to amounts held in escrow or in trust on that date in connection with financing arranged by the Company
for the 1,020-bed South Texas Detention Complex that the Company is currently developing in Frio County, Texas and the 890-bed Northwest Detention Center in Tacoma, Washington, which the Company completed and opened for operation in April 2004.



South Texas Detention Complex:



On January 26, 2004, the Department of Homeland Security, Immigration and Customs
Enforcement (ICE) awarded the Company a contract to provide housing for up to 1,020 detainees in a facility to be located in Frio County, Texas, (Frio County). In furtherance of that contract, the Company entered into an
agreement with Frio County, whereby Frio County created a non-profit, local development corporation pursuant to Chapter 431 Texas Transportation Code. This corporation, South Texas Detention Complex Local Development Corporation (the
Development Corporation), on September 22, 2004 issued $49.4 million of taxable revenue bonds, net of a $88,000 discount, to finance the construction of the 1,020-bed detention facility (the South Texas Detention Complex) in
Frio County. The bonds are non-recourse to the Company. The Company is currently developing the South Texas Detention Complex for the Development Corporation. The Development Corporation, as the owner of the South Texas Detention Complex
simultaneously entered into an operating agreement with the Company, giving the Company the sole and exclusive right to use, occupy, operate and manage the South Texas Detention Complex for a period of 20 years. The Development Corporation also
granted the Company an option to purchase the South Texas Detention Complex for $1.00 upon the bonds being paid in full. The Company has a variable interest in the Development Corporation and it has been consolidated with the accounts of the
Company. The proceeds of the bonds, net of the discount, were disbursed into escrow accounts held in trust at the closing as follows:



|                                |  |   |       
|------------------------------- |  | - | ------
|Issuance cost fund              |  | $ | 6,154 
|Project fund                    |  |   | 35,406
|Debt service and other reserves |  |   | 7,825 
|                                |  |   |       
|                                |  | $ | 49,385
|                                |  |   |       



The proceeds of the bonds in the
project fund are being used to construct and equip the South Texas Detention Complex. The total construction costs of the project are expected to be $39.3 million, including $3.9 million, which was funded by the Company in current and prior periods.
The Company is required by the bond indenture to fund an additional $1.1 million when the facility is complete. Issuance costs of $5.9 million at December 31, 2004, which are classified as deferred loan costs, are being amortized using the effective
interest method over the term of the Bonds. Construction on the facility is expected to be complete by early 2005. The bonds are secured by the facility and payments will be made primarily from the revenues of the ICE contract, which will be used to
make the debt service payments on the bonds. The carrying value of the facility at December 31, 2004 is $19.8 million. The effective interest rate on the bonds, including the amortization of the discount and issuance costs, is approximately 6.8% and
the bonds mature in February 2016.



Included in non-current restricted cash
equivalents and investments as of December 31, 2004 are funds held in trust with respect to the South Texas Detention Complex as follows:



|                                |  |   |       
|------------------------------- |  | - | ------
|Project fund                    |  | $ | 20,287
|Debt service and other reserves |  |   | 7,332 
|                                |  |   |       
|                                |  | $ | 27,619
|                                |  |   |       



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##### Table of Contents

CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)



NOTE I  RESTRICTED CASH EQUIVALENTS AND INVESTMENTS, AND BOND AND NOTE PAYABLE (continued)



Following are the annual maturities of the bonds payable:



|              |  |   |        |  
|------------- |  | - | ------ | -
|2005          |  | $ |       |  
|2006          |  |   |       |  
|2007          |  |   | 4,130  |  
|2008          |  |   | 4,260  |  
|2009          |  |   | 4,405  |  
|Thereafter    |  |   | 36,680 |  
|              |  |   |        |  
|Total         |  |   | 49,475 |  
|Less Discount |  |   | (87    | )
|              |  |   |        |  
|              |  | $ | 49,388 |  
|              |  |   |        |  



Northwest Regional Detention Center



On June 30, 2003 the company arranged financing for the construction of
the Northwest Regional Detention Center in Tacoma, Washington (the Northwest Regional Detention Center), which the Company completed and opened for operation in April 2004. In connection with this financing, CSC of Tacoma LLC, a wholly
owned subsidiary of the Company, issued a $57.2 million note payable, net of a $175,000 discount, to the Washington Economic Development Finance Authority (WEDFA), an instrumentality of the State of Washington, which issued revenue bonds
and subsequently loaned the proceeds of the bond issuance to CSC of Tacoma LLC for the purposes of constructing the Northwest Regional Detention Center. The bonds are non-recourse to the Company and the loan from WEDFA to CSC of Tacoma, LLC is
non-recourse to the Company. The proceeds of the loan were disbursed into escrow accounts held in trust to be used to pay the issuance costs for the revenue bonds, to construct the Northwest Regional Detention Center and to establish debt service
and other reserves. At December 31, 2004, $1.8 million of the proceeds is included in current restricted cash and $6.9 million of the proceeds is included in non-current restricted cash.



Included in non-current restricted cash equivalents and investments is $6.8 million as of December 31, 2004 as funds held in trust with
respect to the Northwest Regional Detention Center for debt service and other reserves.



Following are the annual maturities of the note payable (in thousands):



|              |  |   |        |  
|------------- |  | - | ------ | -
|2005          |  |   | 4,705  |  
|2006          |  |   | 4,905  |  
|2007          |  |   | 5,130  |  
|2008          |  |   | 5,390  |  
|2009          |  |   | 5,680  |  
|Thereafter    |  |   | 31,605 |  
|              |  |   |        |  
|Total         |  |   | 57,415 |  
|Less Discount |  |   | (136   | )
|              |  |   |        |  
|              |  | $ | 57,279 |  
|              |  |   |        |  



The non-current restricted cash as of
December 31, 2004 with respect to both facilities are as follows:



|                                |  |   |       
|------------------------------- |  | - | ------
|Construction fund reserve       |  | $ | 20,287
|Debt service and other reserves |  |   | 14,156
|                                |  |   |       
|                                |  | $ | 34,443
|                                |  |   |       



NOTE J  LONG-LIVED ASSET
IMPAIRMENTS



During the year ended December 31, 2004, the Company approved
plans to discontinue operations at its Canadian, Texas, and its Tarkio, Missouri, facilities. (see NOTE N  DISCONTINUED OPERATIONS) As part of discontinued operations, the Company recognized an impairment of $2.9 million on the net
assets associated with these facilities. The Company also recorded an impairment of $1.5 million for the assets of its Colorado County facility in Texas. The impairment charge and results of operations for this facility are included in continuing
operations. The Company incurred no impairment charge for the year ended December 31, 2003, but did recognize an impairment of $1.9 million



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##### Table of Contents

CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)



NOTE J  LONG-LIVED ASSET IMPAIRMENTS (continued)



associated with the assets of the Keweenaw, Michigan facility during the year ended December
31, 2002. The Company also discontinued the operations at its Newport News, Virginia facility during year ended December 2003, however, this facilitys assets are currently being marketed for sale, and the Company does not anticipate a loss on
the future sale. The assets have a book value of $5.9 million and are classified under assets held for sale. Following are the impairment charges included in discontinued operations by facility (in thousands).



|               |  |                           |       |      |   |      |  |   |      
|-------------- |  | ------------------------- | ----- | ---- | - | ---- |  | - | -----
|               |  | Years ending December 31,
|               |  | 2004                      |       | 2003 |   | 2002
|Canadian       |  | $                         | 1,393 |      | $ |     |  | $ |     
|Tarkio Academy |  |                           | 1,463 |      |   |     |  |   |     
|Keweenaw       |  |                           |      |      |   |     |  |   | 1,926
|               |  |                           |       |      |   |      |  |   |      
|               |  | $                         | 2,856 |      | $ |     |  | $ | 1,926
|               |  |                           |       |      |   |      |  |   |      



NOTE K  LOANS PAYABLE



Loans payable consists of the following (in thousands):



|                                                                                                                                                                                                                              |  |              |     |   |      |   |     |  
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------ | --- | - | ---- | - | --- | -
|                                                                                                                                                                                                                              |  | December 31, |    
|                                                                                                                                                                                                                              |  | 2004         |     |   | 2003 |  
|Revolving line of credit maturing September 25, 2005. Interest payable at LIBOR plus 4.00% or prime plus 2.00% and is payable monthly.                                                                                        |  |              |    |   |      |   |    |  
|Note payable due in semi-annual installments of $17,083, which includes principal plus interest at 10% per annum, due in full October 2006, collateralized by restricted cash in the amount of
$399,000 at December 31, 2003. |  |              | 305 |   |      |   | 309 |  
|                                                                                                                                                                                                                              |  |              |     |   |      |   |     |  
|                                                                                                                                                                                                                              |  |              | 305 |   |      |   | 309 |  
|Less current portion                                                                                                                                                                                                          |  |              | (3  | ) |      |   | (4  | )
|                                                                                                                                                                                                                              |  |              |     |   |      |   |     |  
|                                                                                                                                                                                                                              |  | $            | 302 |   |      | $ | 305 |  
|                                                                                                                                                                                                                              |  |              |     |   |      |   |     |  



In October 2002, the Company entered
into a new long-term financing agreement with GE Capital (Credit Agreement), which has been amended various times since inception. The Credit Agreement is subject to compliance with various financial covenants based on a minimum net
worth, minimum monthly cash flow requirements, EBITDA requirements, and borrowing base criteria. The Company is in compliance with, or received waivers for, all covenants as of December 31, 2004. Additionally, the Credit Agreement prohibits the
payment of any dividends. In association with the Credit Agreement, the Company incurred $995,000 in loan fees, which are being amortized as interest expense over the term of the Credit Agreement. The Credit Agreement is secured by all of the assets
of the Company, except real property, and consists of a $19 million revolving line of credit accrues interest at the lesser of LIBOR plus 4.0%, or prime plus 2.0%. The Company also incurs a monthly fee based on 0.5% of its unused line of credit,
with an annual fee of $75,000. The line of credit is used primarily to fund the working capital requirements of the Company. As of December 31, 2004, there is no outstanding balance under this revolving line of credit and approximately $7.0 million
in borrowing availability. The credit agreement matures on September 25, 2005. The Company expects to enter into a new long-term financing agreement under similar terms and conditions; however, there can be no assurances that the Company will be
successful in obtaining this new agreement.



NOTE L  CAPITAL LEASE
OBLIGATION AND DEFERRED GAIN



In December 2002, the Company sold its
Florence, Arizona facility to an unrelated not-for-profit entity for approximately $10.4 million. The Company leases back the property under a non-recourse agreement that is classified as a capital lease, with a term of twenty years. The $692,000
gain on the sale is being deferred and recognized ratably over the life of the lease, and is included in other long-term liabilities in the financial statements. Under the sale-leaseback transaction discussed above, the underlying financing was
provided by a municipal bond issuance with the proceeds loaned to the not-for-profit entity. As a result, cash otherwise due to the Company under its contract with the



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##### Table of Contents

CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)



NOTE L  CAPITAL LEASE OBLIGATION AND DEFERRED GAIN (continued)



state is first used to pay bond debt service and other costs. Therefore, while the Company
recognizes revenue for the full amount under its contract, a portion of the associated cash is not received by the Company and is treated as a reduction in its capital lease obligation and interest expense.



The Company also recorded a capital lease of $1.3 million, during 2004, related to business
copier equipment.



Future minimum capital lease payments are as follows (in
thousands):



|                              |  |   |        |  
|----------------------------- |  | - | ------ | -
|Years ending December 31,     |  |   |       
|2005                          |  |   | 1,394  |  
|2006                          |  |   | 1,391  |  
|2007                          |  |   | 1,392  |  
|2008                          |  |   | 1,392  |  
|2009                          |  |   | 1,140  |  
|Thereafter                    |  |   | 13,725 |  
|                              |  |   |        |  
|Total lease payments          |  |   | 20,434 |  
|Less imputed interest at 7.9% |  |   | (9,336 | )
|                              |  |   |        |  
|                              |  |   | 11,098 |  
|Less current portion          |  |   | (500   | )
|                              |  |   |        |  
|                              |  | $ | 10,598 |  
|                              |  |   |        |  



NOTE M - OTHER LONG TERM
OBLIGATIONS



On July 31, 2002, the Company entered into a transaction with
an unrelated not-for-profit entity with respect to the Companys Phoenix, Arizona facility and received approximately $8.5 million from the issuance of tax-exempt contract revenue bonds, issued by the Industrial Development Authority of
Maricopa County, Arizona. The bondholders have a security interest in the facility. The bonds will be paid exclusively from revenue generated by the facility, and are non-recourse to the Company. The Company used the proceeds to reduce the balance
of its revolving line of credit facility. In conjunction with the transaction, the State of Arizona has an option to purchase the facility for an initial purchase price of $8.5 million. The States option price will decline over time. In the
event that the State exercises its option, there may be a shortfall between the proceeds of the sale and the funds needed to redeem the bonds. The Company has provided to the bondholders a letter of credit, secured by a certificate of deposit, which
would be utilized to fund the aforementioned shortfall, if any. The letter of credit has an initial balance of $1.4 million and decreases over time as the calculated difference between the sale proceeds that would be due from the State and the
unpaid principal balance of the bonds narrows. After 2010, the sale proceeds from the State would be sufficient to satisfy the redemption requirement. The Company will continue to operate the facility under a management agreement through 2012,
subject to two five-year renewal options, exercisable by the State. Due to the Companys continuing involvement in the operation of the facility, and its partial guarantee of the redemption proceeds by virtue of the letter of credit, the
Company has not recorded the transaction as a sale in accordance with SFAS No. 66, Accounting for Sales of Real Estate and SFAS No. 98 Accounting for Leases. On the date of the transaction, the book value of the facility in the amount
of $8.7 million and accumulated depreciation of $2.1 million continued to be reflected in the Companys financial statements. The Company has also recorded a long-term obligation initially equal to the net proceeds from the transaction in the
amount of $8.4 million. Upon the earliest occurrence of either 1) the State exercising its purchase option, 2) the expiration or termination of the Companys management agreement with the State or 3) when conditions exist such that the
transaction is deemed to have been a sale in accordance with the generally accepted accounting principles, as discussed above, the sales transaction will be reflected in the financial statements and a gain of approximately $1.9 million will be
recorded.



During December 2002, the Company sold its Florence, Arizona
facility to an unrelated not for profit entity for approximately $10.4 million, as discussed above. The Company leases back the property under a non recourse agreement that is classified as a capital lease, with a term of twenty years (see NOTE L
 CAPITAL LEASE OBLIGATION AND DEFERRED GAIN). The $692,000 gain on the sale is being deferred and recognized ratably over the life of the lease, and is included in other long-term liabilities in the financial statements.



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##### Table of Contents

CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)



NOTE M - OTHER LONG TERM OBLIGATIONS (continued)



At December 31, 2004 aggregate maturities of other long-term obligations are as follows (in
thousands):



|                          |  |   |       |  
|------------------------- |  | - | ----- | -
|Years ending December 31, |  |   |      
|2005                      |  |   | 303   |  
|2006                      |  |   | 324   |  
|2007                      |  |   | 346   |  
|2008                      |  |   | 370   |  
|2009                      |  |   | 397   |  
|Thereafter                |  |   | 6,668 |  
|                          |  |   |       |  
|Total                     |  |   | 8,408 |  
|Less current portion      |  |   | (313  | )
|                          |  |   |       |  
|Total                     |  | $ | 8,095 |  
|                          |  |   |       |  



NOTE N  DISCONTINUED
OPERATIONS



During the year ended December 31, 2004 the Company
discontinued its operations at its Canadian, Texas, and Tarkio, Missouri facilities. During the year ended December 31, 2003, the Company discontinued operations at its Newport News, Virginia and Keweenaw, Michigan facilities. The Company has
disclosed the results of operations of these facilities under discontinued operations for the years ended December 31, 2004, 2003, and 2002. These facilities also had assets that were impaired. Also, see NOTE J  RESTRUCTURING, IMPAIRMENT AND
LOSS CONTRACT RESERVES.



Following is the revenue, impairment, and pre-tax loss
included in discontinued operations:



|                       |  |                           |        |   |      |   |        |      |  |   |        |  
|---------------------- |  | ------------------------- | ------ | - | ---- | - | ------ | ---- |  | - | ------ | -
|                       |  | Years ending December 31, |       
|                       |  | 2004                      |        |   | 2003 |   |        | 2002 | 
|Revenue:               |  |                           |        |   |      |   |        |      |  |   |        |  
|Canadian               |  | $                         | 860    |   |      | $ | 2,441  |      |  | $ | 2,265  |  
|Tarkio                 |  |                           | 3,201  |   |      |   | 6,787  |      |  |   | 7,799  |  
|Keweenaw               |  |                           | 76     |   |      |   | 2,249  |      |  |   | 2,334  |  
|Newport News           |  |                           |       |   |      |   | 2,248  |      |  |   | 3,508  |  
|                       |  |                           |        |   |      |   |        |      |  |   |        |  
|                       |  | $                         | 4,137  |   |      | $ | 13,725 |      |  | $ | 15,906 |  
|                       |  |                           |        |   |      |   |        |      |  |   |        |  
|                       | 
|                       |  | Years ending December 31, |       
|                       |  | 2004                      |        |   | 2003 |   |        | 2002 | 
|Asset impairment:      |  |                           |        |   |      |   |        |      |  |   |        |  
|Canadian               |  | $                         | 1,393  |   |      | $ |       |      |  | $ |       |  
|Tarkio                 |  |                           | 1,463  |   |      |   |       |      |  |   |       |  
|Keweenaw               |  |                           |       |   |      |   |       |      |  |   | 1,926  |  
|                       |  |                           |        |   |      |   |        |      |  |   |        |  
|                       |  | $                         | 2,856  |   |      | $ |       |      |  | $ | 1,926  |  
|                       |  |                           |        |   |      |   |        |      |  |   |        |  
|                       | 
|                       |  | Years ending December 31, |       
|                       |  | 2004                      |        |   | 2003 |   |        | 2002 | 
|Pre-tax income (loss): |  |                           |        |   |      |   |        |      |  |   |        |  
|Canadian               |  | $                         | (1,987 | ) |      | $ | 116    |      |  | $ | (112   | )
|Tarkio                 |  |                           | (2,376 | ) |      |   | 290    |      |  |   | 682    |  
|Keweenaw               |  |                           | (357   | ) |      |   | 740    |      |  |   | (3,974 | )
|Newport News           |  |                           | (447   | ) |      |   | (936   | )    |  |   | (90    | )
|                       |  |                           |        |   |      |   |        |      |  |   |        |  
|                       |  | $                         | (5,167 | ) |      | $ | 210    |      |  | $ | (3,494 | )
|                       |  |                           |        |   |      |   |        |      |  |   |        |  



NOTE O - RENTAL AGREEMENTS



The Company has operating leases for certain facilities and certain
machinery and equipment which expire at various dates. Substantially all the facility leases provide for payment by the Company of all property taxes and insurance.



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CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)



NOTE O - RENTAL AGREEMENTS (continued)



Future minimum rental commitments under both cancelable and non-cancelable leases as of December 31, 2004 are as follows (in thousands):



|                         |  |       |        |                  |   |      
|------------------------ |  | ----- | ------ | ---------------- | - | -----
|Year ending December 31, |  | Total |        | RelatedCompanies
|2005                     |  | $     | 2,871  |                  | $ | 780  
|2006                     |  |       | 2,635  |                  |   | 780  
|2007                     |  |       | 2,064  |                  |   | 780  
|2008                     |  |       | 1,876  |                  |   | 780  
|2009                     |  |       | 1,675  |                  |   | 780  
|Thereafter               |  |       | 2,355  |                  |   |     
|                         |  |       |        |                  |   |      
|                         |  | $     | 13,476 |                  | $ | 3,900
|                         |  |       |        |                  |   |      



The Company leases a facility from a
related party. The President, director, and a stockholder of the Company own less than 55% of the related party. The lease commenced January 1, 1994 and expires December 31, 2008. The Company has a five-year renewal option, beginning January 1,
2009. In addition to the base rent, the Company pays taxes, insurance, repairs and maintenance on this facility. The Company paid $780,000 in rent payments for the year ended December 31, 2004, and $480,000 for years 2003 and 2002.



Rental expense of operating leases and machinery and equipment for the years ended December
31, 2004, 2003, and 2002, aggregated $3.9 million, $3.6 million, and $5.1 million, respectively.



NOTE P - INCOME TAXES



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



|                          |  |                          |        |   |      |   |       |      |  |   |      |  
|------------------------- |  | ------------------------ | ------ | - | ---- | - | ----- | ---- |  | - | ---- | -
|                          |  | Years Ended December 31, |       
|                          |  | 2004                     |        |   | 2003 |   |       | 2002 | 
|Current:                  |  |                          |        |   |      |   |       |      |  |   |      |  
|Federal                   |  | $                        |       |   |      | $ |      |      |  | $ |     |  
|State and local           |  |                          | 48     |   |      |   | (42   | )    |  |   | 191  |  
|Deferred:                 |  |                          |        |   |      |   |       |      |  |   |      |  
|Federal, state, and local |  |                          | (1,683 | ) |      |   | 1,332 |      |  |   | (468 | )
|                          |  |                          |        |   |      |   |       |      |  |   |      |  
|                          |  | $                        | (1,635 | ) |      | $ | 1,290 |      |  | $ | (277 | )
|                          |  |                          |        |   |      |   |       |      |  |   |      |  



The current provision in 2004 and 2002
is included in continuing operations. The current benefit in 2003 is included in discontinued operations.



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



|                                        |  |                          |   |  |      |   |  |       |   
|--------------------------------------- |  | ------------------------ | - |  | ---- | - |  | ----- | --
|                                        |  | Years Ended December 31, |  
|                                        |  | 2004                     |   |  | 2003 |   |  | 2002  |   
|Statutory federal rate                  |  | 34.0                     | % |  | 34.0 | % |  | 34.0  | % 
|State taxes, net of federal tax benefit |  | 3.8                      |   |  | 6.5  |   |  | 5.6   |   
|Non-deductible items                    |  | (2.7                     | ) |  | 9.7  |   |  | 4.9   |   
|Valuation allowance and reconciliation  |  |                         |   |  | (1.1 | ) |  | (53.5 | ) 
|Other                                   |  | (1.6                     | ) |  | 0.1  |   |  | (4.3  | ) 
|                                        |  |                          |   |  |      |   |  |       |   
|                                        |  | 33.5                     | % |  | 49.2 | % |  | (13.3 | )%
|                                        |  |                          |   |  |      |   |  |       |   



At December 31, 2004, the Company had
net operating loss carryforwards of approximately $13.2 million, $39.4 million and $5.7 million for federal, state, and foreign income tax purposes, respectively, that expire in periods beginning in 2007 through 2022. At December 31, 2004, the
Company also had an Alternative Minimum Tax (AMT) credit of approximately $432,000, which does not expire.



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##### Table of Contents

CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)



NOTE P - INCOME TAXES (continued)



A portion of the net operating loss carryforwards are subject to IRS Section 382 limitations and other limitations, which limit the
utilization of the federal and state net operating loss carryforwards in any given year. Realization of the portion of the deferred tax asset resulting from the Companys net operating loss carryforward in certain states is not considered more
likely than not. Accordingly, a valuation allowance has been established for the full amount of those deferred tax assets. The Company, after considering its pattern of profitability, its taxable income during the previous three years, and its
anticipated future taxable income forecasted in the next five years, believes it is more likely than not that the remaining deferred tax assets will be realized.



During December 2002, the Company recognized a $1.4 million decrease in its deferred tax asset valuation allowance principally associated
with the expected exiting of Puerto Rico operations and related tax attributes of intercompany loans and investments. 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 (in thousands):



|                                 |  |              |        |   |      |   |        |  
|-------------------------------- |  | ------------ | ------ | - | ---- | - | ------ | -
|                                 |  | December 31, |       
|                                 |  | 2004         |        |   | 2003 |  
|Restructuring and impairment     |  | $            | 665    |   |      | $ | 1,097  |  
|Vacation accrual                 |  |              | 283    |   |      |   | 438    |  
|Accrued expenses                 |  |              | 2,485  |   |      |   | 2,226  |  
|Basis difference of fixed assets |  |              | 457    |   |      |   | 1,278  |  
|Net operating loss carryforwards |  |              | 8,191  |   |      |   | 5,270  |  
|Alternative minimum tax credit   |  |              | 432    |   |      |   | 414    |  
|Other                            |  |              | 1,013  |   |      |   | 1,120  |  
|                                 |  |              |        |   |      |   |        |  
|                                 |  |              | 13,526 |   |      |   | 11,843 |  
|Valuation allowance              |  |              | (2,045 | ) |      |   | (2,045 | )
|                                 |  |              |        |   |      |   |        |  
|                                 |  | $            | 11,481 |   |      | $ | 9,798  |  
|                                 |  |              |        |   |      |   |        |  



The current portion of net deferred
tax assets at December 31, 2004 and 2003 of $2.9 million and $2.2 million respectively, represent the amount expected to be realized during the following 12 months.



NOTE Q  COMMITMENTS AND CONTINGENCIES



|1. | Legal Matters
|-- | -------------



The nature of the Companys business results in numerous claims against the Company for damages allegedly arising from the conduct of its employees
and others. The Company believes that most of these claims and suits lack legal merit and/or that the Company has meritorious defenses to the claims, and vigorously defends against these types of actions. The Company also has procured liability
insurance to protect the Company against most of the types of claims that reasonably could be expected to be asserted against the Company based upon the Companys past experience and an assessment of the risks of the Companys business,
including workers compensation, employment-related, negligence and other types of tort and civil rights claims and suits.



The Company believes, based upon the Companys past experience, that, except as noted below, the insurance coverage maintained by the Company for the
claims and suits currently pending against the Company or which reasonably can be expected to be asserted against the Company, should be adequate to protect the Company from any material exposure in any given matter, even if the outcome of the
matter is unfavorable to the Company. However, the dollar amount of certain of the claims currently pending against the Company exceed the amount of insurance coverage available to the Company, and, therefore, if the Company is unsuccessful in
defending against such claims, the insurance coverage available to the Company may not be sufficient to satisfy those claims, and such a result could have a material adverse effect on the Companys results of operations, financial condition and
liquidity. In addition, if all, or a substantial number of, the claims and suits currently pending against the Company are resolved unfavorably to the Company, the insurance coverage available to the Company may not be sufficient to satisfy all such
claims, and such a result could have a material adverse effect on the Companys results of operations, financial condition and liquidity. Notwithstanding the foregoing, however, the Company currently believes that no material adverse effect on
its financial condition, liquidity or results of operations will result from the outcome of any of the claims and suits currently pending against the Company.



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CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)



| | 1. | Alexander, Rickey, et al. v. Correctional Services Corporation, Unidentified CSC Employees, Knyvette Reyes, R.N., Dr. Samuel Lee, D.O., & Tony Schaffer, Esq., in the 236thJudicial District Court, Tarrant County, Cause No. 236-187481-01.
| | -- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



In September, 2003, following a trial related to the death of a trainee in
the boot camp program at the Tarrant County Community Correctional Center, which was being operated by the Company at the time of the trainees death, a Tarrant County, Texas trial court entered a judgment against the Company for a total of
$37.5 million in compensatory damages and $750,000 in punitive damages. The Company has filed a notice of appeal in this case, notifying the trial court of its intention to appeal the judgment to the Second Court of Appeals of Texas. The Company had
originally expected to file its initial brief in this appeal during the first half of 2004; however, due to delays attributable solely to the failure of the court reporter to file certified copies of the transcript from the trial with the appellate
court, the Company was unable to prepare and file its initial brief for the appeal at that time. In addition, in November, 2004, the co-defendant in this case, Knyvette Reyes, who was employed by the Company as a nurse at the facility, filed a
petition for personal bankruptcy, which placed an automatic stay on all further proceedings in this case. Accordingly, the Company has been unable to file its brief in support of its appeal. In light of this development, the Company is currently
evaluating the options available to it in order to pursue its appeal notwithstanding the bankruptcy filing by the co-defendant. Accordingly, at this time, it is not possible to provide any estimate as to when this matter will be resolved and when
the Second Court of Appeals will hear the Companys appeal. Nevertheless, based upon the advice of defense counsel, the Company believes that there is substantial likelihood that, on appeal, the Company will obtain relief from the judgment
entered against it by the trial court.



In the meantime, on or
about December 28, 2003, the Companys general liability insurance carrier posted with the trial court bonds in the aggregate amount of $25 million in order to secure the judgment pending the outcome of the Companys appeal. (Although the
judgment in this case exceeds $25 million, Texas law required that only $25 million in bonds be posted in this case in order to secure the judgment.) Consequently, the plaintiffs are precluded by Texas law from executing upon the judgment pending
the outcome of the appeal.



The primary general and excess
liability insurance policies of the Company in effect at the time of the trainees death provided $35 million of coverage, which, less amounts paid on other claims under the policies, should be available for these purposes. (As of the date
hereof, a total of $415,000 has been paid by the Companys insurers on other claims covered by the applicable policies.) However, as previously announced by the Company, Northland Insurance Company, the Companys primary general liability
insurance carrier at the time of the death of the trainee, filed a declaratory judgment action in federal court against the Company seeking to disclaim any obligation to defend or indemnify the Company or its former employee with respect to this
case. On July 28, 2004, the federal district court in which this action had been filed denied Northlands motion for summary judgment in its action, and entered a memorandum order in the case which contained an explicit finding by the court
that the Companys insurers were obligated to defend and indemnify the Company and its employees against the claims made in this case. In light of this ruling, the Company recently has filed a petition with the Court seeking a final judgment
from the Court that Northland and the Companys excess liability insurance carrier are obligated to indemnify the Company against the judgment entered against it in the underlying suit and to pay on behalf of the Company all pre-judgment and
post-judgment interest that has or will accrue on the amounts awarded in the judgment. This petition is currently pending with the Court. The Company believes, based upon the advice of its counsel, that the Court will enter a final judgment in this
case that hold that Northland and the Companys excess liability insurance carrier are obligated to indemnify the Company to the extent of their respective policy limits against the judgment in the underlying suit and to pay on behalf of the
Company, in addition to its policy limits, all pre-judgment and post-judgment interest that has or will accrue on the amounts awarded in the judgment.



Nevertheless, because the amount of the judgment in this case exceeds the total amount of insurance available to the Company by approximately $2.5
million, the Company has an uninsured exposure in this case of approximately $2.5 million. However, based upon the advice of counsel, the Company at this time does not believe that the ultimate settlement or final judgment in this case will exceed
the amount of the bonds posted to secure the judgment or that it is probable that the Company will incur any material loss in this case.



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CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)



Accordingly, no loss has been recognized in connection with this litigation. The Company will
continue to assess this matter with its legal counsel in accordance with SFAS No. 5, Accounting for Contingencies, and, if and when deemed appropriate, will reflect the potential impact of the case on its financial statements.



The Company also notes that, because it maintained the primary and excess
liability policies that provide coverage for the foregoing case on an occurrence basis, to the extent that the Companys insurers make any payments to the plaintiffs in the foregoing case under the policies, such payments will serve
to reduce the amount of insurance coverage available to the Company for other claims made against the Company that are covered by the same policies. Likewise, to the extent that the Companys insurers make any payments to any other plaintiffs
or claimants in order to settle any other claims covered under these policies, such payments will serve to reduce the amount of insurance coverage available to the Company for the settlement of or payment of the judgment in the Alexander case
described above. As noted above, as of the date hereof, a total of $415,000 has been paid by the Companys insurers on other claims covered by the applicable policies.



At present, there is currently only one lawsuit pending against the Company that relates to an occurrence that
occurred during the policy period covered by these policies, which is described below:



| |  |  | Layman, Ryan v. Jennifer Burkley, Youth Services International, Inc., The State of Nevada, Department of Human Resources, Division of Child and Family Services, Roes I  X,
Does I  X, Case No. CV-S-03-0086-KJD-LRL, in the United States District Court for the District of Nevada.
| | - |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



The Plaintiff in this case is a former resident of the Summit View Youth Correctional Facility (which was formerly operated by the Company) who has
brought civil rights, intentional infliction of emotional distress, assault and battery and negligence claims against the Company arising out of allegations that, between November, 2000 and January, 2001, the Plaintiff was subjected to
repeated sexual assaults by co-Defendant Jennifer Burkley, a former employee of the Company. Plaintiff alleges that the alleged encounters with co-defendant Burkley were the cause of his current mental and psychological problems and seeks
compensatory damages in the amount of $2,000,000 and unspecified punitive damages. The Company has not disputed that co-Defendant Burkley engaged in sexual activities with the Plaintiff while he was incarcerated at the Summit View Correctional
Facility, but has denied the Plaintiff was sexually assaulted and that the Company has any liability for these activities. The Company also has asserted that none of the alleged sexual encounters with co-defendant Burkley were the
proximate cause of his mental and psychological problems. The State of Nevada has been dismissed from this case on governmental immunity grounds. The Company is not providing a defense to co-defendant Burkley and Burkley has not sought coverage or a
defense from the Company or its insurance carrier.



At the
conclusion of discovery in this case, the Company filed a motion to exclude the purported expert testimony proffered by the Plaintiff to support his claims that the Companys or Burkleys actions were the proximate cause of the
Plaintiffs alleged damages under the above-referenced theories of liability, and also filed a motion for summary judgment on all claims asserted in this case. On January 24, 2005, the District Court entered an order that granted the
Companys motion to exclude the purported experts testimony and an order that granted summary judgment to the Company on the civil rights, intentional infliction of emotional distress and negligence claims that had been asserted
against the Company, but that denied the Companys motion with respect to the assault and battery claims. Accordingly, the assault and battery claim is the only claim remaining in this case and defense counsel is preparing this claim for
trial.



The basis of the Courts decision to grant
summary judgment to the Company on the civil rights, intentional infliction of emotional distress and negligence claims was that, in light of the exclusion of the proffered experts testimony, the Plaintiff did not develop sufficient facts to
support his claims that the Companys or Burkleys actions or inaction were the proximate cause of the Plaintiffs alleged damages under these theories. The Court did not address any of the Companys other arguments for summary
judgment on these claims in its decision to grant summary judgment, finding that the lack of evidence to support proximate causation was fatal to each of these causes of action, which obviated the need to address these alternative grounds. In the
Companys summary judgment motion on the assault and battery claim, the Company argued that the Plaintiff consented to each of the alleged sexual encounters with Burkley and that, in any event, Burkley was acting outside the course and scope of
her employment in engaging in the alleged encounters with Plaintiff. The basis of the Courts decision to deny the Companys motion for summary judgment on the assault and battery claims was that, in light of the testimony developed during
discovery, the Plaintiff is entitled to have a jury determine whether he actually consented to the sexual encounters with co-defendant Burkley and whether Burkley was acting within the scope of her employment when she engaged in the sexual
encounters with Plaintiff.



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CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)



Nevertheless, in light of the facts that (a) the assault and battery claim is the only claim
remaining in this case; (b) the District Courts recent order prohibits the Plaintiff from presenting at trial any expert testimony to support his claims that his current mental and psychological problems resulted from his encounters with
Burkley; and (c) Plaintiff did not suffer any physical injuries as a result of the alleged encounters, the Company does not believe that is probable that the Company will incur any material loss in connection with this case, and therefore, no loss
has been recognized in connection with this litigation. However, as noted above, if, and to the extent that, the Companys liability insurers make any payments to the plaintiff in this case for settlement or otherwise, the amount of any such
payment will reduce the amount of insurance coverage available to the Company for the settlement of or payment of the judgment in the Alexander case described above.



| | 2. | Jama, Hawa Abdi, et al. v. Esmor Correctional Services, Inc., et al., Case No. 973093 in the United States District Court for the District of New Jersey.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------



The Jama case was initiated in July 1997 by
group of former detainees in the INS Detention Center that the Company formerly operated in Elizabeth, New Jersey. The suit asserts that the Company is liable for personal injuries and property damage allegedly caused by the negligent and
intentional acts of the Company, certain of the current and former officers of the Company and a number of former employees of the Company who served as guards at the detention facility. The Complaint filed in this case asserts numerous legal
theories. No monetary damages have been stated. The Plaintiffs in this case are represented by the Rutgers University Law School Constitutional Law Clinic. The Company believes that it has meritorious legal and factual defenses to the claims
asserted by the plaintiffs in this case, and is vigorously pursuing its defense of those claims.



This case is currently in the latter stages of discovery. During the course of discovery, the trial court has dismissed and/or granted summary judgment to
the Company on a number of the claims initially asserted by the plaintiffs in this case. Accordingly, at the present time, the Companys defense counsel is preparing the remaining claims for trial. The Company also has filed an interlocutory
appeal from the District Court asserting that the District Court erred in ruling that the nine (9) remaining plaintiffs properly opt-out of the Brown, Samson class action, discussed below. This appeal is currently pending before the
Third Circuit Court of Appeals. (As discussed below, the District Court approved a settlement in the Brown, Samson class action on February 17, 2005.) In any event, the Company believes that it should have more than adequate insurance
coverage available to it to cover any adverse outcome in this case. Therefore, at this time, the Company does not believe that it is probable that the Company will incur any material loss in connection with this case, and therefore, no loss has been
recognized in connection with this litigation.



| | 3. | City of Tallulah v. Trans-American Development Assoc. and Correctional Services Corporation, 6th Judicial District Court Madison Parish, LA, Case No. 2001 000146.
| | -- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------



In June, 2001, the City of Tallulah filed suit
against Trans-American Development Assoc. & Correctional Services Corporation, alleging that either or both parties are obligated to continue to pay to the City an annual management fee of $150,000 related to the Tallulah
Correctional Center for Youth, despite the fact that neither party is currently operating the facility. The Complaint filed by the City in this matter does not specify the amount of damages that the City is seeking, but, based on the theory outlined
in the Citys complaint, the Company has estimated that the City likely will seek approximately $3,250,000 in this case. The Company believes that the Citys case against the Company is wholly without merit and is vigorously defending
against this claim. However, in light of the fact that this matter is not covered by any form of insurance available to the Company, and given the inherent uncertainties associated with litigation, no assurance can be given that this litigation will
be resolved favorably to the Company.



| | 4. | Scianetti, Adorno, Womble and Johnson v. Correctional Services Corporation, Case. No. 01 CV 9170 in the United States District Court for the Southern District of New York.
| | -- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------



This suit was served upon the Company in
November, 2001 by four (4) female former residents of the LeMarquis Community Correctional Center that the Company formerly operated in New York, each of whom alleges that Miguel Corriera, who was formerly employed by the Company as a prisoner
advocate at LeMarquis, sexually assaulted and battered them while they were housed at LeMarquis. Plaintiff Johnson



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CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)



further alleges that Mr. Corriera raped her while she was housed at LeMarquis. Each Plaintiff asserted causes of action for negligence against the Company.
Each Plaintiff sought $50,000,000 in compensatory damages from the Company. In 2003, the Companys general liability insurance carrier settled the claims of Plaintiffs Scianetti and Adorno for a total of $25,000, leaving only the claims of
Plaintiffs Womble and Johnson remaining in the suit. The Company believes that it has meritorious defenses to the claims made by the remaining plaintiffs in this case and is vigorously pursuing its defenses to those claims. However, given the
inherent uncertainties associated with litigation and the fact that the damages sought by the plaintiffs in this case substantially exceeds the amount of insurance coverage available to the Company, no assurance can be given that the outcome of this
litigation will not have a materially adverse effect on the Company. A trial on the remaining Plaintiffs claims commenced on February 7, 2005, but, the next day, the trial judge had a family emergency and declared a mistrial. The Court has not
yet set a new date for the trial of this case.



| | 5. | Brown, Samson, et al., v. Esmor Correctional Services, Inc., Esmor, Inc., Esmor New York State Correctional Facilities, Inc., Esmor Management, Inc., Esmor Manhattan, Inc, Esmor
Brooklyn, Inc., Esmor New Jersey, Inc., James Slattery and Aaron Speisman, Superior Court of the State of New York, No. 8654/96; removed to US District Court for the Southern District of New York; transferred to the US District Court for the
District of New Jersey
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



As noted above in Item
1, on February 17, 2005, the United States District Court for the District of New Jersey approved preliminarily the terms of a settlement negotiated by the Companys liability insurance carrier and the plaintiffs counsel with respect to
this matter. This suit was filed in March 1996 in the Supreme Court of the State of New York, County of Bronx by several former detainees in the INS Detention Center that the Company formerly operated for the INS in Elizabeth, New Jersey, on behalf
of themselves and others similarly situated, in which the plaintiffs in the suit claimed $500,000,000 in compensatory and punitive damages on a variety of legal theories. This suit was removed to the United States District Court, Southern District
of New York, in April 1996, and subsequently transferred to the United States District Court for the District of New Jersey. The plaintiffs in this case obtained certification from the Court to try their case as a class action on behalf of
themselves and all other persons who were detained in the Elizabeth INS Detention Center while the Company operated it. The Company has no obligation to contribute to this settlement.



|2. | Contracts
|-- | ---------



Renewal of government contracts 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.



|3. | Disputed Receivables
|-- | --------------------



During 2003, the Company initiated legal action against the Puerto Rican government to recover unpaid revenues and receive reimbursement for costs
and breach of contract damages. The Puerto Rican government initiated a counter suit seeking a similar amount for alleged damages to the Bayamon, Puerto Rico facility. The Company had approximately $2.0 million in receivables and approximately
$560,000 in deferred charges related to assets purchased by the Company, for use at the facility as of December 31, 2003, pending resolution of the aforementioned lawsuit. During the year ended December 31, 2004, the Company settled its dispute with
the government, whereby the Company received $1.4 million as the net payment for its settlement, including $2.0 million received for its accounts receivables and as settlement of all claims the company had against the government, partially offset by
$600,000 for settlement of alleged damages payable by the Company. The $600,000 amount was accrued as of December 31, 2003. As a result of this settlement, the Company wrote off $560,000 in deferred charges which is included in the accompanying
financial statements as loss on disposal of assets.



Until to
March 31, 2004, the Company operated a program under a contract whereby revenues recognized as reimbursable costs were incurred through a gross maximum price cost reimbursement arrangement. This contract had costs, including indirect costs, subject
to audit and adjustment by negotiations with government



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CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)



representatives. Pursuant to the results of an audit for the seventeen months beginning July 1, 2001 and ended November, 2002 the State asserted it is due
refunds totaling approximately $1.8 million and withheld the amount from payments made for February and March 2004 services. Based on the Companys review of the States computation of the assessment, the Company believes it will recover
the entire assessment, and accordingly, has not recorded a reserve against this amount. In addition, the State is currently conducting an audit for the remainder of the contract period through March 31, 2004. The Companys contract expired
March 31, 2004 and the Company elected not to compete in the competitive bid process to operate the facility past March 31, 2004.



In December 1998, the Company entered into a subcontract to operate the Tallulah Correctional Center for Youth (TCCY) in Tallulah, Louisiana.
The TCCY was utilized by the State of Louisiana pursuant to a contract with the City of Tallulah, the express terms of which obligated the State to maintain the facility at a full population of 686 juveniles; however, in light of the conditions at
the facility inherited by the Company and the States desire to maintain the population of the facility at less than 686 juveniles on an interim basis, the Company entered into the subcontract to operate the TCCY on the good faith belief that
the State would honor an agreement between the Company and the State under which the State would pay the Company only for the actual monthly population for a period of six-months from the commencement of operations by the Company and thereafter
would either increase the population to the full capacity or pay for its full utilization, regardless of the actual population level. Accordingly, commencing in July 1999, the Company began billing the State at the 686 population level of the
original contract. However, despite this agreement and the express contract terms, in September 1999, the State disavowed any obligation to increase the population to the full capacity of the facility or, in lieu thereof, to pay for the its full
utilization, insisting that it was only obligated to pay for the actual number of juveniles housed in the facility, and paid the Company for services provided in accordance with this position. Accordingly, in light of this dispute, in order to be
conservative, the Company recognized revenues for July, August and September 1999 only with respect to a population level of 620 (the population level the facility was approved to house by the local judicial authority prior to commencement of
operations by the Company) despite its belief that it was entitled to payment assuming full utilization of the facility regardless of the court order. The Company discontinued operations of the facility on September 24, 1999. The Company has filed
suit in federal court seeking payment of all funds that would be owed under the original contract from the commencement of operation as well as damages for breach of the contract by the State. Pursuant to an agreement between the Company and the
State, the Company has asked the court to first rule upon the States payment obligations, and has reserved pursuit of its other breach of contract claims. This matter has been submitted to court and the Company is awaiting the courts
decision. The Company did not incur any material losses in conjunction with this closure. At December 31, 2004, the Company has not reserved any of the approximately $673,000 receivable from the State, as the Company does not believe that it is
probable that the asset has been impaired and, accordingly, expects collection of the full amount of the receivable.



|4. | Concentrations of Credit Risk
|-- | -----------------------------



The Companys contracts in 2004, 2003, and 2002 with government agencies where revenues exceeded 10% of the Companys total consolidated
revenues were as follows:

|
|

|                                                 |  |                          |   |  |      |   |  |      |  
|------------------------------------------------ |  | ------------------------ | - |  | ---- | - |  | ---- | -
|                                                 |  | Years Ended December 31, |  
|                                                 |  | 2004                     |   |  | 2003 |   |  | 2002 |  
|Arizona Department of Corrections                |  | 20                       | % |  | 19   | % |  | 9    | %
|Florida Department of Juvenile Justice           |  | 8                        | % |  | 7    | % |  | 13   | %
|Various Other Agencies in the State of Texas     |  | 14                       | % |  | 18   | % |  | 21   | %
|Various Federal Agencies                         |  | 31                       | % |  | 23   | % |  | 17   | %
|State of Maryland Department of Juvenile Justice |  | 3                        | % |  | 11   | % |  | 10   | %



|5. | Construction Commitments
|-- | ------------------------



The Company has construction commitments of approximately $35.0 million at December 31, 2004 related to a project the Company was awarded in July 2004 to
construct the South Texas Detention Complex, which will be used principally by the ICE. The Company also has two construction commitments totaling $3.1 million to expand existing facilities.



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)



|6. | Letters of Credit
|-- | -----------------



The Company obtained letters of credit in the amount of $5.1 million in favor of workers compensation insurance carriers for the policy periods of
February 2001 through February 2005 that are renewed quarterly, as deemed contractually necessary.



In conjunction with the South Texas Detention Complex construction project the Company obtained a letter of credit in the amount of $3.0 million in favor
of U.S. Bank National Association as trustee for the term of the construction phase of the facility.



In June 2002, the Company obtained a letter of credit, in favor of the State of Arizona, related to the Phoenix West facility transaction discussed in
NOTE M  OTHER LONG TERM OBLIGAIONS. The letter of credit balance decreases over time as the calculated difference between the sale proceeds that would be due from the state upon purchase of the facility, and the unpaid principal balance of the
bonds narrows. After 2010, the sale proceeds from the State would be sufficient to satisfy the redemption requirement. As of December 31, 2004 this letter of credit was valued at $785,000.



In the ordinary course of its business, the Company is required to
collateralize certain contractual obligations with letters of credit in favor of the other party to the contract. The amounts of these letters of credit are approximately $375,000.



|7. | Indemnification
|-- | ---------------



The Company is required by its contracts to maintain certain levels of insurance coverage for general liability, workers compensation, vehicle
liability and property loss or damage. The Company is also required to indemnify contracting agencies for claims and costs arising out of the Companys operations and in certain cases, to maintain performance bonds. As of December 31, 2004, the
Company has no obligation arising as a result of these indemnifications.



NOTE R  EARNINGS (LOSS) PER SHARE



The following table
sets forth the computation of basic and diluted income (loss) per share in accordance with SFAS No. 128 (in thousands, except for per share data):



|                                                              |  |                          |        |   |      |   |        |  |   |        |  
|------------------------------------------------------------- |  | ------------------------ | ------ | - | ---- | - | ------ |  | - | ------ | -
|                                                              |  | Years Ended December 31, |       
|                                                              |  | 2004                     |        |   | 2003 |   | 2002   | 
|Numerator:                                                    |  |                          |        |   |      |   |        |  |   |        |  
|Income (loss)from continuing operations                       |  | $                        | (97    | ) |      | $ | 1,206  |  | $ | 4,494  |  
|Income (loss) from discontinuing operations                   |  |                          | (3,151 | ) |      |   | 128    |  |   | (2,131 | )
|                                                              |  |                          |        |   |      |   |        |  |   |        |  
|Net income (loss)                                             |  | $                        | (3,248 | ) |      | $ | 1,334  |  | $ | 2,363  |  
|                                                              |  |                          |        |   |      |   |        |  |   |        |  
|Denominator:                                                  |  |                          |        |   |      |   |        |  |   |        |  
|Basic income per share:                                       |  |                          |        |   |      |   |        |  |   |        |  
|Weighted average shares outstanding                           |  |                          | 10,165 |   |      |   | 10,157 |  |   | 10,155 |  
|Effect of dilutive securities  stock options and warrants    |  |                          |        |   |      |   | 80     |  |   | 40     |  
|                                                              |  |                          |        |   |      |   |        |  |   |        |  
|Denominator for diluted income per share                      |  |                          | 10,165 |   |      |   | 10,237 |  |   | 10,195 |  
|                                                              |  |                          |        |   |      |   |        |  |   |        |  
|Income from continuing operations per common share:           |  |                          |        |   |      |   |        |  |   |        |  
|Basic and Diluted                                             |  | $                        | (0.01  | ) |      | $ | 0.12   |  | $ | 0.44   |  
|                                                              |  |                          |        |   |      |   |        |  |   |        |  
|Income (loss) from discontinuing operations per common share: |  |                          |        |   |      |   |        |  |   |        |  
|Basic and Diluted                                             |  | $                        | (0.31  | ) |      | $ | 0.01   |  | $ | (0.21  | )
|                                                              |  |                          |        |   |      |   |        |  |   |        |  
|Net income                                                    |  |                          |        |   |      |   |        |  |   |        |  
|Basic and Diluted                                             |  | $                        | (0.32  | ) |      | $ | 0.13   |  | $ | 0.23   |  
|                                                              |  |                          |        |   |      |   |        |  |   |        |  



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CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)



NOTE R  EARNINGS (LOSS) PER SHARE (continued)



During the years ended December 31, 2004, 2003, and 2002, there were approximately 597,000,
408,000, and 691,000 common stock equivalents, respectively, that were excluded from the calculation of earnings per share because their effect would have been anti-dilutive.



NOTE S - STOCK OPTIONS



In October 1993, the Company adopted a stock option plan that provided 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 share that could be sold pursuant to options granted under the stock option plan were 1.5 million, however no more options may be
granted under this plan. In July 2004, the Company adopted the 2004 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 share that may be sold pursuant to options granted under the stock option plan is 1.5 million. There are still 1.5 million options available for grant with this plan.



In June 1994, the Company adopted a Non-employee Directors Stock Option Plan,
which provides for the grant of non-qualified options to purchase up to 150,000 shares of the Companys Common Stock. There are no options available for grant under this plan. In May 1999, the Company adopted the 1999 Non-Employee Director
Stock Option Plan, which provides for the grant of non-qualified options to purchase up to 300,000 shares of the Companys Common Stock. There are still 145,000 options available for grant under this plan.



Options granted under all 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 all plans will expire not more than ten years from the date of grant.



For purposes of the pro forma presentation in NOTE A  SUMMARY OF
SIGNIFICANT ACCOUNTING POLICIES, the fair value of these options was estimated at the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions for the years ended December 31, 2004, 2003, and 2002.



|               |  |                          |   |  |         |   |  |         |  
|-------------- |  | ------------------------ | - |  | ------- | - |  | ------- | -
|               |  | Years Ended December 31, |  
|               |  | 2004                     |   |  | 2003    |   |  | 2002    |  
|Volatility     |  | 75                       | % |  | 75      | % |  | 75      | %
|Risk free rate |  | 5.50                     | % |  | 5.00    | % |  | 5.00    | %
|Expected life  |  | 3 years                  |   |  | 3 years |   |  | 3 years |  



The weighted average fair value of
options granted during 2004, 2003, and 2002, for which the exercise price equals the market price on the grant date was $0.95, $1.45, and $0.24, respectively.



The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options that 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 assumptions 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.



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##### Table of Contents

CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)



NOTE S - STOCK OPTIONS (continued)



Stock option activity during 2004, 2003, and 2002 is summarized below:



|                           |  |          |   |  |                               
|-------------------------- |  | -------- | - |  | ------------------------------
|                           |  | Options  |   |  | Weighted-AverageExercise Price
|Balance, December 31, 2001 |  | 838,250  |   |  | 8.73                          
|Granted                    |  | 250,000  |   |  | 1.73                          
|Exercised                  |  |         |   |  |                              
|Canceled                   |  | (357,500 | ) |  | 8.71                          
|                           |  |          |   |  |                               
|Balance, December 31, 2002 |  | 730,750  |   |  | 6.33                          
|Granted                    |  | 10,000   |   |  | 2.76                          
|Exercised                  |  | (3,832   | ) |  | 1.61                          
|Canceled                   |  | (48,584  | ) |  | 7.34                          
|                           |  |          |   |  |                               
|Balance, December 31, 2003 |  | 688,334  |   |  | 6.24                          
|Granted                    |  | 20,000   |   |  | 2.65                          
|Exercised                  |  | (7,833   | ) |  | 1.61                          
|Canceled                   |  | (76,167  | ) |  | 2.17                          
|                           |  |          |   |  |                               
|Balance, December 31, 2004 |  | 624,334  |   |  | 6.67                          
|                           |  |          |   |  |                               



The following table summarizes
information concerning currently outstanding and exercisable stock options at December 31, 2004:



|                         |  |                   |  |                                                  |       |                                          |   |      
|------------------------ |  | ----------------- |  | ------------------------------------------------ | ----- | ---------------------------------------- | - | -----
|Range of Exercise Prices |  | NumberOutstanding |  | Weighted-AverageRemainingContractual Life(Years) |       | Weighted-AverageExercise Price ($/share)
|$ 1.61  4.12            |  | 239,334           |  |                                                  | 6.8   |                                          | $ | 1.98 
|4.12  6.18              |  | 10,000            |  |                                                  | 5.1   |                                          |   | 4.19 
|6.18  8.25              |  | 210,000           |  |                                                  | 4.3   |                                          |   | 7.48 
|8.25  10.31             |  | 15,000            |  |                                                  | 1.3   |                                          |   | 8.75 
|10.31  12.37            |  |                  |  |                                                  |      |                                          |   |     
|12.37  14.44            |  | 150,000           |  |                                                  | 3.1   |                                          |   | 13.00
|                         |  |                   |  |                                                  |       |                                          |   |      
|                         |  | 624,334           |  |                                                  | 4.5   |                                          |   | 6.67 
|                         |  |                   |  |                                                  |       |                                          |   |      
|                         |  |                   | 
|Range of Exercise Prices |  | NumberExercisable |  | Weighted-AverageExercise Price ($/share)         |       |                                         
|$ 1.61  4.12            |  | 169,830           |  | $                                                | 2.01  |                                          |   |      
|4.12  6.18              |  | 13,000            |  |                                                  | 4.193 |                                          |   |      
|6.18  8.25              |  | 210,000           |  |                                                  | 7.48  |                                          |   |      
|8.25  10.31             |  | 15,000            |  |                                                  | 8.75  |                                          |   |      
|10.31  12.37            |  |                  |  |                                                  |      |                                          |   |      
|12.37  14.44            |  | 150,000           |  |                                                  | 13.00 |                                          |   |      
|                         |  |                   |  |                                                  |       |                                          |   |      
|                         |  | 557,830           |  |                                                  | 7.27  |                                          |   |      
|                         |  |                   |  |                                                  |       |                                          |   |      



NOTE T - EMPLOYEE BENEFIT PLANS



On January 1, 2002, the Company merged its CSC and YSI contributory
retirement plans under Section 401(k) of the Internal Revenue Code into a single plan. This plan benefits employees meeting certain minimum service requirements. Eligible employees can contribute $13,000 in 2004, $12,000 in 2003, and $11,000 in 2002
to the plan. The Company accrued or contributed $122,000, $120,000, and $120,000, in 2004, 2003, and 2002, respectively, to the plan.



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##### Table of Contents

CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)



NOTE U  WORKERS COMPENSATION AND HEALTH INSURANCE



See Note A regarding workers compensation expenses and accrued liabilities.



The Company maintains a group health plan subject to a loss limit of $150,000
per individual. At December 31, 2004 the plan had approximately 1,300 participants and a medical insurance liability of $900,000. This liability approximates, on average, two months of claims paid during the year ended December 31, 2004 and
represents the Companys estimated liability as of December 31, 2004.



NOTE V  RELATED PARTY TRANSACTIONS



A director of the
Company is a member of a law firm that provides legal services as the Companys legal counsel. Payments to this firm amounted to approximately $28,000, $40,000, and $47,000, in legal fees from the Company for the years ended December 31, 2004,
2003 and 2002, respectively.



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##### Table of Contents

CORRECTIONAL SERVICES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)



NOTE W  SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED)



The following are the unaudited quarterly results of operations for the years ended December
31, 2004 and 2003 (in thousands, except for per share data).



|                                             |  |               |        |   |                |   |        |               |  |   |                |   |  |      |        |   |      |   |        |      |  |   |        |   |  |   |        |   |  |   |        |  
|-------------------------------------------- |  | ------------- | ------ | - | -------------- | - | ------ | ------------- |  | - | -------------- | - |  | ---- | ------ | - | ---- | - | ------ | ---- |  | - | ------ | - |  | - | ------ | - |  | - | ------ | -
|                                             |  | First Quarter |        |   | Second Quarter |   |        | Third Quarter |  |   | Fourth Quarter |  
|                                             |  | 2004          |        |   | 2003           |   |        | 2004          |  |   | 2003           |   |  | 2004 |        |   | 2003 |   |        | 2004 |  |   | 2003   |  
|Revenues                                     |  | $             | 32,041 |   |                | $ | 34,396 |               |  | $ | 33,235         |   |  | $    | 31,576 |   |      | $ | 34,302 |      |  | $ | 30,671 |   |  | $ | 34,141 |   |  | $ | 29,888 |  
|                                             |  |               |        |   |                |   |        |              
|Facility Expenses                            |  |               |        |   |                |   |        |               |  |   |                |   |  |      |        |   |      |   |        |      |  |   |        |   |  |   |        |   |  |   |        |  
|                                             |  |               |        |   |                |   |        |              
|Operating expenses                           |  |               | 28,109 |   |                |   | 30,378 |               |  |   | 28,353         |   |  |      | 27,586 |   |      |   | 29,236 |      |  |   | 26,753 |   |  |   | 29,251 |   |  |   | 27,661 |  
|                                             |  |               |        |   |                |   |        |              
|Start up costs                               |  |               | 1,705  |   |                |   |       |               |  |   | 1,134          |   |  |      |       |   |      |   | 385    |      |  |   | 18     |   |  |   | 52     |   |  |   | 360    |  
|                                             |  |               |        |   |                |   |        |               |  |   |                |   |  |      |        |   |      |   |        |      |  |   |        |   |  |   |        |   |  |   |        |  
|Contribution from Operations                 |  |               | 2,227  |   |                |   | 4,018  |               |  |   | 3,748          |   |  |      | 3,990  |   |      |   | 4,681  |      |  |   | 3,900  |   |  |   | 4,838  |   |  |   | 1,867  |  
|General and Administrative                   |  |               | 2,183  |   |                |   | 2,432  |               |  |   | 2,148          |   |  |      | 2,352  |   |      |   | 2,052  |      |  |   | 2,369  |   |  |   | 2,069  |   |  |   | 2,058  |  
|Impairment                                   |  |               |       |   |                |   |       |               |  |   |               |   |  |      |       |   |      |   |       |      |  |   |       |   |  |   | 1,496  |   |  |   |       |  
|Loss (gain) on disposal of asset             |  |               | (30    | ) |                |   |       |               |  |   | 563            |   |  |      | (20    | ) |      |   | 16     |      |  |   | (24    | ) |  |   | 69     |   |  |   | (9     | )
|                                             |  |               |        |   |                |   |        |               |  |   |                |   |  |      |        |   |      |   |        |      |  |   |        |   |  |   |        |   |  |   |        |  
|Operating income (loss)                      |  |               | 74     |   |                |   | 1,586  |               |  |   | 1,037          |   |  |      | 1,658  |   |      |   | 2,613  |      |  |   | 1,555  |   |  |   | 1,204  |   |  |   | (182   | )
|                                             |  |               |        |   |                |   |        |              
|Interest and income taxes                    |  |               | (329   | ) |                |   | (993   | )             |  |   | (1,164         | ) |  |      | (1,022 | ) |      |   | (1,865 | )    |  |   | (968   | ) |  |   | (1,667 | ) |  |   | (428   | )
|                                             |  |               |        |   |                |   |        |               |  |   |                |   |  |      |        |   |      |   |        |      |  |   |        |   |  |   |        |   |  |   |        |  
|Income (loss) from continuing operations     |  |               | (255   | ) |                |   | 593    |               |  |   | (127           | ) |  |      | 636    |   |      |   | 748    |      |  |   | 587    |   |  |   | (463   | ) |  |   | (610   | )
|Income (loss) from discontinued operations   |  |               | (402   | ) |                |   | (162   | )             |  |   | (1,328         | ) |  |      | (207   | ) |      |   | (1,306 | )    |  |   | (190   | ) |  |   | (115   | ) |  |   | 687    |  
|                                             |  |               |        |   |                |   |        |               |  |   |                |   |  |      |        |   |      |   |        |      |  |   |        |   |  |   |        |   |  |   |        |  
|Net income (loss)                            |  | $             | (657   | ) |                | $ | 431    |               |  | $ | (1,455         | ) |  | $    | 429    |   |      | $ | (558   | )    |  | $ | 397    |   |  | $ | (578   | ) |  | $ | 77     |  
|                                             |  |               |        |   |                |   |        |               |  |   |                |   |  |      |        |   |      |   |        |      |  |   |        |   |  |   |        |   |  |   |        |  
|Basic and diluted earnings (loss) per share: |  |               |        |   |                |   |        |               |  |   |                |   |  |      |        |   |      |   |        |      |  |   |        |   |  |   |        |   |  |   |        |  
|                                             |  |               |        |   |                |   |        |              
|Net income (loss)                            |  | $             | (0.06  | ) |                | $ | 0.04   |               |  | $ | (0.14          | ) |  | $    | 0.04   |   |      | $ | (0.05  | )    |  | $ | 0.04   |   |  | $ | (0.06  | ) |  | $ | 0.01   |  
|                                             |  |               |        |   |                |   |        |               |  |   |                |   |  |      |        |   |      |   |        |      |  |   |        |   |  |   |        |   |  |   |        |  



See NOTE N  DISCONTINUED
OPERATIONS for the discussion of the Companys operations that were discontinued during the year ended December 31, 2004.



Included in the second quarter of 2004 discontinued operations is an impairment of asset of $1.5 million from the Tarkio Academy. Included in the third quarter of 2004
discontinued operations is the impairment of assets of $1.4 million for the Canadian, Texas facility. Included in the fourth quarter of 2004 is the impairment of asset of $1.5 million related to the Colorado County Facility. Also included in the
fourth quarter operating expenses, is a $450,000 reversal of tax expense principally as a result of favorable rulings on property tax valuation, and $400,000 in accrued legal claims expense.



Included in the fourth quarter of 2003 operating expenses is $1.1 million in accrued legal
claims. Included in the fourth quarter 2003 income from discontinued operations is a loss contract recovery of $896,000 representing a change in estimate of contract losses.



F-31