UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

(Mark One)

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

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File Number: 0-19673

America Service Group Inc.

(Exact name of registrant as specified in its charter)

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

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

     Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No þ

     Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15 (d) of the Act. Yes o No þ

     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 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 þ No o

     Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o

     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. o

     Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one)

Large Accelerated Filer o		Accelerated Filer þ		Non-Accelerated filer o		Smaller Reporting Company o
				(Do not check if a smaller reporting company)

     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

     The aggregate market value of the Common Stock held by non-affiliates of the registrant as of June 30, 2010 (based on the last reported closing price per share of Common Stock as reported on the Nasdaq Global Select Market on such date) was approximately $149,243,832. As of March 1, 2011, the registrant had 9,295,946 shares of Common Stock outstanding.

Documents Incorporated by Reference

     Portions of the Company’s Annual Report to Stockholders for fiscal year 2010 and portions of the Company’s Definitive Proxy Statement relating to the 2011 Annual Meeting of Stockholders are incorporated by reference in Part II and Part III of this Annual Report on Form 10-K.

 

 

PART I

Cautionary Statement Regarding Forward-Looking Information

     This Annual Report on Form 10-K contains statements that are forward-looking statements as defined within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements give the Company’s current expectations of forecasts of future events. All statements other than statements of current or historical fact contained in this annual report, including statements regarding the Company’s future financial position, business strategy, budgets, projected costs and plans and objectives of management for future operations, are forward-looking statements. The words “anticipate,” “believe,” “continue,” “estimate,” “expect,” “intend,” “may,” “plan,” “projects,” “will,” and similar expressions, as they relate to the Company, are intended to identify forward-looking statements. These statements are based on the Company’s current plans and anticipated future activities, and its actual results of operations may be materially different from those expressed or implied by the forward-looking statements. Some of the factors that may cause the Company’s actual results of operations to differ materially from those expressed or implied by forward looking statements including, among other things:

	•		the Company’s ability to obtain shareholder approval, regulatory approval and close the transaction discussed in Part I — Item 1. “Business — Significant Recent Development;”
	•		the Company’s ability to retain existing client contracts and obtain new contracts at acceptable pricing levels;
	•		whether or not government agencies continue to privatize correctional healthcare services;
	•		risks arising from governmental budgetary pressures and funding;
	•		the possible effect of adverse publicity on the Company’s business;
	•		increased competition for new contracts and renewals of existing contracts;
	•		risks arising from the possibility that the Company may be unable to collect accounts receivable or that accounts receivable collection may be delayed;
	•		the Company’s ability to limit its exposure for inmate medical costs, catastrophic illnesses, injuries and medical malpractice claims in excess of amounts covered under contracts or insurance coverage;
	•		the Company’s ability to maintain and continually develop information technology and clinical systems;
	•		the outcome or adverse development of pending litigation, including professional liability litigation;
	•		the Company’s determination whether to continue the payment of quarterly cash dividends, and if so, at the current amount;
	•		the Company’s determination whether to repurchase shares under its stock repurchase program;
	•		the Company’s dependence on key management and clinical personnel;
	•		risks arising from potential weaknesses or deficiencies in the Company’s internal control over financial reporting;
	•		risks associated with the possibility that the Company may be unable to satisfy covenants under its credit facility;
	•		the risk that government or municipal entities (including the Company’s government and municipal customers) may bring enforcement actions against, seek additional refunds from, or impose penalties on, the Company or its subsidiaries as a result of the matters investigated by the Audit Committee in prior years; and
	•		the Company’s ability to expand its business beyond its traditional correctional health client base.

     Any or all of the Company’s forward-looking statements in this annual report may turn out to be inaccurate. They can be affected by inaccurate assumptions the Company might make or by known or unknown risks, uncertainties and assumptions, including the risks, uncertainties and assumptions described below in Item 1A. “Risk Factors.”

     In light of these risks, uncertainties and assumptions, the forward-looking events and circumstances discussed in this annual report may not occur and actual results could differ materially from those expressed or implied in the forward-looking statements. When considering these forward-looking statements, keep in mind these risk factors and other cautionary statements in this annual report, included in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Business,” and in other documents that the Company files from time to time with the Securities and Exchange Commission (“SEC”).

     The Company’s forward-looking statements speak only as of the date made. The Company undertakes no obligation to publicly update or revise forward-looking statements, whether as a result of new information, future events or otherwise. All subsequent written and oral forward-looking statements attributable to the Company or persons acting on its behalf are expressly qualified in their entirety by the cautionary statements contained in this annual report.

Item 1. Business

     America Service Group Inc. (“ASG” or the “Company”), through its subsidiaries Prison Health Services, Inc. (“PHS”) and Correctional Health Services, LLC (“CHS”), contracts to provide and/or administer managed healthcare services to over 140 correctional facilities throughout the United States.

Significant Recent Development

     On March 2, 2011, the Company entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Valitás Health Services, Inc., a Delaware corporation (“Valitás”), and Whiskey Acquisition Corp., a Delaware corporation and a wholly owned subsidiary of Valitás (“Merger Sub”), providing for the acquisition of the Company by Valitás. Subject to the terms and conditions of the Merger Agreement, the Merger Sub will be merged with and into the Company (the “Merger”), with the Company surviving the Merger as a wholly owned subsidiary of Valitás.

     At the effective time of the Merger (the “Effective Time”), each share of common stock of the Company that is issued and outstanding as of immediately prior to the Effective Time (other than shares held by the Company, Valitás or any of their respective subsidiaries or shares held by stockholders who have properly exercised and perfected appraisal rights under Delaware law) will be automatically converted into the right to receive $26.00 in cash, without interest (such per share amount, the “Merger Consideration”). As of the Effective Time, all such converted shares of common stock of the Company shall no longer be outstanding and shall automatically be canceled and shall cease to exist.

     Each issued and outstanding option to purchase shares of Company common stock will vest in full as of immediately prior to and contingent on the closing of the Merger, and each holder of an option that has an exercise price per share that is less than the Merger Consideration will be entitled to receive after the Effective Time an amount in cash equal to the excess of the Merger Consideration over such exercise price per share, in each case multiplied by the number of shares of Company common stock underlying the option. Additionally, all restricted shares of Company common stock that are subject to vesting or forfeiture conditions (whether time-based or performance-based) that are outstanding as of immediately prior to the Effective Time shall become fully vested immediately prior to and contingent on the closing of the Merger.

     The Company’s Board of Directors (the “Board of Directors”), based on the recommendation of the disinterested members of the Board of Directors, unanimously approved the Merger Agreement and the transactions contemplated thereby, including the Merger. In connection with such approval, Oppenheimer & Co. Inc. rendered its opinion to the Board of Directors that, as of the date of the opinion and subject to the various assumptions and qualifications set forth therein, the Merger Consideration to be received by the Company’s stockholders is fair, from a financial point of view, to such stockholders.

     The consummation of the Merger is subject to certain customary conditions, including, without limitation: (i) the approval by the holders of at least a majority of the outstanding shares of Company common stock entitled to vote on the Merger Agreement and the transactions contemplated thereby, including the Merger; (ii) receipt of any required approvals or expiration or termination of the applicable waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended (the “HSR Act”); and (iii) the absence of any law or order prohibiting or otherwise making illegal the Merger. Moreover, each party’s obligation to consummate the Merger is subject to certain other conditions, including, without limitation: (i) the accuracy of the representations and warranties made by the other party to the Merger Agreement, subject to customary materiality qualifiers; and (ii) the compliance by the other party with its obligations and preclosing covenants thereunder, subject to customary materiality qualifiers.

     The Merger Agreement contains customary representations and warranties of the parties. The Merger Agreement also contains customary covenants, including covenants requiring: (i) each of the parties to use reasonable best efforts to cause the Merger to be consummated; and (ii) the Company to call and hold a stockholders’ meeting at which the Board of Directors will recommend, subject to certain exceptions based on its fiduciary duties, that the stockholders approve the Merger Agreement and the transactions contemplated thereby, including the Merger. The Merger Agreement also requires the Company to

conduct its operations in the ordinary course of business consistent with past practice during the period between the execution of the Merger Agreement and the Effective Time.

     Under the terms of the Merger Agreement, the Company may solicit, initiate and encourage other proposals to acquire the Company, and provide non-public information and participate in discussions or negotiations in connection therewith, until 12:00 a.m. (Eastern time) on April 17, 2011 (the “No-Shop Period Start Date”). Starting on the No-Shop Period Start Date, the Company will be subject to customary “no-shop” restrictions on its ability to solicit alternative acquisition proposals from third parties and to provide information to and engage in discussions with third parties who have not submitted an acquisition proposal to the Company prior to the No-Shop Period Start Date. Until 12:00 a.m. (Eastern time) on May 1, 2011, however, the Company may continue discussions or negotiations with any “Excluded Party,” which is generally defined in the Merger Agreement as any party from whom the Company receives an acquisition proposal prior to the No-Shop Period Start Date that, before the No-Shop Period Start Date, the Board of Directors determines in good faith, after consultation with its independent financial advisors, is or would reasonably be expected to result in a Superior Proposal (as such term is defined in the Merger Agreement), and which acquisition proposal has not been withdrawn or failed to be a Superior Proposal or an acquisition proposal that would reasonably be expected to result in a Superior Proposal for any continuous period of at least five business days.

     The “no-shop” restrictions in the Merger Agreement are also subject to a customary “fiduciary-out” provision which allows the Company under certain circumstances to provide information to and participate in discussions with third parties with respect to an unsolicited alternative acquisition proposal that the Board of Directors has determined is or would reasonably be expected to result in a Superior Proposal. Notwithstanding the foregoing, the Company is required to provide Valitás with certain information regarding its discussions with third parties, and under specified circumstances to negotiate in good faith with Valitás in the event of other acquisition proposals and/or certain other developments.

     The Merger Agreement also contains certain termination rights in favor of each party, including rights allowing the Company to terminate the Merger Agreement in order to accept a Superior Proposal. Upon termination of the Merger Agreement under certain specified circumstances, the Company will be required to pay to Valitás a specified fee and to reimburse Valitás for up to $2.0 million in transaction expenses. For instance, in the event that Valitás or the Company exercises its rights to terminate the Merger Agreement in certain circumstances, the Company will be required to pay to Valitás a fee in the amount of $8.0 million, plus transaction expenses. However, if certain terminations result from the Company’s acceptance of a Superior Proposal made by an Excluded Party, then the fee payable to Valitás will be reduced to $4.5 million, plus transaction expenses.

     Barclays Bank PLC and Bank of America, N.A. (collectively, the “Senior Lenders”) have provide customory senior debt commitment letters dated March 2, 2011, to provide Valitás with $360.0 million in senior secured credit facilities, comprised of: (i) a term loan facility of $285.0 million; and (ii) a revolving credit facility of $75.0 million. In addition, funds managed by GSO Capital Partners LP and its affilates (the “Mezzanine Lender” and collectively with the Senior Lenders, the “Lenders”) have provided customory mezzanine financing commitment letters dated March 2, 2011, to provide Valitás with $100.0 million in gross proceeds from the issuance and sale by Valitás of unsecured senior subordinated notes pursuant to a private placement. The obligations of the Lenders to provide the debt financing under the respective debt commitment letters are subject to a number of conditions which the Company believes are customary for financings of this type or are otherwise similar to certain conditions in the Merger Agreement. The final termination date for the commitments under each debt commitment letter is August 31, 2011. The Merger Agreement does not contain any financing condition or reverse termination fee.

     The Merger is currently expected to be completed in the second quarter of 2011.

General

      Prior to May 1, 2007, the Company, through its subsidiary Secure Pharmacy Plus, LLC (“SPP”), was also a distributor of pharmaceuticals and medical supplies. The Company is a leading non-governmental provider and/or administrator of correctional healthcare services in the United States.

     On April 12, 2007, SPP and PHS, as guarantor, entered into an asset purchase agreement with Maxor National Pharmacy Services Corporation (“Maxor”) whereby SPP agreed to sell certain of its assets at net book value (the “Transaction”). The closing of the Transaction occurred on May 3, 2007, with an effective date as of April 30, 2007. The net book value of the assets included in the Transaction was approximately $3.8 million as of April 30, 2007, which consisted of approximately $1.9 million in inventory and approximately $2.0 million in fixed assets, offset by approximately $0.1 million of liabilities for accrued vacation assumed by Maxor. Additionally, as a condition to the closing of the Transaction, Maxor and PHS entered into a long-term pharmacy services agreement (the “Services Agreement”) pursuant to which Maxor became the provider of pharmaceuticals and medical supplies to PHS. The Services Agreement commenced effective May 1, 2007 and will remain in effect until October 31, 2014 (unless terminated earlier in accordance with the terms of the Services Agreement). During the term of the Services Agreement, PHS will utilize Maxor on an exclusive basis to provide pharmaceuticals and medical and surgical supplies to PHS, except in certain specified situations, including when a PHS client elects or requires PHS to utilize another pharmacy services provider.

     The following table sets forth certain information regarding the Company’s correctional healthcare and, prior to May 1, 2007, pharmacy contracts.

		Historical December 31,
		2010				2009				2008				2007				2006
Number of correctional contracts(1)			57				62				64				60				92
Average number of inmates in all facilities covered by correctional contracts(2)			162,209				173,172				130,749				131,459				175,728

     ASG was incorporated in 1990 as a Delaware holding company for PHS. Unless the context otherwise requires, the terms “ASG” or the “Company” refer to ASG and its direct and indirect subsidiaries. ASG’s executive offices are located at 105 Westpark Drive, Suite 200, Brentwood, Tennessee 37027.

Audit Committee Investigation

     On October 24, 2005, the Company announced that the Audit Committee had initiated an internal investigation into certain matters related to SPP. As disclosed in further detail in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005, on March 15, 2006 the Company announced that the Audit Committee had concluded its investigation and reached certain conclusions with respect to findings of the investigation that resulted in an accrual of $3.7 million of aggregate refunds due to customers, including PHS, that were not charged by SPP in accordance with the terms of the respective contracts. In circumstances where SPP’s incorrect billings resulted in PHS billing its clients incorrectly, PHS passed the applicable amount through to its clients. This amount plus associated interest represented management’s best estimate of the amounts due to affected customers, based on the results of the Audit Committee’s investigation. As of December 31, 2010, the Company has paid all of these refunds plus associated interest to customers except for $0.4 million which has been tendered for payment to the Delaware Department of Corrections, which was serviced by a customer of SPP (see Note 21 to the Company’s consolidated financial statements and Item 3. “Legal Proceedings”). The ultimate amounts paid could differ from the Company’s estimates; however, actual amounts to date have not differed materially from the estimated amounts. There can be no assurance that the Company, a customer or a third-party, including a governmental entity, will not assert that additional amounts, which may include penalties and/or associated interest, are owed to these customers. During the year ended December 31, 2010, the Company recognized additional expense totaling $0.5 million relative to this matter which is primarily due to legal expenses incurred as part of the Company reaching a settlement on February 19, 2010, regarding the shareholder litigation filed against the Company and certain individual defendants on April 6, 2006 and related litigation filed by the Company against one of its insurance carriers (see Note 21 to the Company’s consolidated financial statements and Item 3. “Legal Proceedings”).

Correctional Healthcare Services

     The Company, through PHS and CHS, contracts with state, county and local governmental agencies to provide and/or administer healthcare services to inmates of prisons and jails. The Company’s revenues from correctional healthcare services are generated primarily by payments from governmental entities, none of which are dependent on third party payment sources although they are dependent on appropriate governmental funding. The Company provides and/or administers a wide range of on-site healthcare programs, and arranges for and oversees off-site hospitalization and specialty outpatient care. The hospitalization and specialty outpatient care is performed by third parties through arrangements with independent doctors and local hospitals. For each of the years ended December 31, 2010, 2009 and 2008, revenues from correctional healthcare services accounted for 100% of the Company’s healthcare revenues from continuing operations and discontinued operations combined.

     The Company’s target correctional market consists of state prison systems and county and local jails. A prison is a facility in which an inmate is incarcerated for an extended period of time (typically one year or longer). A jail is a facility in which the inmate is held for a shorter period of time, often while awaiting trial or sentencing. The expected higher inmate turnover in jails typically requires that healthcare be provided to a much larger number of individual inmates over time and includes the costs associated with stabilizing and treating whatever health conditions or injuries are present at the time of initial incarceration. As a result of the higher number of individual inmate patient encounters and the greater likelihood of previously undiagnosed acute healthcare needs associated with healthcare in jail settings, the severity and therefore related costs of treating such patients, particularly with respect to professional liability costs, are typically greater in jails as opposed to prison systems. Conversely, the costs of chronic healthcare requirements are generally greater with respect to state prison contracts. State prison contracts often cover a larger number of facilities and often have longer terms than jail contracts.

     Services Provided and/or Administered. Although the precise type of services to be provided and/or administered by the Company vary depending on the specific terms of a contract, generally, the Company’s obligation to provide and/or administer medical services to a particular inmate begins upon the inmate’s booking into the correctional facility and ends upon the inmate’s release. In order to reduce costs and provide better care, emphasis is placed upon early identification of serious injuries or illnesses so that prompt and clinically-effective treatment is commenced.

     Medical services provided and/or administered on-site may include physical and mental health screening upon intake. Screening includes the compilation of the inmate’s health history and the identification of any current, chronic or acute healthcare needs. After initial screening, services provided and/or administered may include regular physical and dental screening and care, psychiatric care, OB-GYN screening and care and diagnostic testing. Hospitalization is provided off-site at acute-care hospitals. Sick call is regularly conducted and physicians, nurse practitioners, physicians’ assistants and others are also involved in the delivery of care on a regular basis. Necessary medications are administered by clinical staff.

     Medical services provided and/or administered off-site may include specialty outpatient diagnostic testing and care, emergency room care, surgery and hospitalization. This care is performed by third parties through arrangements with independent doctors and local hospitals. In addition, the Company provides administrative support services on-site, at regional offices and at the Company’s headquarters. Administrative support services may include program management, maintenance of on-site medical records and

employee recruitment, scheduling, continuing education and quality assurance, medical audits, credentialing, and clinical program development activities.

     Most of the Company’s correctional contracts require it to staff the facilities it serves with nurses 24 hours a day. Doctors at the facilities have regular hours and are generally available on call. In addition, dentists, psychiatrists and other specialists are available on a routine basis at facilities where correctional contracts cover such services.

     The National Commission on Correctional Health Care (“NCCHC”) and the American Correctional Association (“ACA”) set standards for and offer accreditation to facilities that meet their respective standards. These standards provide specific guidance related to a service provider’s operations including administration, personnel, support services such as hospital care, regular services such as sick call, records management and medical and legal issues. Accreditation with NCCHC and ACA standards is voluntary and includes many other aspects of the operation of the correctional facility other than the healthcare component. As such, not all of the Company’s clients seek this accreditation. For those clients that do request the Company to seek such accreditation, the Company believes it has a 100% success rate of obtaining and maintaining accreditation with these organizations.

     The NCCHC, an independent not-for-profit organization initially formed by the American Medical Association, was established to improve the quality of health care in jails, prisons, and juvenile confinement facilities. NCCHC offers a voluntary health services accreditation program through external peer review to determine whether correctional institutions meet certain standards in their provision of health services. NCCHC renders a professional judgment and assists in the improvement of services provided and/or administered. The ACA, an independent not-for-profit organization, was established to develop uniformity and industry standards for the operation of correctional facilities and the provision of inmate healthcare. Accreditation involves an extensive audit and compliance procedure, and is generally granted for a three-year period.

     Contract Provisions. The Company’s contracts with correctional institutions typically fall into one of three general categories: fixed fee, population based, or cost plus a fee. For fixed fee contracts, the Company’s revenues are based on fixed monthly amounts established in the service contract irrespective of inmate population. The Company’s revenues for population-based contracts are based either on a fixed fee that is subsequently adjusted using a per diem rate for variances in the inmate population from predetermined population levels or on a per diem rate multiplied by the average or actual inmate population for the period of service. For cost plus a fee contracts, the Company’s revenues are based on actual expenses incurred during the service period plus a contractual fee.

     Some contracts provide for annual increases in the fixed fee or per diem based upon the regional medical care component of the Consumer Price Index. In all other contracts that extend beyond one year, the Company utilizes a projection of the future inflation rate of the Company’s costs of services when bidding and negotiating the fixed fee for future years. The Company often bears the risk of increased or unexpected costs, which could result in reduced profits or cause it to sustain losses when costs are higher than projected. Conversely, the Company will derive increased profits when costs are lower than projected. Certain contracts also contain financial penalties when performance and/or staffing criteria are not achieved.

     Generally, the Company’s contracts will also include additional provisions that mitigate a portion of the Company’s risk related to cost increases. Off-site utilization risk is mitigated in the majority of the Company’s contracts through aggregate pools or caps for off-site expenses, stop-loss provisions, cost plus a fee arrangements or, in some cases, the entire exclusion of certain or all off-site service costs. Pharmacy expense risk is similarly mitigated in certain of the Company’s contracts. Typically, under the terms of such provisions, the Company’s revenue under the contract increases to offset increases in specified cost categories such as off-site expenses or pharmaceutical costs. While such provisions serve to mitigate the Company’s exposure to losses resulting from cost fluctuations in the specified cost categories, the Company will still experience variances in its gross margin percentage on these contracts as the additional revenue under these contract provisions is typically equal to the additional costs incurred by the Company. Many contracts contain termination provisions which allow either party to terminate the contract under agreed-upon notice periods. The ability to terminate a contract serves to mitigate the Company’s risk related to increasing costs of services being provided.

     At December 31, 2010, contracts accounting for approximately 8.7% of the Company’s correctional healthcare services revenues from continuing operations for the year ended December 31, 2010 contain no limits on the Company’s exposure for treatment costs related to off-site expenses, catastrophic illnesses or injuries to inmates. However, none of these contracts has longer than one year remaining without a termination provision.

     Moreover, when preparing bid proposals, the Company estimates the extent of its exposure to cost increases, severe individual cases and catastrophic events and attempts to compensate for its exposure in the pricing of its bids. The Company’s management has experience in evaluating these risks for bidding purposes and maintains an extensive database of historical experience. Nonetheless, increased or unexpected costs against which the Company is not protected could render a contract unprofitable. Furthermore, in an effort to manage risk under contracts that contain no limits on the Company’s exposure for treatment costs related to off-site expenses, catastrophic illnesses or injuries to inmates, the Company typically maintains stop loss insurance from an unaffiliated insurer with

respect to, among other things, inpatient and outpatient hospital expenses (as defined in the policy) for amounts in excess of $375,000 per inmate up to an annual cap of $1.0 million per inmate and $3.0 million in total. Amounts reimbursable per claim under the policy are further limited to the lesser of billed charges, the amount paid or the contracted amounts in situations where the Company has negotiated rates with the applicable providers.

     The average length of a contract for services is generally one to three years, with subsequent renewal options. In general, contracts may be terminated by the governmental agency, and often by the Company as well, without cause at any time upon proper notice. The required notice period for such contracts ranges from one day to six months, but is typically between 60 and 120 days. Governmental agencies may be subject to political or financial influences that could lead to termination of a contract through no fault of the Company. As with other governmental contracts, the Company’s contracts are subject to adequate budgeting and appropriation of funds by the governing legislature or administrative body.

     Administrative Systems. The Company has centralized administrative systems in order to enhance economies of scale and to provide management with accurate, up-to-date field data for forecasting purposes. These systems also enable the Company to refine its bids and help the Company reduce the costs associated with the delivery of consistent healthcare.

     The Company maintains a utilization review system to monitor the extent and duration of most healthcare services required by inmates on an inpatient and outpatient basis. The current automated utilization review program is an integral part of the services provided and/or administered at each facility. The system is designed to ensure that the medical care rendered is medically necessary and is provided safely in a clinically appropriate setting while maintaining traditional standards of quality of care. The system provides for determinations of medical necessity by medical professionals through a process of pre-authorization and concurrent review of the appropriateness of any hospital stay. The system seeks to identify the maximum capability of on-site healthcare units to allow for a more timely discharge from the hospital back to the correctional facility. The utilization review staff consists of doctors and nurses who are supported by medical directors at the regional and corporate levels.

     The Company has developed a variety of customized databases to facilitate and improve operational review including (i) a claims management tracking system that monitors current outpatient charges and inpatient stays, (ii) a comprehensive cost review system that analyzes the Company’s average costs per inmate at each facility, which includes pharmaceutical utilization and trend analysis available from Maxor, and (iii) a daily operating report to manage inpatient stays.

     Bid Process. Contracts with governmental agencies are obtained primarily through a competitive bidding process, which is governed by applicable state and local statutes and ordinances. Although practices vary, typically a formal request for proposal (“RFP”), or similar request or invitation, is issued by the governmental agency, stating the scope of work to be performed, length of contract, performance bonding requirements, minimum qualifications of bidders, selection criteria and the format to be followed in the bid or proposal. Usually, a committee appointed by the governmental agency reviews bids and makes an award determination. The committee may award the contract to a particular bidder or decide not to award the contract. Typically, the committee considers a number of factors, including the technical quality of the proposal, the bid price and the reputation of the bidder for providing quality care. The award of a contract may be subject to formal or informal protest by unsuccessful bidders through a governmental appeals process. If the committee does not award a contract, the correctional agency may, among various options, continue to provide healthcare services to its inmates with its own personnel or the existing provider.

     Contractual and Regulatory Compliance. The Company’s contracts with governmental agencies often require it to comply with numerous additional requirements regarding record-keeping and accounting, non-discrimination in the hiring of personnel, safety, safeguarding confidential information, management qualifications, professional licensing requirements, emergency healthcare needs of corrections employees and other matters. If a violation of the terms of an applicable contractual or statutory provision occurs, a contractor may be debarred or suspended from obtaining future contracts for specified periods of time in the applicable location. The Company has never been debarred or suspended from seeking procurements in any jurisdiction.

     Marketing. The Company gathers, monitors and analyzes relevant information on potential jail and prison systems which meet predefined new business criteria. These criteria include facility size, location, revenue and margin potential and exposure to risk. The Company then devotes the necessary resources in securing new business.

     The Company believes it is one of the largest private providers of healthcare services to county/municipal jails and detention centers in the United States. The Company will continue to focus its business development efforts on those facilities where stabilization and treatment of the population is the primary mission. The Company will also continue to pursue certain opportunities at state prison systems, where in many cases, services are provided to a larger system with a more permanent population. Due to the more permanent population at the state prison facilities, the primary healthcare mission shifts to disease management and treatment.

     The Company maintains a staff of sales and marketing representatives assigned to specific projects, geographic areas or markets. In addition, the Company uses consultants, from time to time, to help identify marketing opportunities, to determine the needs of

specific potential customers and to engage customers and others on the Company’s behalf. The Company uses paid advertising and promotion to reach prospective clients as well as to reinforce its image with existing clients.

     Management believes that the constitutional requirement to provide healthcare to inmates, an increasing inmate population and medical Consumer Price Index, combined with public sector budget constraints, will continue the trend toward privatization of correctional healthcare and present opportunities for future revenue growth for the Company.

Pharmaceutical Distribution Services

     Prior to May 1, 2007, the Company, through SPP, contracted with federal, state and local governments and certain private entities (including PHS) to distribute pharmaceuticals and certain medical supplies to inmates of correctional facilities. However, as discussed above in Item 1. “General — Business,” SPP sold certain of its assets to Maxor effective April 30, 2007 which ended the Company’s participation in pharmaceutical distribution services as a separate segment.

Employees and Independent Contractors

     The services provided and/or administered by the Company require an experienced staff of healthcare professionals and facilities administrators. In particular, a nursing staff with experience in correctional healthcare and specialized skills in all necessary areas contributes significantly to the Company’s ability to provide efficient service. In addition to nurses, the Company’s staff of employees and independent contractors includes physicians, dentists, psychologists and other healthcare professionals.

     As of December 31, 2010, the Company had approximately 3,290 employees, including approximately 191 doctors and 1,516 nurses. The Company also utilizes approximately 1,204 independent contractors, including physicians, dentists, psychiatrists, psychologists and other healthcare professionals. Of the Company’s employees, approximately 507 are represented by labor unions. The Company believes that its employee relations are good.

Seasonality

     The Company’s business of correctional healthcare services is not materially impacted by seasonality.

Competition

     The business of providing correctional healthcare services to governmental entities is highly fragmented and competitive with few barriers to entry. The Company is in direct competition with local, regional and national correctional healthcare providers including certain state medical schools and other state or municipal organizations. The Company estimates that it currently has approximately 6% of the combined privatized and non-privatized market, based on its estimates of national aggregate annual expenditures on correctional healthcare services. Its primary competitors are Correctional Medical Services, which the Company estimates currently has approximately 7% of the combined privatized and non-privatized market, and Correct Care Solutions, LLC and Wexford Health Sources, Inc., which the Company estimates each currently have approximately 2% of such market. The market share estimates shown above for the Company reflect its contracts currently in place. The market share estimates shown above for Correctional Medical Services, Correct Care Solutions, LLC and Wexford Health Sources, Inc., reflect the Company’s estimate of contracts currently held by these competitors. As the private market for providing correctional healthcare matures, the Company’s competitors may gain additional experience in bidding and administering correctional healthcare contracts. In addition, new competitors, some of whom may have extensive experience in related fields or greater financial resources than the Company, may enter the market.

Government Regulation

     Governmental Regulations and Court Orders. The industry in which the Company operates is subject to extensive federal, state and local regulations and/or orders of judicial authorities, including healthcare, pharmaceutical and safety regulations and judicial orders, decrees and judgments. Some of the regulations and orders are unique to the Company’s industry, and the combination of regulations and orders it faces is unique. Generally, prospective providers of healthcare services to correctional facilities must be able to comply with a variety of applicable state and local regulations and judicial orders. The Company’s contracts typically include reporting requirements as well as, supervision and on-site monitoring by representatives of the contracting governmental agencies or courts. In addition, the Company’s doctors, nurses and other healthcare professionals who provide services on its behalf are in most cases required to obtain and maintain professional licenses and are subject to state regulation regarding professional standards of conduct. The Company’s services are also subject to operational and financial audits by the governmental agencies with which the Company has contracts and by the courts of competent jurisdiction. The Company may not always successfully comply with these regulations or court orders and failure to comply can result in material penalties, or non-renewal or termination of contracts with correctional facilities, or prohibition from proposing for new business in certain jurisdictions.

     Health Insurance Portability and Accountability Act of 1996. The Administrative Simplification Provisions of the Health Insurance Portability and Accountability Act of 1996 (“HIPAA”) require the use of uniform electronic data transmission standards for healthcare claims and payment transactions (“standard transactions”) submitted or received electronically. These provisions are intended to encourage electronic commerce in the healthcare industry. Beginning January 28, 2010, the Company began conducting certain standard transactions electronically. As a result, the Company became a HIPAA covered entity and is subject to applicable HIPAA regulations.

     HIPAA includes extensive privacy and security regulations governing the use and disclosure of protected health information by health care providers, health care plans and health care clearinghouses (“covered entities”) and requires covered entities to implement administrative, physical and technical safeguards to protect the security of such information. The American Recovery and Investment Act of 2009 (“ARRA”) expanded the scope of the HIPAA privacy and security regulations. ARRA increases civil penalties for violations of HIPAA and broadens the applicability of criminal penalties to employees of covered entities. ARRA also strengthens enforcement of HIPAA by requiring the U.S. Department of Health and Human Services to conduct periodic audits and authorizes state attorney generals to bring civil actions seeking injunctions or damages in response to violations of HIPAA privacy and security regulations that threaten the privacy of state residents. In addition to HIPAA, most states have enacted laws governing the use and disclosure of patient health information These state laws supersede HIPAA to the extent they are more restrictive than the privacy and security standards in HIPAA. The Company has in place a HIPAA compliance plan which is enforced and monitored for compliance by our privacy and security officers.

     Corporate Practice of Medicine/Fee Splitting. Many of the states in which the Company operates have laws that prohibit unlicensed persons or business entities, including corporations, from employing physicians or laws that prohibit certain direct or indirect payments or fee-splitting arrangements between physicians and unlicensed persons or business entities. Possible sanctions for violations of these laws include loss of a physician’s license, civil and criminal penalties and rescission of business arrangements that may violate these restrictions. These statutes vary from state to state, are often vague and seldom have been interpreted by the courts or regulatory agencies. The Company reviews, on an ongoing basis, the applicable laws in each state in which the Company operates and reviews its arrangements with its healthcare providers to ensure that these arrangements comply with all applicable laws. The Company can provide no assurance that governmental officials responsible for enforcing these laws will not assert that the Company, or transactions in which it is involved, are in violation of such laws, or that such laws ultimately will be interpreted by the courts in a manner consistent with the Company’s interpretations.

Major Contracts

     Substantially all of the Company’s operating revenue is derived from contracts with state, county and local governmental entities. The Company’s Rikers Island, New York contract accounted for approximately 18.7% of the total healthcare revenues from continuing and discontinued operations combined for the year ended December 31, 2010. The Company’s Commonwealth of Pennsylvania, Department of Corrections contract accounted for approximately 15.1% of the total healthcare revenues from continuing and discontinued operations combined for the year ended December 31, 2010. The Company’s contract to provide prisoner health care services to prisoners under the care of the State of Michigan Department of Corrections accounted for approximately 17.1% of the total healthcare revenues from continuing and discontinued operations combined for the year ended December 31, 2010. No other contract accounted for 10% or more of such revenues during the years ended December 31, 2010, 2009 or 2008. Summaries of the Company’s three largest contracts based on healthcare revenues from continuing and discontinued operations combined for the fiscal year ended December 31, 2010 follow below.

     Rikers Island Contract. Effective January 1, 2005, the Company, through PHS, entered into a contract with the New York City Department of Health and Mental Hygiene (“NYCDOH”) to provide management and administrative services with respect to the provision of comprehensive medical, mental health, dental and ancillary services to inmates in the custody of the New York City Department of Correction. The three-year “cost plus fixed fee” contract commenced on January 1, 2005 and was renewed, effective as of January 1, 2008 (the “Renewal Agreement”). Pursuant to the Renewal Agreement, PHS, through arrangements with professional service corporations, who are also parties to the Renewal Agreement, administered the provision of comprehensive medical, mental health, dental and ancillary services to inmates in the custody of the New York City Department of Correction. The renewed “cost plus fixed fee” contract had a term of three years ending on December 31, 2010. Pursuant to the Renewal Agreement, PHS was subject to mandatory staffing and other performance requirements. Additionally, NYCDOH was required to indemnify PHS and the professional service corporations and their respective employees for damages for personal injuries and/or death alleged to have been sustained by an inmate by reason of malpractice, except where PHS or the professional service corporations or their respective employees had engaged in intentional misconduct or a criminal act.

     On December 30, 2010, PHS and the NYCDOH entered into a two-year contract, effective January 1, 2011 for PHS to provide administrative services related to the provision of comprehensive medical, mental health, dental and ancillary services to inmates in the custody of the New York City Department of Correction. The new contract with NYCDOH has substantially the same contract provisions as the Renewal Agreement discussed above.

     Commonwealth of Pennsylvania, Department of Corrections. The Company, through PHS, entered into a contract with the Commonwealth of Pennsylvania, Department of Corrections (“Pennsylvania DOC”) on September 1, 2003, for a period of five years for medical services exclusive of mental health and pharmacy. On January 31, 2008, PHS and the Pennsylvania DOC entered into Contract Modification Agreement No. 3 to the current contract, which extended the current contract with Pennsylvania DOC for a period of five additional years through August 31, 2013. The contract covers each of the 27 Pennsylvania state prison system facilities. The Pennsylvania DOC pays the Company a flat rate per month, which is adjusted for changes in inmate population levels. Under the terms of the contract, the Company is reimbursed for the costs of the medical malpractice insurance related to this contract and its exposure to off-site medical costs related to this contract is limited to a specified maximum amount. Pharmacy and mental health services are provided by separate contractors to the Pennsylvania DOC. The Pennsylvania DOC may terminate the contract on six months’ notice. The Company may terminate the contract without cause subject to delivery of nine months notice to the Pennsylvania DOC.

     Michigan Department of Corrections. On February 10, 2009, the Company, through PHS, and the State of Michigan entered into a three-year contract under which PHS will provide prisoner health care services to prisoners under the care of the State of Michigan Department of Corrections (the “Michigan Contract”). PHS began providing prisoner health care services under the Michigan Contract on April 1, 2009. Compensation payable to PHS under the Michigan Contract is based on a fixed per prisoner per month rate that will be adjusted for changes in monthly average prisoner population and annually for inflation. Compensation is also subject to adjustment in accordance with the risk-sharing terms described in the Michigan Contract. After its initial three-year term, the Michigan Contract may be renewed for up to four additional one-year periods by mutual, written agreement of the parties not less than 30 days before the expiration of the then current term. Under the terms of the Michigan Contract, the State of Michigan may terminate the Michigan Contract for cause if PHS (i) breaches any of its material duties or obligations under the Michigan Contract, or (ii) fails to cure a breach within the time period specified in the written notice of breach provided by the State of Michigan. In addition, the State of Michigan may terminate the Michigan Contract if it determines that a termination is in its best interest. PHS has also agreed to indemnify, defend and hold harmless the State of Michigan from liability for injuries or damages that are attributable to the negligence or tortious acts of PHS, its employees, agents or subcontractors in its performance of the Michigan Contract.

Other Available Information

     The Company files its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and all amendments to those reports with the SEC. Copies of these documents may be obtained by visiting the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549, by calling the SEC at 1-800-SEC-0330 or by accessing the SEC’s website at http://www.sec.gov. In addition, as soon as reasonably practicable, after such materials are filed with or furnished to the SEC, the Company makes copies of these documents available to the public free of charge through its web site at http://www.asgr.com or by contacting its Corporate Secretary at its principal offices, which are located at 105 Westpark Drive, Suite 200, Brentwood, Tennessee 37027, telephone number (615) 373-3100.

PART I

Item 1A. Risk Factors

     If any of the events discussed in the following risks were to occur, the Company’s business, financial condition, results of operations, cash flows or prospects could be materially and adversely affected. Additional risks and uncertainties not presently known, or currently deemed immaterial by the Company, may also constrain its business and operations. In either case, the trading price of the Company’s common stock could decline and stockholders could lose all or part of their investment.

     The Company has entered into the Merger which is subject to shareholder approval, regulatory approval and the performance of the parties to the Merger Agreement. As discussed in Part 1. — Item 1. “Business — Significant Recent Development”, on March 2, 2011, the Company entered into the Merger Agreement. Management of the Company is unable to predict what effect the Merger may have on its business, financial condition, results of operations or stock price. The material factors that could have an effect on the Company’s business, financial condition, results of operations or stock price include, without limitation, the following: (1) the inability to complete the Merger in a timely manner; (2) the inability to complete the Merger due to the failure to obtain stockholder approval or the failure to satisfy other conditions to completion of the Merger, including expiration or termination of the waiting period under the HSR Act; (3) the occurrence of any event, change or other circumstance that could give rise to the termination of the Merger Agreement; (4) the failure to obtain the necessary debt financing arrangements set forth in the commitment letters received by Valitás in connection with the Merger Agreement; (5) the impact of the substantial indebtedness incurred to finance the consummation of the Merger; (6) the possibility that competing offers will be made; (7) the effect of the announcement of the transaction on the Company’s business relationships, operating results and business generally, either before or after the consummation of the transaction; (8) diversion of management’s attention from ongoing business concerns as a result of the pendency or consummation of the Merger; and (9) general economic or business conditions and other factors.

     The Company has paid refunds to customers and may be required to pay, or incur expenses investigating claims of, additional refunds. As a result of the internal investigation described in Item 1. “Business — Audit Committee Investigation,” the Audit Committee determined that, in certain instances, SPP did not charge its customers in accordance with applicable contracts. As a result, the Company recorded accruals to provide aggregate refunds to customers of approximately $3.7 million, covering all periods since the Company’s acquisition of SPP in September 2000, plus interest at the applicable federal rate (which ranged from 4% to 9%) during the period covered by the investigation. These amounts represented management’s best estimate of the amounts due to affected customers based on the Audit Committee’s investigation. However, the Company can provide no assurance that a customer or a third-party, including a governmental entity, will not assert that additional amounts, which may include penalties, are owed to these customers and, that as a result of such assertions, the Company will not incur additional investigation and related expenses or be required to make additional refunds.

     The Company is the subject of a certain government inquiry and the Company could become the subject of additional government investigations, enforcement actions or penalties in the future, any of which could adversely affect the Company. The Company could be the subject of future government investigations, enforcement actions or penalties. As previously and currently disclosed, the Company was the subject of a informal inquiry by the SEC as it related to the Audit Committee investigation. However, in November 2009, the SEC confirmed that its informal inquiry has been formally closed without any enforcement action. The SEC further confirmed it never issued a formal order of investigation or a Wells Notice relating to this matter.

     The Company was also the subject of an informal inquiry by the U.S. Attorney for the Middle District of Tennessee (the “U.S. Attorney”) with respect to those matters that were the subject of the Audit Committee’s internal investigation. The Company was informed in early 2010 that the U.S. Attorney has no active investigation against the Company. In addition, the Company has received notice from the Delaware Department of Justice, Office of Attorney General that it is conducting an inquiry into the indirect payment of claims by the Delaware Department of Correction to SPP for pharmaceutical services (see Note 21 to the Company’s consolidated financial statements and Item 3. “Legal Proceedings”). Both the Audit Committee and the Company have cooperated and intend to continue to cooperate fully with the Delaware Attorney General regarding its inquiry. However, there can be no assurance that the U.S. Attorney and the Delaware Attorney General or any other governmental authority (including, without limitation, the governmental entities with which the Company entered into contractual relationships) will not take any action that would adversely affect the Company as a result of the matters investigated by the Audit Committee. Such actions could result in criminal, civil or other penalties, including the imposition of fines, the termination of existing contracts, the debarment from pursuing future business in certain jurisdictions or additional restatements of the Company’s financial statements. Management of the Company is unable to predict the effect that any such actions may have on its business, financial condition, results of operations, cash flows or stock price.

     The Company was a defendant in a shareholder class action lawsuit and was required to pay damages in excess of the coverage of its directors and officers liability insurance. The Company and certain of its executive officers were named defendants in a shareholder class action lawsuit (see Note 21 to the Company’s consolidated financial statements and Item 3. “Legal Proceedings”). The Company and its current or former directors or officers could be named defendants in future shareholder class actions and could be required to pay damages in excess of the coverage of its directors and officers liability insurance in the future.

     The Company’s revenue depends on client contracts that are generally terminable without cause and termination of contracts accounting for a significant portion of its revenue could adversely affect its financial condition, results of operations and cash flows. The Company’s operating revenue is derived almost exclusively from contracts with state, county and local governmental agencies. Generally, contracts may be terminated by the governmental agency without cause upon proper notice (typically between 60 and 120 days). Governmental agencies may be subject to political or financial influences, including governmental budgetary concerns, that could lead to termination of a contract or failure to renew or extend a contract through no fault of the Company. Although the Company generally attempts to renew or renegotiate contracts at or prior to their termination, contracts that are put out for bid are subject to intense competition. As a result, the Company’s portfolio of contracts is subject to change. The changes in the Company’s portfolio of contracts are largely unpredictable, which creates uncertainties about the amount of its total revenues from period to period. The Company must engage in competitive bidding for new business to replace contracts that expire or are terminated. The Company, therefore, can provide no assurance that it will be able to replace contracts that expire or are terminated or are not renewed on favorable terms or otherwise. The non-renewal or termination, or renewal on unfavorable terms, of any of the Company’s

contracts with governmental agencies could have a material adverse affect on its financial condition, results of operations and cash flows.

     Additionally, the Company relies on a small number of client contracts for a significant portion of its revenues. The combined revenues of the Company’s Rikers Island, New York, Commonwealth of Pennsylvania, Department of Corrections and State of Michigan Department of Corrections contracts accounted for approximately 50.9% of the total healthcare revenues from continuing and discontinued operations combined for the year ended December 31, 2010. The loss of any of these contracts could have a material adverse effect on the Company’s financial condition, results of operations and cash flows. For more information on the Company’s significant contracts, see Item 1. “Business — Major Contracts.”

     The Company’s cash flow depends on timely payment and any delay or failure of its clients to make payments could adversely affect its results of operations or cash flows. The Company’s cash flow is subject to the receipt of sufficient funding of, and timely payment by, the governmental entities with which it contracts. Economic circumstances at the national, state or local level could affect governmental entity budgets, which could result in insufficient funding, increased pricing pressure or termination of contracts. In addition, federal, state and local governments are constantly under pressure to control additional spending or reduce current levels of spending. Accordingly, if a governmental entity does not receive sufficient or timely funding to cover its obligations under a healthcare services contract, the contract may be terminated and payment for the Company’s services could be delayed or not occur. The termination of contracts, a significant delay in payment or non-payment could adversely affect the Company’s financial condition, results of operations or cash flows.

     The Company’s future growth depends, in part, on further privatization of correctional healthcare services and it can provide no assurances that such further privatization will occur. The Company’s future revenue growth depends, in part, on continued privatization by state, county and local governmental agencies of healthcare services for correctional facilities. The Company believes, based on marketplace information and internal estimates that no significant annualized correctional healthcare contract revenues were newly privatized in 2010 by governmental agencies either for the first time or as a result of the expansion of existing contracted services to encompass additional or expanded services. There can be no assurance that this market will continue to grow or that existing contracts will continue to be made available to the private sector. Revenue growth could also be adversely affected by material decreases in the inmate population of correctional facilities. Any of these results could cause the Company’s revenue to decline and harm its business and operating results.

     Negative publicity concerning the Company or its business could adversely affect the Company’s business, results of operations and ability to obtain future business. Negative publicity regarding the provision of correctional healthcare services by for-profit companies, including the Company, or specific alleged actions or inactions of the Company could adversely affect the Company’s results of operations or business. Privatization of healthcare services for correctional facilities may encounter resistance from groups or constituencies that believe that healthcare services to correctional facilities should only be provided by governmental agencies. Negative publicity regarding the privatization of correctional healthcare services or specific alleged actions or inactions of the Company or other industry participants may result in increased regulation and legislative review of industry practices that further increase the Company’s costs of doing business and adversely affect its results of operations by:

	•		requiring the Company to change its services;
	•		placing pressure on certain of the Company’s clients either to force such clients to change the way they do business with the Company or sever their relationship with the Company altogether;
	•		increasing the Company’s exposure to litigation;
	•		increasing the regulatory burdens under which it operates; or
	•		adversely affecting its ability to market its services.

     Moreover, negative publicity relating to the Company in particular also may adversely affect its ability to renew or maintain existing contracts or to obtain new contracts, which could have a material adverse effect on its business.

     The Company is subject to extensive government regulations and its failure to comply with such regulations could adversely affect its business or results of operations. Failure to comply with governmental regulations and/or orders of judicial authorities could result in material penalties or non-renewal or termination of the Company’s contracts to manage correctional and detention facilities. The industry in which the Company operates is subject to extensive federal, state and local regulations, including educational, healthcare, pharmacy and safety regulations and judicial orders, decrees and judgments. Some of the regulations are unique to the Company’s industry, and the combination of regulations it faces is unique. Generally, providers of healthcare services to correctional facilities must be able to comply with a variety of applicable state and local regulations and court orders. The Company’s contracts

typically include reporting requirements, supervision and on-site monitoring by representatives of the contracting governmental agencies or courts. The Company may not always successfully comply with these regulations or court orders, and failure to comply can result in material penalties, sanctions or non-renewal or termination of contracts, which could have a materially adverse affect on the Company’s business and results of operation. For a discussion of certain specific governmental regulations, see Item 1. “Business — Government Regulations.”

     The Company is subject to audits and investigations of governmental agencies, which could result in reduced reimbursements from its clients, refunds to its clients or civil or criminal penalties. Certain of the governmental agencies with which the Company contracts have the authority to audit and investigate its contracts with them. As part of that process, governmental agencies may review the Company’s performance of the contract, its pricing practices, its cost structure and its compliance with applicable laws, regulations and standards. For contracts that actually or effectively provide for certain reimbursement of expenses, if an agency determines that the Company has improperly allocated costs to a specific contract, it may not be reimbursed for those costs, and it could be required to refund the amount of any such costs that have been reimbursed. If a government audit asserts improper or illegal activities by the Company, it may be subject to civil and criminal penalties and administrative sanctions, including termination of contracts, forfeitures of profits, suspension of payments, fines and suspension or disqualification from doing business with certain governmental entities. Any adverse determination could adversely impact the Company’s ability to bid in response to RFPs in one or more jurisdictions and could have a materially adverse affect on the Company’s business and results of operation. Additionally, as a result of any governmental agency investigations and/or audits, the Company’s collections of balances due from its customers could be substantially delayed. See risk factors below for more information on the Company’s risk of accounts receivable collection.

     The Company’s business is highly competitive and increased competition could harm its business and operating results. The business of providing correctional healthcare services to governmental agencies is highly competitive with few barriers to entry. The Company is in direct competition with local, regional and national correctional healthcare providers, including certain state medical schools and other state or municipal organizations. The Company estimates that it currently has approximately 6% of the combined privatized and non-privatized market, based on its estimates of national aggregate annual expenditures on correctional healthcare services. Its primary competitors are Correctional Medical Services, which the Company estimates currently has approximately 7% of the combined privatized and non-privatized market, and Correct Care Solutions, LLC and Wexford Health Sources, Inc., which the Company estimates both currently have approximately 2% of such market. The market share estimates shown above for the Company reflect its contracts currently in place. The market share estimates shown above for Correctional Medical Services, Correct Care Solutions, LLC and Wexford Health Sources, Inc., reflect the Company’s estimate of contracts currently held by these competitors. As the private market for providing correctional healthcare matures, the Company’s competitors may gain additional experience in bidding and administering correctional healthcare contracts. In addition, new competitors, some of whom may have extensive experience in related fields or greater financial resources than the Company, may enter the market. Increased competition could result in a loss of contracts and market share, or less favorable contract terms, and could seriously harm the Company’s business and operating results.

     The Company’s growth strategy in part depends on its ability to identify, fund and integrate any future acquisitions and no assurances can be made that it will do so successfully. The Company’s expansion strategy involves both internal growth and, as opportunities become available, acquisitions. The inability to identify, fund and successfully integrate future acquisitions may significantly reduce the Company’s potential growth.

     Certain of the Company’s contracts expose it to costs related to catastrophic events, and therefore any such event could adversely affect the Company’s financial condition or results of operations. At December 31, 2010, contracts accounting for approximately 8.7% of the Company’s correctional healthcare services revenues from continuing operations for the year ended December 31, 2010 contain no limits on the Company’s exposure for treatment costs related to catastrophic illnesses or injuries to inmates. Although the Company attempts to compensate for the increased financial risk when pricing contracts that do not contain catastrophic limits there can be no assurance that the Company will not experience a catastrophic illness or injury of a patient that exceeds its coverage in the future. The occurrence of severe individual cases outside of the catastrophic limits contained in the Company’s insurance coverage could render contracts unprofitable and could have a material adverse effect on the Company’s financial condition and results of operations.

     The Company depends on key personnel, the loss of whom could adversely affect its business and operating results. The success of the Company depends in large part on the ability and experience of its senior management. The loss of services of one or more key employees could adversely affect the Company’s business and operating results. The Company has employment contracts with Richard Hallworth, President and Chief Executive Officer; Michael W. Taylor, Executive Vice President and Chief Financial Officer; Carl J. Keldie, M.D., Chief Medical Officer of PHS and Jonathan B. Walker, Senior Vice President and Chief Development Officer, as well as certain other key personnel. The Company does not maintain key man life insurance on any member of its senior management.

     The Company faces significant competition for qualified healthcare professionals and its failure to attract such professionals could adversely affect its operating results. The Company faces stiff competition for staffing, which may increase its labor,

professional liability and other costs (including contractually mandated penalties) and reduce profitability. The Company competes with other healthcare and service providers in recruiting qualified management and staff personnel for the day-to-day operations of its business, including nurses and other healthcare professionals. In some markets, the scarcity of physicians, nurses and other medical support personnel is a significant operating issue to healthcare businesses. This scarcity may require the Company to enhance wages and benefits to recruit and retain qualified nurses and other healthcare professionals. Because a significant percentage of the Company’s existing contracts are structured as fixed fee and/or population based contracts, the Company’s ability to pass along increased labor costs is limited. If the Company is not successful in attracting and retaining a sufficient number of qualified healthcare personnel in the future, it may not be able to perform under its contracts, which could lead to the loss of existing contracts or its ability to obtain new contracts. Moreover, lack of success in this area could further result in the provision of negligent healthcare services or in the provision of untimely healthcare services, or in the allegation of such negligent or untimely services (whether valid or invalid), any or all of which could increase the Company’s exposure to professional, medical, pharmaceutical or other liability expenses. Additionally, approximately 47% of the Company’s contracts contain financial penalties that apply when performance or staffing criteria are not achieved. For the year ended December 31, 2010, the Company incurred revenue deductions related to these criteria totaling approximately $0.2 million, or less than 1% of the Company’s total healthcare revenues from continuing operations and discontinued operations combined. Failure to attract qualified management and staff personnel for the day-to-day operations of the Company’s business could materially adversely affect the Company’s business and operating results.

     As a result of its business, the Company is exposed to professional liability claims and can provide no assurances that adequate levels of liability insurance will continue to be available or that it will not be exposed to claims in excess of its insurance coverage. The Company’s business ordinarily results in the Company becoming involved in actions for medical malpractice and other claims related to the provision of healthcare services with the attendant risk of substantial damage awards, or court endorsed non-monetary relief such as changes in operating practices or procedures, which may lead to the potential for substantial increases in the Company’s operating expenses. The most significant source of potential liability in this regard is the risk of suits brought by inmates (or their successors) alleging negligent healthcare services or the lack of timely adequate healthcare services. The Company may also be liable, as employer, for the negligence of healthcare professionals it employs or healthcare professionals or entities with whom it contracts. All but one of the Company’s contracts generally provides for the Company to indemnify the governmental agency for losses incurred related to healthcare provided by the Company and its agents. The Company maintains professional and general liability insurance; however, due to the use of adjustable premium policies in 2002 through 2006 and 2008 through 2010, with respect to a majority of its patients, the Company is effectively self-insured for professional liability claims incurred under its primary program. For 2007, the Company is insured through a claims made policy subject to per event and aggregate coverage limits. Any amounts ultimately incurred above the coverage limits contained in the Company’s professional and general liability insurance policies would be the responsibility of the Company. In addition to its primary program, the Company also has traditional risk transfer insurance policies that relate to certain specific healthcare services contracts. Many of the Company’s independent contractors maintain professional liability insurance in amounts deemed appropriate by management based upon the Company’s claims history and the nature and risks of its business. The Company indemnifies and pays for such coverage for some of its independent contractors. Management establishes reserves for the estimated losses that will be incurred under these insurance policies after taking into consideration the Company’s professional liability claims department and external counsel evaluations of the merits of the individual claims, analysis of claim history, actuarial analysis and coverage limits where applicable. However, there can be no assurance that a future claim or claims will not exceed management’s loss estimates or the limits of available insurance coverage, the result of which could have a material adverse impact on the Company’s financial condition, results of operations or cash flows.

     If the Company is unable to obtain adequate levels of insurance at reasonable costs its business and results of operations may be adversely affected. Adequate levels of malpractice and other liability insurance may not continue to be available to the Company at a reasonable price or at all. The Company is dependent on the financial health of the insurance carriers with whom it has insurance policies. Substantially all of the Company’s contracts require the Company to be insured at certain levels. Failure to obtain sufficient levels of professional liability insurance at a reasonable price or at all or deterioration in an insurance carrier’s financial health, may expose the Company to significant financial or contractual losses, which could have a material adverse impact on the Company’s financial condition, results of operations or cash flows.

     The Company’s business depends on the operation of its information technology systems and the failure or disruption of these systems could adversely affect its results of operations. The Company depends on its information technology systems for timely and accurate information. Failure to maintain effective and efficient information technology systems or disruptions in the Company’s information technology systems could cause disruptions in its business operations, loss of existing customers, difficulty in attracting new customers, disputes with customers and providers, potential regulatory problems, increases in administrative expenses and other adverse consequences.

     The Company’s failure to maintain effective internal control over financial reporting could adversely affect its business and operating results. Under rules of the SEC, promulgated under Section 404 of the Sarbanes-Oxley Act of 2002, the Company is required to furnish in its Annual Report on Form 10-K for each fiscal year a report by management on its internal control over financial reporting. The Company’s report must contain, among other matters, an assessment of the effectiveness of its internal

control over financial reporting as of December 31 of the applicable fiscal year, including a statement as to whether or not its internal control over financial reporting is effective. In the course of the Company’s assessment of the effectiveness of its internal control over financial reporting as of December 31, 2010, the Company has not identified any material weaknesses in its internal control over financial reporting. However, the Company cannot assure you that deficiencies or weaknesses in its controls and procedures will not be identified in the future. Any weaknesses or deficiencies that might be identified in the future, could harm the Company’s business and operating results, and could result in adverse publicity and a loss in investor confidence in the accuracy and completeness of its financial reports.

     The Company may be dependent on its credit facility for its capital requirements and it can make no assurances that it will be able to obtain alternative financing. The Company’s debt consists of a credit facility dated July 28, 2009, which was subsequently amended on March 2, 2010 with CapitalSource Bank. The Company may be dependent on the availability of borrowings pursuant to this credit facility to meet its working capital needs, capital expenditure requirements and other cash flow requirements.

     Recent market and economic conditions have been unprecedented and challenging, with significantly tighter credit markets. As a result of these conditions, the cost and availability of credit has been and may continue to be adversely affected in the United States. Concern about the stability of the markets, generally, and the strength of numerous financial institutions, specifically, has led many lenders to reduce, and in some cases, cease, to provide funding to borrowers. If these market and economic conditions continue, they may limit the Company’s ability to borrow money from CapitalSource Bank or other lenders. If the Company is unable to borrow sufficient amounts of money to fund its capital requirements, its financial condition, business and cash flows may be materially adversely affected.

     In addition, the Company’s access to funds under its credit facility depends on the ability of CapitalSource Bank to meet its funding commitment to the Company. The Company can provide no assurance that continuing long-term disruptions in the global economy and the continuation of tighter credit conditions among, and potential failures of, third party financial institutions as a result of such disruptions, will not have an adverse effect on CapitalSource Bank and its lenders. If the Company’s lenders are not able to meet their funding commitments, the Company’s business, results of operation, cash flows and financial condition could be adversely affected.

     The credit facility requires the Company to meet certain financial covenants related to minimum levels of earnings. The financial covenants contained in the credit facility are described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources” contained in this Annual Report on Form 10-K. Should the Company fail to meet its projected results, fail to remain in compliance with the terms of the credit facility or fail to obtain a waiver, amendment or other curative document, in the event of default, it may be forced to seek alternative sources of financing. No assurances can be made that the Company can obtain alternative financing arrangements on terms acceptable to it, or at all.

     A prolonged economic slowdown or recession could adversely affect the Company’s business and operating results. The Company may be exposed to risks related to the overall macro-economic environment, including deflationary pressures on pricing and governmental budgetary shortfalls that could result in inadequate payments under its healthcare services contracts. Unfavorable economic conditions also could increase the Company’s funding and working capital costs, limit its access to the capital markets or result in a decision by lenders not to extend credit to the Company, any of which would adversely affect the Company’s business, financial condition, operating results or cash flows.

     An increase in inflation could adversely affect the Company’s operating results. Some of the Company’s contracts provide for annual increases in the fixed base fee based upon changes in the regional medical care component of the Consumer Price Index. In all other contracts that extend beyond one year, the Company utilizes a projection of the future inflation rate of its cost of services when bidding and negotiating the fixed fee for future years. If inflation exceeds projected levels, depending on the contract structure, the Company’s profitability could be adversely affected.

     The Company is required to maintain performance bonds and if it is unable to obtain or renew such bonds its financial condition and results of operations could be adversely affected. The Company is required under certain contracts to provide a performance bond and may also be required to post performance bonds for other business reasons. At December 31, 2010, the Company had outstanding performance bonds totaling $6.6 million. The performance bonds are renewed on an annual basis. The Company is also dependant on the financial health of the surety companies that it relies on to issue its performance bonds. An inability to obtain new or renew existing performance bonds could result in limitations on the Company’s ability to bid for new or renew existing contracts which could have a negative effect on the Company’s ability to retain existing contracts or be awarded new contracts.

     A change in the Company’s estimate of collectibility, or a delay in collection, of its accounts receivable, could adversely affect its results of operations. The Company’s accounts receivable are stated at estimated net realizable value. The Company recognizes allowances for doubtful accounts based on a variety of factors, including the length of time receivables are past due, significant one-time events, contractual rights, client funding and/or political pressures, discussions with clients and historical experience. If

circumstances change, estimates of the recoverability of receivables would be further adjusted and such adjustments could have a material adverse effect on the Company’s results of operations in the period in which they are recorded. Additionally, the timing of the collection of accounts receivable, if delayed, could have a material adverse effect on the Company’s cash flows from operations, days sales outstanding in accounts receivable, cash balances and debt levels outstanding.

     The Company’s stock repurchase program could affect its stock price and add volatility. There can be no assurance that the repurchases will be made or will be made at the best possible price. The existence of a stock repurchase program could also cause the Company’s stock price to be higher than it would be in the absence of such a program and could potentially reduce the market liquidity for its stock. Additionally, the Company is permitted to and could discontinue its stock repurchase program at any time and any such discontinuation could cause the market price of its stock to decline.

     The failure of a third party insurance carrier with whom the Company contracts could result in the Company losing insurance coverage or access to loss funding which has been prepaid to the insurance carrier. The Company contracts with third party insurance carriers to provide insurance related to worker’s compensation and professional liability claims for years 2002 to 2006 and 2008 through 2010. The Company’s insurance coverage under these policies is essentially self-insurance in the form of retro-premium adjustments based on actual claims experience. Under the terms of its insurance coverage for these policy periods, the Company was required to prepay insurance premiums to its third party insurance carrier, which are held by the third party insurance carrier to pay valid claims made under the policies in the same or subsequent years. For the 2007 professional liability claims policy, the Company has maintained an insurance policy that provides for per event and aggregate coverage limits on a claims made basis based on a fixed paid premium. If the financial position and/or liquidity of one of these third party insurance carriers were to become impaired such that the third party insurer was unable to pay claims or meet its contractual obligations to the Company, the Company could lose all or a portion of its prepaid premiums to such carrier and/or lose the benefit of the coverage it has paid for, the occurrence of which could have a material adverse effect on the Company’s financial position and its results of operations.

     The Company regularly maintains cash balances at a commercial bank in excess of the Federal Deposit Insurance Corporation insurance limit and the failure of such commercial bank could result in the loss of a portion of such cash deposits. The Company regularly maintains cash balances at a commercial bank in excess of the Federal Deposit Insurance Corporation insurance limit. If the commercial bank were to fail or be seized by federal regulators, the Company could lose a portion of its cash deposits at such bank, the result of which could have a material adverse effect on the Company’s financial position and results of operations.

     The Company has not established a minimum dividend payment level for its common stockholders and there are no assurances of the Company’s ability to pay dividends to common stockholders in the future. In July 2009, the Company’s Board of Directors adopted a quarterly dividend program for the purpose of returning capital to the Company’s stockholders. However, the Company has not established a minimum dividend payment level for its common stockholders and its ability to pay dividends may be harmed by the risks and uncertainties described in this Annual Report on Form 10-K and in the other documents it files from time to time with the SEC. Future dividends, if any, will be authorized by the Company’s Board of Directors and declared by the Company based upon a variety of factors deemed relevant by the Company’s directors, including, among other things, the Company’s financial condition, liquidity, earnings projections and business prospects. In addition, financial covenants in the Company’s credit facility may restrict the Company’s ability to pay future quarterly dividends. The Company can provide no assurance of its ability to pay dividends in the future.

     A decline in the fair value of the Company’s business could cause the Company to impair its goodwill resulting in a material non-cash charge to earnings. At December 31, 2010, the Company had approximately $41.0 million of goodwill recorded on its books. The Company expects to recover the carrying value of this goodwill through its future cash flows. On an ongoing basis, the Company evaluates, based on the fair value of its business, whether the carrying value of its goodwill is impaired. If the carrying value of the Company’s goodwill is impaired, it may incur a material non-cash charge to earnings. The current turmoil in the financial markets and weakness in macroeconomic conditions globally continue to be challenging and the Company cannot be certain of the duration of these conditions and their potential impact on its stock price performance. If a material decline in the Company’s market capitalization and other factors resulted in the decline in its fair value, it is reasonably likely that a goodwill impairment assessment prior to the next annual review, at December 31, 2011, would be necessary. If such an assessment is required, an impairment of goodwill may be recognized. A non-cash goodwill impairment charge would have the effect of decreasing the Company’s earnings or increasing its losses in the period the impairment is recognized. The amount of such effect on earnings and losses is dependent on the size of the impairment charge.

     Due to the Company’s participation in multiemployer pension plans, it could have exposure under those plans that may extend beyond what its current period obligations would be with respect to its employees. The Company contributes to two multiemployer pension plans on behalf of employees covered by collective bargaining agreements under the Rikers Island, New York contract. Contributions to these funds could increase as a result of future collective bargaining agreements, a shrinking contribution base as a result of the insolvency or withdrawal of other companies that currently contribute to these funds, inability or failure of withdrawing

companies to pay their withdrawal liability, low interest rates, lower than expected returns on pension fund assets or other funding deficiencies.

     We have no current intention to withdraw from any multiemployer pension plan, but if the Company were to do so, under the Employee Retirement Income Security Act of 1974, as amended (“ERISA”), the Company may be liable for a proportionate share of a plan’s unfunded vested liability, if any. No liability is presently required to be recorded as the future funded status of the plans, as well as the probability of any withdrawal event, are unknown.

Item 1B. Unresolved Staff Comments

     None.

Item 2. Properties

     The Company occupies approximately 51,490 square feet of leased office space in Brentwood, Tennessee, where it maintains its corporate headquarters. The Company’s lease on its current headquarters expires in April 2016. The Company leases additional office facilities in Alameda, California; Lansing, Michigan; Verona, New Jersey; Astoria, New York; Camp Hill, Pennsylvania and Richmond, Virginia. While the Company may open additional offices to meet the local needs of future contracts awarded in new areas, management believes that its current facilities are adequate for its existing contracts for the foreseeable future.

Item 3. Legal Proceedings

Litigation and Claims

     The Company is a party to various legal proceedings incidental to its business. With respect to all litigation matters, the Company considers the likelihood of a negative outcome typically in consultation with outside counsel handling the Company’s defense in these matters and estimates of the probable costs for resolution of these matters are based upon an estimated range of potential results, assuming a combination of litigation and settlement strategies. If the Company determines the likelihood of a negative outcome is probable and the amount of the loss can be reasonably estimated, the Company records an estimated loss for the expected outcome of the litigation. However, it is difficult to predict the outcome or estimate a possible loss or range of loss in some instances because litigation is subject to significant uncertainties. It is possible that future results of operations for any particular quarterly or annual period could be materially affected by changes in assumptions, new developments or changes in approach, such as a change in settlement strategy in dealing with litigation.

     DeSantis Professional Liability Suit. On August 26, 2010, Theresa DeSantis and Julie Giangiolini, as guardians of the estate of Anthony DeSantis, Jr., filed a complaint in the Court of the Sixteenth Judicial Circuit in Kane County, Illinois alleging that PHS, by and through the actions of its medical staff committed medical negligence which caused Anthony DeSantis Jr. to suffer from significant injuries. Plaintiffs seek damages to recoup compensation for past and future pain and suffering, loss of income, medical bills incurred and for the cost of future medical treatment. This matter is currently in the discovery phase; however, the Company believes that a negative outcome is probable and has recorded significant reserves related to this matter. Such reserve is included in the Company’s reserves for professional liability claims which total $22.6 million at December 31, 2010. Should the ultimate resolution of this matter exceed the Company’s recorded reserves and available insurance coverage, such resolution could have a material adverse effect on the Company’s results of operations, financial position or cash flows in future periods.

     Dawkins Professional Liability Suit. On September 18, 2009, Johnathan Dawkins, Sara H. Humphrey, guardian ad litem of Johnathan Dawkins, a mentally incapacitated person and Sara H. Humphrey, individually, filed a complaint in the U.S. District Court of New Jersey, against CHS, the New Jersey Counties of Essex and Union and a broad number of correctional personnel. The complaint alleges that in 2007 Johnathan Dawkins suffered permanent injuries while incarcerated at the Union County Jail as a result of actions of the defendants. This matter is currently in the discovery stage. Management currently believes this matter is covered under the policy limits of its 2007 professional liability insurance policy, however, should the ultimate resolution of this matter exceed such policy limits, such resolution could have a material adverse effect on the Company’s results of operations, financial position or cash flows in future periods.

     Chatham County, Georgia, Tuberculosis Matter. On December 22, 2010, attorneys on behalf of Phillip Perez, a former detainee at the Chatham County Detention Center, asserted an Ante Litem Notice of Claim to PHS, Inc. and a broad number of governmental entities, including Chatham County, Georgia Department of Corrections and Georgia Department of Community Health for a proposed class of individuals who were allegedly exposed to, and contracted, tuberculosis from December 2009 to present. Claimants’ allegations include the contraction of tuberculosis due to defendants’ acts and/or omissions in testing, medical care and policies and procedures. Mr. Perez claims special and general damages for pain and suffering and/or wrongful death of proposed class members. Defendants are currently in the process of investigating this matter and therefore, the Company is unable to

determine the significance of this matter. As of December 31, 2010, the Company has minimal reserves related to this matter; however, if claimant does file suit and is successful at certifying a class of plaintiffs, the outcome of such a lawsuit could have a material adverse effect on the Company’s financial position, results of operations or cash flows in future periods.

     Andrew Berkowitz, M.D., Individually and on behalf of all others similarly situated v. Prison Health Services, Inc. and City of Philadelphia. On or about August 2, 2006, plaintiff, an individual physician independent contractor in Philadelphia, Pennsylvania, filed a putative class action suit against PHS and the City of Philadelphia (the “City”) in the Court of Common Pleas of Philadelphia County, Trial Division, seeking unspecified damages for the class, but damages in the amount of approximately $10,000 individually. Plaintiff alleges that he provided services to inmates in the Philadelphia Prison System at the request of the defendants and that the defendants breached the alleged contractual duties owed to him by paying an amount alleged to be less than the full amount plaintiff billed for his medical services. On September 22, 2006, the City filed a New Matter Crossclaim against PHS alleging breach of contract, negligence and seeking indemnification. On September 29, 2006, PHS filed its Answer to plaintiff’s complaint, which Answer included a crossclaim against the City for contribution and indemnification. The plaintiff filed his motion for class certification on October 1, 2007; and PHS and the City responded to this motion. On January 16, 2009, the trial court denied the plaintiff’s motion for class certification. In May 2010, the superior court upheld the denial for class certification. In October 2010, the trial court issued an order closing the case. As of December 31, 2010, the Company has no reserves associated with this proceeding and considers this matter closed.

     Saint Joseph’s Regional Medical Center v. Correctional Health Services, et al. On or about February 8, 2007, CHS, was served with a lawsuit by plaintiff, Saint Joseph’s Regional Medical Center (“St. Joseph’s”). Plaintiff filed suit in the Superior Court of New Jersey, Law Division: Passaic County, against CHS, Barnert Hospital, County of Bergen, Bergen County Jail, County of Essex, Essex County Jail, County of Hudson, Hudson County Jail, County of Passaic and Passaic County Jail, “John Does #1-30”, “ABC Corporations #1-30”, “XYZ Jails, Prisons and/or Detention Centers” seeking damages from CHS totaling approximately $2.5 million. Plaintiff claims that CHS failed to administer various contracts with respect to medical claims for the treatment of certain patients and the payment of such claims between each of the respective counties and jails named in the complaint and Barnert Hospital, to which St. Joseph’s claims it was an intended third-party beneficiary. On August 15, 2007, Barnert Hospital filed for Chapter 11 bankruptcy protection. As a result, the court has stayed the proceedings in the lawsuit pending resolution of the bankruptcy. CHS intends to defend itself vigorously, and maintains that it is not responsible for any payments that may be due and owing to the plaintiff. However, a judgment adverse to CHS could have a material adverse effect on the Company’s financial position and its results of operations. As of December 31, 2010, the Company has no reserves associated with this proceeding.

     Matters involving PHS and Baltimore County, Maryland. PHS is currently involved in a lawsuit with its former client, Baltimore County, Maryland (the “County”) in the Circuit Court for Baltimore County, Maryland seeking collection of outstanding receivable balances, damages for breach of contract, quantum meruit, and unjust enrichment as well as prejudgment interest (the “Collection Matter”). The outstanding receivable balances total approximately $1.7 million at December 31, 2010 and are primarily related to services performed by PHS between April 1, 2006 and September 14, 2006 while PHS and the County were jointly seeking a judicial interpretation of a contract dispute regarding whether the County had timely exercised its first renewal option under its contract with PHS.

     PHS contended that the original term of its contract with the County expired on June 30, 2005, without the County exercising the first of three, two-year renewal options. On July 1, 2005, PHS sent a letter to the County stating its position that PHS’ contract to provide services expired on June 30, 2005 due to the County’s failure to provide such extension notice. The County disputed PHS’ contention asserting that it properly exercised the first renewal option and that the term of the contract therefore was through June 30, 2007, with extension options through June 30, 2011. In July 2005, the County and PHS agreed to have a judicial authority interpret the contract through formal judicial proceedings (the “Contract Matter”). At the written request of the County, PHS continued to provide healthcare services to the County from July 1, 2005 to September 14, 2006, under the terms and conditions of the contested contract, pending the judicial resolution of the Contract Matter, while reserving all of its rights. Finally, during September 2006, amid reciprocal claims of default, both PHS and the County took individual steps to terminate the relationship between the parties. PHS contends that it terminated the relationship effective September 14, 2006, due to various breaches by the County, including failure to remit payment of approximately $1.7 million primarily related to services rendered between April 1, 2006 and September 14, 2006. On October 27, 2006, PHS initiated the Collection Matter lawsuit against the County.

     The Collection Matter, although filed, was initially dormant, pending the resolution of the Contract Matter. As discussed in more detail below, the Contract Matter was resolved in favor of PHS on August 26, 2008, when the Maryland Court of Appeals (the State’s highest appellate court) denied the County’s request for a review of a Maryland Court of Special Appeals decision in favor of PHS. After the resolution of the Contract Matter, the parties, during 2009, commenced the discovery process on the Collection Matter. On March 30, 2010, the court held a scheduling conference in which the judge set February 8, 2011 as the trial date for the Collection Matter. Prior to the trial date, preliminary settlement discussions were conducted without resolution. Subsequently, the parties agreed to forego the trial and resolve the Collection Matter through binding arbitration which is expected to occur during the second quarter of 2011. PHS believes, in the case of the Collection Matter, that it has a valid and meritorious cause of action and, as a result, has

concluded that the outstanding receivables, which represent services performed under the relationship between the parties, continues to be probable of collection. However, although PHS believes it has valid contractual and legal arguments, an adverse result in the Collection Matter could have a negative impact on PHS’ ability to collect the outstanding receivable amount and result in losses in future periods.

     During 2008, the Contract Matter, mentioned above, was resolved in the following manner. In November 2005, the Circuit Court for Baltimore County, Maryland ruled in favor of the County, with respect to the Contract Matter, ruling that the County properly exercised its first, two-year renewal option by sending a faxed written renewal amendment to PHS on July 1, 2005. PHS appealed this ruling. On December 6, 2006, the Maryland Court of Special Appeals (i) reversed this judgment; (ii) ruled that the County did not timely exercise its renewal option by its actions of July 1, 2005; and (iii) remanded the case to the Circuit Court to determine whether the County properly exercised the option by its conduct prior to June 30, 2005 — an issue not originally decided by the Circuit Court. On May 15, 2007, the Circuit Court, upon remand, held a hearing on the parties’ pending cross motions for summary judgment. The Court issued an oral opinion at the end of the hearing indicating its intention to rule in favor of the County’s motion for summary judgment and against PHS’ motion for summary judgment. On June 6, 2007, the Court filed its order memorializing the aforementioned ruling. In its order, the Court ruled that, by its actions, the County properly and timely exercised the first two-year renewal option. The Company filed a Notice of Appeal and on May 14, 2008, the Maryland Court of Special Appeals issued its ruling that the actions the County claimed constituted an exercise of renewal were ineffective. Accordingly, the Court of Special Appeals reversed the Circuit Court’s ruling and directed it to grant the Company’s motion for summary judgment in the lawsuit. On June 27, 2008, the County petitioned the Maryland Court of Appeals (the State’s highest appellate court) to review the May 14, 2008 Court of Special Appeals decision. By order dated August 26, 2008, the Court of Appeals denied the County’s request to review the decision, resulting in the ruling of the Court of Special Appeals in favor of the Company becoming final, thereby bringing closure to the Contract Matter.

Matters Related to the Audit Committee Investigation and Shareholder Litigation

     As disclosed in further detail in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005, on March 15, 2006 the Company announced that its Audit Committee had concluded its investigation and reached certain conclusions with respect to findings of the investigation that resulted in the recording of amounts due to SPP’s customers that were not charged in accordance with the terms of their respective contracts.

     Shareholder Litigation. On April 6, 2006, plaintiffs filed the first of four similar securities class action lawsuits in the United States District Court for the Middle District of Tennessee against the Company and the Company’s Chief Executive Officer, at that time, and Chief Financial Officer. Plaintiffs’ allegations in these class action lawsuits were substantially identical and generally alleged on behalf of a putative class of individuals who purchased the Company’s common stock between September 24, 2003 and March 16, 2006 that, prior to the Company’s announcement of the Audit Committee investigation, the Company and/or the Company’s Chief Executive Officer, at that time, and Chief Financial Officer violated Sections 10(b) and 20(a) of the Securities and Exchange Act of 1934 and SEC Rule 10b-5 by making false and misleading statements, or concealing information about the Company’s business, forecasts and financial performance. The complaints sought certification as a class action, unspecified compensatory damages, attorneys’ fees and costs, and other relief. By order dated August 3, 2006, the district court consolidated the lawsuits into one consolidated action and on October 31, 2006, plaintiff filed an amended complaint adding SPP, Enoch E. Hartman III and Grant J. Bryson as defendants. Enoch E. Hartman III is a former employee of the Company and SPP and Grant J. Bryson is a former employee of SPP. The amended complaint also generally alleged that defendants made false and misleading statements concerning the Company’s business which caused the Company’s securities to trade at inflated prices during the class period. Plaintiff sought an unspecified amount of damages in the form of (i) restitution; (ii) compensatory damages, including interest; and (iii) reasonable costs and expenses. Defendants moved to dismiss the amended complaint on January 19, 2007, and the parties completed the briefs on the motion in May 2007. On March 31, 2009, the Court ruled on the defendants’ motion to dismiss, granting it in part and denying it in part. While the Court’s ruling dismissed significant portions of plaintiffs’ amended complaint and, as a result, narrowed the scope of plaintiffs’ claims, none of the defendants were dismissed from the case and several of plaintiffs’ claims under Sections 10(b) and 20(a) of the Securities and Exchange Act of 1934 and SEC Rule 10b-5 remained. The parties were not in agreement as to the scope of the Court’s order and defendants filed a motion to confirm which claims the Court dismissed in its March 31, 2009 ruling. The Court granted defendants’ motion to confirm the scope of the dismissal order on July 20, 2009, ruling that certain of Plaintiff’s claims had been in fact dismissed. The Court also confirmed, however, that certain other claims remained viable.

     On July 22, 2009, the Court administratively closed the shareholder litigation case, while the parties pursued mediation of this matter. On February 19, 2010, the parties agreed to the terms of a mediator’s proposal to settle all of the claims in this lawsuit. At a hearing on October 15, 2010, the Court approved the settlement, entering a final judgment and dismissing with prejudice all claims against all defendant in the litigation. The settlement provided for payment by the Company of $10.5 million and issuance by the Company of 300,000 shares of common stock. The total value of the settlement, based upon the Company’s closing share price for its common stock of $15.12 per share on October 15, 2010, is approximately $15.0 million. During the second quarter of 2010, the $10.5 million cash component of the settlement was paid by the Company to the escrow agent appointed by the Court. On October 18,

2010, the Company issued 300,000 shares of its common stock to the escrow agent appointed by the Court thereby fulfilling all terms of the approved settlement. The Company considers this matter closed.

     In September 2009, the Company and its primary directors and officers liability (“D&O”) carrier reached an agreement under which the Company and the primary D&O carrier mutually released each other from future claims related to this matter and the primary D&O carrier remitted insurance proceeds to the Company totaling $8.0 million, less approximately $0.4 million in legal fees paid by the primary D&O carrier as of the settlement date.

     In addition to its primary D&O carrier, with which the Company has settled all claims, the Company also maintains D&O insurance with an excess D&O carrier that provides for additional insurance coverage of up to $5.0 million for losses in excess of $10.0 million. The excess D&O carrier has denied coverage of this matter. After failing to reach agreement with the excess D&O carrier concerning the amount of their contribution to the settlement, the Company filed suit against the excess D&O carrier in the second quarter of 2010. This suit is currently in the discovery phase.

     Delaware Department of Justice Inquiry. On April 4, 2006, the Company received a letter notifying it that the Office of the Attorney General, Delaware Department of Justice is conducting an inquiry into the indirect payment of claims by the Delaware Department of Correction to SPP beginning in July 2002 and ending in the spring of 2005 for pharmaceutical services. There can be no assurance that the Delaware Department of Justice inquiry will not result in the Company incurring additional investigation and related expenses; being required to make additional refunds; incurring criminal, or civil penalties, including the imposition of fines; or being debarred from pursuing future business in certain jurisdictions. Management of the Company is unable to predict the effect that any such actions may have on its business, financial condition, results of operations or stock price. During the second quarter of 2010, the Company received a written offer from the Delaware Department of Justice to settle the inquiry in exchange for a cash payment. The Company has reserves totaling $0.4 million related to this matter which is the Company’s estimate of refund and associated interest due to the Delaware Department of Corrections, which was serviced by a customer of SPP (see Item 1. Business — Audit Committee Investigation). This amount is recorded in accrued expenses in the Company’s consolidated balance sheet. The Company is continuing to cooperate with the Delaware Department of Justice during its inquiry.

Other Matters

     The Company’s business ordinarily results in labor and employment related claims and matters, actions for professional liability and related allegations of deliberate indifference in the provision of healthcare and other causes of action related to its provision of healthcare services. Therefore, in addition to the matters discussed above, the Company is a party to a multitude of filed or pending legal and other proceedings incidental to its business. An estimate of the amounts payable on existing claims for which the liability of the Company is probable and estimable is included in accrued expenses. The Company is not aware of any unasserted claims that would have a material adverse effect on its consolidated financial position, results of operations or cash flows.

Item 4. Reserved

PART II

Item 5. Market For Registrant’s Common Stock, Related Stockholder Matters and Issuer Purchases of Equity Securities

     The Company’s common stock is traded on The Nasdaq Global Select Market’s National Market System under the symbol “ASGR.” As of March 1, 2011, there were approximately 71 registered holders of record of the Company’s common stock. The high and low sales prices of the Company’s common stock as reported on The Nasdaq Global Select Market during each quarter from January 1, 2009 through December 31, 2010 are shown below as well as the dividends per share declared on shares of the Company’s common stock by its Board of Directors for each quarter:

Quarter Ended		High				Low				Dividends
March 31, 2009		$	13.76			$	8.98			$	—
June 30, 2009		$	17.22			$	12.28			$	—
September 30, 2009		$	19.00			$	15.37			$	0.05
December 31, 2009		$	16.80			$	12.34			$	0.05
March 31, 2010		$	17.00			$	14.62			$	0.06
June 30, 2010		$	19.30			$	15.25			$	0.06
September 30, 2010		$	18.18			$	12.84			$	0.06
December 31, 2010		$	16.90			$	14.28			$	0.06

     The Company did not pay cash dividends on its common stock during the quarter ended March 31, 2009 and quarter ended June 30, 2009. The Company paid a $0.05 per share dividend on the Company’s common stock for each of the quarters ended September 30, 2009 and December 31, 2009 and a $0.06 per share dividend on the Company’s common stock for each of the quarters ended March 31, 2010, June 30, 2010, September 30, 2010 and December 31, 2010. On March 2, 2011, the Company’s Board of Directors declared a quarterly cash dividend of $0.06 per share on the Company’s common stock for the quarter ended March 31, 2011. The dividend will be paid on April 12, 2011 to stockholders of record on March 22, 2011.

     The Board of Directors’ adoption of a dividend program reflects the Company’s intent to return capital to stockholders. The Company expects that any future quarterly cash dividends will be paid from cash generated by the Company’s business in excess of its operating needs, interest and principal payments on indebtedness, dividends on any future senior classes of the Company’s capital stock, if any, capital expenditures, taxes and future reserves, if any. Any future dividends will be authorized by the Board of Directors and declared by the Company based upon a variety of factors deemed relevant by directors of the Company. In addition, financial covenants in the Credit Agreement may restrict the Company’s ability to pay future quarterly dividends. The Board of Directors will continue to evaluate the Company’s dividend program each quarter and will make adjustments as necessary, based on a variety of factors, including, among other things, the Company’s financial condition, liquidity, earnings projections and business prospects, and no assurance can be given that this dividend program will not change in the future. The Company is prohibited under the terms of the Merger Agreement from paying any additional dividends until the Merger closes or the Merger Agreement is terminated. See Part I - Item 1. “Business - Significant Recent Development”.

     On February 27, 2008, the Company’s Board of Directors approved a stock repurchase program to repurchase up to $15 million of the Company’s common stock through the end of 2009. On July 28, 2009, the Company’s Board of Directors authorized the extension of this program by two years through the end of 2011, while maintaining the total $15 million limit. See Note 18 of the Company’s consolidated financial statements included in this Annual Report for further information. As of December 31, 2010, the Company has repurchased and retired a total of 891,850 shares of common stock under the stock repurchase program at an aggregate cost of approximately $11.2 million. There was no repurchase activity during the fourth quarter of 2010. The Company is prohibited under the terms of the Merger Agreement from making any additional repurchases of its common stock until the Merger closes or the Merger Agreement is terminated. See Part I - Item 1. “Business - Significant Recent Development”.

     The information required by Item 201(d) of Regulation S-K, Securities Authorized for Issuance under Equity Compensation Plans, and Item 201(e) of Regulation S-K, Performance Graph, may be found in the Company’s Annual Report to Stockholders for fiscal year 2010, which is incorporated herein by reference.

Item 6. Selected Financial Data

     The following financial information should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and the consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K.

		Year Ended December 31,
		2010				2009				2008				2007				2006
		(In thousands, except per share data)
Statement of Operations Data:
Healthcare revenues		$	630,303			$	579,474			$	460,457			$	428,960			$	420,707
Income (loss) from continuing operations before income taxes			17,604				4,288				3,364				(8,153	)			(12,197	)
Income (loss) from continuing operations			9,882				2,113				1,735				(5,023	)			(7,929	)
Income (loss) from discontinued operations, net of taxes			(333	)			1,169				2,099				7,838				4,549
Net income (loss)		$	9,549			$	3,282			$	3,834			$	2,815			$	(3,380	)
Net income (loss) available to common shareholders		$	9,368			$	3,176			$	3,757			$	2,815			$	(3,380	)
Net income (loss) available to common shareholders per common share — basic:
Continuing operations		$	1.10			$	0.23			$	0.19			$	(0.53	)		$	(0.75	)
Discontinued operations, net of taxes			(0.04	)			0.13				0.22				0.83				0.43
Net income (loss) available to common shareholders per common share		$	1.06			$	0.36			$	0.41			$	0.30			$	(0.32	)
Net income (loss) available to common shareholders per common share — diluted:
Continuing operations		$	1.09			$	0.23			$	0.19			$	(0.53	)		$	(0.75	)
Discontinued operations, net of taxes			(0.04	)			0.13				0.22				0.83				0.43
Net income (loss) available to common shareholders per common share		$	1.05			$	0.36			$	0.41			$	0.30			$	(0.32	)
Weighted average common shares outstanding — basic			8,860				8,917				9,144				9,395				10,511
Weighted average common shares outstanding — diluted			8,934				8,959				9,153				9,395				10,511
Cash dividends per share		$	0.24			$	0.10			$	—			$	—			$	—

     See “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Note 6 to the Company’s consolidated financial statements included in this Annual Report for a description of the reclassification from continuing operations to discontinued operations of expired contracts. During 2006, the Company recorded a non-cash impairment charge for goodwill of $3.0 million related to the Company’s pharmaceutical distribution services segment. During 2010, 2009, 2008, 2007 and 2006, the Company recorded increases of approximately $6.6 million, $3.2 million, $6.3 million, $10.5 million and $4.2 million, respectively, to healthcare expenses as a result of adverse development related to professional liability claims. During 2010, 2009, 2008, 2007 and 2006, the Company incurred Audit Committee investigation and related expenses totaling $0.5 million, $8.4 million, $0.2 million, $0.1 million and $5.3 million, respectively, related to an internal investigation into matters at SPP and costs related to shareholder litigation. The Audit Committee investigation and related expenses incurred in the year ended December 31, 2010 are primarily due to legal expenses incurred as part of the Company reaching a settlement on February 19, 2010, regarding the shareholder litigation filed against the Company and certain individual defendants on April 6, 2006 and related litigation filed by the Company against one of its insurance carriers. For further information regarding the shareholder litigation, see Item 3. “Legal Proceedings.” See Item 1A. “Risk Factors” for a discussion of material risks that could affect the Company’s results of operations in the future.

		As of December 31,
		2010				2009				2008				2007				2006
		(In thousands)
Balance Sheet Data:
Working capital (deficit)		$	15,738			$	(2,812	)		$	8,284			$	(5,004	)		$	4,796
Total assets			177,364				175,212				141,883				150,920				184,183
Long-term debt, including current portion			—				—				—				7,500				10,000
Stockholders’ equity			55,764				41,973				44,046				39,650				46,454

     The working capital amounts as of December 31, 2007 and 2006 include $7.5 million and $10.0 million, respectively, of borrowings outstanding under the Company’s revolving credit facilities in place on those dates which were classified as current liabilities based on the maturity date of the credit facility or in accordance with the U.S. GAAP as discussed below. Borrowings outstanding at December 31, 2007 were current due to the fact that the credit facility was scheduled to mature within a year from the balance sheet date. Borrowings outstanding at December 31, 2006 were scheduled to mature at a date in excess of a year from the respective balance sheet dates; however, due to the presence of a typical material adverse effect clause in the loan agreement combined with the existence of a mandatory lock-box agreement, borrowings outstanding under the revolving credit facilities have been classified as current liabilities in accordance with the U.S. GAAP. For further discussion, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations — Liquidity and Capital Resources” or Note 14 to the Company’s consolidated financial statements included in this Annual Report.

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

     The following discussion should be read in conjunction with the Company’s consolidated financial statements and related notes thereto provided under Part II, Item 8 of this Annual Report on Form 10-K. This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors, including, but not limited to, those described under “Risk Factors” and included in other portions of this report.

Critical Accounting Policies And Estimates

General

     This “Management’s Discussion and Analysis of Financial Condition and Results of Operations” is based upon the Company’s consolidated financial statements, which have been prepared in accordance with U.S. GAAP. The preparation of these financial statements requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, the Company evaluates its estimates, including, but not limited to, those related to:

	•		revenue (net of contractual allowances) and cost recognition (including the estimated cost of off-site medical claims);
	•		allowance for doubtful accounts;
	•		loss contracts;
	•		professional and general liability self-insurance retention;
	•		other self-funded insurance reserves;
	•		legal contingencies;
	•		impairment of intangible assets and goodwill;
	•		amortizable life of contract intangibles;
	•		income taxes; and
	•		share-based compensation.

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

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

Revenue and Cost Recognition

     The Company’s contracts to provide healthcare services to correctional institutions are principally fixed price contracts with revenue adjustments for census fluctuations and risk sharing arrangements, such as stop-loss provisions and aggregate limits for off-site medical provider or pharmaceutical costs. Such contracts typically have a term of one to three years with subsequent renewal options and generally may be terminated by either party without cause upon proper notice. Revenues earned under contracts with correctional institutions are recognized in the period that services are rendered. Cash received in advance for future services is recorded as deferred revenue and recognized as income when the service is performed.

     Revenues are calculated based on the specific contract terms and fall into one of three general categories: fixed fee, population based, or cost plus a fee.

     For fixed fee contracts, revenues are recorded based on fixed monthly amounts established in the service contract irrespective of inmate population. Revenues for population-based contracts are calculated either on a fixed fee that is subsequently adjusted using a per diem rate for variances in the inmate population from predetermined population levels or by a per diem rate multiplied by the average inmate population for the period of service. For cost plus a fee contracts, revenues are calculated based on actual expenses incurred during the service period plus a contractual fee.

     Generally, the Company’s contracts will also include additional provisions which mitigate a portion of the Company’s risk related to cost increases. Off-site medical provider utilization risk is mitigated in the majority of the Company’s contracts through aggregate pools or caps for off-site medical provider expenses, stop-loss provisions, cost plus a fee arrangements or, in some cases, the entire exclusion of certain or all off-site medical provider service costs. Pharmacy expense risk is similarly mitigated in certain of the Company’s contracts. Typically, under the terms of such provisions, the Company’s revenue under the contract increases to offset increases in specified cost categories such as off-site medical provider expenses or pharmaceutical costs. For contracts that include such provisions, the Company recognizes the additional revenues due from clients based on its estimates of applicable contract to date costs incurred as compared to the corresponding pro rata contractual limit for such costs. Because such provisions typically specify how often such additional revenue may be invoiced and require all such additional revenue to be ultimately settled based on actual expenses, the additional revenues are initially recorded as unbilled receivables until the time period for billing has been met and actual costs are known. Any differences between the Company’s estimates of incurred costs and the actual costs are recorded in the period in which such differences become known along with the corresponding adjustment to the amount of recorded additional revenues.

     Under all contracts, the Company records revenues net of any estimated contractual allowances for potential adjustments resulting from a failure to meet performance or staffing related criteria. If necessary, the Company revises its estimates for such adjustments in future periods when the actual amount of the adjustment is determined.

     The table below illustrates these revenue categories as a percentage of total revenues from continuing operations for the years ended December 31, 2010, 2009 and 2008.

		Percentage of Revenue from Continuing Operations
		For the Year Ended				For the Year Ended				For the Year Ended
Contract Category		December 31, 2010				December 31, 2009				December 31, 2008
Fixed Fee			12.5	%			12.7	%			15.3	%
Population Based			67.6	%			65.2	%			59.3	%
Cost Plus a Fee			19.9	%			22.1	%			25.4	%

     Contracts under the population based and fixed fee categories generally have similar margins which are higher than margins for contracts under the cost plus a fee category. Cost plus a fee contracts generally have lower margins but with much less potential for variability due to the limited risk involved. The Company’s profitability under each of the three general contract categories discussed above varies based on the level of risk assumed under the contract terms with the most potential for variability being in contracts under the population based or fixed fee categories which do not contain the risk mitigating provisions related to off-site medical provider utilization described above. For the year ended December 31, 2010, contracts accounting for approximately 8.7% of the Company’s correctional healthcare services revenues from continuing operations do not contain such risk mitigating provisions.

     Healthcare expenses include the compensation of physicians, nurses and other healthcare professionals and related benefits and all other direct costs of providing and/or administering the managed care, including the costs associated with services provided and/or administered by off-site medical providers, the costs of professional and general liability insurance and other self-funded insurance reserves discussed more fully below. Many of the Company’s contracts require the Company’s customers to reimburse the Company for all treatment costs or, in some cases, only treatment costs related to certain catastrophic events, and/or for specific disease diagnoses illnesses. Certain of the Company’s contracts do not contain such limits. The Company attempts to compensate for the

increased financial risk when pricing contracts that do not contain individual, catastrophic or specific disease diagnosis-related limits. However, the occurrence of severe individual cases, specific disease diagnoses illnesses or a catastrophic event in a facility governed by a contract without such limitations could render the contract unprofitable and could have a material adverse effect on the Company’s operations. For certain of its contracts that do not contain catastrophic protection, the Company maintains stop loss insurance from an unaffiliated insurer with respect to, among other things, inpatient and outpatient hospital expenses (as defined in the policy) for amounts in excess of $375,000 per inmate up to an annual cap of $1.0 million per inmate and $3.0 million in total. Amounts reimbursable per claim under the policy are further limited to the lessor of billed charges, the amount paid or the contracted amounts in situations where the Company has negotiated rates with the applicable providers.

     The cost of healthcare services provided, administered or contracted for are recognized in the period in which they are provided and/or administered based in part on estimates, including an accrual for estimated unbilled off-site medical provider services rendered through the balance sheet date. The Company estimates the accrual for unbilled off-site medical provider services using actual utilization data including hospitalization, one-day surgeries, physician visits and emergency room and ambulance visits and their corresponding costs, which are estimated using the average historical cost of such services. Additionally, the Company’s utilization management personnel perform a monthly review of inpatient hospital stays in order to identify any stays which would have a cost in excess of the historical average rates. Once identified, reserves for such stays are determined which take into consideration the specific facts of the stay. An actuarial analysis is also prepared at least quarterly as an additional tool to be considered by management in evaluating the adequacy of the Company’s total accrual related to contracts which have sufficient claims payment history. The analysis takes into account historical claims experience (including the average historical costs and billing lag time for such services) and other actuarial data.

     Actual payments and future reserve requirements will differ from the Company’s current estimates. The differences could be material if significant fluctuations occur in the healthcare cost structure or the Company’s future claims experience. Changes in estimates of claims resulting from such fluctuations and differences between actuarial estimates and actual claims payments are recognized in the period in which the estimates are changed or the payments are made. In 2010, the Company recorded an increase of approximately $1.2 million to its prior year claims liabilities as a result of revisions to its estimated claims expense. In 2009 and 2008, the Company recorded decreases of approximately $0.4 million and $0.7 million, respectively, to its prior year claims liabilities as a result of revisions to its estimated claims expense. The impact to net income of these reductions to the Company’s claims reserves and associated expense is dependent upon whether any of the associated customer contracts contained provisions limiting risk of off-site medical provider costs. These reductions to claims reserves did not result in a significant impact to the Company’s net income as the changes occurred primarily in connection with contracts which contained provisions limiting risk of off-site medical provider costs and, as a result, these changes were off-set by corresponding additions or reductions to revenue.

Allowance for Doubtful Accounts

     Accounts receivable are stated at estimated net realizable value. The Company recognizes allowances for doubtful accounts based on a variety of factors, including the length of time receivables are past due, significant one-time events, contractual rights, client funding and/or political pressures, discussions with clients and historical experience. If circumstances change, estimates of the recoverability of receivables would be further adjusted and such adjustments could have a material adverse effect on the Company’s results of operations in the period in which they are recorded.

     Unbilled accounts receivable generally represent additional revenue earned under shared-risk contracting models that remain unbilled at each balance sheet date, due to provisions within the contracts governing the timing for billing such amounts.

     The Company and its clients will, from time to time, have disputes over amounts billed under the Company’s contracts. The Company records a reserve for contractual allowances in circumstances where it concludes that a loss from such disputes is probable.

     As discussed more fully in Part I — Item 3. “Legal Proceedings,” PHS is currently involved in a lawsuit with its former client, Baltimore County, Maryland (the “County”) involving the County’s lack of payment for services rendered. PHS has approximately $1.7 million of receivables due from the County, primarily related to services rendered between April 1, 2006 and September 14, 2006, the date the Company’s relationship with the County was terminated. The County has refused to pay PHS for these amounts and therefore, on October 27, 2006, PHS filed suit against the County in the Circuit Court for Baltimore County, Maryland seeking collection of the outstanding receivables balance, damages for breach of contract, quantum meruit, and unjust enrichment as well as prejudgment interest. During February 2011, the parties agreed to resolve this matter through binding arbitration which is expected to occur during the second quarter of 2011. At December 31, 2010, the Company has classified these receivables as current assets in its consolidated balance sheet.

     As discussed more fully in Part I — Item 3. “Legal Proceedings,” PHS believes, in the case of this lawsuit, that it has a valid and meritorious cause of action and, as a result, has concluded that the outstanding receivables, which represent services performed under the contractual relationship between the parties, continues to be probable of collection. Although PHS believes it has valid contractual

and legal arguments, an adverse result in this lawsuit could have a negative impact on the results of this matter and/or PHS’ ability to collect the outstanding receivables amount.

     As stated above, the Company believes the recorded amount represents valid receivables which are contractually due from the County and expects full collection. However, due to the factors discussed above and more fully in Part I — Item 3. “Legal Proceedings,” there is a heightened risk of uncollectibility of these receivables which may result in future losses. Nevertheless, the Company intends to take all necessary and available measures in order to collect these receivables.

     Changes in circumstances related to the matter discussed above involving the County, or any other receivables, could result in a change in the allowance for doubtful accounts or the estimate of contractual adjustments in future periods. Such change, if it were to occur, could have a material adverse affect on the Company’s results of operations and financial position in the period in which the change occurs.

Loss Contracts

     On a quarterly basis, the Company performs a review of its portfolio of contracts for the purpose of identifying potential loss contracts and developing a loss contract reserve for succeeding periods if any loss contracts are identified. The Company accrues losses under its fixed price contracts when it is probable that a loss has been incurred and the amount of the loss can be reasonably estimated. The Company performs this loss accrual analysis on a specific contract basis taking into consideration such factors as the Company’s ability to terminate the contract, future contractual revenue, projected future healthcare and maintenance costs, projected future stop-loss insurance recoveries and the contract’s specific terms related to future revenue increases as compared to increased healthcare costs. The projected future healthcare and maintenance costs are estimated based on historical trends and management’s estimate of future cost increases. These estimates are subject to the same adverse fluctuations and future claims experience as previously noted.

     In the course of performing its reviews in future periods, the Company might identify contracts which have become loss contracts due to a change in circumstances. Circumstances that might change and result in the identification of a contract as a loss contract in a future period include interpretations regarding contract termination or expiration provisions, unanticipated adverse changes in the healthcare cost structure, inmate population or the utilization of outside medical services in a contract, where such changes are not offset by increased healthcare revenues. Should a contract be identified as a loss contract in a future period, the Company would record, in the period in which such identification is made, a reserve for the estimated future losses that would be incurred under the contract. The identification of a loss contract in the future could have a material adverse effect on the Company’s results of operations in the period in which the reserve is recorded.

     There are no loss contracts identified as of December 31, 2010 and 2009.

Professional and General Liability Self-Insurance Retention

     As a healthcare provider, the Company’s business occasionally results in actions for negligence and other causes of action related to its provision of healthcare services with the attendant risk of substantial damage awards, or court ordered non-monetary relief such as, changes in operating practices or procedures, which may lead to the potential for substantial increases in the Company’s operating expenses. The most significant source of potential liability in this regard is the risk of suits brought by inmates alleging negligent healthcare services, deliberate indifference to their medical needs or the lack of timely or adequate healthcare services. The Company may also be liable, as employer, for the negligence of healthcare professionals it employs or healthcare professionals with whom it contracts. The Company’s contracts generally provide for the Company to indemnify the governmental agency for losses incurred related to healthcare provided by the Company and its agents.

     To mitigate a portion of this risk, the Company maintains a primary professional liability insurance program, principally on a claims-made basis. For 2002 through 2006 and 2008 through 2010 with respect to the majority of its patients, the Company purchased commercial insurance coverage, but is effectively self-insured due to the terms of the coverage which include adjustable premiums. For 2002 through 2006 and 2008 through 2010, the Company is covered by separate policies, each of which contains a premium that is retroactively adjusted, with adjustment based on actual losses. The Company’s ultimate premium for its 2002 through 2006 and 2008 through 2010 policies will depend on the final incurred losses related to each of these separate policy periods. For 2007, the Company is insured through claims made policies subject to per event and aggregate coverage limits. In addition to the coverage described above, effective January 1, 2010, the Company has purchased an excess liability policy which provides coverage on a claims made basis for indemnity losses in excess of $4.0 million up to a maximum coverage of $10 million per loss and in the aggregate. Any amounts ultimately incurred above these coverage limits would be the responsibility of the Company. Management establishes reserves for the estimated losses that will be incurred under these insurance policies after taking into consideration the Company’s professional liability claims department and external counsel evaluations of the merits of the individual claims, analysis of

claim history, actuarial analysis and coverage limits where applicable. Any adjustments resulting from the review are reflected in current earnings.

     Given the fact that many claims are not brought during the year of occurrence, in addition to its reserves for known claims, the Company maintains a reserve for incurred but not reported claims. The reserve for incurred but not reported claims is recorded on an undiscounted basis. The Company’s estimates of this reserve are supported by various analyses, including an actuarial analysis, which is performed on a quarterly basis.

     At December 31, 2010, the Company’s reserves for both known and incurred but not reported claims totaled $22.6 million. Reserves for medical malpractice claims fluctuate because the number of claims and the severity of the underlying incidents change from one period to the next. Reserves for medical malpractice claims can also fluctuate as a result of court decisions or as new facts become available. Furthermore, payments with respect to previously estimated liabilities frequently differ from the estimated liability. Changes in estimates of losses resulting from such fluctuations and differences between management’s established reserves and actual loss payments are recognized by an adjustment to the reserve for medical malpractice claims in the period in which the estimates are changed or payments are made. In 2010, 2009 and 2008, the Company recorded increases of approximately $6.6 million, $3.2 million and $6.3 million, respectively, to its prior year claims reserves as a result of adverse development on individual claims or matters. The reserves can also be affected by changes in the financial health of the third-party insurance carriers used by the Company. If a third party insurance carrier fails to meet its contractual obligations under the agreement with the Company, the Company would then be responsible for such obligations. Such changes could have a material adverse effect on the Company’s financial position and its results of operations in the period in which the changes occur.

Other Self-Funded Insurance Reserves

     At December 31, 2010, the Company has approximately $8.0 million in accrued liabilities for employee health and workers’ compensation claims. Approximately $6.5 million of this amount is related to workers’ compensation claims, of which approximately $4.0 million is included within the noncurrent portion of accrued expenses as it is not expected to be paid within a year. The Company is essentially self-insured for employee health and workers’ compensation claims subject to certain individual case stop loss levels. As such, its insurance expense is largely dependent on claims experience and the ability to control claims. The Company accrues the estimated liability for employee health insurance based on its history of claims experience and estimated time lag between the incident date and the date of actual claim payment. The Company accrues the estimated liability for workers’ compensation claims based on evaluations of the merits of the individual claims and analysis of claims history. These estimated liabilities are recorded on an undiscounted basis. An actuarial analysis is prepared at least annually as an additional tool to be considered by management in evaluating the adequacy of the Company’s reserve for workers’ compensation claims. These estimates of self-funded insurance reserves could change in the future based on changes in the factors discussed above. Any adjustments resulting from such changes in estimates are reflected in current earnings. In 2010, 2009 and 2008, the Company recorded decreases of approximately $1.6 million, approximately $0.2 million and approximately $0.9 million, respectively, related to its prior year other self-insurance reserves as a result of revisions to its estimated claims experience.

Legal Contingencies

     In addition to professional and general liability claims, the Company is also subject to other legal proceedings in the ordinary course of business. Such proceedings generally relate to labor, employment or contract matters. When estimable, the Company accrues an estimate of the probable costs for the resolution of these claims. Such estimates are developed in consultation with outside counsel handling the Company’s defense in these matters and are based upon an estimated range of potential results, assuming a combination of litigation and settlement strategies. It is possible that future results of operations for any particular quarterly or annual period could be materially affected by changes in assumptions, new developments or changes in approach, such as a change in settlement strategy in dealing with such litigation. See discussion of certain outstanding legal matters in Part I — Item 3. “Legal Proceedings.”

     In addition to professional and general liability claims and other legal proceedings in the ordinary course of business, the Company is involved in other legal matters related to an Audit Committee investigation, which was announced by the Company on October 24, 2005. See Part 1 — Item 1. “Business — Audit Committee Investigation” and Part I — Item 3. “Legal Proceedings” for further information regarding the Audit Committee investigation and related legal matters.

Intangible Assets and Goodwill

     Goodwill acquired is not amortized but is reviewed for impairment on an annual basis or more frequently whenever events or circumstances indicate that the carrying value may not be recoverable. U.S. GAAP requires that goodwill be tested at the reporting unit level, defined as an operating segment or one level below an operating segment (referred to as a component), with the fair value of the reporting unit being compared to its carrying amount, including goodwill. If the fair value of the reporting unit exceeds its carrying amount, goodwill of the reporting unit is not considered to be impaired. The Company has determined that it has one

operating, as well as one reportable, segment. The Company’s policy is to perform its annual goodwill impairment test as of the last day of each fiscal year, i.e. December 31.

     In performing its annual goodwill impairment test, the Company uses a two-step process. The first step is a screen for potential impairment, while the second step measures the amount of the impairment, if any. The first step of the goodwill impairment test compares the fair value of a reporting unit with its carrying amount, including goodwill. The Company determined the fair value of its reporting unit to equal the market capitalization of its common stock as of the testing date. As of December 31, 2010, the indicated fair value of the Company’s reporting unit exceeded the carrying value of its reporting unit by a substantial amount, and, as such, the Company concluded that there was no indication of goodwill impairment.

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

     Important factors taken into consideration when evaluating the need for an impairment review, other than the annual impairment test, include the following:

	•		significant underperformance or loss of key contracts relative to expected historical or projected future operating results;
	•		significant changes in the manner of use of the Company’s assets or in the Company’s overall business strategy;
	•		significant negative industry or economic trends; and
	•		an adverse change in the Company’s market capitalization.

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

     The Company’s other identifiable intangible assets which represent customer contracts acquired in acquisitions and are amortized on the straight-line method over their estimated useful lives. The Company also assesses the potential impairment of its contract intangibles whenever events or changes in circumstances indicate that the carrying value may not be recoverable.

     When the Company determines that the carrying value of contract intangibles may not be recoverable based upon the existence of one or more of the above indicators of impairment, such impairment will be measured using an estimate of the asset’s fair value based on the projected net cash flows expected to result from that asset, including eventual disposition.

Amortizable Life of Contract Intangibles

     The Company amortizes its contract intangibles on a straight-line basis over their estimated useful life. The Company evaluates the estimated remaining useful life of its contract intangibles on at least a quarterly basis, taking into account new facts and circumstances, including its retention rate for acquired contracts. If such facts and circumstances indicate the current estimated useful life is no longer reasonable, the Company adjusts the estimated useful life on a prospective basis.

Income Taxes

     The Company accounts for income taxes under the provisions of U.S. GAAP related to income taxes. Under the asset and liability method of U.S. GAAP related to income taxes, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases.

     The Company regularly reviews its deferred tax assets for recoverability taking into consideration such factors as historical losses, projected future taxable income and the expected timing of the reversals of existing temporary differences. U.S. GAAP requires the Company to record a valuation allowance when it is “more likely than not that some portion or all of the deferred tax assets will not be realized.” At December 31, 2010, the Company’s valuation allowance of approximately $0.2 million represents management’s estimate of state net operating loss carryforwards which will expire unused.

     The Company accounts for tax contingency accruals under the provisions of U.S. GAAP related to accounting for uncertainty in income taxes. The Company’s tax contingency accruals are reviewed quarterly and can be adjusted in light of changing facts and circumstances, such as the progress of tax audits, case law and emerging legislation. Adjustments to the tax contingency accruals are recorded in the period in which the new facts or circumstances become known, therefore the accruals are subject to change in future periods and such change, if it were to occur, could have a material adverse effect on the Company’s results of operations.

     It is the Company’s policy to recognize accrued interest and penalties related to its tax contingencies as income tax expense. As the Company has no tax contingencies at December 31, 2010, there is no accrued interest and penalties included in income tax expense for the year ended December 31, 2010.

     The Company files income tax returns in the U.S. federal jurisdiction and various state jurisdictions. The Company may be subject to examination by the Internal Revenue Service (“IRS”) for calendar years 2007 through 2010. The Company is currently under audit for the 2008 tax year. Additionally, open tax years related to certain state and local jurisdictions remain subject to examination.

Share-Based Compensation

     The Company measures and recognizes compensation expense for all share-based payment awards based on estimated fair values at the date of grant. Determining the fair value of share-based awards at the grant date requires judgment in developing assumptions, which involve a number of variables. These variables include, but are not limited to, the expected stock price volatility over the term of the awards and expected stock option exercise behavior. In addition, the Company also uses judgment in estimating the number of share-based awards that are expected to be forfeited.

Results of Operations

     The following table sets forth, for the years indicated, the percentage relationship to healthcare revenues of certain items in the consolidated statements of operations.

		Year Ended December 31,
		2010				2009				2008
Healthcare revenues			100.0	%			100.0	%			100.0	%
Healthcare expenses			91.3				92.1				91.9
Gross margin			8.7				7.9				8.1
Selling, general and administrative expenses			5.1				5.2				5.9
Merger expenses			0.1				—				—
Corporate restructuring expenses			—				—				0.5
Audit Committee investigation and related expenses			0.1				1.4				—
Depreciation and amortization			0.6				0.5				0.8
Income from operations			2.8				0.8				0.9
Interest expense, net			—				0.1				0.2
Income from continuing operations before income tax provision			2.8				0.7				0.7
Income tax provision			1.2				0.3				0.3
Income from continuing operations			1.6				0.4				0.4
Income (loss) from discontinued operations, net of taxes			(0.1	)			0.2				0.4
Net income			1.5				0.6				0.8

     As discussed in Note 6 to the Company’s consolidated financial statements, the Company is applying the discontinued operations provisions of U.S. GAAP to all correctional healthcare service contracts upon expiration of the contracts. In accordance with U.S. GAAP, the results of operations of contracts that expire, less applicable income taxes, are classified on the Company’s consolidated statements of operations separately from continuing operations. The presentation prescribed for discontinued operations requires the collapsing of healthcare revenues and expenses, as well as other specifically identifiable costs, into the income or loss from discontinued operations, net of taxes. Items such as indirect selling, general and administrative expenses or interest expense cannot be allocated to expired contracts. The U.S. GAAP accounting presentation as it relates to discontinued operations and the Company’s expired contracts has no impact on net income, earnings per share, total cash flows or stockholders’ equity. As a result of the application of U.S. GAAP related to discontinued operations, “healthcare revenues” and “healthcare expenses” on the Company’s consolidated statements of operations for any period presented will only include revenues and expenses from continuing contracts.

Year Ended December 31, 2010 Compared to Year Ended December 31, 2009

     Healthcare revenues. Healthcare revenues for the year ended December 31, 2010 increased $50.8 million, or 8.8%, from $579.5 million in 2009 to $630.3 million in 2010. Healthcare revenues in 2010 included $25.6 million of revenue growth resulting from new correctional healthcare services contracts added subsequent to January 1, 2009 through marketing activities. The primary correctional healthcare services contract added during this time period was the Company’s new contract to provide healthcare services to the State of Michigan Department of Corrections, which commenced on April 1, 2009. Correctional healthcare services contracts in place at January 1, 2009 and continuing beyond December 31, 2010, experienced revenue growth of 5.1% consisting of an increase in revenue of $25.2 million during 2010 as the result of contract renegotiations and automatic price adjustments. As discussed in the discontinued operations section below, all healthcare services contracts that have expired or otherwise been terminated have been classified as discontinued operations.

     Healthcare expenses. Healthcare expenses for the year ended December 31, 2010 increased $41.7 million, or 7.8%, from $533.9 million, or 92.1% of revenues, in 2009 to $575.6 million, or 91.3% of revenues, in 2010. Expenses related to new correctional healthcare services contracts added subsequent to January 1, 2009 through marketing activities accounted for $14.4 million of the increase. The primary correctional healthcare services contract added during this time period was the Company’s contract to provide healthcare services to the State of Michigan Department of Corrections, which commenced on April 1, 2009. Correctional healthcare services contracts in place at January 1, 2009 and continuing beyond December 31, 2010, accounted for $27.4 million of the increase as a result of increases in the levels of staff and staff compensation, increases in the off-site medical services and pharmacy costs associated with providing healthcare to inmates at existing contracts. Included in this increase for continuing contracts is insurance expense of approximately $6.6 million and $3.2 million for the years ended December 31, 2010 and 2009, respectively, as a result of adverse development related to professional liability claims. Also included in healthcare expenses for the years ended December 31, 2010 and 2009 is approximately $0.8 million and $0.9 million of accrued bonus expenses related to the Company’s 2010 incentive compensation plan and 2009 incentive compensation plan, respectively.

     Selling, general and administrative expenses. Selling, general and administrative expenses were $32.2 million, or 5.1% of revenues, and $30.0 million, or 5.2% of revenues, for the years ended December 31, 2010 and 2009, respectively. Included in the selling, general and administrative expenses for the years ended December 31, 2010 and 2009 is approximately $1.9 million and $1.8 million, respectively, related to share-based compensation expense. Also included in selling, general and administrative expenses for the year ended December 31, 2010 is approximately $2.2 million of accrued bonus expense related to the Company’s 2010 incentive compensation plan. Included in selling, general and administrative expenses for the year ended December 31, 2009 is approximately $2.7 million of accrued bonus expense related to the Company’s 2009 incentive compensation plan.

      Merger expenses. During the year ended December 31, 2010, the Company incurred $0.7 million of expenses related to the Merger discussed in Part I—Item 1. “Business-Significant Recent Development”. There were no merger expenses incurred for the year ended December 31, 2009.

     Corporate restructuring expenses. Corporate restructuring expenses were $0.3 million for the year ended December 31, 2010, which related to the management transitional changes implemented in the second quarter of 2010. There were no corporate restructuring expenses incurred for the year ended December 31, 2009.

     Audit Committee investigation and related expenses. Audit Committee investigation and related expenses were $0.5 million for the year ended December 31, 2010 as compared to $8.4 million for the year ended December 31, 2009. The Audit Committee investigation and related expenses incurred in the year ended December 31, 2010, primarily related to legal expenses incurred as part of the Company reaching a settlement on February 19, 2010, regarding the shareholder litigation filed against the Company and certain individual defendants on April 6, 2006 and related litigation filed by the Company against one of its insurance carriers. The Audit Committee investigation and related expenses incurred in the year ended December 31, 2009 are primarily due to the Company recording a reserve related to the settlement discussed above, which was reached on February 19, 2010; an insurance settlement for $8.0 million entered into by the Company and its primary D&O insurance carrier; and legal expenses. See Part I — Item 3. “Legal Proceedings” for further discussion of the Audit committee investigation and related legal matters.

     Depreciation and amortization. Depreciation and amortization expense was $3.5 million and $2.8 million for the years ended December 31, 2010 and 2009, respectively. The increase in depreciation and amortization is primarily due to an increase in capital expenditures.

     Interest expense, net. Net interest income was $0.1 million for the year ended December 31, 2010 compared to net interest expense of $0.1 million in 2009. During the year ended December 31, 2010, the Company had no borrowings outstanding on its Credit Agreement resulting in a reduction in interest expense. This reduction, combined with earnings on cash balances, resulted in net interest income for the period.

     Income tax provision. The income tax provision for the year ended December 31, 2010 was $7.7 million as compared to $2.2 million in 2009. See Note 15 to the Company’s consolidated financial statements for more information on the Company’s income tax provision.

     Income from continuing operations. Income from continuing operations for the year ended December 31, 2010 was $9.9 million, or 1.6% of revenues, as compared with $2.1 million, or 0.4% of revenues, in 2009.

     Income (loss) from discontinued operations, net of taxes. The loss from discontinued operations, net of taxes for the year ended December 31, 2010 was $0.3 million as compared with income from discontinued operations, net of taxes of $1.2 million in 2009. Income (loss) from discontinued operations, net of taxes represents the operating results of the Company’s correctional healthcare services contracts that have expired. The classification of these expired contracts is the result of the Company’s application of U.S. GAAP related to discontinued operations. See Note 6 to the Company’s consolidated financial statements for further discussion of discontinued operations.

     Net income. Net income for the year ended December 31, 2010 was $9.5 million, or 1.5% of revenues, as compared with $3.3 million, or 0.6% of revenues, in 2009. The increase is due to the factors discussed above.

Year Ended December 31, 2009 Compared to Year Ended December 31, 2008

     Healthcare revenues. Healthcare revenues for the year ended December 31, 2009 increased $119.0 million, or 25.8%, from $460.5 million in 2008 to $579.5 million in 2009. Healthcare revenues in 2009 included $88.3 million of revenue growth resulting from new correctional healthcare services contracts added subsequent to January 1, 2008 through marketing activities. The primary correctional healthcare services contract added during this time period was the Company’s new contract to provide healthcare services to the State of Michigan Department of Corrections, which commenced on April 1, 2009. Correctional healthcare services contracts in place at January 1, 2008 and continuing beyond December 31, 2010, experienced revenue growth of 6.7% consisting of an increase in revenue of $30.7 million during 2009 as the result of contract renegotiations and automatic price adjustments. As discussed in the discontinued operations section below, all healthcare services contracts that have expired or otherwise been terminated have been classified as discontinued operations.

     Healthcare expenses. Healthcare expenses for the year ended December 31, 2009 increased $110.9 million, or 26.2%, from $423.1 million, or 91.9% of revenues, in 2008 to $533.9 million, or 92.1% of revenues, in 2009. Expenses related to new correctional healthcare services contracts added subsequent to January 1, 2008 through marketing activities accounted for $87.5 million of the increase. The primary correctional healthcare services contract added during this time period was the Company’s contract to provide healthcare services to the State of Michigan Department of Corrections, which commenced on April 1, 2009. Correctional healthcare services contracts in place at January 1, 2008 and continuing beyond December 31, 2010, accounted for $22.9 million of the increase as a result of increases in the levels of staff and staff compensation, increases in the off-site medical services and pharmacy costs associated with providing healthcare to inmates at existing contracts. Included in this increase for continuing contracts is insurance expense of approximately $3.2 million and $6.3 million for the years ended December 31, 2009 and 2008, respectively, as a result of adverse development related to professional liability claims. Also included in healthcare expenses for the years ended December 31, 2009 and 2008 is approximately $0.9 million and $0.4 million of accrued bonus expenses related to the Company’s 2009 incentive compensation plan and 2008 incentive compensation plan, respectively.

     Selling, general and administrative expenses. Selling, general and administrative expenses were $30.0 million, or 5.2% of revenues, and $27.0 million, or 5.9% of revenues, for the years ended December 31, 2009 and 2008, respectively. Included in the selling, general and administrative expenses for the years ended December 31, 2009 and 2008 is approximately $1.8 million and $2.0 million, respectively, related to share-based compensation expense. Also included in selling, general and administrative expenses for the year ended December 31, 2009 is approximately $2.7 million of accrued bonus expense related to the Company’s 2009 incentive compensation plan. Included in selling, general and administrative expenses for the year ended December 31, 2008 is approximately $1.6 million of accrued bonus expense related to the Company’s 2008 incentive compensation plan.

     Corporate restructuring expenses. Corporate restructuring expenses were $2.3 million for the year ended December 31, 2008, which related to the Company entering into a separation and general release with its former Chief Executive Officer on September 15, 2008. There were no corporate restructuring expenses incurred for the year ended December 31, 2009.

     Audit Committee investigation and related expenses. Audit Committee investigation and related expenses were $8.4 million for the year ended December 31, 2009 as compared to $0.2 million for the year ended December 31, 2008. The Audit Committee investigation and related expenses incurred in the year ended December 31, 2009 are primarily due to the Company recording a reserve related to the settlement in principle reached on February 19, 2010, regarding the shareholder litigation filed against the Company and certain individual defendants on April 6, 2006; an insurance settlement for $8.0 million entered into by the Company and its primary D&O insurance carrier; and legal expenses. The Audit Committee investigation and related expenses incurred in the

year ended December 31, 2008, primarily related to the legal costs of inquiry responses and lawsuit defenses as a result of an internal investigation conducted by the Audit Committee. See Item 3. “Legal Proceedings” for further discussion of the Audit committee investigation and related legal matters.

     Depreciation and amortization. Depreciation and amortization expense was $2.8 million and $3.8 million for the years ended December 31, 2009 and 2008, respectively. The reduction in depreciation and amortization expense is due to a reduction in contract amortization.

     Interest expense, net. Net interest expense decreased to $0.1 million in 2009, from $0.7 million in 2008. This decrease is the result of a decrease in the average borrowings outstanding.

     Income tax provision. The income tax provision for the year ended December 31, 2009 was $2.2 million as compared to $1.6 million in 2008. See Note 15 to the Company’s consolidated financial statements for more information on the Company’s income tax provision.

     Income from continuing operations. Income from continuing operations for the year ended December 31, 2009 was $2.1 million, or 0.4% of revenues, as compared with $1.7 million, or 0.4% of revenues, in 2008.

     Income from discontinued operations, net of taxes. Income from discontinued operations, net of taxes for the year ended December 31, 2009 was $1.2 million as compared with $2.1 million in 2008. Income from discontinued operations, net of taxes represents the operating results of the Company’s correctional healthcare services contracts that have expired. The classification of these expired contracts is the result of the Company’s application of U.S. GAAP related to discontinued operations. See Note 6 to the Company’s consolidated financial statements for further discussion of discontinued operations.

     Net income. Net income for the year ended December 31, 2009 was $3.3 million, or 0.6% of revenues, as compared with $3.8 million, or 0.8% of revenues, in 2008. The decrease is due to the factors discussed above.

Liquidity and Capital Resources

     Overview

     The Company had working capital of $15.7 million at December 31, 2010 compared to negative working capital of $2.8 million at December 31, 2009. At December 31, 2010, days sales outstanding in accounts receivable were 30, accounts payable days outstanding were 30 and medical claims liability days outstanding were 48. At December 31, 2009, days sales outstanding in accounts receivable were 25, accounts payable days outstanding were 19 and medical claims liability days outstanding were 46.

     The Company had net income of $9.5 million for the year ended December 31, 2010 compared to $3.3 million for the year ended December 31, 2009. The Company had stockholders’ equity of $55.8 million at December 31, 2010 as compared to $42.0 million at December 31, 2009. The Company’s cash and cash equivalents increased to $39.6 million at December 31, 2010 from $37.7 million at December 31, 2009. The increase in cash and cash equivalents was primarily due to cash flows from operating activities less capital expenditures, stock repurchases and dividend payments. The Company had no outstanding balance on its credit facility at December 31, 2010 or 2009.

     Cash flows from operating activities represent net income plus depreciation and amortization, changes in various components of working capital and adjustments for various non-cash charges, such as share-based compensation expense and deferred income taxes. Cash flows provided by operating activities were $9.2 million for the year ended December 31, 2010 as compared with $24.5 million for the year ended December 31, 2009. The decrease was the result of a combined reduction of $8.2 million in accounts payable, accrued expenses, accrued medical claims liability and deferred revenue in the year ended December 31, 2010 as compared with a combined net increase of $32.6 million in these operating liabilities in the year ended December 31, 2009. This was partially offset by a combined reduction of $2.1 million in accounts receivable, deferred taxes, prepaid expenses and other current assets and other assets in the year ended December 31, 2010 as compared with a combined net increase of $16.1 million in these operating assets in the year ended December 31, 2009.

     Cash flows used in investing activities were $4.9 million and $4.5 million, respectively, for the years ended December 31, 2010 and 2009 which represented purchases of property and equipment and management information systems under development, which were financed through cash flows from operating activities.

     Cash flows used in financing activities during the year ended December 31, 2010 were $2.4 million which represented dividends on common stock of $2.2 million, share repurchases of $0.5 million and restricted stock repurchased from employees for employees’

tax liability of $1.0 million, partially offset by the issuance of common stock under the Company’s employee stock purchase plan of $0.4 million and cash receipts resulting from option exercises of $0.9 million. Cash flows used in financing activities during the year ended December 31, 2009 were $7.2 million which represented share repurchases of $8.3 million, restricted stock repurchased from employees for employees’ tax liability of $0.2 million and dividends on common stock of $0.9 million, partially offset by the issuance of common stock under the Company’s employee stock purchase plan of $0.3 million, excess tax benefits from share-based compensation arrangements of $0.1 million and cash receipts resulting from option exercises of $1.7 million.

     Share Repurchases

     On February 27, 2008, the Company’s Board of Directors approved a stock repurchase program to repurchase up to $15 million of the Company’s common stock through the end of 2009. On July 28, 2009, the Company’s Board of Directors authorized the extension of this program by two years through the end of 2011, while maintaining the total $15 million limit. As of December 31, 2010, the Company has repurchased and retired a total of 891,850 shares of common stock under the stock repurchase program at an aggregate cost of approximately $11.2 million. The Company is prohibited under the terms of the Merger Agreement from making any additional repurchases of its common stock until the Merger closes or the Merger Agreement is terminated. See Part I — Item 1. “Business — Significant Recent Development”.

     The stock repurchase program is intended to be implemented through purchases made from time to time in either the open market or through private transactions, in accordance with SEC requirements. The Company may elect to terminate or modify the program at any time. Under the stock repurchase program, no shares will be purchased directly from officers or directors of the Company. The timing, prices and sizes of purchases will depend upon prevailing stock prices, general economic and market conditions and other considerations. Funds for the repurchase of shares are expected to come primarily from cash provided by operating activities and also from funds on hand, including amounts available under the Company’s credit facility.

     See Note 18 of the Company’s consolidated financial statements included in this annual report for further information.

     Dividends

     The Company paid a $0.05 cash dividend per share on the Company’s common stock for each of the quarters ended September 30, 2009 and December 31, 2009. The Company paid a $0.06 cash dividend per share on the Company’s common stock for each of the quarters ended March 31, 2010, June 30, 2010, September 30, 2010 and December 31, 2010. On March 2, 2011, the Company’s Board of Directors declared a quarterly cash dividend of $0.06 per share on the Company’s common stock for the quarter ended March 31, 2011. The dividend will be paid on April 12, 2011 to stockholders of record on March 22, 2011.

     The Board of Directors’ adoption of a dividend program reflects the Company’s intent to return capital to stockholders. The Company expects that any future quarterly cash dividends will be paid from cash generated by the Company’s business in excess of its operating needs, interest and principal payments on indebtedness, dividends on any future senior classes of the Company’s capital stock, if any, capital expenditures, taxes and future reserves, if any. Any future dividends will be authorized by the Board of Directors and declared by the Company based upon a variety of factors deemed relevant by directors of the Company. In addition, financial covenants in the Credit Agreement may restrict the Company’s ability to pay future quarterly dividends. The Board of Directors will continue to evaluate the Company’s dividend program each quarter and will make adjustments as necessary, based on a variety of factors, including, among other things, the Company’s financial condition, liquidity, earnings projections and business prospects, and no assurance can be given that this dividend program will not change in the future. The Company is prohibited under the terms of the Merger Agreement from paying any additional dividends until the Merger closes or the Merger Agreement is terminated. See Part I — Item 1. “Business — Significant Recent Development”.

     Credit Facility

     On July 28, 2009, the Company entered into a Revolving Credit and Security Agreement which was subsequently amended on March 2, 2010 (the “Credit Agreement”) with CapitalSource Bank (“CapitalSource”). The Credit Agreement is set to mature on October 31, 2011 and includes a $40.0 million revolving credit facility, with a current facility cap of $20.0 million, under which the Company has available standby letters of credit up to $15.0 million. The Company may request an increase in the current facility cap of up to an additional $20.0 million subject to lender approval. The amount available to the Company for borrowings under the Credit Agreement is based on the Company’s collateral base, as determined under the Credit Agreement, and is reduced by the amount of each outstanding standby letter of credit. The Credit Agreement is secured by substantially all assets of the Company and its operating subsidiaries. At December 31, 2010 and 2009, the Company had no borrowings outstanding under the Credit Agreement. At December 31, 2010, the Company had $20.0 million available for borrowing, based on the current facility cap and the Company’s collateral base on that date and no standby letters of credit.

     Borrowings under the Credit Agreement are limited to the lesser of (1) 85% of eligible receivables or (2) $20.0 million (the “Borrowing Capacity”). Interest under the Credit Agreement is payable monthly at an annual rate of one-month LIBOR plus 2%, subject to a minimum LIBOR rate of 3.14%. The Company is also required to pay a monthly collateral management fee equal to 0.042% on average borrowings outstanding under the Credit Agreement.

     Under the terms of the Credit Agreement, the Company is required to pay a monthly unused line fee equal to 0.0375% on the Borrowing Capacity less the actual average borrowings outstanding under the Credit Agreement for the month and the balance of any outstanding letters of credit.

     All amounts outstanding under the Credit Agreement will be due and payable on October 31, 2011. If the Credit Agreement is extinguished prior to July 31, 2011, the Company will be required to pay an early termination fee equal to $0.4 million.

     The Credit Agreement requires the Company to maintain a minimum level of EBITDA of $8.0 million on a trailing twelve-month basis to be measured at the end of each calendar quarter. The Credit Agreement defines EBITDA as net income plus interest expense, income taxes, depreciation expense, amortization expense, any other non-cash non-recurring expense, loss from asset sales outside of the normal course of business and charges and cash expenses arising out of the Audit Committee investigation into matters at SPP including any expenses or charges incurred in the associated shareholder securities suit provided such amounts, net of insurance recoveries, do not exceed $4.5 million in the aggregate, minus gains on asset sales outside the normal course of business or other non-recurring gains. The Company was in compliance with the minimum level of EBITDA covenant requirement at December 31, 2010.

     The Credit Agreement permits the Company to declare and pay cash dividends, but requires the Company to maintain both a pre-distribution fixed charge coverage ratio and a post-distribution fixed charge coverage ratio both calculated on a trailing twelve-month basis to be measured at the end of each calendar quarter. The Credit Agreement defines the pre-distribution fixed charge coverage ratio as EBITDA, as defined above, divided by the sum of principal payments on outstanding debt, cash interest expense on outstanding debt, capital expenditures and cash income taxes paid or accrued. The Credit Agreement requires that the Company maintain a minimum pre-distribution fixed charge coverage ratio of 1.75. The Credit Agreement defines the post-distribution fixed charge coverage ratio as EBITDA, as defined above, divided by the sum of principal payments on outstanding debt, cash interest expense on outstanding debt, capital expenditures, cash income taxes paid or accrued, and cash dividends paid or accrued or declared. The Credit Agreement requires a minimum post-distribution fixed charge coverage ratio of 1.25 if the Company’s average net cash (cash less outstanding debt) plus the average amount available for borrowing under the Credit Agreement is greater than or equal to $20.0 million for the most recent calendar quarter; or, a minimum post-distribution fixed charge coverage ratio of 1.50 if the Company’s average net cash (cash less outstanding debt) plus the average amount available for borrowing under the Credit Agreement is less than $20.0 million for the most recent calendar quarter. At December 31, 2010, the Company was in compliance with both the pre-distribution fixed charge coverage ratio and the post-distribution fixed charge coverage ratio.

     Liquidity and Capital Resources Outlook

     The Company currently believes that cash flows from operating activities, its available cash, and its expected available credit under the Amended Credit Agreement will continue to enable it to meet its contractual obligations and capital expenditure requirements for the foreseeable future. The Company may, from time to time, consider acquisitions involving other companies or assets. Such acquisitions or other opportunities may require the Company to raise additional capital by expanding its existing credit facility and /or issuing debt or equity, as market conditions permit. If the Company is unable to obtain such additional capital on a timely basis, on favorable terms or at all, it could have inadequate capital to operate its business, meet its contractual obligations and capital expenditure requirements or fund potential acquisitions. Current market and economic conditions, including turmoil and uncertainty in the financial services industry and credit markets, have caused credit markets to tighten and led many lenders and institutional investors to reduce, and in some cases, cease to provide, funding to borrowers. Should the credit markets not improve, the Company can make no assurances that it would be able to secure additional financing if needed and, if such funds were available, whether the terms or conditions would be acceptable.

     Contractual Obligations And Commercial Commitments

     The Company has certain contractual obligations as of December 31, 2010, summarized by the period in which payment is due, as follows (dollar amounts in thousands):

		Current				2-3 years				4-5 years				After 5 years
Operating leases		$	1,433			$	2,527			$	2,524			$	916
Workers compensation claims			2,473				2,251				979				766
Professional and general liability claims			7,026				14,032				1,521				67
Total		$	10,932			$	18,810			$	5,024			$	1,749

     The amounts included in the table above do not include future cash payments for interest. At December 31, 2010, the Company has no debt outstanding.

     Other Financing Transactions

     At December 31, 2010, the Company was contingently liable for $6.6 million of performance bonds.

     Off-Balance Sheet Transactions

     As of December 31, 2010, the Company did not have any off-balance sheet financing transactions or arrangements except the operating leases noted above.

     Inflation

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

     Recent Accounting Pronouncements

     Health Care Entities: Presentation of Insurance Claims and Related Insurance Recoveries. In August 2010, the FASB issued an accounting standards update which clarifies that a health care entity should not net insurance recoveries against a related claim liability. The guidance provided is effective as of the beginning of the first fiscal year beginning after December 15, 2010. The adoption of this standard will have no material impact of the Company’s financial position or results of operations.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

     Market risk represents the risk of loss that may impact the consolidated financial statements of the Company due to adverse changes in financial market prices and rates. The Company’s exposure to market risk is primarily related to changes in the variable interest rate under the Company’s Credit Agreement. The Credit Agreement contains an interest rate based on the one-month LIBOR rate, subject to a minimum LIBOR rate of 3.14%; therefore the Company’s cash flow may be affected by changes in the one-month LIBOR rate. A hypothetical 10% change in the underlying interest rate would have would have had no material effect on interest expense paid under the Credit Agreement. Net interest expense (income) represents less than 1% of the Company’s revenues for each the years ended December 31, 2010 and 2009. The Company has no debt outstanding at December 31, 2010.

Item 8. Financial Statements and Supplementary Data

     The Company’s consolidated financial statements, together with the reports thereon of Deloitte & Touche LLP, dated March 2, 2011 and Ernst & Young LLP, dated March 3, 2009, except for Note 6, as to which the date is March 2, 2011, begin on page F-1 of this Annual Report on Form 10-K and are incorporated herein by reference.

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

     Changes in Independent Registered Public Accounting Firm

     As previously disclosed by the Company, in its Current Report on Form 8-K filed June 12, 2009, the Company’s Audit Committee of the Board of Directors (the “Audit Committee”) conducted a competitive process to select a firm to serve as the Company’s independent registered public accounting firm for the fiscal year ending December 31, 2009. As a result of this process and following careful deliberation, on June 10, 2009, the Audit Committee engaged Deloitte & Touche LLP (“Deloitte”) as the Company’s independent registered public accounting firm for the fiscal year ending December 31, 2009, and dismissed Ernst & Young LLP (“E&Y”) from that role on June 10, 2009.

     E&Y’s audit reports on the Company’s consolidated financial statements as of and for the fiscal year ended December 31, 2008 and 2007 did not contain an adverse opinion or a disclaimer of opinion and were not qualified or modified as to uncertainty, audit scope or accounting principles.

     During the fiscal years ended December 31, 2008 and 2007 and in the subsequent interim period through June 10, 2009, neither the Company, nor anyone acting on its behalf, consulted with Deloitte on any matters or events set forth in Item 304(a)(2) of Regulation S-K.

     Disagreements with Accountants on Accounting and Financial Disclosure

     There are no disagreements with accountants on accounting and financial disclosure required to be reported in this annual report pursuant to Item 304 of Regulation S-K.

Item 9A. Controls and Procedures

     Conclusion Regarding the Effectiveness of Disclosure Controls and Procedures

     Disclosure controls and procedures are the Company’s controls and other procedures that are designed to ensure that information required to be disclosed in the reports that the Company files or submits under the Securities Exchange Act of 1934, as amended, (the “Exchange Act”) is recorded, processed, summarized and reported in a complete, accurate and appropriate manner, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in the reports that the Company files under the Exchange Act is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

     As of December 31, 2010, the Company evaluated under the supervision and with the participation of management, including the Chief Executive Officer and Chief Financial Officer, the effectiveness of the design and operation of the Company’s disclosure controls and procedures, pursuant to Exchange Act Rule 13a-15 and Rule 15d-15. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective to ensure that information required to be disclosed in the reports that the Company files under the Exchange Act is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

     Management’s Annual Report on Internal Control Over Financial Reporting

     The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rules 13a — 15(f). Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies and procedures may deteriorate. Under the supervision and with the participation of management, including the Chief Executive Officer and Chief Financial Officer, management conducted an evaluation of the effectiveness of internal control over financial reporting based on the framework in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”). Based on management’s assessment under such framework, management concluded that the Company’s internal control over financial reporting was effective as of December 31, 2010.

     Deloitte & Touche LLP, the independent registered public accounting firm that audited the Company’s consolidated financial statements for the year ended December 31, 2010, has issued an attestation report on the Company’s internal control over financial reporting which is included on page 36.

     Changes in Internal Controls

     There have been no changes in the Company’s internal control over financial reporting during the Company’s fourth fiscal quarter that materially affect, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of
America Service Group Inc.
Brentwood, Tennessee

We have audited the internal control over financial reporting of America Service Group Inc. and subsidiaries (the “Company”) as of December 31, 2010, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Annual Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.

We conducted our audit 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 effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2010, based on the criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements and financial statement schedule as of and for the year ended December 31, 2010 of the Company and our report dated March 2, 2011 expressed an unqualified opinion on those financial statements and financial statement schedule.

/s/ DELOITTE & TOUCHE LLP

Nashville, Tennessee
March 2, 2011

Item 8B. Other Information

     None.

PART III

Item 10. Directors, Executive Officers and Corporate Governance

     For information regarding the Directors and Executive Officers of the Company, Audit Committee and Audit Committee Financial Experts of the Company, the heading “Corporate Governance,” “Information as to Directors, Nominees and Executive Officers” and the subsection “Section 16(a) Beneficial Reporting Compliance” under the heading “Additional Information” in the Company’s Proxy Statement for its 2011 Annual Meeting of Stockholders (the “Company’s 2011 Proxy Statement”) and the accompanying text are incorporated herein by reference.

     America Service Group Code Of Conduct & Ethics

     America Service Group has a Code of Conduct & Ethics that applies to all its employees, including senior executives and its Board of Directors. This ethics policy may be viewed on the Company’s web site at www.asgr.com. The Company intends to satisfy the disclosure requirement under Item 5.05 of Form 8-K relating to amendments to or waivers from any provision of the Code of Conduct & Ethics applicable to the Company’s Chief Executive Officer and Chief Financial Officer by posting such information on its website.

Item 11. Executive Compensation

     The heading “Director and Executive Officer Compensation” in the Company’s 2011 Proxy Statement and the accompanying text are incorporated herein by reference.

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

     The headings “Security Ownership of Directors and Officers,” “Principal Stockholders” and the subsection “Equity Compensation Plan Information” under the heading “Director and Executive Officer Compensation” in the Company’s 2011 Proxy Statement and the accompanying text are incorporated herein by reference.

Item 13. Certain Relationships and Related Transactions, and Director Independence

     The heading “Certain Related Person Transactions” and the subsection “Director Independence” under the heading “Information as to Directors, Nominees and Executive Officers” in the Company’s 2011 Proxy Statement and the accompanying text is incorporated herein by reference.

Item 14. Principal Accountant Fees and Services

     The heading “Proposal Two: Ratification of Appointment of Independent Registered Public Accounting Firm” in the Company’s 2011 Proxy Statement and the accompanying text is incorporated herein by reference.

PART IV

Item 15. Exhibits and Financial Statement Schedule

(a)		(1) Financial Statements
		Listed on the Index to the Consolidated Financial Statements and Schedule on page F-1 of this Report.
		(2) Financial Statement Schedule
		Listed on the Index to the Consolidated Financial Statements and Schedule on page F-1 of this Report.
		(3) Exhibits

Exhibit		Description
3.1		Amended and Restated Certificate of Incorporation of America Service Group Inc. (incorporated herein by reference to Exhibit 3.1 to the Company’s Quarterly Report on Form 10-Q for the three-month period ended June 30, 2002).
3.2		Certificate of Amendment of Amended and Restated Certificate of Incorporation of America Service Group Inc. (incorporated herein by reference to Exhibit 3.4 to the Company’s Quarterly Report on Form 10-Q for the three month period ended June 30, 2004).
3.3		Amended and Restated By-Laws of America Service Group Inc. (incorporated herein by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K filed on March 3, 2009).
4.1		Specimen Common Stock Certificate (incorporated herein by reference to Exhibit 4.1 to the Company’s Quarterly Report on Form 10-Q for the three-month period ended June 30, 2002).
4.2		Certificate of Designation of the Series A Convertible Preferred Stock (incorporated herein by reference to Exhibit 99.3 to the Company’s Current Report on Form 8-K filed on February 10, 1999).
10.1		Registration Rights Agreement, dated as of January 26, 1999, among America Service Group Inc., Health Care Capital Partners L.P. and Health Care Executive Partners L.P. (incorporated herein by reference to Exhibit 99.9 to the Company’s Current Report on Form 8-K filed on February 10, 1999).
10.2		Amended and Restated Employment Agreement, dated as of September 15, 2008, between America Service Group Inc. and Richard Hallworth (incorporated herein by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed on September 19, 2008).*
10.3		Separation Agreement and General Release, dated as of September 15, 2008, between America Service Group Inc. and Michael Catalano (incorporated herein by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on September 19, 2008).*
10.4		Letter Agreement, dated as of November 7, 2008, between America Service Group Inc. and Michael Catalano (incorporated herein by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on November 10, 2008).*
10.5		Amended and Restated Employment Agreement, dated as of September 15, 2008, between America Service Group Inc. and Michael W. Taylor (incorporated herein by reference to Exhibit 10.3 to the Company’s Current Report on Form 8-K filed on September 19, 2008).*
10.6		Employment Agreement, dated March 24, 1998, between Lawrence H. Pomeroy and America Service Group Inc. (incorporated herein by reference to Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q for the three month period ended March 31, 2004).*
10.7		Employment Agreement, dated as of January 26, 2009, between America Service Group Inc. and Jonathan Walker (incorporated herein by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on March 13, 2009).*
10.8		Employment Agreement, dated as of October 11, 2010, between America Service Group Inc. and Dr. Carl J. Keldie (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on October 12, 2010).*

Exhibit		Description
10.9		America Service Group Inc. Amended and Restated Incentive Stock Plan (incorporated herein by reference to Exhibit 10.12 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2002).*
10.10		America Service Group Inc. Amended and Restated 1999 Incentive Stock Plan (incorporated herein by reference to Appendix B to the Company’s Definitive Proxy Statement for its Annual Meeting of Stockholders held on June 16, 2004, which Definitive Proxy Statement was filed on April 29, 2004).*
10.11		America Service Group Inc. 2009 Equity Incentive Plan (incorporated by reference to Annex A of the Company’s Definitive Proxy Statement on Schedule 14A filed April 30, 2009).*
10.12		Amended and Restated Employee Stock Purchase Plan of America Service Group Inc. (incorporated herein by reference to Exhibit 10.16 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2004).*
10.13		2010 Incentive Compensation Plan of America Service Group Inc. (incorporated herein by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed on March 2, 2010).*
10.14		2011 Incentive Compensation Plan of America Service Group Inc. (incorporated herein by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed on March 3, 2011).*
10.15		Summary of 2011 Director and Executive Officer Compensation.*
10.16		Contract between Prison Health Services, Inc, and the New York City Department of Health and Mental Hygiene (incorporated herein by reference to Exhibit 10.12 to the Company’s Annual Report on Form 10-K filed on March 31, 2006).
10.17		Renewal, effective as of January 1, 2008, to an Agreement dated January 1, 2005, as amended, effective July 1, 2005 (incorporated herein by reference to Exhibit 99.1 to the Company’s Current Report on Form 8-K filed on January 4, 2008).
10.18		Agreement between New York City Department of Health and Mental Hygiene and Prison Health Services, Inc., effective January 1, 2011 (incorporated herein by reference to Exhibit 99.1 to the Company’s Current Report on Form 8-K filed on January 4, 2011).
10.19		Form of New Director Stock Grant Certificate under the America Service Group Inc. Amended and Restated 1999 Incentive Stock Plan (incorporated herein by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on June 14, 2006).*
10.20		Form of Director Non-Qualified Stock Option Agreement under the America Service Group Inc. Amended and Restated Incentive Stock Plan (incorporated herein by reference to Exhibit 10.19 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2004).*
10.21		Form of Employee Non-Qualified Stock Option Agreement under the America Service Group Inc. Amended and Restated Incentive Stock Plan (incorporated herein by reference to Exhibit 10.20 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2004).*
10.22		Form of Director Non-Incentive Stock Option Agreement under the America Service Group Inc. Amended and Restated 1999 Incentive Stock Plan (incorporated herein by reference to Exhibit 10.21 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2004).*
10.23		Form of Employee Non-Incentive Stock Option Agreement under the America Service Group Inc. Amended and Restated 1999 Incentive Stock Plan (incorporated herein by reference to Exhibit 10.22 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2004).*
10.24		Form of Employee Incentive Stock Option Agreement under the America Service Group Inc. Amended and Restated 1999 Incentive Stock Plan (incorporated herein by reference to Exhibit 10.23 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2004).*
10.25		Form of Stock Grant Certificate under the America Service Group Inc. Amended and Restated 1999 Incentive Stock Plan (incorporated herein by reference to Exhibit 10.2 to the Company’s Quarterly Report on Form 10-Q filed on August 8, 2007) (supersedes previous form filed as Exhibit 10.24 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2004 (Commission File No. 000-19673) filed with the Commission on March 14, 2005).*
10.26		Form of Employee Stock Grant Certificate under the America Service Group Inc. Amended and Restated 1999 Incentive Stock Plan (incorporated herein by reference to Exhibit 10.3 to the Company’s Quarterly Report on Form 10-Q filed on August 8, 2007).*

Exhibit		Description
10.27		Form of 2008 Employee Stock Grant Certificate under the America Service Group Inc. Amended and Restated 1999 Incentive Stock Plan (incorporated herein by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on August 7, 2008).*
10.28		Form of 2008 Non-employee Director Stock Grant Certificate under the America Service Group Inc. Amended and Restated 1999 Incentive Stock Plan (incorporated herein by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on August 7, 2008).*
10.29		Form of March 2009 Employee Stock Grant Certificate under the America Service Group Inc. Amended and Restated 1999 Incentive Stock Plan (incorporated herein by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed on March 13, 2009).*
10.30		Form of August 2009 Employee Stock Grant Certification under the America Service Group Inc. 2009 Equity Incentive Plan (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on August 11, 2009).*
10.31		Form of October 2010 Employee Stock Option Agreement under the America Service Group Inc. 2009 Equity Incentive Plan (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on October 12, 2010).*
10.32		Contract between Prison Health Services, Inc. and the Commonwealth of Pennsylvania Department of Corrections (incorporated herein by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on August 28, 2003).
10.33		Contract Modification Agreement No. 1 to Medical Services Agreement between Commonwealth of Pennsylvania Department of Corrections and Prison Health Services, Inc. (incorporated herein by reference to Exhibit 10.28 to the Company’s Annual Report on Form 10-K filed on March 31, 2006).
10.34		Contract Modification Agreement No. 2 to Medical Services Agreement between Commonwealth of Pennsylvania Department of Corrections and Prison Health Services, Inc. (incorporated herein by reference to Exhibit 10.29 to the Company’s Annual Report on Form 10-K filed on March 31, 2006).
10.35		Contract Modification Agreement No. 3 to Medical Services Agreement between Commonwealth of Pennsylvania Department of Corrections and Prison Health Services, Inc. (incorporated herein by reference to Exhibit 99.1 to the Company’s Current Report on Form 8-K filed on February 6, 2008).
10.36		Pharmacy Service Agreement, dated as of May 1, 2007, by and among Prison Health Service, Inc., Correctional Health Services, LLC and Maxor National Pharmacy Services Corporation (incorporated herein by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q filed on August 8, 2007).+
10.37		Revolving Credit and Security Agreement dated July 28, 2009 between America Service Group Inc., a Delaware corporation, Prison Health Services, Inc., a Delaware corporation, Prison Health Services of Indiana, LLC, an Indiana limited liability company, Secure Pharmacy Plus, LLC, a Tennessee limited liability company, Correctional Health Services, LLC, a New Jersey limited liability company, and CapitalSource Bank, a California industrial bank, as lender and collateral and administrative agent (incorporated herein by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on July 29, 2009).
10.38		Amendment No.1 and Waiver to the Revolving Credit and Security Agreement, dated March 2, 2010 between America Service Group Inc., a Delaware corporation, Prison Health Services, Inc., a Delaware corporation, Prison Health Services of Indiana, LLC, an Indiana limited liability company, Secure Pharmacy Plus, LLC, a Tennessee limited liability company, Correctional Health Services, LLC, a New Jersey limited liability company, and CapitalSource Bank, a California industrial bank, as lender and collateral and administrative agent (incorporated herein by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on March 2, 2010).
10.39		Contract between Prison Health Services, Inc. and the State of Michigan, dated February 10, 2009 (incorporated herein by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on February 13, 2009).
10.40		Change Notice No. 2 to the Contract between Prison Health Service, Inc. and the State of Michigan (incorporated herein by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on August 26, 2010).
11.0		Computation of Per Share Earnings.**
21.1		Subsidiaries of the Company.

Exhibit		Description
23.1		Consent of Deloitte & Touche LLP.
23.2		Consent of Ernst & Young LLP.
31.1		Certification of the Chief Executive Officer Pursuant to Rule 13a-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2		Certification of the Chief Financial Officer Pursuant to Rule 13a-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1		Certification of the Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2		Certification of the Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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, on March 2, 2011.

     Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on March 2, 2011.

Signatures		Title
/s/ RICHARD HALLWORTH		Director, President and Chief Executive Officer
Richard Hallworth		(Principal Executive Officer)
/s/ MICHAEL W. TAYLOR		Director, Executive Vice President, Chief Financial Officer and Treasurer
Michael W. Taylor		(Principal Financial and Accounting Officer)
/s/ RICHARD D. WRIGHT		Director, Chairman
Richard D. Wright
/s/ BURTON C. EINSPRUCH		Director
Burton C. Einspruch
/s/ WILLIAM M. FENIMORE, JR.		Director
William M. Fenimore, Jr.
/s/ JOHN W. GILDEA		Director
John W. Gildea

AMERICA SERVICE GROUP INC.

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULE

		Page
Consolidated Financial Statements
Reports of Independent Registered Public Accounting Firms			F-2
Consolidated Balance Sheets at December 31, 2010 and 2009			F-4
Consolidated Statements of Operations for the years ended December 31, 2010, 2009, and 2008			F-5
Consolidated Statements of Changes in Stockholders’ Equity for the years ended December 31, 2010, 2009 and 2008			F-6
Consolidated Statements of Cash Flows for the years ended December 31, 2010, 2009 and 2008			F-7
Notes to Consolidated Financial Statements			F-8
Financial Statement Schedule
Valuation and Qualifying Accounts and Reserves (Schedule II) for the years ended December 31, 2010, 2009 and 2008			F-35

     All other schedules are omitted as the required information is inapplicable or is presented in the Company’s Consolidated Financial Statements or the Notes thereto.

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of
America Service Group Inc.
Brentwood, Tennessee

We have audited the accompanying consolidated balance sheets of America Service Group Inc. and subsidiaries (the “Company”) as of December 31, 2010 and 2009, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the two years in the period ended December 31, 2010. Our audits also included the financial statement schedule listed in the Index at Item 15 (a). These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on the financial statements and financial statement schedule 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. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of America Service Group Inc. and subsidiaries as of December 31, 2010 and 2009, and the results of their operations and their cash flows for each of the two years in the period ended December 31, 2010, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2010, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 2, 2011 expressed an unqualified opinion on the Company’s internal control over financial reporting.

/s/ DELOITTE & TOUCHE LLP

Nashville, Tennessee
March 2, 2011

Report of Independent Registered Public Accounting Firm

The Board of Directors and Shareholders of
America Service Group Inc.

We have audited the accompanying consolidated statements of operations, changes in stockholders’ equity and cash flows of America Service Group Inc. for the year ended December 31, 2008. Our audit also included the financial statement schedule listed in the Index at Item 15(a). These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audit.

We conducted our audit 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. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated results of operations and cash flows of America Service Group Inc. for the year ended December 31, 2008, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

/s/ ERNST & YOUNG LLP

Nashville, Tennessee
March 3, 2009, except for Note 6, as to which the date is March 2, 2011

AMERICA SERVICE GROUP INC.

CONSOLIDATED BALANCE SHEETS
(shown in 000’s except share and per share amounts)

		December 31,
		2010				2009
ASSETS
Current assets:
Cash and cash equivalents		$	39,584			$	37,655
Accounts receivable: healthcare and other, less allowances of $411 and $358, respectively			52,481				44,629
Inventories			2,868				2,929
Prepaid expenses and other current assets			13,750				16,754
Current deferred tax assets			3,359				9,252
Total current assets			112,042				111,219
Property and equipment, net			11,040				9,447
Goodwill			40,772				40,772
Contracts, net			1,658				1,937
Other assets			11,852				11,837
Total assets		$	177,364			$	175,212
LIABILITIES AND EQUITY
Current liabilities:
Accounts payable		$	23,691			$	15,393
Accrued medical claims liability			23,750				22,358
Accrued expenses			38,810				62,895
Deferred revenue			10,053				13,385
Total current liabilities			96,304				114,031
Noncurrent portion of accrued expenses			20,460				15,481
Noncurrent deferred tax liabilities			4,836				3,727
Total liabilities			121,600				133,239
Commitments and contingencies (Note 21)
Stockholders’ equity:
Preferred stock, $0.01 par value, 2,000,000 shares authorized at December 31, 2010 and 2009; no shares issued or outstanding			—				—
Common stock, $0.01 par value, 20,000,000 shares authorized at December 31, 2010 and 2009; 9,280,382 and 8,947,370 shares issued and outstanding at December 31, 2010 and 2009, respectively			93				89
Additional paid-in capital			40,015				33,608
Retained earnings			15,656				8,276
Total stockholders’ equity			55,764				41,973
Total liabilities and equity		$	177,364			$	175,212

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

AMERICA SERVICE GROUP INC.

CONSOLIDATED STATEMENTS OF OPERATIONS
(shown in 000’s except share and per share amounts)

		Year Ended December 31,
		2010				2009				2008
Healthcare revenues		$	630,303			$	579,474			$	460,457
Healthcare expenses			575,628				533,928				423,075
Gross margin			54,675				45,546				37,382
Selling, general, and administrative expenses			32,159				29,972				27,045
Merger expenses			740				—				—
Corporate restructuring expenses			290				—				2,255
Audit Committee investigation and related expenses			496				8,413				226
Depreciation and amortization			3,462				2,756				3,770
Income from operations			17,528				4,405				4,086
Interest expense (income), net			(76	)			117				722
Income from continuing operations before income tax provision			17,604				4,288				3,364
Income tax provision			7,722				2,175				1,629
Income from continuing operations			9,882				2,113				1,735
Income (loss) from discontinued operations, net of taxes			(333	)			1,169				2,099
Net income		$	9,549			$	3,282			$	3,834
Net income available to common shareholders (Note 17)		$	9,368			$	3,176			$	3,757
Net income (loss) available to common shareholders per common share — basic:
Continuing operations		$	1.10			$	0.23			$	0.19
Discontinued operations, net of taxes			(0.04	)			0.13				0.22
Net income available to common shareholders per common share (Note 17)		$	1.06			$	0.36			$	0.41
Net income (loss) available to common shareholders per common share — diluted:
Continuing operations		$	1.09			$	0.23			$	0.19
Discontinued operations, net of taxes			(0.04	)			0.13				0.22
Net income available to common shareholders per common share (Note 17)		$	1.05			$	0.36			$	0.41
Weighted average common shares outstanding:
Basic			8,859,829				8,916,737				9,144,102
Diluted			8,934,028				8,959,087				9,152,712
Dividends declared and paid per share		$	0.24			$	0.10			$	—

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

AMERICA SERVICE GROUP INC.

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
(shown in 000’s except share amounts)

										Additional
		Common Stock								Paid-In				Retained
		Shares				Amount				Capital				Earnings				Total
Balance at December 31, 2007			9,316,014				93				37,485				2,072				39,650
Net income			—				—				—				3,834				3,834
Total comprehensive income																			3,834
Issuance of common stock under employee stock plan			37,294				1				234				—				235
Exercise of options and related tax benefits			15,300				—				84				—				84
Issuance of restricted shares			148,000				1				(1	)			—				—
Income tax deficiency from share-based employee compensation			—				—				(145	)			—				(145	)
Forfeiture of restricted shares			(9,000	)			—				—				—				—
Share-based employee compensation expense			—				—				2,762				—				2,762
Repurchase and retirement of common stock			(246,900	)			(2	)			(2,372	)			—				(2,374	)
Balance at December 31, 2008			9,260,708				93				38,047				5,906				44,046
Net income			—				—				—				3,282				3,282
Total comprehensive income																			3,282
Dividends on common stock ($0.10 per common share)			—				—				—				(912	)			(912	)
Issuance of common stock under employee stock plan			37,608				—				319				—				319
Exercise of options and related tax benefits			149,088				1				1,862				—				1,863
Issuance of restricted shares			132,700				1				(1	)			—				—
Restricted stock repurchased from employees for employees’ tax liability			(10,284	)			—				(177	)			—				(177	)
Forfeiture of restricted shares			(11,000	)			—				—				—				—
Share-based employee compensation expense			—				—				1,822				—				1,822
Repurchase and retirement of common stock			(611,450	)			(6	)			(8,264	)			—				(8,270	)
Balance at December 31, 2009			8,947,370				89				33,608				8,276				41,973
Net income			—				—				—				9,549				9,549
Total comprehensive income																			9,549
Dividends on common stock ($0.24 per common share)			—				—				—				(2,169	)			(2,169	)
Issuance of common stock under employee stock plan			28,625				1				391				—				392
Exercise of options			78,410				1				886				—				887
Issuance of restricted shares			15,000				—				—				—				—
Shares issued in shareholder settlement			300,000				3				4,533				—				4,536
Restricted stock repurchased from employees for employees’ tax liability			(54,490	)			(1	)			(956	)			—				(957	)
Forfeiture of restricted shares			(1,033	)			—				—				—				—
Share-based employee compensation expense			—				—				2,097				—				2,097
Repurchase and retirement of common stock			(33,500	)			—				(544	)			—				(544	)
Balance at December 31, 2010			9,280,382			$	93			$	40,015			$	15,656			$	55,764

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

AMERICA SERVICE GROUP INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS
(shown in 000’s)

		Year Ended December 31,
		2010				2009				2008
Cash flows from operating activities
Net income		$	9,549			$	3,282			$	3,834
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization			3,473				2,842				3,841
Loss on retirement of fixed assets			99				32				81
Finance cost amortization			31				114				40
Deferred income taxes			7,002				(1,908	)			2,640
Share-based compensation expense			2,097				1,822				2,813
Excess tax benefits from share-based compensation expense			—				(144	)			(51	)
Changes in operating assets and liabilities:
Accounts receivable, net			(7,852	)			(3,622	)			21,656
Inventories			61				4				66
Prepaid expenses and other current assets			3,004				(3,767	)			(2,260	)
Other assets			(42	)			(6,767	)			3,958
Accounts payable			8,298				(4,177	)			(694	)
Accrued medical claims liability			1,392				7,615				(7,441	)
Accrued expenses			(14,570	)			23,865				4,286
Deferred revenue			(3,332	)			5,333				(3,944	)
Net cash provided by operating activities			9,210				24,524				28,825
Cash flows from investing activities
Capital expenditures			(4,890	)			(4,547	)			(3,384	)
Net cash used in investing activities			(4,890	)			(4,547	)			(3,384	)
Cash flows from financing activities
Net payments on line of credit facility			—				—				(7,500	)
Dividends on common stock			(2,169	)			(912	)			—
Restricted stock repurchased from employees for employees’ tax liability			(957	)			(177	)			—
Excess tax benefits from share-based compensation expense			—				144				51
Share repurchases			(544	)			(8,270	)			(2,374	)
Issuance of common stock			392				319				235
Exercise of stock options			887				1,719				33
Net cash used in financing activities			(2,391	)			(7,177	)			(9,555	)
Net increase in cash and cash equivalents			1,929				12,800				15,886
Cash and cash equivalents at beginning of year			37,655				24,855				8,969
Cash and cash equivalents at end of year		$	39,584			$	37,655			$	24,855
Supplemental cash flow information
Cash paid for interest		$	41			$	208			$	929
Cash paid for income taxes		$	4,282			$	1,668			$	342
Supplemental schedule of non-cash activities
Capital expenditures funded by tenant improvement allowance		$	—			$	899			$	—
Common stock issued in shareholder settlement		$	4,536			$	—			$	—

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

AMERICA SERVICE GROUP INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2010

1. Description of Business

     America Service Group Inc. (“ASG” or the “Company”) and its consolidated subsidiaries provide managed healthcare services to correctional facilities under contracts with state and local governments and certain private entities. The health status of inmates impacts the results of operations under such contractual arrangements. The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries, Prison Health Services, Inc. (“PHS”), Correctional Health Services, LLC (“CHS”) and Secure Pharmacy Plus, LLC (“SPP”).

2. Summary of Significant Accounting Policies

Principles of Consolidation

     All intercompany accounts and transactions have been eliminated in consolidation.

Use of Estimates

     The preparation of the consolidated financial statements in conformity with United States Generally Accepted Accounting Principles (“U. S. GAAP”) requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates. Some of the more significant areas requiring estimates in the consolidated financial statements include the Company’s accruals for unbilled medical services calculated based upon a claims payment lag methodology, realization of goodwill, estimated amortizable life of contract intangibles, reductions in revenue for contractual allowances, allowance for doubtful accounts, legal contingencies and share-based compensation as well as accruals associated with employee health, workers’ compensation and professional and general liability claims, for which the Company is substantially self-insured. Estimates change as new events occur, more experience is acquired, or additional information is obtained. A change in an estimate is accounted for in the period of change.

Fair Value of Financial Instruments

     The Company’s financial instruments reported in the consolidated balance sheets consist of cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities. Due to the short term nature of these instruments and the variable interest rate nature of the cash equivalents, the carrying amounts approximate fair value.

Revenue and Cost Recognition

     The Company’s contracts to provide healthcare services to correctional institutions are principally fixed price contracts with revenue adjustments for census fluctuations and risk sharing arrangements, such as stop-loss provisions and aggregate limits for off-site medical provider or pharmaceutical costs. Such contracts typically have a term of one to three years with subsequent renewal options and generally may be terminated by either party without cause upon proper notice. Revenues earned under contracts with correctional institutions are recognized in the period that services are rendered. Cash received in advance for future services is recorded as deferred revenue and recognized as income when the service is performed.

     Revenues are calculated based on the specific contract terms and fall into one of three general categories: fixed fee, population based, or cost plus a fee.

     For fixed fee contracts, revenues are recorded based on fixed monthly amounts established in the service contract irrespective of inmate population. Revenues for population-based contracts are calculated either on a fixed fee that is subsequently adjusted using a per diem rate for variances in the inmate population from predetermined population levels or by a per diem rate multiplied by the average inmate population for the period of service. For cost plus a fee contracts, revenues are calculated based on actual expenses incurred during the service period plus a contractual fee.

     Generally, the Company’s contracts will also include additional provisions which mitigate a portion of the Company’s risk related to cost increases. Off-site medical provider utilization risk is mitigated in the majority of the Company’s contracts through aggregate pools or caps for off-site medical provider expenses, stop-loss provisions, cost plus a fee arrangements or, in some cases, the entire exclusion of certain or all off-site medical provider service costs. Pharmacy expense risk is similarly mitigated in certain of the Company’s contracts. Typically, under the terms of such provisions, the Company’s revenue under the contract increases to offset increases in specified cost categories such as off-site medical provider expenses or pharmaceutical costs. For contracts that include such provisions, the Company recognizes the additional revenues due from clients based on its estimates of applicable contract to date costs incurred as compared to the corresponding pro rata contractual limit for such costs. Because such provisions typically specify how often such additional revenue may be invoiced and require all such additional revenue to be ultimately settled based on actual expenses, the additional revenues are initially recorded as unbilled receivables until the time period for billing has been met and actual costs are known. Any differences between the Company’s estimates of incurred costs and the actual costs are recorded in the period in which such differences become known along with the corresponding adjustment to the amount of recorded additional revenues.

     Under all contracts, the Company records revenues net of any estimated contractual allowances for potential adjustments resulting from a failure to meet performance or staffing related criteria. If necessary, the Company revises its estimates for such adjustments in future periods when the actual amount of the adjustment is determined.

     The table below illustrates these revenue categories as a percentage of total revenues from continuing operations for the years ended December 31, 2010, 2009 and 2008.

		Percentage of Revenue from Continuing Operations
		For the Year Ended				For the Year Ended				For the Year Ended
Contract Category		December 31, 2010				December 31, 2009				December 31, 2008
Fixed Fee			12.5	%			12.7	%			15.3	%
Population Based			67.6	%			65.2	%			59.3	%
Cost Plus a Fee			19.9	%			22.1	%			25.4	%

     Contracts under the population based and fixed fee categories generally have similar margins which are higher than margins for contracts under the cost plus a fee category. Cost plus a fee contracts generally have lower margins but with much less potential for variability due to the limited risk involved. The Company’s profitability under each of the three general contract categories discussed above varies based on the level of risk assumed under the contract terms with the most potential for variability being in contracts under the population based or fixed fee categories which do not contain the risk mitigating provisions related to off-site medical provider utilization described above.

     Healthcare expenses include the compensation of physicians, nurses and other healthcare professionals and related benefits and all other direct costs of providing and/or administering the managed care, including the costs associated with services provided and/or administered by off-site medical providers, the costs of professional and general liability insurance and other self-funded insurance reserves discussed more fully below. Many of the Company’s contracts require the Company’s customers to reimburse the Company for all treatment costs or, in some cases, only treatment costs related to certain catastrophic events, and/or for specific disease diagnoses illnesses. Certain of the Company’s contracts do not contain such limits. The Company attempts to compensate for the increased financial risk when pricing contracts that do not contain individual, catastrophic or specific disease diagnosis-related limits. However, the occurrence of severe individual cases, specific disease diagnoses illnesses or a catastrophic event in a facility governed by a contract without such limitations could render the contract unprofitable and could have a material adverse effect on the Company’s operations. For certain of its contracts that do not contain catastrophic protection, the Company maintains stop loss insurance from an unaffiliated insurer with respect to, among other things, inpatient and outpatient hospital expenses (as defined in the policy) for amounts in excess of $375,000 per inmate up to an annual cap of $1.0 million per inmate and $3.0 million in total. Amounts reimbursable per claim under the policy are further limited to the lessor of billed charges, the amount paid or the contracted amounts in situations where the Company has negotiated rates with the applicable providers.

     The cost of healthcare services provided, administered or contracted for are recognized in the period in which they are provided and/or administered based in part on estimates, including an accrual for estimated unbilled off-site medical provider services rendered through the balance sheet date. The Company estimates the accrual for unbilled off-site medical provider services using actual utilization data including hospitalization, one-day surgeries, physician visits and emergency room and ambulance visits and their corresponding costs, which are estimated using the average historical cost of such services. Additionally, the Company’s utilization management personnel perform a monthly review of inpatient hospital stays in order to identify any stays which would have a cost in

excess of the historical average rates. Once identified, reserves for such stays are determined which take into consideration the specific facts of the stay. An actuarial analysis is also prepared at least quarterly as an additional tool to be considered by management in evaluating the adequacy of the Company’s total accrual related to contracts which have sufficient claims payment history. The analysis takes into account historical claims experience (including the average historical costs and billing lag time for such services) and other actuarial data.

     Actual payments and future reserve requirements will differ from the Company’s current estimates. The differences could be material if significant fluctuations occur in the healthcare cost structure or the Company’s future claims experience. Changes in estimates of claims resulting from such fluctuations and differences between actuarial estimates and actual claims payments are recognized in the period in which the estimates are changed or the payments are made. In 2010, the Company recorded an increase of approximately $1.2 million to its prior year claims liabilities as a result of revisions to its estimated claims expense. In 2009 and 2008, the Company recorded decreases of approximately $0.4 million and $0.7 million, respectively, to its prior year claims liabilities as a result of revisions to its estimated claims expense. The impact to net income of these reductions to the Company’s claims reserves and associated expense is dependent upon whether any of the associated customer contracts contained provisions limiting risk of off-site medical provider costs. The reductions to claims reserves did not result in a significant impact to the Company’s net income as the changes occurred primarily in connection with contracts which contained provisions limiting risk of off-site medical provider costs and, as a result, these changes were off-set by corresponding additions or reductions to revenue.

Cash and Cash Equivalents

     Cash and cash equivalents include cash on hand, demand deposits, money market funds and investments which can be liquidated within three months or less when purchased. Due to the short term nature of these instruments, the carrying amounts approximate fair value.

     Additionally, the Company regularly maintains cash balances at a commercial bank in excess of the Federal Deposit Insurance Corporation insurance limit. If the commercial bank were to fail or be seized by federal regulators, the Company could lose a portion of its cash deposits at such bank, the result of which could have a material adverse effect on the Company’s financial position and results of operations.

Accounts Receivable

     Accounts receivable represent amounts due from state and local governments for healthcare services provided and/or administered by the Company. Included in unbilled accounts receivable is the Company’s estimate of revenue earned under risk sharing provisions.

     Accounts receivable are stated at estimated net realizable value. The Company recognizes allowances for doubtful accounts based on a variety of factors, including the length of time receivables are past due, significant one-time events, contractual rights, client funding and/or political pressures, discussions with clients and historical experience. If circumstances change, estimates of the recoverability of receivables would be further adjusted and such adjustments could have a material adverse effect on the Company’s results of operations in the period in which they are recorded.

Inventories

     Pharmacy and medical supplies inventories are stated at the lower of cost (first-in, first-out method) or market.

Property and Equipment

     Property and equipment are recorded at cost and depreciated on a straight-line basis over the estimated useful lives of the assets. Expenditures for maintenance and repairs are charged to expense as incurred, whereas expenditures for improvements and replacements are capitalized. The cost and accumulated depreciation of assets sold or otherwise disposed of are removed from the accounts and the resulting gain or loss is reflected in the consolidated statements of operations.

Software Costs

     The Company capitalizes costs associated with internally developed software systems that have reached the application development stage. Capitalized costs include external direct costs of materials and services utilized in developing or obtaining

internal-use software and payroll and payroll-related expenses for employees who are directly associated with and devote time to the internal-use software project. Capitalization of such costs begins when the preliminary project stage is complete and ceases no later than the point at which the project is substantially complete and ready for its intended purpose. In addition, the Company capitalizes costs associated with upgrades or enhancements to its internally developed software systems which result in additional functionality.

Goodwill

     Goodwill acquired is not amortized but is reviewed for impairment on an annual basis or more frequently whenever events or circumstances indicate that the carrying value may not be recoverable. U.S. GAAP requires that goodwill be tested at the reporting unit level, defined as an operating segment or one level below an operating segment (referred to as a component), with the fair value of the reporting unit being compared to its carrying amount, including goodwill. If the fair value of the reporting unit exceeds its carrying amount, goodwill of the reporting unit is not considered to be impaired. The Company has determined that it has one operating, as well as one reportable, segment. The Company’s policy is to perform its annual goodwill impairment test as of the last day of each fiscal year, i.e. December 31.

     In performing its annual goodwill impairment test, the Company uses a two-step process. The first step is a screen for potential impairment, while the second step measures the amount of the impairment, if any. The first step of the goodwill impairment test compares the fair value of a reporting unit with its carrying amount, including goodwill. The Company determined the fair value of its reporting unit to equal the market capitalization of its common stock as of the testing date. As of December 31, 2010, the indicated fair value of the Company’s reporting unit exceeded the carrying value of its reporting unit by a substantial amount, and, as such, the Company concluded that there was no indication of goodwill impairment.

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

     Important factors taken into consideration when evaluating the need for an impairment review, other than the annual impairment test, include the following:

	•		significant underperformance or loss of key contracts relative to expected historical or projected future operating results;
	•		significant changes in the manner of use of the Company’s assets or in the Company’s overall business strategy;
	•		significant negative industry or economic trends; and
	•		an adverse change in the Company’s market capitalization.

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

Contract Intangibles

     The Company’s other identifiable intangible assets represent customer contracts which were acquired in acquisitions and are amortized on the straight-line method over the contract’s estimated useful lives. The Company evaluates the estimated remaining useful life of its contract intangibles on at least a quarterly basis, taking into account new facts and circumstances, including its retention rate for acquired contracts. If such facts and circumstances indicate the current estimated useful life is no longer reasonable, the Company adjusts the estimated useful life on a prospective basis. Contract amortization expense totaled approximately $0.3 million, $0.3 million and $1.7 million for the years ended December 31, 2010, 2009 and 2008, respectively.

     The Company also assesses the potential impairment of its contract intangibles whenever events or changes in circumstances indicate that the carrying value may not be recoverable. When the Company determines that the carrying value of contract intangibles may not be recoverable based upon the existence of one or more of the above indicators of impairment, such impairment will be measured using an estimate of the asset’s fair value based on the projected net cash flows expected to result from that asset, including eventual disposition.

Other Assets

     Other assets at December 31, 2010 and 2009 include cash deposits totaling approximately $11.5 million and $9.8 million, respectively, which are held by the Company’s professional liability insurer and workers compensation insurer and are not expected to be utilized within the next year. In addition to cash deposits recorded within other assets, the Company has recorded cash deposits for professional liability claims losses totaling $5.5 million and $8.5 million at December 31, 2010 and 2009, respectively, within prepaid expenses and other current assets, which are expected to be utilized within a year. Under the terms of the Company’s professional liability insurance policies for 2002 through 2006 and 2008 through 2010, this cash will be used by the insurer to pay any professional liability claims made against the Company during those years. Based on evaluation of outstanding claims, management estimates the amount of cash deposits that will be utilized by the insurer to pay losses within a year.

     Also included in other assets at December 31, 2010 and 2009 are deferred financing costs associated with the Company’s credit facility (see Note 14). Such costs are being amortized over the life of the credit facility and such amortization is included in interest expense on the accompanying consolidated statements of operations. Amortization expense associated with deferred financing costs was approximately $31,000, $0.1 million and $40,000 for the years ended December 31, 2010, 2009 and 2008, respectively.

Long-Lived Assets

     The Company considers whether indicators of impairment of long-lived assets held for use (including the Company’s property and equipment, contracts and other intangibles) are present. If such indicators are present, the Company determines whether the sum of the estimated undiscounted future cash flows attributable to such assets is less than their carrying amount, and if so, recognizes an impairment loss based on the excess of the carrying amount of the assets over their fair value. Accordingly, management periodically evaluates the ongoing value of property and equipment and intangible assets and considers events, circumstances and operating results, including consideration of contract performance at the fixed price contract level, to determine if impairment exists. If long-lived assets are deemed impaired, management adjusts the asset value to fair value.

Income Taxes

     The Company accounts for income taxes under the provisions of U.S. GAAP related to income taxes. Under the asset and liability method of U.S. GAAP related to income taxes, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases.

     The Company regularly reviews its deferred tax assets for recoverability taking into consideration such factors as historical losses, projected future taxable income and the expected timing of the reversals of existing temporary differences. U.S. GAAP requires the Company to record a valuation allowance when it is “more likely than not that some portion or all of the deferred tax assets will not be realized.” At December 31, 2010, the Company’s valuation allowance of approximately $0.2 million represents management’s estimate of state net operating loss carryforwards which will expire unused.

     The Company accounts for tax contingency accruals under the provisions of U.S. GAAP related to accounting for uncertainty in income taxes, as adopted on January 1, 2007. The Company’s tax contingency accruals are reviewed quarterly and can be adjusted in light of changing facts and circumstances, such as the progress of tax audits, case law and emerging legislation. Adjustments to the tax contingency accruals are recorded in the period in which the new facts or circumstances become known, therefore the accruals are subject to change in future periods and such change, if it were to occur, could have a material adverse effect on the Company’s results of operations.

     It is the Company’s policy to recognize accrued interest and penalties related to its tax contingencies as income tax expense. As the Company has no tax contingencies at December 31, 2010, there is no accrued interest and penalties included in income tax expense for the year ended December 31, 2010.

     The Company files income tax returns in the U.S. federal jurisdiction and various state jurisdictions. The Company may be subject to examination by the Internal Revenue Service (“IRS”) for calendar years 2007 through 2010. The Company is currently under audit for the 2008 tax year. Additionally, open tax years related to certain state and local jurisdictions remain subject to examination.

Professional and General Liability Self-Insurance Retention

     As a healthcare provider, the Company’s business occasionally results in actions for negligence and other causes of action related to its provision of healthcare services with the attendant risk of substantial damage awards, or court ordered non-monetary relief such as, changes in operating practices or procedures, which may lead to the potential for substantial increases in the Company’s operating expenses. The most significant source of potential liability in this regard is the risk of suits brought by inmates alleging negligent healthcare services, deliberate indifference to their medical needs or the lack of timely or adequate healthcare services. The Company may also be liable, as employer, for the negligence of healthcare professionals it employs or healthcare professionals with whom it contracts. The Company’s contracts generally provide for the Company to indemnify the governmental agency for losses incurred related to healthcare provided by the Company and its agents.

     To mitigate a portion of this risk, the Company maintains a primary professional liability insurance program, principally on a claims-made basis. For 2002 through 2006 and 2008 through 2010 with respect to the majority of its patients, the Company purchased commercial insurance coverage, but is effectively self-insured due to the terms of the coverage which include adjustable premiums. For 2002 through 2006 and 2008 through 2010, the Company is covered by separate policies, each of which contains a premium that is retroactively adjusted, with adjustment based on actual losses. The Company’s ultimate premium for its 2002 through 2006 and 2008 through 2010 policies will depend on the final incurred losses related to each of these separate policy periods. For 2007, the Company is insured through claims made policies subject to per event and aggregate coverage limits. In addition to the coverage described above, effective January 1, 2010, the Company has purchased an excess liability policy which provides coverage on a claims made basis for indemnity losses in excess of $4.0 million up to a maximum coverage of $10 million per loss and in the aggregate. Any amounts ultimately incurred above these coverage limits would be the responsibility of the Company. Management establishes reserves for the estimated losses that will be incurred under these insurance policies after taking into consideration the Company’s professional liability claims department and external counsel evaluations of the merits of the individual claims, analysis of claim history, actuarial analysis and coverage limits where applicable. Any adjustments resulting from these ongoing reviews are reflected in current earnings.

     Given the fact that many claims are not brought during the year of occurrence, in addition to its reserves for known claims, the Company maintains a reserve for incurred but not reported claims. The reserve for incurred but not reported claims is recorded on an undiscounted basis. The Company’s estimates of this reserve are supported by various analyses, including an actuarial analysis, which is performed on a quarterly basis.

Other Self-funded Insurance Reserves

     As of December 31, 2010, the Company has approximately $8.0 million in accrued liabilities for employee health and workers’ compensation claims. Approximately $6.5 million of this amount is related to workers’ compensation claims, of which approximately $4.0 million is included within the noncurrent portion of accrued expenses as it is not expected to be paid within a year. The Company is essentially self-insured for employee health and workers’ compensation claims subject to certain individual case stop loss levels. As such, its insurance expense is largely dependent on claims experience and the ability to control claims. The Company accrues the estimated liability for employee health insurance based on its history of claims experience and estimated time lag between the incident date and the date of actual claim payment. The Company accrues the estimated liability for workers’ compensation claims based on evaluations of the merits of the individual claims and analysis of claims history. These estimated liabilities are recorded on an undiscounted basis. An actuarial analysis is prepared at least annually as an additional tool to be considered by management in evaluating the adequacy of the Company’s reserve for workers’ compensation claims. These estimates of self-funded insurance reserves could change in the future based on changes in the factors discussed above. Any adjustments resulting from such changes in estimates are reflected in current earnings. In 2010, 2009 and 2008, the Company recorded decreases of approximately $1.6 million, $0.2 million and $0.9 million, respectively, related to its prior year other self-insurance reserves as a result of revisions to its estimated claims experience. After considering the impact of earnings that would have been allocated to participating securities in calculating net income per common share (see Note 17), the Company’s net income available to common shareholders and basic and diluted net income per common share were positively impacted as a result of revisions to its estimated experience by amounts totaling $1.0 million and $0.11 per common share, for the year ended December 31, 2010, $0.1 million and $0.01 per common share, for the year ended December 31, 2009 and $0.5 million and $0.06 per common share, for the year ended December 31, 2008.

Comprehensive Income (Loss)

     Comprehensive income (loss) encompasses all changes in stockholders’ equity (except those arising from transactions with owners) and includes net income (loss), unrealized gains or losses on derivatives that qualify as hedges, net unrealized capital gains or

losses on available for sale securities and foreign currency translation adjustments. The Company’s comprehensive income (loss) is presented in the accompanying consolidated statements of changes in stockholders’ equity. The Company had no elements of comprehensive income (loss) apart from net income (loss) during any of the years presented.

Share-Based Compensation

     The Company measures and recognizes compensation expense for all share-based payment awards based on estimated fair values at the date of grant. Determining the fair value of share-based awards at the grant date requires judgment in developing assumptions, which involve a number of variables. These variables include, but are not limited to, the expected stock price volatility over the term of the awards and expected stock option exercise behavior. In addition, the Company also uses judgment in estimating the number of share-based awards that are expected to be forfeited.

     See Note 16 for further information on share-based compensation.

Operating Leases

     The Company leases office space and equipment under certain noncancelable operating leases. In accordance with the provisions of lease accounting, rent expense under these operating leases with scheduled rent increases is accounted for on a straight-line basis over the lease term, beginning on the effective date of the lease agreement. Where operating leases contain rent holidays and tenant build-out incentives or allowances, the Company applies them in the determination of straight-line rent expense over the lease term. The amount of the excess of straight-line rent expense over scheduled payments is recorded as a deferred liability on the accompanying consolidated balance sheets.

Credit and Other Concentration Risks

     The Company’s credit risks relate primarily to cash and cash equivalents, accounts receivable and deposits on professional liability and other insurance programs. Cash and cash equivalents are primarily held in bank accounts and overnight investments. The Company’s accounts receivable represent amounts due primarily from governmental agencies. Accounts receivable due from the Virginia Department of Corrections and the Commonwealth of Pennsylvania, Department of Corrections represent approximately 37% and 20% of accounts receivable, less allowances, at December 31, 2010, respectively. Deposits on professional liability and other insurance programs represent amounts paid by the Company that are subject to future refund from the insurance company which provides the coverage. Currently, these balances are carried by American International Group (“AIG”) for workers compensation and various regulated subsidiaries of AIG for professional liability. The Company’s financial instruments are subject to the possibility of loss in carrying value as a result of either the failure of other parties to perform according to their contractual obligations or changes in market prices that make the instruments less valuable. Additionally, if the financial position and/or liquidity of one of these third party insurance carriers were to become impaired such that the third party insurer was unable to pay claims or meet its contractual obligations to the Company, the Company could lose all or a portion of its prepaid premiums to such carrier and/or lose the benefit of the coverage the Company has paid for, the occurrence of which could have a material adverse effect on the Company’s financial position, results of operations or cash flows.

     Substantially all of the Company’s revenue for the years ended December 31, 2010, 2009 and 2008 relates to amounts earned under contracts with state and local governments.

     Approximately 15% of the Company’s workforce is represented by labor unions.

Recent Accounting Pronouncements

     Health Care Entities: Presentation of Insurance Claims and Related Insurance Recoveries. In August 2010, the FASB issued an accounting standards update which clarifies that a health care entity should not net insurance recoveries against a related claim liability. The guidance provided is effective as of the beginning of the first fiscal year beginning after December 15, 2010. The adoption of this standard will have no material impact of the Company’s financial position or results of operations.

3. Audit Committee Investigation

     On October 24, 2005, the Company announced that the Audit Committee had initiated an internal investigation into certain matters related to SPP. As disclosed in further detail in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005, on March 15, 2006 the Company announced that the Audit Committee had concluded its investigation and reached certain conclusions with respect to findings of the investigation that resulted in an accrual of $3.7 million of aggregate refunds due to customers, including PHS, that were not charged by SPP in accordance with the terms of the respective contracts. In circumstances where SPP’s incorrect billings resulted in PHS billing its clients incorrectly, PHS passed the applicable amount through to its clients. This amount plus associated interest represented management’s best estimate of the amounts due to affected customers, based on the results of the Audit Committee’s investigation. As of December 31, 2010, the Company has paid all of these refunds plus associated interest to customers except for $0.4 million which has been tendered for payment to the Delaware Department of Corrections, which was serviced by a customer of SPP (see Note 21). The ultimate amounts paid could differ from the Company’s estimates; however, actual amounts to date have not differed materially from the estimated amounts. There can be no assurance that the Company, a customer or a third-party, including a governmental entity, will not assert that additional amounts, which may include penalties and/or associated interest, are owed to these customers. During the year ended December 31, 2010, the Company recognized additional expense totaling $0.5 million relative to this matter which are primarily due to legal expenses incurred as part of the Company reaching a settlement on February 19, 2010, regarding shareholder litigation filed against the Company and certain individual defendants on April 6, 2006 and related litigation filed by the Company against one of its insurance carriers (see Note 21).

4. Restructuring Charge

     On June 16, 2010, the former Senior Vice President, Chief Administrative Officer and Chief Compliance Officer of the Company, resigned his position, effective July 16, 2010. In connection with his resignation and this restructuring, his duties and responsibilities were reassigned to various members of management. The Company incurred a one-time termination charge related to the restructuring of approximately $0.3 million, comprised of $0.2 million in accrued compensation and benefits and a $0.1 million non-cash charge related to the accelerated vesting of remaining unvested restricted shares. The accrued compensation and benefits, which will be fully paid by July 16, 2011, are included in accrued expenses in the Company’s condensed consolidated balance sheet. The non-cash charge related to the stock based compensation is included in additional paid in capital in the Company’s condensed consolidated balance sheet.

     A reconciliation of the related restructuring liability at December 31, 2010 is as follows (in thousands):

		One-time
		Termination
		Benefits
Balance at December 31, 2009		$	—
Plus: Costs incurred			245
Less: Amounts paid			(101	)
Balance at December 31, 2010		$	144

     On September 15, 2008, the Company entered into a separation agreement and general release with Michael Catalano, which was subsequently modified on November 7, 2008 (the “Separation Agreement”). Under the terms of the Separation Agreement, Mr. Catalano resigned his position as Chief Executive Officer of the Company effective December 30, 2008. The Separation Agreement also provided for Mr. Catalano’s resignation from the Company and from its Board of Directors effective January 1, 2009, the termination of Mr. Catalano’s previously existing employment agreement and the release of claims by each of Mr. Catalano and the Company against each other. Additionally, in connection with this resignation, the Company elected to its Board of Directors and amended the employment agreements of Richard Hallworth, its current President and Chief Executive Officer, and Michael W. Taylor, its current Executive Vice President, Chief Financial Officer and Treasurer. The Company incurred a charge related to the Separation Agreement of approximately $2.3 million, comprised of $1.5 million in compensation and benefits, a $0.7 million non-cash charge related to the accelerated vesting of remaining unvested stock options and restricted shares and the modification of the time period in which to exercise stock options and $0.1 million in legal and consulting fees. The non-cash charge related to the stock based compensation is included in additional paid in capital in the Company’s consolidated balance sheet.

5. Reserve for Loss Contracts

     On a quarterly basis, the Company performs a review of its portfolio of contracts for the purpose of identifying potential loss contracts and developing a loss contract reserve for succeeding periods if any loss contracts are identified. The Company accrues losses under its fixed price contracts when it is probable that a loss has been incurred and the amount of the loss can be reasonably estimated. The Company performs this loss accrual analysis on a specific contract basis taking into consideration such factors as the Company’s ability to terminate the contracts, future contractual revenue, projected future healthcare and maintenance costs, projected future stop-loss insurance recoveries and each contract’s specific terms related to future revenue increases as compared to increased healthcare costs. The projected future healthcare and maintenance costs are estimated based on historical trends and management’s estimate of future cost increases. These estimates are subject to the same adverse fluctuations and future claims experience as previously noted.

     In the course of performing its reviews in future periods, the Company might identify contracts which have become loss contracts due to a change in circumstances. Circumstances that might change and result in the identification of a contract as a loss contract in a future period include interpretations regarding contract termination or expiration provisions, unanticipated adverse changes in the healthcare cost structure, inmate population or the utilization of outside medical services in a contract, where such changes are not offset by increased healthcare revenues. Should a contract be identified as a loss contract in a future period, the Company would record, in the period in which such identification is made, a reserve for the estimated future losses that would be incurred under the contract. The identification of a loss contract in the future could have a material adverse effect on the Company’s results of operations in the period in which the reserve is recorded.

     There are no loss contracts identified as of December 31, 2010 and 2009.

6. Discontinued Operations

     Pursuant to U.S. GAAP related to discontinued operations, 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, net of applicable income taxes, have been presented as discontinued operations and prior period consolidated statements of operations have been reclassified.

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

		Year Ended December 31,
		2010				2009				2008
Healthcare revenues		$	9,188			$	30,990			$	44,632
Healthcare expenses			9,739				28,931				41,018
Gross margin			(551	)			2,059				3,614
Depreciation and amortization			11				85				71
Income (loss) from discontinued operations before income tax provision (benefit)			(562	)			1,974				3,543
Income tax provision (benefit)			(229	)			805				1,444
Income (loss) from discontinued operations, net of taxes		$	(333	)		$	1,169			$	2,099

7. Fair Value

     Fair value is a market-based measurement, not an entity-specific measurement. Therefore, a fair value measurement should be determined based on the assumptions that market participants would use in pricing the asset or liability. As a basis for considering market participant assumptions in fair value measurements, the Company utilizes the U.S. GAAP fair value hierarchy that distinguishes between market participant assumptions based on market data obtained from sources independent of the reporting entity (observable inputs that are classified within Levels 1 and 2 of the hierarchy) and the reporting entity’s own assumption about market participant assumptions (unobservable inputs classified within Level 3 of the hierarchy).

     The Company has available-for-sale securities and money market accounts totaling $4.0 million and $15.0 million at December 31, 2010 and 2009, respectively, that are classified as cash equivalents on the accompanying consolidated balance sheet. The Company had no such securities at December 31, 2008. These financial assets are recorded at fair value in accordance with the U.S. GAAP fair value hierarchy, classified as a Level 1 measurement. Inputs used to measure fair value in accordance with Level 1 are quoted market prices.

8.   Accounts Receivable

      Accounts receivable consist of the following (in thousands):

		December 31,
		2010				2009
Billed accounts receivable		$	23,894			$	20,762
Unbilled accounts receivable			28,262				25,485
Other accounts receivable			943				648
			53,099				46,895
Less: Allowances			(411	)			(358	)
			52,688				46,537
Less: Receivables reclassified as noncurrent			(207	)			(1,908	)
		$	52,481			$	44,629