UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

Commission File Number: 0-20135

AMERICA SERVICE GROUP INC.

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

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

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

     There were 10,796,970 shares of common stock, par value $0.01 per share, outstanding as of November 2, 2004.

AMERICA SERVICE GROUP INC.

QUARTERLY REPORT ON FORM 10-Q

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PART I:

FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

AMERICA SERVICE GROUP INC.

CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)

The accompanying notes to condensed consolidated financial statements
are an integral part of these balance sheets. The condensed consolidated balance sheet at
December 31, 2003 is taken from the audited financial statements at that date.

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AMERICA SERVICE GROUP INC.

CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)

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

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AMERICA SERVICE GROUP INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)

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

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AMERICA SERVICE GROUP INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004
(unaudited)

1. Basis of Presentation

     The interim Condensed Consolidated Financial Statements of America Service Group Inc. and its consolidated subsidiaries (collectively, the “Company”) as of September 30, 2004 and for the quarters and nine month periods ended September 30, 2004 and 2003 are unaudited, but in the opinion of management, have been prepared in conformity with U.S. generally accepted accounting principles applied on a basis consistent with those of the annual audited Consolidated Financial Statements. Such interim Condensed Consolidated Financial Statements reflect all adjustments (consisting of normal recurring accruals) necessary for a fair presentation of the financial position and the results of operations for the quarters and nine month periods presented. The results of operations for the quarters and nine month periods presented are not necessarily indicative of the results to be expected for the year ending December 31, 2004. The interim Condensed Consolidated Financial Statements should be read in connection with the audited Consolidated Financial Statements for the year ended December 31, 2003 available in the Company’s Annual Report on Form 10-K.

     On September 24, 2004, the Company’s Board of Directors authorized and approved a three-for-two stock split effected in the form of a 50 percent dividend on the Company’s common stock. Such additional shares of common stock were issued on October 29, 2004 to all shareholders of record as of the close of business on October 8, 2004. All share and per share amounts have been adjusted to reflect the stock split.

2. Description of Business

     The Company provides managed healthcare services to correctional facilities under contracts with state and local governments, certain private entities and a medical facility operated by the Veterans Administration. The health status of inmates impacts the results of operations under such contractual arrangements. In addition to providing managed healthcare services, the Company also provides pharmaceutical distribution services through one of its operating subsidiaries, Secure Pharmacy Plus, LLC.

3. Recently Issued Accounting Pronouncement

     In December 2003, the FASB issued Interpretation No. 46R, Consolidation of Variable Interest Entities, or FIN No. 46. This interpretation addresses consolidation by business enterprises of variable interest entities when certain characteristics are present. The Company adopted the provisions of FIN No. 46 effective January 1, 2004. Such adoption did not impact the Company’s consolidated financial position, results of operations or cash flows.

4. Settlement of Florida Legal Matter

     On March 30, 2004, EMSA Limited Partnership, a subsidiary of the Company, which was acquired in January 1999, entered into a settlement agreement with the Florida Attorney General’s office, related to allegations, first raised in connection with an investigation of EMSA Correctional Services (“EMSA”) in 1997, that the Company may have played an indirect role in the improper billing of Medicaid by independent providers treating incarcerated patients.

     The settlement agreement with the Florida Attorney General’s office constitutes a complete resolution and settlement of the claims asserted against EMSA and required EMSA Limited Partnership to pay $5.0 million to the State of Florida. This payment was made by the Company on March 30, 2004. Under the terms of the settlement agreement, the Company and all of its subsidiaries are released from liability for any alleged actions which might have occurred from December 1, 1998 to March 31, 2004. Both parties entered into the settlement agreement to avoid the delay, uncertainty, inconvenience and expense of protracted litigation. The settlement agreement states that it is not punitive in purpose or effect, it should not be construed or used as admission of any fault, wrongdoing

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or liability whatsoever, and that EMSA specifically denies intentionally submitting any medical claims in violation of state or federal law.

     The Company recorded a charge of $5.2 million in its results of operations for the first quarter of 2004, reflecting the settlement agreement with the Florida Attorney General’s office and related legal expenses.

5. Stock Options

     The Company has elected to follow Accounting Principles Board Opinion (“APB”) No. 25, Accounting for Stock Issued to Employees, and related Interpretations in accounting for its employee stock options. Under APB No. 25, compensation expense is generally recognized as the difference between the exercise price of the Company’s employee stock options and the market price of the underlying stock on the date of grant.

     Pro forma information regarding net income and earnings per share is required by Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (“SFAS No. 123”), which also requires that the information be determined as if the Company has accounted for its employee stock options granted subsequent to December 31, 1994 under the fair value method of SFAS No. 123. The fair value of options issued during 2004 and 2003 was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions:

     The following table illustrates the effect on net income (loss) per common share as if the Company had applied the fair value recognition provisions of SFAS No. 123 for each of the quarters and nine month periods ended September 30, 2004 and 2003 (in thousands except per share data):

     The resulting pro forma disclosures may not be representative of that to be expected in future years. The weighted average fair value of options granted during the nine month periods ended September 30, 2004 and 2003 as determined under the fair value provisions of SFAS No. 123, is $14.63 and $6.22, respectively. The weighted average fair value of options granted during the quarter ended September 30, 2004 as determined under the fair value provisions of SFAS No. 123 is $15.44. No options were issued during the quarter ended September 30, 2003. For periods prior to July 1, 2004, the above pro forma adjustments do not include any offsetting income tax benefits due to the Company’s use of a tax valuation allowance during those periods.

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6. Discontinued Operations

     In August 2001, the FASB issued Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets (“SFAS No. 144”). SFAS No. 144 expanded the scope of financial accounting and reporting of discontinued operations to require that all components of an entity that have either been disposed of (by sale, by abandonment, or in a distribution to owners) or are held for sale and whose operations and cash flows can be clearly distinguished, operationally and for financial reporting purposes from the rest of the entity, should be presented as discontinued operations. The provisions for presenting the components of an entity as discontinued operations are effective only for disposal activities after the effective date of SFAS No. 144. The Company adopted the provisions of SFAS No. 144 effective January 1, 2002. Pursuant to SFAS No. 144, each of the Company’s correctional healthcare services contracts is a component of an entity, whose operations can be distinguished from the rest of the Company. Therefore, when a correctional healthcare services contract terminates, by expiration or otherwise, the contract’s operations generally will be eliminated from the ongoing operations of the Company and classified as discontinued operations. Accordingly, the operations of such contracts, that have expired during 2004 and 2003, net of applicable income taxes, have been presented as discontinued operations and prior period Condensed Consolidated Statements of Income have been reclassified.

The components of income from discontinued operations, net of taxes, are as follows (in thousands):

7. Prepaid Expenses and Other Current Assets

     Prepaid expenses and other current assets are stated at amortized cost and comprised of the following (in thousands):

8. Property and Equipment

     Property and equipment are stated at cost and comprised of the following (in thousands):

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     Depreciation expense for the quarters ended September 30, 2004 and 2003 was approximately $516,000 and $589,000, respectively. Depreciation expense for the nine months ended September 30, 2004 and 2003 was approximately $1,567,000 and $1,851,000, respectively.

9. Other Assets

     Other assets are comprised of the following (in thousands):

10. Contracts and Other Intangible Assets

     The gross and net values of contracts and other intangible assets consist of the following (in thousands):

     Estimated aggregate amortization expense related to the above intangibles for the remainder of 2004 is $450,000 and for each of the next four years is $1.8 million.

11. Accounts Payable and Accrued Expenses

     Accounts payable consist of the following (in thousands):