AMERICA SERVICE GROUP INC /DE, 10-K405/A, 1999-07-28

AMERICA SERVICE GROUP INC /DE
10-K405/A, 1999-07-28
MISC HEALTH & ALLIED SERVICES, NEC

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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K/A

<TABLE>
<C> <S>
(MARK ONE)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ____________ TO ____________
</TABLE>

Commission File Number: 0-23340

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America Service Group Inc.
(Exact name of registrant as specified in its charter)

<TABLE>
<S> <C>
DELAWARE 51-0332317
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)

105 WESTPARK DRIVE, SUITE 300
BRENTWOOD, TENNESSEE 37027
(Address of principal executive offices) (Zip Code)
</TABLE>

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

Securities Registered Pursuant to Section 12(b) of the Act:

NONE

Securities Registered Pursuant to Section 12(g) of the Act:

COMMON STOCK, PAR VALUE $.01 PER SHARE

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 [X] NO [ ]

Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]

The aggregate market value of the Common Stock held by non-affiliates of
the registrant as of March 23, 1999 (based on the last reported closing price
per share of Common Stock as reported on The Nasdaq National Market on such
date) was approximately $43,927,182. As of March 23, 1999, the registrant had
3,576,163 shares of Common Stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Not applicable.

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PART I

ITEM 1. BUSINESS

This Form 10-K contains statements which may constitute "forward-looking
statements" within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended.
Those statements include statements regarding the intent, belief or current
expectations of America Service Group Inc. and members of its management team.
Prospective investors are cautioned that any such forward-looking statements are
not guarantees of future performance and involve risks and uncertainties, and
that actual results may differ materially from those contemplated by such
forward-looking statements. Important factors currently known to management that
could cause actual results to differ materially from those in forward-looking
statements are set forth below under the caption "Cautionary Statements."
America Service Group Inc. undertakes no obligation to update or revise forward-
looking statements to reflect changed assumptions, the occurrence of
unanticipated events or changes to future operating results over time.

GENERAL

America Service Group Inc. ("ASG" or the "Company"), through its subsidiary
Prison Health Services, Inc. ("PHS") and indirect subsidiaries EMSA Correctional
Care, Inc. ("EMSA Correctional") and EMSA Military, Inc. ("EMSA Military"),
contracts to provide managed healthcare services to correctional facilities and
military installations throughout the United States. ASG was incorporated in
1990 as a holding company for PHS. Unless the context otherwise requires, the
term "Company" refers to ASG and its direct and indirect subsidiaries. ASG's
executive offices are located at 105 Westpark Drive, Suite 300 Brentwood,
Tennessee 37027. Its telephone number is (615) 373-3100.

RECENT DEVELOPMENTS

On January 26, 1999, the Company purchased all of the outstanding stock of
EMSA Government Services, Inc. ("EMSA") from InPhyNet Administrative Services,
Inc. ("InPhyNet") for $67.0 million in cash pursuant to a Stock Purchase
Agreement, dated as of December 18, 1998 (the "Stock Purchase Agreement"), as
amended by the First Amendment to Stock Purchase Agreement, dated as of January
26, 1999 (the "First Amendment"), between the Company and InPhyNet. InPhyNet is
a wholly-owned subsidiary of MedPartners, Inc. ("MedPartners").

EMSA conducts its operations through two wholly-owned subsidiaries, EMSA
Correctional and EMSA Military Services, each of which became indirect
subsidiaries of the Company as a result of its acquisition of EMSA. EMSA
Correctional provides comprehensive managed healthcare solutions to state and
local correctional facilities, managing healthcare for approximately 70,000
inmates. Following the EMSA acquisition, the Company, through EMSA Correctional
and PHS, manages healthcare for approximately 133,000 inmates in 25 states. EMSA
Military contracts with the U.S. Department of Defense (the "DOD") and the
Veterans Administration (the "VA") to provide emergency medicine and primary
healthcare services to active and retired military personnel and their
dependents at medical facilities operated by the DOD and the VA. EMSA Military
currently provides such services for military personnel and their dependants at
10 DOD and VA medical facilities.

The purchase price paid to InPhyNet was subject to increase or decrease on
a dollar-for-dollar basis by an amount equal to the amount by which EMSA's
working capital (as defined in the Stock Purchase Agreement), as reflected on
its balance sheet as of January 25, 1999 (the "Closing Date Balance Sheet"),was
in excess of or was less than $27.6 million. The Closing Date Balance Sheet
reflected working capital of $24.0 million. Accordingly, InPhyNet repaid $3.6
million of the purchase price. The Company will account for the EMSA acquisition
using the purchase method of accounting.

Issuing Bank ("NationsBank"), which provides for a revolving credit facility of
up to $52.0 million (the "Credit Facility") and (ii) the Company entered into a
Securities Purchase Agreement, dated as of January 26, 1999 (the "Securities
Purchase Agreement"), with Health Care Capital Partners L.P. ("Capital
Partners") and Health Care Executive Partners L.P. ("Executive Partners"),
private equity funds managed by Ferrer Freeman Thompson & Co. ("FFT"). On
January 26, 1999, pursuant to the Securities Purchase Agreement, the Company
issued to Capital Partners and Executive Partners (i) $15.0 million aggregate
principal amount of the Company's 12% Subordinated Convertible Bridge Notes due
January 26, 2000 (the "Notes") with detachable warrants (the "Warrants") to
purchase an aggregate 135,000 shares of the Company's common stock, par value
$0.01 per share (the "Common Stock"), and (ii) 50,000 shares of the Company's
Series A Convertible Preferred Stock, par value $0.01 per share (the "Preferred
Stock"). ASG received aggregate consideration of $20.0 million for the Notes,
Warrants and Preferred Stock. The Notes, Warrants and Preferred Stock are
referred to collectively as the "Convertible Securities."

The following table sets forth the sources and uses of funds for the EMSA
acquisition (in millions):

<TABLE>
<S> <C>
SOURCES:
Cash........................................................ $ 2.1
Borrowings under the Credit Facility........................ 47.0
Proceeds from sale of the Notes............................. 15.0
Proceeds from sale of the Preferred Stock................... 5.0
-----
Total Sources..................................... $69.1
=====
USES:
Cash Consideration for EMSA ("Purchase Price").............. $67.0
Transaction costs........................................... 2.1
-----
Total Uses........................................ $69.1
=====
</TABLE>

At the option of either the Company or the holders of the Notes, the Notes
are convertible, subject to certain conditions, into shares of Preferred Stock
at a conversion ratio of one share of Preferred Stock for each $100 of
outstanding principal amount of Notes. The Warrants entitle the holder thereof
to purchase 135,000 shares of Common Stock at the lower of $9.45 and the average
closing sale price of the Common Stock for the thirty consecutive trading days
prior to the Stockholder Meeting (as defined), provided that such price shall in
no event be less than $5.50 per share (subject to adjustment) (the "Warrant
Exercise Price"). Subject to certain adjustments, each share of Preferred Stock
is convertible, at the option of the holder thereof, into the number of shares
of Common Stock determined by dividing the face value of such share of Preferred
Stock by the lower of $9.45 and the average closing sale price of the Common
Stock for the thirty consecutive trading days prior to the Stockholder Meeting,
provided that such price shall in no event be less than $5.50 per share (subject
to adjustment).

On July 2, 1999, the Company redeemed $7.5 million aggregate principal
amount of the Notes and in connection therewith the Warrant Exercise Price for
one-half of the Warrants held by Capital Partners and Executive Partners was
reduced to $.01.

The conversion of the Notes into shares of Preferred Stock is conditioned
upon, among other things, the Company's stockholders approving the issuance of:
(i) the shares of Preferred Stock issued to Capital Partners and Executive
Partners on January 26, 1999, (ii) the shares of Preferred Stock issuable upon
conversion of the Notes and (iii) the shares of Common Stock issuable upon
conversion or exercise, as applicable, of the Convertible Securities, to the
extent that the number of shares of Common Stock to be issued will be in excess
of 20% of the number of shares of Common Stock outstanding, without regard to
the shares of Common Stock issuable upon conversion of the Convertible
Securities (the "Stock Issuance"). The Securities Purchase Agreement obligates
the Company to convene a meeting of its stockholders (the "Stockholder Meeting")
to consider and vote upon the approval of the Stock Issuance (the "Stockholder
Approval") as soon as practicable following the closing of the Securities
Purchase Agreement and no later than August 31, 1999.

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If the Company fails to convene the Stockholder Meeting on or before August
31, 1999, the interest on the Notes will increase by 0.05% on September 1, 1999
and will further increase by 0.05% per month to a maximum monthly interest rate
of 1.5% (which represents an annual interest rate of 18%) until the Company
convenes the Stockholder Meeting. In addition, if the Company fails to convene
the Stockholder Meeting on or before August 31, 1999, fails to take other
actions in connection with obtaining Stockholder Approval or fails to take
certain other actions required by the terms of the Warrants, the Warrant
Exercise Price will be reduced to $.01 per share. The interest on the Notes will
not be increased as described above and the Warrant Exercise Price will not be
reduced as described above until the maturity of the Notes, in each case, if the
sole reason the Company fails to obtain Stockholder Approval is the failure of
the holders of the Common Stock to approve the Stock Issuance at a meeting duly
called and convened in accordance with the Securities Purchase Agreement.

The Company entered into a Registration Rights Agreement, dated as of
January 26, 1999 (the "Registration Rights Agreement"), with Capital Partners
and Executive Partners pursuant to which it agreed to register the Common Stock
issuable upon conversion of the Preferred Stock issued or issuable to Capital
Partners and Executive Partners pursuant to the Securities Purchase Agreement
and exercise of the Warrants for resale by the holders thereof.

The summaries contained herein of certain provisions of the Credit
Agreement, the Securities Purchase Agreement, the Notes, the Warrants, the
Certificate of Designation of the Preferred Stock, the Registration Rights
Agreement, the Stock Purchase Agreement and the First Amendment are qualified in
their entirety by reference to all the provisions of such documents, including
the definitions therein of certain terms which are not otherwise defined herein.
A copy of the Stock Purchase Agreement was filed as an exhibit to the Company's
Current Report on Form 8-K filed with the Securities and Exchange Commission
(the "Commission") on January 5, 1999. A copy of an amendment to the Securities
Purchase Agreement entered into by the parties thereto on June 17, 1999 is filed
as an exhibit to this Annual Report on Form 10-K. The Securities Purchase
Agreement as amended is referred to herein as the "Securities Purchase
Agreement." Copies of each of the other documents listed above were filed as
exhibits to the Company's Current Report on Form 8-K filed with the Commission
on February 10, 1999.

CORRECTIONAL HEALTHCARE SERVICES

Generally. ASG, through PHS and EMSA Correctional, contracts with state,
county and local governmental agencies to provide comprehensive healthcare
services to inmates of prisons and jails, with a focus on those facilities that
maintain an average daily population of over 300 inmates.

ASG generally enters into fixed fee contracts to provide comprehensive
healthcare to inmates from their admission to the facility through their
release. All of ASG's revenues from correctional healthcare services are
generated by payments from governmental agencies, none of which are dependent on
third party payment sources. Services provided by ASG include a wide range of
on-site healthcare programs, as well as off-site hospitalization and specialty
outpatient care. See "-- Services Provided." Hospitalization and most outpatient
care is performed through subcontract arrangements with independent doctors and
local hospitals.

The following table sets forth information regarding ASG's correctional
contracts.

<TABLE>
<CAPTION>
PRO
FORMA (1) HISTORICAL
--------- ------------------------------------------
DECEMBER 31,
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1998 1998 1997 1996 1995 1994
--------- ------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C> <C>
Number of correctional contracts(2).......... 96 35 32 34 35 35
Average number of inmates in all facilities
covered by correctional contracts(3)....... 132,991 63,783 54,364 83,288 82,310 51,939
</TABLE>

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(1) Indicates the combined number of contracts or inmates, as the case may be,
for PHS and EMSA Correctional as of December 31, 1998.
(2) Indicates the number of contracts in force at the end of the period
specified.
(3) Based on an average number of inmates during the last month of each period
specified.

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ASG's target correctional market consists of state prisons 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 higher inmate turnover in jails requires that
healthcare be provided to a much larger number of individual inmates over time.
Conversely, the costs of long-term healthcare requirements are 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. Generally, ASG's obligation to provide services to a
particular inmate begins upon the inmate's admission into the correctional
facility and ends upon the inmate's release. Emphasis is placed upon early
identification of serious injuries or illnesses so that prompt and
cost-effective treatment is commenced.

Medical services provided on-site 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 may include regular physical
and dental screening and care, psychiatric care, OB-GYN screening and care and
diagnostic testing. Sick call is held on a regular basis and infirmary bed care
is provided in some facilities. Nursing rounds are regularly conducted and
physicians, nurse practitioners, physicians' assistants and others are also
involved in the delivery of care on a regular basis. Appropriate medications are
administered by nursing staff, as needed.

Medical services provided off-site include specialty out-patient diagnostic
testing and care, emergency room care, surgery and hospitalization. In addition,
ASG provides administrative support services both on-site and at ASG's
headquarters and regional offices. Administrative programs include on-site
medical records and management and employee education and licensing. Central and
regional offices provide quality assurance, medical audits, credentialing,
continuing education and clinical program development activities. ASG maintains
a utilization review system to monitor the extent and duration of most
healthcare services required by inmates on an inpatient and outpatient basis.
See "-- Administrative Systems."

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 often available on a routine basis. ASG
enters into contractual arrangements with independent doctors and local
hospitals with respect to more significant off-site procedures and
hospitalization. ASG is responsible for all of the costs of such arrangements,
unless the relevant contract contains a limit on ASG's obligations in connection
with the treatment costs. See "-- Contract Provisions."

The National Commission on Correctional Health Care (the "NCCHC") sets
standards for the correctional healthcare industry and offers accreditation to
facilities that meet its 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. Although accreditation is
voluntary, many contracts require compliance with NCCHC standards.

Contract Provisions. ASG's correctional contracts generally provide for a
fixed fee, payable monthly, often in advance. In addition to the fixed annual
fee, some of ASG's contracts provide for per diem price adjustments based upon
fluctuations in the size of inmate populations beyond a specified range. Most
contracts also provide for annual increases in the fixed fee based upon the
regional medical care component of the Consumer Price Index. In all other
contracts that extend beyond one year, ASG utilizes a projection of the future
inflation rate when bidding and negotiating the fixed fee for future years. ASG
bears the risk of increased or unexpected costs, which could reduce its profits
or cause it to sustain losses, and benefits when costs are lower than projected.
Certain contracts also contain financial penalties when performance criteria are
not achieved.

Contracts accounting for approximately 76% of revenues for the year ended
December 31, 1998, and 63% on a pro forma basis after giving effect to the EMSA
acquisition, including ASG's contracts with the Indiana Department of Correction
(the "Indiana Contract"), Delaware Department of Corrections, Kansas Department
of Corrections, and Alameda County, California, contain no limits on ASG's
exposure for treatment costs related to catastrophic illnesses or injuries to
inmates. Although the specific terms of the limits vary, typically a dollar
limit is placed on ASG's responsibility for costs related to illness of or
injury to an individual
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inmate, injuries to more than one inmate resulting from an accident or
contagious illnesses affecting more than one inmate. When preparing bid
proposals, ASG 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. ASG'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 ASG is not protected could render a contract unprofitable. In an effort to
manage risk of catastrophic illness or injury of inmates under contracts that do
not limit ASG's exposure to such risk, ASG maintains stop loss insurance from an
unaffiliated insurer covering hospitalization for amounts in excess of $200,000
per inmate for PHS contracts and $170,000 per inmate for EMSA Correctional
contracts. Such stop loss insurance covers 80% of ASG's exposure for such
treatment costs. ASG believes this insurance mitigates its exposure to
unanticipated expenses of catastrophic hospitalization. See "-- Risk
Management."

In general, contracts may be terminated by the governmental agency, and
often by ASG as well, without cause at any time upon proper notice (typically
between 30 and 180 days). Governmental agencies may be subject to political
influences that could lead to termination of a contract with no fault of the
contractor. As with other governmental contracts, ASG's contracts are subject to
adequate budgeting and appropriation of funds by the governing legislature or
administrative body.

The Indiana Contract provides for fixed payment on a per inmate, per day
basis. The City of Philadelphia Contract provides for a fixed payment on a fixed
dollar basis with a per diem price adjustment based on any increase in the size
of the inmate population above a set number. The remainder of ASG's largest
existing contracts for the year ended December 31, 1998 -- contracts with the
Kansas Department of Corrections, the Delaware Department of Corrections and
Alameda County, California -- provide for per diem price adjustments based upon
fluctuations in the size of inmate populations beyond a specified range. The
fixed fees under all five contracts take into account projected levels of
inflation. See "-- Major Contracts."

Administrative Systems. ASG has centralized its 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 ASG to
refine its bids and help ASG reduce the costs associated with the delivery of
consistent healthcare.

ASG 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 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 program 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 program seeks
to identify the maximum capability of on-site healthcare units so as to allow
for a more timely discharge from the hospital back to the correctional facility.
The utilization review staff consists of nurses who are supported by a medical
director at the corporate level and a panel of medical specialists who are
consultants to ASG.

ASG has developed a variety of customized databases to facilitate and
improve operational review including (i) a claims management tracking system
that monitors current incidents, claims and litigation against ASG, (ii) a
comprehensive cost review system that analyzes ASG's average costs per inmate at
each facility and (iii) a daily operating report to control staffing and
off-site utilization.

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") is issued 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 to the
private sector. The award of a contract may be subject to formal or informal
protest, through a governmental appeals process, by unsuccessful bidders.

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Many RFPs for significant contracts require the bidder to post a bid bond.
Performance bonding requirements are for the length of the contract and at
December 31, 1998, generally ranged between 4% and 60% (and in one case, 100%)
of the 1998 contract fee.

A successful bidder must often agree to comply with numerous additional
requirements regarding record-keeping and accounting, non-discrimination in the
hiring of personnel, safety, safeguarding classified information, management
qualifications, professional licensing requirements, emergency healthcare needs
of corrections employees and other matters. Upon a violation of the terms of an
applicable contractual or statutory provision, a contractor may be debarred or
suspended from obtaining future contracts for specified periods of time in the
applicable location. ASG has never been debarred or suspended in any
jurisdiction.

Marketing. ASG gathers and analyzes information on prisons and jails
around the country in order to identify the ones that best meet its marketing
criteria. Relevant factors include the quality and costs of healthcare in the
region, the management and operations of the correctional facility, the
financial stability of the governmental agency and the composition of the inmate
population. ASG then devotes a substantial portion of its marketing resources to
such potential customers. State prison systems, because of their more stable
inmate populations and, in many cases, larger number of facilities and longer
contract terms, are an important focal point of ASG's marketing plans. Also, ASG
will continue to identify those county and local jails that fit its market
profile and will pursue contracts with those facilities.

ASG maintains a staff of sales and marketing representatives assigned to
specific geographic areas of the United States. In addition, ASG uses
consultants to help identify marketing opportunities, to determine the needs of
specific potential customers and to engage customers on ASG's behalf. ASG uses
paid advertising and promotion to reach prospective clients as well as to
reinforce its image with existing clients.

Risk Management. Prior to December 1, 1997, Harbour Insurance, Inc.
("Harbour"), a wholly owned subsidiary of PHS and a captive insurance company,
provided insurance covering PHS's medical professional and general liability
arising out of its provision of healthcare services. Since December 1, 1997, the
Company has maintained professional and general liability insurance through an
unaffiliated insurer. ASG was able to substantially fix its insurance costs for
medical malpractice liability exposure over the next two years through such
unaffiliated insurer. In October 1998, ASG liquidated Harbour and entered into a
novation agreement pursuant to which an unaffiliated insurer assumed
substantially all of the liabilities of Harbour for outstanding claims as of
August 31, 1998.

Prior to October 1998, for contracts where ASG's exposure to the risk of
inmates' catastrophic illness or injury was not limited, the Company maintained
stop loss insurance for an unaffiliated insurer with respect to hospitalization
for amounts in excess of $125,000 per inmate. This stop loss insurance covered
70% of the Company's exposure for such treatment costs. Since October 1998, for
contracts where ASG's exposure to the risk of inmates' catastrophic illness or
injury is not limited, ASG has maintained stop loss insurance to cover 80% of
ASG's exposure with respect to hospitalization for amounts in excess of $200,000
per inmate for PHS contracts and $170,000 per inmate for EMSA Correctional
contracts. ASG believes this insurance mitigates its exposure to unanticipated
expenses of catastrophic hospitalization.

There can be no assurance that third-party commercial insurance will
continue to be available in the future or will be available at reasonable
prices. ASG believes its insurance coverage is maintained at reasonable levels,
but there can be no assurance that it will cover all claims that may be asserted
against ASG and its employees and agents.

MILITARY SERVICES

EMSA Military provides a broad range of emergency medicine and primary
healthcare services to active and retired military personnel and their
dependents in medical facilities operated by the DOD and the VA. EMSA Military
began providing healthcare services to DOD clients in 1988 and has provided in
excess of 3.5 million patient visits. During the fiscal year ended December 31,
1998, EMSA Military provided services under 10 contracts.

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Most military contracts are for a period of five years, with an initial one
year base period and four one year options. EMSA Military's bidding strategy is
to seek contract opportunities that will be awarded on a best value, rather than
a low cost basis. This allows EMSA to highlight the Company's operational
expertise and the overall quality of its provider staff. Margins are determined
by the size and risk associated with a specific contract. The current target
markets include VA emergency departments ($1.4 to $2.4 million per site per year
in annual revenue) and multi-level facilities operated by TRICARE Prime, a
healthcare provider for military personnel and their dependents ($8 to $10
million per site per year in annual revenue).

EMPLOYEES AND INDEPENDENT CONTRACTORS

The services provided by ASG 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 ASG's ability to provide efficient service.
In addition to nurses, ASG's staff of employees or independent contractors
includes physicians, dentists, psychologists and other healthcare professionals.

As of December 31, 1998, on a pro forma basis after giving effect to the
EMSA acquisition, ASG had approximately 2,950 full-time equivalent employees,
including 2,050 medical personnel. ASG also had, on such pro forma basis, under
contract 375 independent contractors, most of whom are part-time, including
physicians, dentists, psychiatrists and psychologists. ASG's employees at its
Alameda County, California, City of Philadelphia and Delaware facilities are
represented by labor unions. ASG believes that its employee relations are good.

COMPETITION

The business of providing correctional healthcare services to governmental
agencies is highly competitive. ASG is in direct competition with local,
regional and national correctional healthcare providers. ASG believes that some
of its competitors may have larger staffs and greater resources than ASG. As the
private market for providing correctional healthcare matures, ASG'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 ASG,
may enter the market.

MAJOR CONTRACTS

ASG's operating revenue with respect to its correctional healthcare
operations is derived exclusively from contracts with state, county and local
governmental agencies. ASG's contracts with the States of Indiana and Kansas,
the City of Philadelphia and Alameda County, California, accounted for
approximately 21%, 17% 16% and 11%, respectively, of revenues during the year
ended December 31, 1998. Generally, contracts may be terminated by the
governmental agency at will and without cause upon proper notice (typically
between 30 and 180 days). Governmental agencies may be subject to political
influences that could lead to termination of a contract through no fault of the
contractor. Although ASG 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. The loss of one or more of the major contracts could have a
material adverse effect on ASG's business.

CAUTIONARY STATEMENTS

All statements made by ASG that are not historical facts are based on
current expectations. These statements are forward looking in nature and involve
a number of risks and uncertainties. Actual results may differ materially. Among
the factors that could cause actual results to differ materially are the
following: dependence on major contracts; price competition in the prison
healthcare industry; ASG's ability to provide adequate staffing to meet its
contractual commitments; changes in performance bonding requirements;
substantial damage awards against ASG in connection with medical malpractice
claims; changes in laws or regulations or the application thereof; general
business and economic conditions; ASG's ability to integrate EMSA's operations
successfully into its existing operations; and the other risk factors described
in ASG's reports filed from time to time with the Securities and Exchange
Commission.

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Dependence on Major Contracts. ASG's operating revenue is derived
exclusively from contracts with federal, state, county and local governmental
agencies. Generally, contracts may be terminated by the governmental agency at
will and without cause upon proper notice (typically between 30 and 180 days).
Governmental agencies may be subject to political influences that could lead to
termination of a contract through no fault of the contractor. Although ASG
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. The loss of one or more of the major contracts could have a
material adverse effect on ASG's business.

Contracts with government agencies are generally complex in nature and
subject contractors to extensive regulation under federal, state, county and
local law. Under certain circumstances, a government contractor may be debarred
or suspended from obtaining future contracts. While ASG considers the
possibility remote, such debarment or suspension could have a material adverse
effect on ASG.

Privatization of Government Services, Competition and Correctional
Population. ASG's future financial performance will depend in part on continued
privatization by state, county and local governmental agencies of healthcare
services for correctional facilities. 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. The business of providing correctional
healthcare services to governmental agencies is highly competitive. ASG is in
direct competition with local, regional and national correctional healthcare
providers. ASG believes that some of its competitors may have larger staffs and
greater resources than ASG. As the private market for providing correctional
healthcare matures, ASG'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 ASG, may enter the market. ASG's business could
also be adversely affected by material decreases in the inmate population of
correctional facilities.

Acquisitions. ASG's expansion strategy involves both internal growth and,
as attractive opportunities become available, acquisitions. The Company took a
significant step toward implementing this strategy with the EMSA acquisition.
ASG has limited experience acquiring businesses and integrating them into its
operations. There can be no assurances that ASG will be able to integrate EMSA
or any additional acquired business successfully into its existing operations.
Furthermore, there can be no assurance that ASG will be able to operate EMSA or
any additional acquired business in a profitable manner.

Catastrophic Limits. Contracts accounting for 76% of revenues for the year
ended December 31, 1998, and 63% on a pro forma basis after giving effect to the
EMSA acquisition, contain no limits on ASG's exposure for treatment costs
related to catastrophic illnesses or injuries to inmates. For those contracts
that contain no catastrophic limits, ASG maintains stop loss insurance for 80%
of its exposure with respect to catastrophic illnesses or injuries for amounts
in excess of $200,000 per inmate for such PHS contracts and $170,000 per inmate
for such EMSA Correctional contracts. ASG attempts to compensate for the
increased financial risk when pricing contracts that do not contain catastrophic
limits. Although, the occurrence of severe individual cases without such limits
could render the contract unprofitable and could have a material adverse effect,
ASG believes the potential impact of any such occurrences is mitigated by such
insurance.

Dependence on Key Personnel. The success of ASG 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 ASG's operations. ASG has
employment contracts with Michael Catalano, President and Chief Executive
Officer, Gerard F. Boyle, Executive Vice President and Chief Operating Officer
of the Company, Bruce A. Teal, Senior Vice President and Chief Financial
Officer, and Jean L. Byassee, Senior Vice President, General Counsel and
Secretary.

Dependence on Healthcare Personnel. ASG's success depends on its ability
to attract and retain highly skilled healthcare personnel. A shortage of trained
and competent employees and/or independent contractors may result in overtime
costs or the need to hire less efficient temporary staff. Attracting qualified
nurses at a reasonable cost has been and continues to be of concern to ASG.
There can be no assurance that ASG will be successful in attracting and
retaining a sufficient number of qualified healthcare personnel in the future.

8
<PAGE> 10

Corporate Exposure to Professional Liability. ASG periodically becomes
involved in medical malpractice claims with the attendant risk of substantial
damage awards. The most significant source of potential liability in this regard
is the risk of suits brought by inmates alleging lack of timely or adequate
healthcare services. ASG may be liable, as employer, for the negligence of
healthcare professionals who are employees of ASG. ASG may also have potential
liability for the negligence of healthcare professionals engaged by ASG as
independent contractors. ASG's contracts generally provide for ASG to indemnify
the governmental agency for losses incurred related to healthcare provided by
ASG and its agents. ASG maintains professional liability insurance and requires
its independent contractors to maintain professional liability insurance in
amounts deemed appropriate by management based upon ASG's claims history and the
nature and risks of its business. There can be no assurance that a future claim
or claims will not exceed the limits of available insurance coverage or that
such coverage will continue to be available at a reasonable cost.

ITEM 2. PROPERTIES

The Company occupies approximately 12,500 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 October 2003. The
Company leases additional office facilities in Newark, Delaware; Indianapolis,
Indiana; Alameda, California; Topeka, Kansas, Fort Lauderdale, Florida and
Concordeville and Pittsburgh, Pennsylvania. 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

The Company is subject to claims and suits in the ordinary course of
business. In management's opinion, such currently pending legal proceedings and
claims against the Company will not, in the aggregate, have a material adverse
effect on the Company.

ITEM 4. SUBMISSION OF MATTERS TO VOTE OF SECURITY HOLDERS

None.

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON STOCK AND RELATED STOCKHOLDER MATTERS

The Common Stock is traded on The Nasdaq Stock Market's National Market
System under the symbol "ASGR." As of March 25, 1999, there were approximately
187 holders of record of the Common Stock. The high and low prices of the Common
Stock as reported on The Nasdaq Stock Market during each quarter from January 1,
1997 through December 31, 1998 are shown below:

<TABLE>
<CAPTION>
QUARTER ENDED HIGH LOW
- ------------- ------ ------
<S> <C> <C>
March 31, 1997.............................................. $13.63 $ 9.25
June 30, 1997............................................... 14.75 9.25
September 30, 1997.......................................... 15.75 14.00
December 31, 1997........................................... 19.13 13.38

March 31, 1998.............................................. $15.00 $ 7.44
June 30, 1998............................................... 14.50 12.00
September 30, 1998.......................................... 13.00 7.63
December 31, 1998........................................... 14.00 8.63
</TABLE>

The Company did not pay cash dividends on the Common Stock during the years
ended December 31, 1998 and December 31, 1997. The Company does not currently
intend to pay cash dividends on the Common Stock in the foreseeable future as
under the terms of the Credit Agreement, the Company is prohibited from paying
cash dividends on the Common Stock.

9
<PAGE> 11

ITEM 6. SELECTED FINANCIAL DATA

<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31,
----------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA:
Healthcare revenues......................... $113,287 $129,211 $152,282 $115,238 $109,983
Income (loss) before income taxes
(benefits)................................ 5,099 1,786 (9,933) 1,146 1,646
Net income (loss)........................... 5,724 1,685 (8,686) 687 996
Net income (loss) attributable to common
shares.................................... 5,724 1,742 (8,912) 687 996
Net income (loss) per common
shares -- basic........................... 1.61 0.50 (2.81) 0.23 0.33
Net income (loss) per common
shares -- diluted......................... 1.57 0.48 (2.81) 0.21 0.32
Weighted average common shares
outstanding............................... 3,554 3,480 3,171 3,027 2,994
Weighted average common shares outstanding
and common equivalent shares
outstanding............................... 3,653 3,657 3,171 3,221 3,126
Cash dividends per share.................... 0 0 0 0 0
</TABLE>

See Management's Discussion and Analysis of Financial Condition and Results
of Operations and Notes to Consolidated Financial Statements describing the
financial impact for the year December 31, 1998 due to the MedPartners'
Settlement Agreement and 1997 and 1996 for the impact of the nonrenewal of the
contract with the Georgia Department of Corrections.

<TABLE>
<CAPTION>
AS OF DECEMBER 31,
----------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Working capital (deficit)................... $ 10,515 $ 257 $ (2,434) $ 2,692 $ 2,302
Total assets................................ 28,375 27,754 42,709 42,501 32,108
Mandatory redeemable common stock........... 1,842 1,842 1,916 -- --
Common stock, additional paid-in-capital,
retained earnings (deficit) and treasury
stock..................................... 10,949 4,799 2,468 8,667 8,188
</TABLE>

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS

RESULTS OF OPERATIONS

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

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------
PERCENTAGE OF TOTAL REVENUES 1998 1997 1996
- ---------------------------- ----- ----- -----
<S> <C> <C> <C>
Healthcare revenue.......................................... 99.5% 99.5% 99.5%
Interest income............................................. .5 .5 .5
----- ----- -----
Total revenue............................................... 100.0 100.0 100.0
Healthcare expenses......................................... 89.7 91.3 97.0
----- ----- -----
Gross margin................................................ 10.3 8.7 3.0
Selling, general and administrative expenses................ 9.4 7.3 9.5
MedPartners settlement gain................................. (3.6) -- --
----- ----- -----
Income (loss) from operations............................... 4.5 1.4 (6.5)
Provision for income taxes (benefits)....................... (.5) .1 (.8)
----- ----- -----
Net income (loss)........................................... 5.0 1.3 (5.7)
----- ----- -----
Change in redeemable common stock........................... -- -- .1
----- ----- -----
Net income (loss) attributable to common stock.............. 5.0% 1.3% (5.8%)
===== ===== =====
</TABLE>

10
<PAGE> 12

1998 Compared to 1997

Healthcare revenues decreased $15.9 million from $129.2 million in 1997 to
$113.3 million in 1998, representing a 12% decrease. The decline in revenues
resulted from the termination of the Georgia Department of Corrections Contract
(the "Georgia Contract") which expired in June 1997, and provided revenue of
$31.3 million in the year ended December 31, 1997. The Company added three new
contracts in 1998, which generated $0.8 million in new revenues, and experienced
$14.6 million of revenue growth from existing contracts through population
increases, contract renegotiations, automatic price adjustments and from being
in effect a full year. The Company did not lose any contracts in 1998.

Interest income of $0.6 million in 1998 declined from $0.7 million in 1997
due to the dissolution of Harbour and the subsequent liquidation of its
long-term restricted investments.

The cost of healthcare decreased $16.5 million or 14% to $102.1 million in
1998. Healthcare expenses as a percentage of revenues were 90% in 1998 versus
91% in 1997. Healthcare expenses exclusive of the Georgia Contract were 89% in
1997. Personnel costs and fringe benefits related to inmate care were 45% of
revenues in 1998 versus 57% of revenues in 1997. The significant decline is
attributable to the existing contracts generally being more full service versus
staffing only and the Indiana Contract, where PHS is not responsible for nursing
coverage. Costs related to outside services (defined as hospitalization,
emergency room and ambulance and outpatient surgeries and visits) were 15% of
revenues in 1998 and 17% of revenues in 1997. The decline is due to the
Company's continued emphases on network development and case management.

Selling general and administrative expenses were $10.7 million in 1998
compared to $9.5 million in 1997. The increase is due to $0.6 million and $0.7
million of costs associated with the UniSource disposal and employee stay
bonuses, respectively, both relating to the terminated MedPartners merger. In
connection with the anticipated, then terminated, merger, all of the UniSource
employees were informed of the Company's intent to cease UniSource operations
and sell or dispose of all of UniSource's operating assets. In addition, the
Company incurred corporate employee stay bonus and severance costs to either
retain the employees when the anticipated MedPartners merger was terminated or
honor severance agreements.

With the inmate population increasing an average of approximately 6%
compounded annually, the medical CPI's increasing by an average of 3%, the trend
towards privatization of correctional healthcare and the Company being the
second largest provider of healthcare to incarcerated individuals, management
anticipates opportunities for revenue growth, medical loss ratio improvement and
leveraging of selling, general and administrative costs.

The Company recorded a gain of $4.0 million related to the MedPartners
Settlement Agreement. Pursuant to the Settlement Agreement, MedPartners agreed
to pay the Company approximately $3.5 million in cash and to assume certain
other costs incurred by the Company in connection with the merger in the amount
of approximately $1.5 million. Of the amount received from MedPartners, $1.0
million reimbursed the Company for direct costs of the terminated merger that
were included in prepaid expenses and other current assets at December 1997.

The income tax benefit was $0.6 million in 1998 compared to $0.1 million
expense in 1997. The benefit relates to the elimination of valuation allowances
on the Company's deferred tax assets during the fourth quarter of 1998, based on
the trend of future earnings, projected pre-tax income for 1999 and, other than
for 1996, the Company's history of taxable income. The allowance was eliminated
as it is more likely than not that the deferred tax assets will be realized over
the reversion period of existing taxable temporary differences and the carry
forward period of the Company's net operating losses. As of December 31, 1998,
the Company had approximately $5.7 million in net operating loss carry forwards.

1997 Compared to 1996

Healthcare revenues decreased $23.1 million from $152.3 million in 1996 to
$129.2 million in 1997, representing a 15% decrease. The decline in revenues
resulted primarily from the expiration in June 1997 of the Georgia Contract. The
Georgia Contract generated $31.3 million in the year ended December 31, 1997,
compared to $56.7 million in 1996. The Company added five new contracts in 1997,
which generated $9.9
11
<PAGE> 13

million in new revenues, and experienced $13.0 million of revenue growth from
existing contracts through contract renegotiations, automatic price adjustments
and from contracts being in effect a full year. Revenues were negatively
impacted by the loss of eight contracts during 1997, which generated $40.2
million of revenues in 1997, compared to $77.5 million of revenues in 1996.
Contract revenues for 1996 include $9.1 million of revenues from contracts that
were terminated in that year.

Interest income of $.7 million in 1997 declined from $.8 million in 1996
due to the cash expenditure involved with the expiration of the Georgia
Contract. The Company made cash expenditures with respect to the Georgia
Contract in 1997 of $2.2 million for costs accrued at December 31, 1996,
including $0.3 million relating to liquidated damages, penalties and fines and
$1.9 million with respect to 1997 contract operating losses. The Company made
additional payments in 1997 of $1.4 million for additional healthcare costs
relating to the further deterioration of the Georgia Contract operating
performance.

The cost of healthcare decreased $29.8 million or 20% to $118.6 million in
1997. Healthcare expenses as a percentage of revenues were 91% in 1997 versus
97% in 1996. Healthcare expenses in 1996 included accruals of $2.8 million
relating to anticipated losses under the Georgia Contract. Healthcare expenses
exclusive of the Georgia Contract were 89% and 91% in 1997 and 1996,
respectively. Personnel costs and fringe benefits related to inmate care were
57% of revenues in 1997 versus 64% of revenues in 1996. The significant decline
is attributable to the existing contracts generally being more full service
versus staffing only. Costs related to outside services (defined as
hospitalization, emergency room and ambulance and outpatient surgeries and
visits) were 17% of revenues in 1997 and 1996.

At December 31, 1996, the Company had accrued $2.8 million in anticipated
losses relating to the Georgia Contract. The contract was not renewed as the
state reinstituted healthcare within state institutions. During 1997, the
Company recorded an additional $1.4 million in healthcare expenses relating to
the further deterioration of the contract's operating performance in the areas
of off-site utilization including hospitalization, physician visits and
emergency room and ambulance costs, pharmaceuticals and medical supplies.

Due to (i) enhancements revolving around staff development, a proactive
case management department, a new full-time Medical Director and a preventive
risk management approach, and (ii) a significant reduction in the total inmate
population primarily as a result of the termination of the Georgia Contract,
healthcare expenses in 1997 were positively impacted by $1.4 million in
adjustments to Harbour's estimates of medical malpractice claims.

Selling, general and administrative expenses were $9.5 million in 1997
compared to $14.5 million in 1996. The decrease relates primarily to costs
incurred in 1996, including $1.1 million of employee severance costs relating to
the Company's relocation from Delaware to Tennessee and a $2.4 million non-cash
compensation charges relating to the former Chief Executive Officer. In
addition, the decrease was attributable to the corporate reengineering and
downsizing implemented throughout 1997.

The provision for income taxes was $0.1 million of expense in 1997 compared
to $1.2 million of benefit in 1996. Income taxes for 1997 relate to various
state income taxes. The Company did not incur any federal income taxes due to
the utilization of net operating loss carryforwards.

LIQUIDITY AND CAPITAL RESOURCES

The Company's cash and cash equivalents and short-term investments as of
December 31, 1998 were $7.2 million compared to $5.0 million as of December 31,
1997. The increase is attributable to the dissolution of Harbour, which provided
approximately $4.6 million in cash offset by funding the increase in accounts
receivable. Accounts receivable increased due to the timing of payment on two
major contracts' base fees. Payments were received subsequent to December 31,
1998 for both contracts' base fees. During 1998, the Company received $0.3
million in cash from the exercise of stock options.

The Company's allowance for doubtful accounts has declined from $2.0
million at December 31, 1996 to $20,000 at December 31, 1998. This decline is
attributable to the expiration or termination of certain contracts in which
there were disagreements relating to staffing and stop loss reimbursement.
During 1998, the Company instituted more strict procedures and policies that
ensure timely service validation through both
12
<PAGE> 14

remittance and claim audits. Other than the impact of the EMSA acquisition, the
Company would expect the allowance for doubtful accounts to remain at levels
similar to those at December 31, 1998.

Accrued expenses of the Company decreased $3.4 million from $16.5 million
at December 31, 1997 to $13.1 million at December 31, 1998. The reduction is
attributable to the portfolio transfer of all outstanding medical malpractice
claims covered by Harbour and the Company's reduction in average days
outstanding of medical claims under at-risk contracts. The reduction of $1.8
million in the accrual for medical claims in 1998 is attributed to the
outsourcing of medical claims processing being more effective and efficient in
its second year, the focus of corporate personnel who in 1997 were in the midst
of job elimination as part of the MedPartners' transaction and the efficiencies
gained during the full year of operations under the contract with the Indiana
Department of Corrections, which accounted for 21% of the Company's revenue.
Management believes that its accrual for medical claims is adequate as it
utilizes a claims lag methodology which is contract specific. With the addition
of only three new contracts in 1998 with revenue of $0.8 million, the Company
had minimal change in the profile of its payment data and could focus during
1998 on its internal process where providers claims could be matched more
quickly and payment expedited. Management believes that the trend in its
reduction in medical claims lag will continue subsequent to the integration of
the EMSA acquisition.

As part of the EMSA acquisition, the Company increased its $20 million line
of credit facility to a $52 million Credit Facility. Under the Credit Facility,
the Company has available a $10 million line of credit for general corporate
purposes, including working capital and the funding of acquisitions. The
interest rate is based upon LIBOR or prime rate, subject to the quarterly
operating performance of the Company and other funding criteria, as defined in
the Credit Facility. The Credit Facility is subject to certain quarterly
covenants.

The Company believes that the acquisition of EMSA Government Services, Inc.
furthers the Company's objective to become a leading provider of managed
healthcare services to correctional facilities and military installations
throughout the United States. The acquisition of EMSA increased the Company's
portfolio of contracts from 35 to over 100 and increased its business presence
from 16 to 25 states. The financial aspects of the transaction, which are
discussed more fully under Recent Developments, indicate that the Company
purchased EMSA, an entity with $160.8 million in revenue and income from
operations of $4.5 million and net income of $1.8 million in 1998, for $67
million, including $27.6 million for working capital. The Company believes that
the cash flow generated from the combined entities will be sufficient to service
the debt originating from the acquisition.

The portfolio transfer and dissolution of Harbour Insurance, Inc. in 1998
enabled the Company to remove restrictions on $7.2 million of investments and
make $4.6 million available for working capital. Because the Company has had
third party commercial insurance coverage since December 1997 and continues to
utilize third party coverage, the Company does not believe the dissolution of
Harbour will have an impact on operations or capital resources.

The Company believes that the MedPartners Settlement in 1998, the Georgia
contract termination in 1997, the Corporate move from Delaware to Tennessee in
1996 and the compensation charges in 1996 will have no impact on operating
results, liquidity and capital resources in future periods.

Management believes that the current levels of cash, cash equivalents and
investments, when coupled with the internally generated funds and available
credit, are sufficient to meet the Company's immediate foreseeable future cash
needs and anticipated contract renewal activity.

INFLATION

The increase in the healthcare costs in 1998 over 1997 was 3.2%, compared
to an overall increase in the Consumer Price Index of 1.6% for all costs for the
same period.

Some of the Company's contracts provide for annual increases in the fixed
base fee upon changes in the regional medical care component of the Consumer
Price Index. In all other contracts that extend beyond one year, the Company
utilizes a projection of the future inflation rate when bidding and negotiating
the fixed fee for future years. If the rate of inflation exceeds the levels
projected, such excess will be absorbed by the

13
<PAGE> 15

Company. Conversely, the Company will benefit should the actual rate of
inflation fall below the estimated used in the bidding and negotiation process.

IMPACT OF YEAR 2000

The Year 2000 problem is the result of two potential malfunctions that
could have an impact on the Company's operations. The first is computer systems
and software being programmed to use two rather than four digits to define the
applicable year. The second is the use of embedded chips that have been designed
using two rather than four digits to define the applicable year. These chips are
often used in medical equipment used in certain Company sites.

The Company has completed the evaluation of all computer systems and
software it currently utilizes and has determined that 85% of all computer
systems and software will be in compliance without modification. The Company is
currently in the process of modifying or replacing the remaining 15% of its
computer systems and software. The general ledger, accounts payable and accounts
receivable systems have been tested and upgraded, as needed. Timekeeping
software is currently being upgraded and this process is 87% complete. The
timekeeping upgrades will be completed by July 31, 1999. The Company's most
significant outsourcing contract is for medical claims processing and payment
and that vendor has certified that all Year 2000 modifications will be completed
by December 31, 1999.

The Company has undertaken a program to inventory, assess and correct or
replace the equipment that contains embedded chips. The Company has a plan to
inventory its sites, contact vendors, analyze information provided and replace
or modify devices or equipment that will have a direct impact on patient safety
and health. The Company anticipates completion in all material respects of this
portion of its Year 2000 assessment program by July 31, 1999.

The Company is relying on information that is being provided by equipment
and medical device manufacturers regarding the Year 2000 compliance status of
their products. While the Company is attempting to evaluate information provided
by its present vendors, there can be no assurances that in all instances
accurate information is being provided. The Company also cannot in all instances
guarantee that the repair, replacement or upgrade of all items of equipment and
medical device systems will occur on a timely basis. Contingency planning will
be established and implemented in an effort to minimize any impact from Year
2000 related failures of such equipment. The Company anticipates its contingency
planning for this aspect of its Year 2000 assessment to be completed by July 31,
1999. Costs as a result of these types of occurrences are in the process of
being determined.

The Company has also initiated communications with suppliers and vendors
whose supplies are essential for day-to-day operations regarding their state of
Year 2000 readiness. The Company is continuing its effort to obtain such
information from all critical suppliers and vendors and feels that it will be
able to determine its vendors' status by July 31, 1999. Failure of certain
suppliers and vendors to remain in business without interruptions following
December 31, 1999 could have a material impact on operations or the Company's
ability to provide healthcare services. Contingency plans may include
stockpiling medical supplies and materials, increasing inventory levels and
securing alternate sources of supply. The Company anticipates its contingency
planning for this aspect of its Year 2000 assessment to be completed by July 31,
1999. Costs as a result of these types of occurrences are in the process of
being determined.

Because the Company's physical sites are located within facilities owned
and operated by other entities whose Year 2000 readiness efforts it does not
control, there will be issues that arise which are dependent on these clients'
efforts. The Company has communicated with many of its clients on these matters.
The Company anticipates its contingency planning for this aspect of its Year
2000 assessment to be completed by July 31, 1999 and feels costs related to this
phase will be immaterial.

The Company expects to expend approximately $110,000 in connection with
evaluating, modifying and replacing its computer systems and software and
expects to fund such expenditures through operating cash flows. However, there
can be no guarantees that these estimates will be achieved and actual results
could differ materially from those anticipated.

14
<PAGE> 16

The Company's most reasonably likely worst-case scenario relating to the
Year 2000 problem is inadequate preparation by its customers, suppliers or
vendors. If the Company's information technology systems fail or if any software
application or embedded microprocessors central to some healthcare functions
have been overlooked in the assessment or implementation phases, some healthcare
delivery problems or communications problems may be present. However, the
Company is not dependent upon highly technical equipment in the delivery of care
and believes that mechanical alternatives are adequate. If the Company's vendors
or suppliers of power, telecommunications and transportation to the customer
sites where the Company operates fail to provide the Company with supplies and
services, the Company may experience difficulties in delivery of healthcare
services. Likewise, if the Company's major customers' systems do not become Year
2000 compliant on a timely basis, significant problems may be incurred in
reimbursement for Company services. If any of these uncertainties were to occur,
the Company's financial condition and results of operations would be adversely
affected. The Company has contacted most of its client sites and believes that
adequate emergency plans are in place.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not applicable.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The Company's Consolidated Financial Statements, together with the report
thereon of Ernst & Young LLP, dated February 12, 1999, begin on page F-1 of this
Report.

ITEM 9. CHANGES IN AND 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.

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The following table sets forth certain information, including ownership of
the Common Stock, as of March 23, 1999, with respect to: (i) each continuing
director or nominee; (ii) each executive officer; and (iii) all continuing
directors and executive officers as a group. Except as disclosed under Item 12,
"Security Ownership of Certain Beneficial Owners and Management -- Preferred
Stock" with respect to David A. Freeman, none of such persons owned any shares
of Preferred Stock.

15
<PAGE> 17

<TABLE>
<CAPTION>
PRINCIPAL OCCUPATION OR NUMBER OF SHARES
EMPLOYMENT (BY THE COMPANY DIRECTOR OF COMMON
NAME AND AGE UNLESS OTHERWISE INDICATED) SINCE STOCK OWNED (1) PERCENTAGE
------------ ----------------------------- -------- ---------------- ----------
<S> <C> <C> <C> <C>
from March 1995 to Septem-
ber 1, 1998; Chairman,
Manchester Associates, Ltd.,
an international consulting
company, since 1995; Of
Counsel to Kaye Scholer,
Fierman, Hays & Handler, a
law firm, since 1993.
David A. Freeman, 37 Member of Ferrer Freeman 1999(3) 679,101(4) 16.1%
Thompson & Co., General Part-
ner of Health Care Capital
Partners L.P. and Health Care
Executive Partners L.P., each
of which is an investment
management company, since
October 1995; Managing
Director of J.P. Morgan &
Co., Inc., an investment
banking firm, from Septem-
ber 1983 through September
1995.
John W. Gildea, 55(5) Managing Director, Gildea 1986 39,115 1.1%
Management Co., an investment
management company.
Carol R. Goldberg, 68(6) President, AVCAR Group, Ltd., 1991 23,000 *
a management consulting firm.
Jeffrey L. McWaters, 42 Chairman, President and Chief N/A 0 --
Executive Officer of
Amerigroup Corporation
(formerly Americaid, Inc.), a
managed health care company,
since October 1994; President
and Chief Executive Officer
of Options Mental Health, a
managed mental health care
company and a subsidiary of
First Hospital Corporation,
from 1991 through September
1994.
Richard M. Mastaler, 53 Chairman and Chief Executive N/A 0 --
Officer of CCN Managed Care,
Inc., a managed health care
company, since August 1997;
Executive Vice
President -- Mergers and
Acquisitions and Product
Development of Magellan
Health Services, Inc., a
managed behavioral health
care company, from September
1996 through August 1997;
President and Chief Execu-
tive Officer of Unilab
Corporation, a clinical and
pathological
</TABLE>

16
<PAGE> 18

<TABLE>
<CAPTION>
PRINCIPAL OCCUPATION OR NUMBER OF SHARES
EMPLOYMENT (BY THE COMPANY DIRECTOR OF COMMON
NAME AND AGE UNLESS OTHERWISE INDICATED) SINCE STOCK OWNED (1) PERCENTAGE
------------ ----------------------------- -------- ---------------- ----------
<S> <C> <C> <C> <C>
laboratory, from April 1994
through March 1996.
Scott L. Mercy, 37 Chairman and Chief Executive 1996 361,000(7) 9.6%
Officer of LifePoint
Hospitals, a hospital
management company since
September 1998; Chairman of
the Board of Directors since
September 1, 1998; President
and Chief Executive Officer
of the Company from April 1,
1996 through September 1,
1998; Senior Vice
President -- Financial
Operations of Columbia/HCA
Healthcare Corporation from
1994 through 1995; Vice
President -- Financial
Operations and
Director -- Financial
Operations Support of
Hospital Corporation of
America from 1987 through
1994.
Richard D. Wright, 53 Chairman, President and Chief N/A 0 *
Executive Officer of Covation
LLC, a provider of software
integration and data
management services for
health care providers and
organizations, since Decem-
ber 1998; Co-Founder and
Executive Vice President,
Corporate Services of PhyCor,
Inc., a physician practice
management company, from 1997
through December 1998;
Executive Vice President of
Operations from 1988 through
1997.
OTHER EXECUTIVE OFFICERS
Gerard F. Boyle, 44 Executive Vice President of -- 25,671 *
the Company since February
1998; President and Chief
Executive Officer of Prison
Health Services, Inc., a
wholly owned subsidiary of
the Company ("PHS"), since
March 1998; Vice President of
Operations of EMSA Correc-
tional Care, Inc., from
September 1996 through
February 1998; Vice President
and Administrator of Sales
for EMSA Correctional Care,
Inc. from July 1994 through
August 1996; Regional
</TABLE>

17
<PAGE> 19

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

* Less than 1%
(1) Includes the following shares subject to options exercisable presently or
within 60 days: Mr. Catalano, 44,000 shares; Mr. Eberle, 48,000 shares; Mr.
Freeman, 15,000 shares; Mr. Gildea, 38,000 shares; Ms. Goldberg, 23,000
shares; Mr. Mercy, 175,000 shares; Mr. Boyle, 25,000 shares; Mr. Teal,
22,110 shares; and all continuing directors and executive officers as a
group, 390,110 shares.
(2) Mr. Eberle also serves on the Boards of Directors of Ampco-Pittsburgh
Corporation, Mitchell Energy & Development Corporation, Konover Property
Trust and Showscan Entertainment, Inc.
(3) Mr. Freeman was appointed to the Board of Directors on January 26, 1999
pursuant to the terms of the Securities Purchase Agreement (as defined
below). See "Certain Relationships and Related Transactions."
(4) Mr. Freeman is deemed to beneficially own the shares of Common Stock which
are issuable upon the exercise of the Warrants (as defined) and the
conversion of the 50,000 shares of Preferred Stock (the "Initial Preferred
Stock") issued on January 26, 1999 to Health Care Capital Partners L.P.
("Capital Partners") and Health Care Executive Partners L.P. ("Executive
Partners"). See "Certain Relationships and Related Transactions." The
Warrants entitle the holders thereof to purchase 135,000 shares of Common
Stock. The Preferred Stock is convertible into such number of shares of
Common Stock as is determined by dividing the per-share liquidation
preference of the Preferred Stock ($100) by the Conversion Price. The
Conversion Price is equal to the lower of (i) $9.45 and (ii) the Current
Market Price (as defined) of the Common Stock during the 30 consecutive
Trading Days prior to the Company's 1999 annual stockholders meeting,
provided that, the Conversion Price shall in no event be less than $5.50 per
share. Upon conversion of the Initial Preferred Stock, Capital Partners and
Executive Partners will be entitled to receive between 529,101 and 909,091
shares of Common Stock, depending upon the applicable Conversion Price. Such
shares of Common Stock, together with the 135,000 shares of Common Stock
issuable upon exercise of the Warrants, would represent between 15.7% and
22.6% of the outstanding shares of Common Stock. In computing Mr. Freeman's
beneficial ownership as reported in the table above, the Company has assumed
that Capital Partners and Executive Partners will be entitled to receive
529,101 shares of Common Stock upon conversion of the Initial Preferred
Stock (assuming a Conversion Price of $9.45), in addition to the 135,000
shares of Common Stock Capital Partners and Executive Partners will be
entitled to receive upon exercise of the Warrants and the 15,000 shares of

18
<PAGE> 20

Common Stock Mr. Freeman is entitled to receive pursuant to the exercise of
stock options. See Note 1. If the Company's stockholders approve the
conversion of the Notes (as defined) into additional shares of Preferred
Stock, the Notes, all of which are held by Capital Partners and Executive
Partners, will be converted into Preferred Stock which may in turn be
converted into Common Stock. On July 2, 1999, the Company redeemed $7.5
million aggregate principal amount of the Notes. Mr. Freeman will also be
deemed to beneficially own any such shares of Preferred Stock or Common
Stock owned by Capital Partners and Executive Partners. Upon conversion of
the Notes into Preferred Stock and such Preferred Stock into Common Stock,
Capital Partners and Executive Partners will be entitled to receive between
793,651 and 1,363,636 shares of Common Stock, depending upon the applicable
Conversion Price. Such shares of Common Stock, together with the shares of
Common Stock issuable upon exercise of the Warrants and conversion of the
Initial Preferred Stock would represent between 29.0% and 40.2% of the
shares of Common Stock outstanding following such conversion and exercise.
Consequently, including the 15,000 shares of Common Stock Mr. Freeman is
entitled to receive pursuant to the exercise of stock options, Mr. Freeman
would be deemed to beneficially own between 29.2% and 40.4% of the
outstanding shares of Common Stock.
(5) Mr. Gildea also serves on the Boards of Directors of General Chemical Group
Inc. and Konover Property Trust.
(6) Ms. Goldberg also serves on the Board of Directors of The Gillette Company
and Selfcare, Inc.
(7) Includes 146,000 shares of Common Stock purchased by Mr. Mercy from the
Company, 40,000 shares of Common Stock issued under the Old Mercy Agreement
(as defined), (which are presently held in the name of his spouse and
beneficial ownership of which he disclaims), and options to purchase 175,000
shares of Common Stock. The shares of Common Stock purchased by Mr. Mercy
and the shares of Common Stock issued under the Old Mercy Employment
Agreement are subject to certain repurchase rights in favor of the Company
and Mr. Mercy. See Item 11, "Executive Compensation -- Employment
Agreements."

ITEM 11. EXECUTIVE COMPENSATION

SUMMARY COMPENSATION TABLE

The following table sets forth information concerning the compensation of
the Company's Chief Executive Officer and the two most highly compensated
executive officers other than the CEO (the "Named Executives") for each of the
years 1996 through 1998. The Company has no other executive officers other than
the individuals named below.

<TABLE>
<CAPTION>
ANNUAL COMPENSATION LONG-TERM COMPENSATION
----------------------------------------- --------------------------------------------
OTHER ANNUAL RESTRICTED STOCK ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY BONUS COMPENSATION STOCK ($) OPTIONS(#) COMPENSATION (1)
- --------------------------- ---- -------- -------- ------------ ----------- ----------- ----------------
<S> <C> <C> <C> <C> <C> <C> <C>
Scott L. Mercy (2).......... 1998 $155,000 $175,375 $ -- $ -- -- $ --
1997 190,000 -- -- -- -- 16,533
1996 138,846 -- -- 350,000 175,000 9,223
Michael Catalano (3)........ 1998 $186,862 $187,832 $ -- $ -- 62,000 $ 3,454
President and Chief 1997 165,500 -- 56,000(4) -- -- 13,384
Executive Officer 1996 83,077 -- -- -- 60,000 4,452
Gerard F. Boyle (5)......... 1998 $162,413 $ 71,445 $29,068(4) $ -- 85,000 $ 2,500
Executive Vice 1997 -- -- -- -- -- --
President and Chief 1996 -- -- -- -- -- --
Operating Officer
Bruce A. Teal (6)........... 1998 $159,259 $160,643 $ -- $ -- 33,000 $ 2,500
Executive Vice 1997 115,000 -- -- -- -- 102
President and Chief 1996 4,423 -- -- -- 17,000 9
Financial Officer
</TABLE>

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

(1) Includes matching contributions by the Company to its 401(k) Profit Sharing
Plan and life and health insurance premiums paid by the Company on behalf of
the Named Executives.
(2) Mr. Mercy became President and Chief Executive Officer of the Company on
April 1, 1996. Mr. Mercy resigned his position as President and Chief
Executive Officer on September 1, 1998.

19
<PAGE> 21

(3) Mr. Catalano served as Executive Vice President of Development, General
Counsel and Secretary of the Company from July 12, 1996 through September 1,
1998. Mr. Catalano became President and Chief Executive Officer of the
Company on September 1, 1998.
(4) Represents reimbursement for relocation costs.
(5) Mr. Boyle became Executive Vice President and Chief Operating Officer of the
Company on February 12, 1998.
(6) Mr. Teal served as Vice President, Controller and Treasurer of the Company
from December 10, 1996 through February 20, 1998. Mr. Teal became Senior
Vice President and Chief Financial Officer of the Company on February 20,
1998 and Executive Vice President on July 20, 1999.

STOCK OPTION GRANTS AND VALUES

The following table sets forth certain information with respect to stock
options granted to the Named Executives during 1998 and the potential realizable
value of such options.

<TABLE>
<CAPTION>
POTENTIAL
REALIZABLE
VALUE AT ASSUMED
NUMBER OF ANNUAL RATES OF
SECURITIES % OF TOTAL STOCK PRICE
UNDERLYING OPTIONS/SARS APPRECIATION FOR
OPTIONS/ GRANTED TO EXERCISE OR OPTION TERM
SARS GRANTED EMPLOYEES IN BASE PRICE EXPIRATION -------------------
NAME (#) FISCAL YEAR ($/SH) DATE 5% ($) 10% ($)
- ---- -------------- -------------- ------------ ------------- -------------------
<S> <C> <C> <C> <C> <C> <C>
Michael Catalano
Feb. 20, 1998.......................... 12,000 3.7 9.69 Feb. 20, 2008 73,080 185,280
Sept. 1, 1998.......................... 50,000 15.8 8.69 Sept. 1, 2008 273,000 692,000
Gerald Boyle
Feb. 12, 1998.......................... 75,000 23.4 9.37 Feb. 12, 2008 442,500 1,120,500
Sept. 1, 1998.......................... 10,000 3.1 8.69 Sept. 1, 2008 54,600 138,400
Bruce Teal
Feb. 20, 1998.......................... 33,000 10.3 9.69 Feb. 20, 2008 200,970 509,520
</TABLE>

AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUE
TABLE

The following table sets forth certain information with respect to option
exercises by the Named Executives during 1998 and the value of options owned by
the Named Executives at December 31, 1998.

<TABLE>
<CAPTION>
NUMBER OF
SECURITIES UNDERLYING VALUE OF UNEXERCISED
UNEXERCISED OPTIONS IN-THE-MONEY OPTIONS
AT FY-END(#) AT FY-END($)(1)
SHARES ------------------------ ------------------------
ACQUIRED ON VALUE EXERCISABLE/ EXERCISABLE/
NAME EXERCISE(#) REALIZED($) UNEXERCISABLE UNEXERCISABLE
- ---- ----------- ----------- ------------------------ ------------------------
<S> <C> <C> <C> <C>
Scott L. Mercy............... -- -- 175,000/0 $ 743,750/-
Michael Catalano............. -- -- 40,000/82,000 -/225,406
Gerard F. Boyle.............. -- -- 0/85,000 -/315,380
Bruce A. Teal................ -- -- 11,220/38,780 41,374/130,643
</TABLE>

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

(1) Based on the closing price of the Common Stock on the Nasdaq National Market
System on December 31, 1998 of $13.00 per share.

EMPLOYMENT AGREEMENTS

Scott L. Mercy was employed as President and Chief Executive Officer of the
Company from April 1, 1996 through September 1, 1998 pursuant to an employment
agreement, which was amended on June 30, 1997 (the "Old Mercy Agreement"). The
Old Mercy Agreement provided for a minimum annual base salary of $190,000, an
annual bonus based upon performance objectives, and such additional compensation
as determined by the Compensation Committee from time to time. On September 1,
1998, Mr. Mercy and the Company amended and restated the Old Mercy Agreement
(the "New Mercy Agreement") pursuant to

20
<PAGE> 22

which Mr. Mercy was appointed Chairman of the Board of Directors. Pursuant to
the New Mercy Agreement, Mr. Mercy was paid a base salary of $60,000 for his
service as Chairman of the Board during 1998. For years after 1998, the New
Mercy Agreement establishes a minimum annual base salary of $24,000 and such
additional compensation as may be determined by the Compensation Committee from
time to time. Pursuant to the Old Mercy Agreement, Mr. Mercy purchased 146,000
shares of Common Stock from the Company at $8.75 per share, the mean between the
high and low sale prices for the Common Stock on April 1, 1996, received 40,000
shares as a restricted stock award under the Company's Incentive Stock Plan, and
was awarded options to purchase 175,000 additional shares of Common Stock, at
$8.75 per share. Pursuant to the Old Mercy Agreement the restricted stock and
stock options were to vest in installments over four years, or earlier in
one-third installments when the closing price of the Common Stock reached $12,
$14 and $16, respectively. Mr. Mercy's restricted stock and stock options vested
in 1996 when the closing price of the Common Stock exceeded $16 per share.
Pursuant to the New Mercy Agreement, Mr. Mercy has the right to require the
Company to purchase (and the Company has the right to require Mr. Mercy to
sell), at a price not less than $9.90 per share, the purchased shares and the
award shares, but not the option shares, upon Mr. Mercy's termination of
employment. Mr. Mercy is subject to certain non-competition and confidentiality
agreements following termination. The New Mercy Agreement provides for perpetual
employment until terminated by 30 days written notice by either party. The New
Mercy Agreement also provides that the Board of Directors shall take all
necessary actions to ensure that Mr. Mercy is slated as a management nominee to
the Board and elected Chairman of the Board during his employment. Pursuant to
the New Mercy Agreement, Mr. Mercy may terminate his position as Chairman of the
Board, remain a director and otherwise continue his employment under the New
Mercy Agreement, unless it is otherwise terminated.

Michael Catalano was employed as Executive Vice President of Development,
General Counsel and Secretary of the Company from July 12, 1996 through
September 1, 1998 pursuant to an employment agreement (the "Old Catalano
Agreement") which established a minimum annual base salary of $160,000 and such
additional compensation as determined by the Compensation Committee from time to
time. On September 1, 1998, Mr. Catalano and the Company amended and restated
the Old Catalano Agreement (the "New Catalano Agreement") pursuant to which Mr.
Catalano was appointed President and Chief Executive Officer of the Company. The
New Catalano Agreement establishes a minimum annual base salary of $190,000 and
such additional compensation as may be determined by the Compensation Committee
from time to time. Pursuant to the Old Catalano Agreement, on July 12, 1996, the
Company awarded to Mr. Catalano options to purchase 60,000 shares of Common
Stock at an exercise price of $13.125 per share under the Company's Amended
Incentive Stock Plan. The stock options vest ratably on each of the succeeding
three anniversaries of the date of the options and shall be exercisable for a
period of ten years from the date of the grant. Upon termination without cause
or a change of control of the Company, all unexercised stock options granted to
Mr. Catalano under the Company's Amended Incentive Stock Plan shall accelerate
and immediately vest. The issuance of the Preferred Stock to Capital Partners
and Executive Partners upon conversion of the Notes would constitute a change of
control under the New Catalano Agreement. Also, in the event of termination as a
result of death or disability, termination without cause or termination
following a change in control of the Company, Mr. Catalano or his estate is
entitled to two-year's compensation plus an amount equal to the incentive
compensation that Mr. Catalano would have earned in the year of termination, not
to be less than 45% of Mr. Catalano's annual base salary on the date of
termination. Mr. Catalano is subject to certain non-competition and
confidentiality agreements following termination. The New Catalano Agreement
provides for perpetual employment until terminated by appropriate written notice
by either party. The New Catalano Agreement also provides that the Board of
Directors shall take all necessary actions to ensure that Mr. Catalano is slated
as a management nominee to the Board during his employment.

On February 12, 1998, Gerard F. Boyle entered into an employment agreement
(the "Boyle Agreement") with the Company pursuant to which he was appointed
Executive Vice President and Chief Operating Officer of the Company. The Boyle
Agreement establishes a minimum annual salary of $180,000 and such additional
compensation as may be determined by the Compensation Committee from time to
time. The Boyle Agreement provides for perpetual employment until terminated by
either party upon thirty days notice. If there is a change of control of the
Company, all unexercised stock options granted to Mr. Boyle under the Company's
Amended Incentive Stock Plan shall accelerate and immediately vest. The issuance
of the
21
<PAGE> 23

Preferred Stock to Capital Partners and Executive Partners upon conversion of
the Notes would constitute a change of control under the Boyle Agreement. Also,
in the event of a termination without cause, including termination following a
change in control, Mr. Boyle's options shall vest and his annual base salary as
of the date of his termination shall be continued for one year following such
termination date. Mr. Boyle is subject to certain non-competition and
confidentiality agreements following termination.

On February 20, 1998, Bruce Teal entered into an employment agreement (the
"Teal Agreement") with the Company pursuant to which he was appointed Senior
Vice President and Chief Financial Officer of the Company. Mr. Teal had been
serving as Vice President, Controller and Treasurer of the Company since
December 1996; however, the Company and Mr. Teal had not entered into an
employment agreement for his service in that capacity. The Teal Agreement
establishes a minimum annual salary of $160,000 and such additional compensation
as may be determined by the Compensation Committee from time to time. The Teal
Agreement provides for perpetual employment until terminated by either party
upon thirty days notice. If there is a change of control of the Company, all
unexercised stock options granted to Mr. Teal under the Company's Amended
Incentive Stock Plan shall accelerate and immediately vest. The issuance of the
Preferred Stock to FFT upon conversion of the Notes would constitute a change of
control under the Teal Agreement. Also, in the event of a termination without
cause, including termination following a change in control, Mr. Teal's options
shall vest and his annual base salary as of the date of his termination shall be
continued for one year following such termination date. Mr. Teal is subject to
certain non-competition and confidentiality agreements following termination.

COMPENSATION OF DIRECTORS

During 1998, the Company granted each non-employee Director options to
purchase 4,000 shares of Common Stock at an exercise price of $13.56 per share
for serving on the Board and its committees. The Chairman of the Board of
Directors of the Company until September 1, 1998, Mr. William D. Eberle, was
also paid $25,000 for consulting services which he provided to the Company
during 1998. Directors who are also employees of the Company receive no
additional compensation from the Company for attendance at Board or committee
meetings. Under the terms of the Company's Amended Incentive Stock Plan, any
person who is not an employee or independent contractor of the Company and who
becomes a Director will receive an option to purchase 15,000 shares of the
Common Stock at an exercise price equal to the fair market value of the Common
Stock on the date such person becomes a Director. Such options will vest with
respect to 25% of the shares covered thereby on each successive anniversary of
the date of grant. David A. Freeman was granted such options, effective January
26, 1999, upon his appointment to the Board.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

COMMON STOCK

Information with respect to the beneficial ownership of the Common Stock,
as of March 23, 1999, by the Company's directors, director-nominees and
executive officers is included above in Item 10 and is incorporated herein by
reference. The following table sets forth certain information with respect to
the beneficial ownership of the Common Stock, as of June 7, 1999, by each person
who was known by the Company to own beneficially more than 5% of the Common
Stock as of such date, based on information furnished to the

22
<PAGE> 24

Company. Except as otherwise indicated, each person has sole voting and
dispositive power with respect to the shares beneficially owned by such person.

<TABLE>
<CAPTION>
SHARES
BENEFICIALLY % OF SHARES
NAME AND ADDRESS OWNED OUTSTANDING
- ---------------- ------------ -----------
<S> <C> <C>
A group comprised of Health Care Capital Partners L.P. and
Health Care Executive Partners L.P........................ 679,101(1) 16.1%
Value Partners, Ltd......................................... 525,575(2) 14.7%
c/o Ewing & Partners
Suite 808
4514 Cole Avenue
Dallas, Texas 75205
A group comprised of J. Carlo Cannell D/B/A Cannell Capital
Management, Tonga Partners LP, Pleiades Investment
Partners, LP, the Cuttyhunk Fund Limited and Canal
Ltd.(3)................................................... 397,300(4) 11.1%
Scott L. Mercy.............................................. 361,000(5) 9.6%
LifePoint Hospitals
4526 Harding Road
Nashville, Tennessee 37205
Sirach Capital Management, Inc.............................. 267,000(6) 7.5%
3323 One Union Square
Seattle, Washington 98101
Frontier Capital Management Company, Inc.................... 194,670(7) 5.4%
99 Summer Street
Boston, Massachusetts 02110
A group comprised of Mark E. Brady, Robert J. Suttman, III
and Ronald Eubel.......................................... 190,170(8) 5.3%
777 Washington Village Drive
Suite 210
Dayton, Ohio 45459
A group comprised of Wachovia Corporation and Wachovia Bank,
N.A. (collectively, the "Wachovia Group")................. 183,500(9) 5.1%
100 North Main Street
Winston Salem, North Carolina 27104
A group comprised of Sandera Partners, L.P., Sandera Capital
Management, L.L.C., Sandera Capital, L.L.C., John A.
Bricker, Jr., Hunt Financial Partners, L.P. (collectively,
the "Sandera Group"), and Newcastle Partners, L.P. and
Mark Schwartz (collectively, the "Newcastle Group")(10)... 155,500(11) 4.4%
</TABLE>

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

(1) Includes shares of Common Stock issuable upon exercise of the Warrants and
the conversion of the Initial Preferred Stock, which Capital Partners and
Executive Partners are deemed to beneficially own, and 15,000 shares
subject to options exercisable by David A. Freeman which Capital Partners
and Executive Partners are deemed to beneficially own. The Warrants entitle
Capital Partners and Executive Partners to purchase 135,000 shares of
Common Stock. The Preferred Stock is convertible into such number of shares
of Common Stock as is determined by dividing the per-share liquidation
preference of the Preferred Stock ($100) by the Conversion Price, which may
vary between $5.50 and $9.45. Upon conversion of the Initial Preferred
Stock, Capital Partners and Executive Partners will be entitled to receive
between 529,101 and 909,091 shares of Common Stock, depending upon the
applicable Conversion Price. Such shares of Common Stock, together with the
135,000 shares of Common Stock issuable upon exercise of the Warrants,
would represent between 15.7% and 22.6% of the outstanding shares of Common
Stock. On July 2, 1999, the Company redeemed $7.5 million aggregate
principal

23
<PAGE> 25

amount of the $15.0 million Notes. If the Company's stockholders approve
the conversion of the Notes into additional shares of Preferred Stock, the
Notes, all of which are held by Capital Partners and Executive Partners,
will be converted into Preferred Stock which may in turn be converted into
Common Stock. Upon conversion of the Notes into Preferred Stock and such
Preferred Stock into Common Stock, Capital Partners and Executive Partners
will be entitled to receive between 793,651 and 1,363,636 shares of Common
Stock, depending upon the applicable Conversion Price. Such shares of
Common Stock, together with the shares of Common Stock issuable upon
exercise of the Warrants and conversion of the Initial Preferred Stock
would represent between 29.0% and 40.2% of the shares of Common Stock
outstanding following such conversion and exercise.
(2) Based on Amendment No. 4 to a Schedule 13D filed with the SEC on June 7,
1999. According to such Schedule 13D, each of Ewing & Partners, as general
partner of Value Partners, Ltd., and Timothy G. Ewing, as managing general
partner of Ewing & Partners, may direct the vote and disposition of the
shares of Common Stock owned by Value Partners, Ltd. The business address
of Ewing & Partners and Timothy G. Ewing is Suite 808, 4514 Cole Avenue,
Dallas, Texas 75205.
(3) The address of J. Carlo Cannell D/B/A Cannell Capital Management and Tonga
Partners LP is 600 California Street, Floor 14, San Francisco, California
94108. The address of Pleiades Investment Partners, LP is 6022 West Chester
Pike, Newtown Square, Pennsylvania 19073. The address of the Cuttyhunk Fund
Limited is 73 Front Street, Hamilton, HM12, Bermuda. The address of Canal,
Ltd. is 9 Church Street, HM 951, Hamilton HM DX, Bermuda.
(4) Based on a Schedule 13G filed with the SEC on March 1, 1999, J. Carlo
Cannell D/B/A Cannell Capital Management beneficially owns 397,300 shares
of Common Stock, Tonga Partners, LP beneficially owns 167,800 shares of
Common Stock, Pleiades Investment Partners beneficially owns 46,600 shares
of Common Stock, the Cuttyhunk Fund Limited beneficially owns 146,200
shares of Common Stock and Canal Ltd. beneficially owns 36,700 shares of
Common Stock.
(5) Includes 146,000 shares of Common Stock purchased by Mr. Mercy from the
Company, 40,000 shares of Common Stock issued under the Old Mercy Agreement
(which are presently held in the name of his spouse and beneficial
ownership of which he disclaims), and options to purchase 175,000 shares of
Common Stock. The shares of Common Stock purchased by Mr. Mercy and the
shares of Common Stock issued under the Old Mercy Agreement are subject to
certain repurchase rights in favor of the Company and Mr. Mercy. See
"Executive Compensation -- Employment Agreements."
(6) Based upon a Schedule 13G filed with the SEC on February 2, 1999.
(7) Based on a Schedule 13G filed with the SEC on February 27, 1998.
(8) Based on a Schedule 13G filed with the SEC on March 11, 1999, each of Mark
E. Brady, Robert J. Suttman and Ronald Eubel beneficially owns 190,170
shares of Common Stock.
(9) Based on a Schedule 13G filed with the SEC on February 12, 1999, each of
Wachovia Corporation and Wachovia Bank, N.A. beneficially owns 183,500
shares of Common Stock.
(10) The address of each member of the Sandera Group is 1601 Elm Street, Suite
4000, Dallas, Texas 75201. The address of each member of the Newcastle
Group is 4650 Cole Avenue, Suite 331, Dallas, Texas 75205.
(11) Based upon Amendment No. 1 to Schedule 13G filed with the SEC on February
16, 1999, the Sandera Group beneficially owns 151,500 shares of Common
Stock, Newcastle Partners L.P. beneficially owns 4,000 shares and Mark
Schwartz beneficially owns 155,500 shares.

PREFERRED STOCK

Capital Partners owns 48,020 shares of Preferred Stock, which represents
approximately 96% of the outstanding shares of Preferred Stock. Executive
Partners owns 1,980 shares of Preferred Stock, which represents approximately 4%
of the outstanding shares of Preferred Stock. The principal business address of
Capital Partners and Executive Partners is c/o Ferrer Freeman Thompson & Co.
LLC, The Mill, 10 Glenville Street, Greenwich, Connecticut 06831. The shares of
Preferred Stock owned by Capital Partners and Executive Partners constitute all
of the outstanding shares of Preferred Stock. The general partner of each of
Capital Partners and Executive Partners is Ferrer Freeman Thompson & Co ("FFT").
David A. Freeman, a director and director-nominee of the Company, is a member of
FFT and is thereby deemed to beneficially own all of the Preferred Stock owned
by Capital Partners and Executive Partners.

24
<PAGE> 26

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

David A. Freeman, a director and a director-nominee of the Company, is a
member of FFT. On January 26, 1999, the Company entered into the Securities
Purchase Agreement and certain other agreements with Capital Partners and
Executive Partners, investment management companies whose general partner is
FFT, pursuant to which the Company issued the Convertible Securities to Capital
Partners and Executive Partners. See Item 13, "Business -- Recent Developments."
On July 2, 1999, the Company redeemed $7.5 million aggregate principal amount of
the Notes. Capital Partners and Executive Partners currently own 100% of the
outstanding shares of the Preferred Stock, the Notes and the Warrants. In
addition, if the Stock Issuance is approved by the Company's stockholders at the
Company's 1999 Annual Meeting, Capital Partners and Executive Partners will have
the right to receive additional shares of Preferred Stock upon conversion of the
Notes and shares of Common Stock upon conversion of the Preferred Stock and the
Warrants. Mr. Freeman is deemed to beneficially own the Convertible Securities
currently owned by Capital Partners and Executive Partners and will be deemed to
beneficially own any additional Convertible Securities or Common Stock acquired
by Capital Partners and Executive Partners.

On the January 26, 1999, the Board of Directors appointed Mr. Freeman to
the Board of Directors, pursuant to a provision of the Securities Purchase
Agreement which obligated the Company to appoint a designee of Capital Partners
and Executive Partners to the Board of Directors on the date of the closing of
the Securities Purchase Agreement. Pursuant to the Securities Purchase
Agreement, if the stockholders approve the Stock Issuance at the Company's 1999
Annual Meeting, the Company will be obligated to increase the number of members
of the Board of Directors to nine and to nominate designees of Capital Partners
and Executive Partners to three of the nine directorships. Capital Partners and
Executive Partners have designated Mr. Freeman, Richard D. Wright and Jeffrey L.
McWaters to be nominated to directorships. FFT has a 17.3% ownership interest in
Amerigroup Corporation of which Mr. McWaters is Chairman, President and Chief
Executive Officer.

Scott L. Mercy, Chairman of the Board of Directors, is a limited partner of
Executive Partners. His interest in Executive Partners represents 1.5% of
Executive Partners' capital.

PART IV

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE, AND REPORTS ON FORM 8-K

(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

<TABLE>
<CAPTION>
EXHIBIT DESCRIPTION
- ------- -----------
<C> <S> <C>
2.1 -- Stock Purchase Agreement, dated as of December 18, 1998,
between the Company and InPhyNet Administrative Services,
Inc. (incorporated herein by reference to Exhibit 2.1 to the
Company's Current Report on Form 8-K filed on January 5,
1999).
2.2 -- First Amendment to Stock Purchase Agreement, dated as of
January 26, 1999, between the Company and InPhyNet
Administrative Services, Inc. (incorporated herein by
reference to Exhibit 99.8 to the Company's Current Report on
Form 8-K filed on February 10, 1999).
2.3 -- Securities Purchase Agreement , dated as of January 26,
1999, among the Company, Health Care Capital Partners L.P.
and Health Care Executive Partners L.P. (incorporated herein
by reference to Exhibit 99.2 to the Company's Current Report
on Form 8-K filed on February 10, 1999).
2.4 -- First Amendment to Securities Purchase Agreement, dated as
of June 17, 1999, among the Company, Health Care Capital
Partners L.P. and Health Care Executive Partners L.P.
</TABLE>

25
<PAGE> 27

<TABLE>
<CAPTION>
EXHIBIT DESCRIPTION
- ------- -----------
<C> <S> <C>
2.5 -- Plan and Agreement of Merger, as amended, dated October 1,
1997, between the Company, MedPartners, Inc. and ASG Merger
Corporation, a wholly-owned subsidiary of MedPartners, Inc.
(incorporated herein by reference to Exhibit 2.1 to the
Company's Current Report on form 8-K filed on October 2,
1997 and Exhibit 2.1 to the Company's Current Report on Form
8-K filed on December 30, 1997).
2.6 -- Consent and Agreement, dated January 19, 1998, by and among
the Company, MedPartners, Inc. and ASG Merger Corporation, a
wholly-owned subsidiary of MedPartners, Inc. (incorporated
herein by reference to Exhibit 2.1 to the Company's Current
Report on Form 8-K filed on January 20, 1998).
2.7 -- Release and Settlement Agreement, dated February 25, 1998,
by and among the Company, MedPartners, Inc. and ASG Merger
Corporation and EMSA Correctional Care, Inc. (incorporated
herein by reference to Exhibit 2.3 to the Company's Annual
Report on Form 10-K for the fiscal year ended December 31,
1997).
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 Registration Statement on Form
S-1, Registration No. 33-43306).
3.2 -- 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).
3.3 -- Amended and Restated Bylaws of America Service Group Inc.
(incorporated herein by reference to Exhibit 3.2 to the
Company's Annual Report on Form 10-K for the fiscal year
ended December 31, 1996).
4.1 -- The Company's 12% Subordinated Convertible Bridge Notes due
January 26, 2000, issued to Health Care Capital Partners
L.P. on January 26, 1999 (incorporated herein by reference
to Exhibit 99.4 to the Company's Current Report on Form 8-K
filed on February 10, 1999).
4.2 -- The Company's 12% Subordinated Convertible Bridge Notes due
January 26, 2000, issued to Health Care Executive Partners
L.P. on January 26, 1999 (incorporated herein by reference
to Exhibit 99.5 to the Company's Current Report on Form 8-K
filed on February 10, 1999).
4.1 -- Specimen Common Stock Certificate (incorporated by reference
to Exhibit 4.1 to the Company's Registration Statement on
Form S-1, Registration No. 33-43306, as amended).
10.1 -- Amended and Restated Credit Agreement, dated as of January
26, 1999, among the Company, as Borrower, the Company's
subsidiaries as listed therein, as Guarantors, the Lenders
identified therein and NationsBank, N.A., as Administrative
Agent and as Issuing Bank (incorporated herein by reference
to Exhibit 99.1 to the Company's Current Report on Form 8-K
filed on February 10, 1999).
10.2 -- Warrant, dated as of January 26, 1999, issued by the Company
to Health Care Capital Partners L.P. to purchase shares of
the Common Stock (incorporated herein by reference to
Exhibit 99.6 to the Company's Current Report on Form 8-K
filed on February 10, 1999).
10.3 -- Warrant, dated as of January 26, 1999, issued by the Company
to Health Care Executive Partners L.P. to purchase shares of
the Common Stock, dated as of January 26, 199 (incorporated
herein by reference to Exhibit 99.7 to the Company's Current
Report on Form 8-K filed on February 10, 1999).
10.4 -- Registration Rights Agreement , dated as of January 26,
1999, among the Company, Health Care Capital Partners L.P.
and Health Care Executive Partners L.P. (incorporated herein
by reference to Exhibit 99.8 to the Company's Current Report
on Form 8-K filed on February 10, 1999).
10.5 -- Prison Health Services, Inc. 1986 Employees' Stock Option
Plan (incorporated by reference to Exhibit 10.1 to the
Company's Registration Statement on Form S-1, Registration
No. 33-43306, as amended).
</TABLE>

26
<PAGE> 28

<TABLE>
<CAPTION>
EXHIBIT DESCRIPTION
- ------- -----------
<C> <S> <C>
10.6 -- America Service Group Inc. Amended Incentive Stock Plan (as
adopted by the Board of Directors on March 19, 1996)
(incorporated by reference to Exhibit 10.1 to the Company's
Quarterly Report on Form 10-Q for the three month period
ending June 30, 1996), as subsequently amended by resolution
of the Board of Directors on September 16, 1996 to increase
the number of shares reserved for issuance thereunder from
1,075,000 to 1,182,500.
10.7 -- America Service Group Inc. 401(k) Profit Sharing Plan
(incorporated by reference to Exhibit 10.9 to the Company's
Annual Report on Form 10-K for the year ended December 31,
1992).
10.8 -- Prison Health Services, Inc. Medical Services Agreement for
Alameda County, California, dated July 1, 1992 (incorporated
by reference to Exhibit 10.6 to the Company's Annual Report
on Form 10-K for the year ended December 31, 1992).
10.9 -- Prison Health Services, Inc. Agreement for the Department of
Corrections of the State of Kansas, dated February 22, 1991,
and Amendment thereto, dated August 27, 1991 (incorporated
by reference to Exhibit 10.7 to the Company's Registration
Statement on Form S-1, Registration No. 33-43306, as
amended).
10.10 -- Prison Health Services, Inc. Health Services Contract for
State of Maryland, Department of Public Safety and
Correctional Services dated November 30, 1992 (incorporated
by reference to Exhibit 10.14 to the Company's Annual Report
on Form 10-K for the year ended December 31, 1994).
10.11 -- Prison Health Services, Inc. Health Services Contract for
the City of Philadelphia Department of Public Health
(incorporated by reference to Exhibit 10.13 to the Company's
Annual Report on Form 10-K for the year ended December 31,
1993).
10.12 -- Healthcare Services Contract with the State of Delaware,
dated June 3, 1996 (incorporated by reference to Exhibit
10.5 to the Company's Quarterly Report on Form 10-Q for the
three month period ending June 30, 1996).
10.13 -- Contractual Agreement between the Indiana Department of
Correction and Prison Health Services, Inc. dated April 18,
1997 (incorporated by reference to Exhibit 10.26 to the
Company's Quarterly Report on Form 10-Q for the three month
period ending June 30, 1997).
10.14 -- Credit Agreement dated May 30, 1997 for $20,000,000 with
NationsBank of Tennessee, N.A. (incorporated by reference to
Exhibit 10.25 to the Company's Quarterly Report on Form 10-Q
for the three month period ending June 30, 1997).
10.15 -- Employment Agreement, dated April 1, 1996, between Scott L.
Mercy and the Company, as amended (incorporated herein by
reference to Exhibit 10.2 to the Company's Quarterly Report
on Form 10-Q for the three month period ended June 30, 1996
and 10.28 to the Company's Quarterly Report on Form 10-Q for
the three month period ended June 30, 1997).
10.16 -- Amended and Restated Employment Agreement, dated September
1, 1998, between Scott L. Mercy and America Service Group
Inc.*
10.17 -- Employment Agreement, dated November 1, 1996, between
Jeffrey J. Bairstow and the Company (incorporated by
reference to Exhibit 10.17 to the Company's Annual Report on
Form 10-K for the year ended December 31, 1997).
10.18 -- Non-qualified Stock Option by the Company and Jeffrey J.
Bairstow, dated December 18, 1996, (incorporated by
reference to Exhibit 10.18 to the Company's Annual Report on
Form 10-K for the year ended December 31, 1997).
10.19 -- Employment Agreement, dated July 12, 1996, between Michael
Catalano and the Company (incorporated by reference to
Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q
for the three month period ending September 31, 1996).
10.20 -- Amended and Restated Employment Agreement, dated September
1, 1998, between Michael Catalano and the Company
(incorporated by reference to Exhibit 10.1 to the Company's
Quarterly Report on Form 10-Q for the three month period
ending September 31, 1998).
10.21 -- Non-Qualified Stock Option between the Company and Michael
Catalano, dated July 12, 1996, (incorporated by reference to
Exhibit 10.20 to the Company's Annual Report on Form 10-K
for the year ended December 31, 1996).
</TABLE>

27
<PAGE> 29

<TABLE>
<CAPTION>
EXHIBIT DESCRIPTION
- ------- -----------
<C> <S> <C>
10.22 -- Employment Agreement dated February 20, 1998 between Bruce
A. Teal and the Company (incorporated by reference to
Exhibit 10.18 to the Company's Annual Report on Form 10-K
for the year ended December 31, 1997).
10.23 -- Non-Qualified Stock Option between the Company and Bruce A.
Teal dated, December 18, 1996, (incorporated by reference to
Exhibit 10.21 to the Company's Annual Report on Form 10-K
for the year ended December 31, 1996).
10.24 -- Employment Agreement, dated February 12, 1998, between
Gerard F. Boyle and the Company (incorporated by reference
to Exhibit 10.20 to the Company's Annual Report on Form 10-K
for the year ended December 31, 1997).
10.25 -- Non-Qualified Stock Option between the Company and Gerard F.
Boyle, dated February 12, 1998 (incorporated by reference to
Exhibit 10.21 to the Company's Annual Report on Form 10-K
for the year ended December 31, 1997).
10.26 -- Lease Agreement for office located at Two Penns Way, Suite
200, New Castle, Delaware 19720, and amendments thereto
(incorporated herein by reference to Exhibit 10.8 to the
Company's Annual Report on Form 10-K for the year ended
December 31, 1995).
10.27 -- Lease by and between Principal Mutual Life Insurance Company
and America Service Group Inc. dated September 6, 1996
(incorporated herein by reference to Exhibit 10.23 to the
Company's Annual Report on Form 10-K for the year ended
December 31, 1997).
10.28 -- Sublease Agreement, dated April 22, 1997, between the
Company and Citibank Delaware for office space located at
Two Penns Way, Suite 200, New Castle, Delaware (incorporated
herein by reference to Exhibit 10.24 to the Company's
Quarterly Report on Form 10-Q for the three months ending
March 31, 1997).
10.29 -- Amended and Restated Incentive Stock Plan of the Company
(incorporated by reference to Exhibit 10.27 to the Company's
Quarterly Report on Form 10-Q for the three months ending
June 30, 1997).
21.1 -- Subsidiaries of the Company.*
23.1 -- Consent of Ernst & Young LLP.
27.1 -- Financial Data Schedule for the year ended December 31, 1998
(for SEC use only).
</TABLE>

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

*Previously filed.

(b) Reports on Form 8-K.

The following report on Form 8-K was filed during the fourth quarter
of 1998.

(a) Current Report on Form 8-K dated September 3, 1998 reporting
certain changes in the executive officers and Chairman of the Board of the
Company.

28
<PAGE> 30

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registration has duly caused this report to be signed
on behalf of the undersigned, thereunto duly authorized, on July 28, 1999.

AMERICA SERVICE GROUP INC.

By: /s/ MICHAEL CATALANO
------------------------------------
Michael Catalano
President and
Chief Executive Officer

Pursuant to the Requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons in the capacities
indicated on July 28, 1999.

<TABLE>
<CAPTION>
SIGNATURES TITLE
---------- -----
<C> <S>

/s/ MICHAEL CATALANO Director, President and Chief Executive
- -------------------------------------------------- Officer
Michael Catalano

/s/ BRUCE A. TEAL Senior Vice President and Chief Financial
- -------------------------------------------------- Officer
Bruce A. Teal

/s/ SCOTT L. MERCY Director, Chairman of the Board
- --------------------------------------------------
Scott L. Mercy

Director
- --------------------------------------------------
Thomas Bogan

/s/ JACK O. BOVENDER, JR. Director
- --------------------------------------------------
Jack O. Bovender, Jr.

/s/ WILLIAM EBERLE Director
- --------------------------------------------------
William Eberle

/s/ DAVID A. FREEMAN Director
- --------------------------------------------------
David A. Freeman

/s/ JOHN GILDEA Director
- --------------------------------------------------
John Gildea

/s/ CAROL R. GOLDBERG Director
- --------------------------------------------------
Carol R. Goldberg
</TABLE>

29
<PAGE> 31

AMERICA SERVICE GROUP INC.

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULE

<TABLE>
<CAPTION>
PAGE
----
<S> <C>
FINANCIAL STATEMENTS
Report of Independent Auditors.............................. F-2
Consolidated Balance Sheets at December 31, 1998 and 1997... F-3
Consolidated Statements of Operations for the years ended
December 31, 1998, 1997, and 1996......................... F-4
Consolidated Statements of Changes in Common Stock,
Additional Paid-in Capital, Retained Earnings (Deficit)
and Treasury Stock for the years ended December 31, 1998,
1997 and 1996............................................. F-5
Consolidated Statements of Cash Flows for the years ended
December 31, 1998, 1997 and 1996.......................... F-6
Notes to Consolidated Financial Statements.................. F-7

FINANCIAL STATEMENT SCHEDULE
Valuation and qualifying Accounts and Reserves (Schedule II)
for the years ended December 31, 1998, 1997 and 1996...... F-21
</TABLE>

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.

F-1
<PAGE> 32

REPORT OF INDEPENDENT AUDITORS

Board of Directors and Stockholders
America Service Group Inc.

We have audited the accompanying consolidated balance sheets of America
Service Group Inc. as of December 31, 1998 and 1997, and the related
consolidated statements of operations, changes in common stock, additional
paid-in capital, retained earnings (deficit) and treasury stock, and cash flows
for each of the three years in the period ended December 31, 1998. Our audits
also included the financial statement schedule listed in the Index at Item
14(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 based on our audits.

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

In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of America Service
Group Inc. at December 31, 1998 and 1997, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1998, in conformity with 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
February 12, 1999, except for the last paragraph of Note 3 and Note 19, as to
which the date is
July 22, 1999

F-2
<PAGE> 33

AMERICA SERVICE GROUP INC.

CONSOLIDATED BALANCE SHEETS

<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------
1998 1997
----------- -----------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $ 7,211,000 $ 3,445,000
Short-term investments.................................... -- 1,559,000
Accounts receivable: Healthcare and other less allowance
for doubtful accounts of $20,000 and $384,000 at
December 31, 1998 and 1997............................. 13,760,000 8,242,000
Prepaid expenses and other current assets................. 1,098,000 2,384,000
Current deferred taxes.................................... 2,730,000 2,116,000
----------- -----------
Total current assets........................................ 24,799,000 17,746,000
Restricted investments...................................... -- 5,639,000
Property and equipment, net................................. 1,886,000 2,468,000
Deferred taxes.............................................. 1,341,000 1,193,000
Cost in excess of net assets acquired, net.................. -- 411,000
Other assets................................................ 349,000 297,000
----------- -----------
Total assets................................................ $28,375,000 $27,754,000
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.......................................... $ 2,438,000 $ 3,243,000
Accrued expenses.......................................... 11,846,000 12,836,000
Deferred revenue.......................................... -- 1,410,000
----------- -----------
Total current liabilities................................... 14,284,000 17,489,000
Noncurrent portion of accrued expenses...................... 1,300,000 3,624,000
Commitments and contingencies
Mandatory redeemable common stock, $.01 par value, 186,000
shares issued and outstanding at December 31, 1998 and
1997...................................................... 1,842,000 1,842,000
Preferred stock, $.01 par value, 2,000,000 shares
authorized; none outstanding.............................. -- --
Common stock, $.01 par value, 10,000,000 shares authorized;
3,573,000 and 3,529,000 shares issued and outstanding at
December 31, 1998 and 1997................................ 36,000 35,000
Additional paid-in-capital.................................. 8,351,000 7,926,000
Retained earnings (deficit)................................. 2,562,000 (3,162,000)
----------- -----------
Total liabilities and stockholders' equity.................. $28,375,000 $27,754,000
=========== ===========
</TABLE>

See accompanying notes.

F-3
<PAGE> 34

AMERICA SERVICE GROUP INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------
1998 1997 1996
------------ ------------ ------------
<S> <C> <C> <C>
Healthcare revenue................................... $113,287,000 $129,211,000 $152,282,000
Investment and interest income....................... 600,000 679,000 751,000
------------ ------------ ------------
Total revenue........................................ 113,887,000 129,890,000 153,033,000
Healthcare expenses.................................. 102,119,000 118,631,000 148,420,000
------------ ------------ ------------
Gross margin......................................... 11,768,000 11,259,000 4,613,000
Selling, general, and administrative expenses........ 10,716,000 9,461,000 14,504,000
MedPartners settlement gain.......................... (4,047,000) -- --
------------ ------------ ------------
Income (loss) from operations........................ 5,099,000 1,798,000 (9,891,000)
Interest expense..................................... -- 12,000 42,000
------------ ------------ ------------
Income (loss) before income taxes (benefits)......... 5,099,000 1,786,000 (9,933,000)
Provision for income taxes (benefits)................ (625,000) 101,000 (1,247,000)
------------ ------------ ------------
Net income (loss).................................... 5,724,000 1,685,000 (8,686,000)
Decrease (increase) in redeemable common stock....... -- 57,000 (226,000)
------------ ------------ ------------
Net income (loss) attributable to common shares...... $ 5,724,000 $ 1,742,000 $ (8,912,000)
============ ============ ============

Net income (loss) per common share:
Basic.............................................. $ 1.61 $ .50 $ (2.81)
============ ============ ============
Diluted............................................ $ 1.57 $ .48 $ (2.81)
============ ============ ============
Weighted average common shares outstanding:
Basic.............................................. 3,554,000 3,480,000 3,171,000
============ ============ ============
Diluted............................................ 3,653,000 3,657,000 3,171,000
============ ============ ============
</TABLE>

See accompanying notes.

F-4
<PAGE> 35

AMERICA SERVICE GROUP INC.

CONSOLIDATED STATEMENTS OF CHANGES IN COMMON STOCK,
ADDITIONAL PAID-IN CAPITAL, RETAINED EARNINGS
(DEFICIT) AND TREASURY STOCK

<TABLE>
<CAPTION>
COMMON STOCK ADDITIONAL RETAINED
------------------- PAID-IN EARNINGS TREASURY
SHARES AMOUNT CAPITAL (DEFICIT) STOCK
--------- ------- ----------- ----------- -----------
<S> <C> <C> <C> <C> <C>
Balance at January 1, 1996........... 3,404,000 $34,000 $ 6,887,000 $ 4,008,000 $(2,262,000)
Purchase of treasury stock (130,000
shares)............................ -- -- -- -- (875,000)
Issuance of redeemable common
stock.............................. -- -- -- -- 1,004,000
Issuance of common stock under
employee stock plan................ -- -- 67,000 -- 50,000
Exercise of options.................. -- -- (1,442,000) -- 1,875,000
Compensation for stock options....... -- -- 2,034,000 -- --
Increase in redemption value of
common stock....................... -- -- -- (226,000) --
Net loss............................. -- -- -- (8,686,000) --
--------- ------- ----------- ----------- -----------
Balance at December 31, 1996......... 3,404,000 34,000 7,546,000 (4,904,000) (208,000)
Issuance of common stock under
employee stock plan................ 8,000 -- 68,000 -- --
Exercise of options.................. 117,000 1,000 312,000 -- 208,000
Decrease in redemption value of
common stock....................... -- -- -- 57,000 --
Net income........................... -- -- -- 1,685,000 --
--------- ------- ----------- ----------- -----------
Balance at December 31, 1997......... 3,529,000 35,000 7,926,000 (3,162,000) --
Issuance of common stock under
employee stock plan................ 13,000 -- 138,000 -- --
Exercise of options.................. 31,000 1,000 287,000 -- --
Net income........................... -- -- -- 5,724,000 --
--------- ------- ----------- ----------- -----------
3,573,000 $36,000 $ 8,351,000 $ 2,562,000 $ --
========= ======= =========== =========== ===========
</TABLE>

See accompanying notes.

F-5
<PAGE> 36

AMERICA SERVICE GROUP INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------------
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income (loss)....................................... $ 5,724,000 $ 1,685,000 $(8,686,000)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization......................... 802,000 1,114,000 1,533,000
Write-off of cost in excess of net assets acquired.... 397,000 -- --
Noncash compensation charge........................... -- -- 2,384,000
Noncash change in redeemable common stock............. -- (17,000) 62,000
Provision for contract cancellation................... -- 3,802,000
Provision for doubtful accounts....................... -- 841,000 1,822,000
Deferred income tax provision......................... (762,000) (101,000) --
Loss on asset disposals............................... -- 457,000 --
Changes in operating assets and liabilities:
Accounts receivable................................ (5,518,000) 63,000 5,621,000
Assets held for sale............................... -- 2,900,000 --
Prepaid expenses and other current assets.......... 1,286,000 1,304,000 (2,136,000)
Other assets....................................... (52,000) (132,000) (72,000)
Accounts payable................................... (805,000) (4,413,000) 243,000
Accrued expenses................................... (3,314,000) (9,209,000) 4,839,000
Deferred revenue................................... (1,410,000) (3,590,000) (4,109,000)
Income taxes payable............................... -- -- (284,000)
----------- ----------- -----------
Net cash provided by (used in) operating activities..... (3,652,000) (9,098,000) 5,019,000
INVESTING ACTIVITIES
Proceeds (purchases) of short-term investments.......... 1,559,000 546,000 (1,405,000)
Proceeds from maturity or sale of restricted
investments........................................... 7,191,000 625,000 1,392,000
Purchases of restricted investments..................... (1,552,000) (806,000) (2,276,000)
Capital expenditures.................................... (739,000) (961,000) (4,268,000)
Proceeds from sale of property and equipment............ 533,000 -- 81,000
----------- ----------- -----------
Net cash provided by (used in) investing activities..... 6,992,000 (596,000) (6,476,000)
FINANCING ACTIVITIES
Purchase of treasury stock.............................. -- -- (875,000)
Issuance of redeemable common stock..................... -- -- 1,278,000
Issuance of common stock................................ 138,000 68,000 67,000
Exercise of stock options............................... 288,000 521,000 1,487,000
----------- ----------- -----------
Net cash provided by financing activities............... 426,000 589,000 1,957,000
Net increase (decrease) in cash and cash equivalents.... 3,766,000 (9,105,000) 500,000
Cash and cash equivalents at beginning of year.......... 3,445,000 12,550,000 12,050,000
----------- ----------- -----------
Cash and cash equivalents at end of year................ $ 7,211,000 $ 3,445,000 $12,550,000
=========== =========== ===========
SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid for interest.................................. $ -- $ 12,000 $ 42,000
=========== =========== ===========
Cash paid for income taxes.............................. $ 58,000 -- $ 326,000
=========== =========== ===========
</TABLE>

See accompanying notes.

F-6
<PAGE> 37

AMERICA SERVICE GROUP INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 1998

1. DESCRIPTION OF BUSINESS

America Service Group Inc. (the "Company") and its consolidated
subsidiaries provide managed healthcare services to correctional facilities
under capitated contracts (with certain adjustments) with state and local
governments. The health status of inmates may impact results of operations under
such contractual arrangements.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation

The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries, Prison Health Services, Inc. (PHS) and its
wholly-owned captive insurance subsidiary, Harbour Insurance, Inc. (Harbour),
Southern Health Partners, Inc. (SHP) and UniSource, Inc. (UniSource). The
Company liquidated and dissolved Harbour in November 1998 and sold all fixed
operating assets of UniSource during 1998. The Company disposed of 90% of its
interest in SHP in July 1996 and the remaining 10% in July 1997. All significant
intercompany transactions and account balances have been eliminated.

Use of Estimates

The preparation of the consolidated financial statements in conformity with
generally accepted accounting principles 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. Estimates are used primarily in the recording of the accruals of
unbilled medical services calculated based upon a claims payment lag methodology
and professional and general liability claims. The claims payment lag
methodology utilized for recording amounts for unbilled medical claims is based
upon historical payment patterns using actual utilization data including
hospitalization, one day surgeries, physician visits and emergency room and
ambulance visits and their corresponding costs. Additional estimates in 1996
were used in the recording of estimated losses on the Georgia Department of
Corrections contract, sublease receipts and employee severance. 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 carrying amounts of the Company's financial instruments reported in the
Consolidated Balance Sheets, consist of cash and cash equivalents, short-term
investments, accounts receivable, restricted investments, and accounts payable
and approximate their fair values.

Revenue and Cost Recognition

The Company engages principally in fixed price contracts with correctional
institutions adjusted for census fluctuations. 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 on
pharmaceutical and related products are recorded when shipped.

Healthcare expenses include the compensation of physicians, nurses and
other healthcare professionals including any related benefits and all other
direct costs of providing the managed care. The cost of healthcare services
provided or contracted for are recognized in the period in which they are
provided based in part on estimates, including an accrual for unbilled medical
services rendered through the balance sheet dates based upon a claims payment
lag methodology. Additionally, reserves have been recorded for certain reported
and unreported professional and general liability claims associated with the
delivery of medical services.

The Company accrues losses under its fixed price contracts when it is
probable that a loss has been incurred (i.e., expected future healthcare costs
and maintenance costs will exceed anticipated future revenue and stop-loss
insurance recoveries if material) and the amount of the loss can be reasonably
estimated. The Company performs this loss accrual analysis on a specific
contract basis.
F-7
<PAGE> 38
AMERICA SERVICE GROUP INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Cash and Cash Equivalents

Cash and cash equivalents include cash on hand, demand deposits, money
market funds and investments with original maturities of three months or less.

Short-Term Investments

Short-term investments consist of temporary investments in certificates of
deposit. Investments are available for sale and by their nature are stated at
fair value.

Depreciation

Depreciation is provided using straight-line and accelerated methods over
the estimated useful lives of the assets.

Cost in Excess of Net Assets Acquired

Cost in excess of net assets acquired represents the unamortized excess of
the acquisition cost over the fair value of the net assets received at the date
of acquisition. Amortization expense of $14,000, $42,000 and $43,000 for 1998,
1997 and 1996, respectively, was computed using the straight-line method over 15
years. Accumulated amortization as of December 31, 1997 was $323,000. The
Company wrote off the unamortized portion of cost in excess of net assets
acquired of $397,000 in June 1998 with the sale of UniSource.

The carrying value of costs in excess of net assets acquired is reviewed if
the facts and circumstances suggest that it may be impaired. If this review
indicates that cost in excess of net assets acquired will not be recoverable
based on the undiscounted cash flows of the entity acquired over the remaining
amortization period, the Company's carrying value of the cost in excess of net
assets acquired will be reduced to estimated fair value.

Long-Lived Assets

Statement of Financial Accounting Standards (SFAS) No. 121, Accounting for
the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of,
requires that companies consider whether indicators of impairment of long-lived
assets held for use are present. If such indicators are present, companies
determine whether the sum of the estimated undiscounted future cash flows
attributable to such assets is less than their carrying amount, and if so,
companies recognize 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 cost in excess of net
assets acquired and considers events, circumstances and operating results,
including consideration of contract performance at the fixed price contract
level.

Treasury Stock

Prior to December 1996, the Board of Directors had authorized the Company
to purchase treasury stock to be available for issuance under stock options and
other benefits under the Company's Incentive Stock Plan. Upon exercise of the
stock options, the difference between the cost of the treasury shares, on a
first-in, first-out basis, and the price of options exercised is reflected in
additional paid-in capital. Treasury stock includes 31,000 common shares at
December 31, 1996. The 31,000 common shares held in treasury as of December 31,
1996, were issued during 1997.

F-8
<PAGE> 39
AMERICA SERVICE GROUP INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Preferred Stock

The Board of Directors has the power and authority to establish preferences
related to dividends, redemptions, payment on liquidation, conversion privileges
and voting rights. As of December 31, 1998 and 1997, the Company had no shares
of preferred stock issued.

Income Taxes

The Company uses the liability method of accounting for federal and state
income taxes. Under the liability method, deferred tax assets and liabilities
are determined based on the difference between the financial statement carrying
amounts and tax bases of assets and liabilities using enacted tax rates in
effect in the years in which the differences are expected to reverse.
Differences between taxable income and income for financial statement purposes
result from the recognition of certain income and expense items for tax purposes
in periods which differ from those used for financial statement purposes.

Income (Loss) Per Share

In 1997, the Financial Accounting Standards Board ("FASB") issued Statement
No. 128, Earnings Per Share ("Statement 128"). Statement 128 replaced the
calculation of primary and fully diluted earnings per share with basic and
diluted earnings per share. Unlike primary earnings per share, basic earnings
per share excludes any dilutive effects of options, warrants and convertible
securities. Diluted earnings per share is very similar to the previously
reported fully diluted earnings per share, and uses the treasury stock method in
calculating dilution. All earnings per share amounts for all periods have been
presented and restated to conform to Statement 128 requirements.

Stock Options

The Company has elected to follow Accounting Principles Board Opinion No.
25, (Accounting for Stock Issued to Employees) ("APB 25"), and related
Interpretations in accounting for its employee stock options because the
alternative fair value accounting provided for under SFAS No. 123, (Accounting
for Stock-Based Compensation), requires use of option valuation models that were
not developed for use in valuing employee stock options. Under APB 25,
compensation expense is recognized as the difference between the exercise price
of the Company's employee stock options and the market price of the underlying
stock on the date of grant.

Recently Issued Accounting Pronouncements

No recently issued accounting pronouncements are expected to impact the
Company.

3. ACQUISITION OF GOVERNMENT SERVICES DIVISION

EMSA conducts its operations through two wholly-owned subsidiaries, EMSA
Correctional Care, Inc. and EMSA Military Services, Inc., each of which became
indirect subsidiaries of the Company pursuant to its acquisition of EMSA. EMSA
Correctional provides comprehensive managed healthcare solutions to state and
local correctional facilities, managing healthcare for approximately 70,000
inmates. Following the EMSA acquisition, the Company, through EMSA Correctional
and PHS, manages healthcare for approximately 133,000 inmates in 25 states. EMSA
Military contracts with the U.S. Department of Defense (the "DOD")
F-9
<PAGE> 40
AMERICA SERVICE GROUP INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

and the Veterans Administration (the "VA") to provide emergency medicine and
primary healthcare services to active and retired military personnel and their
dependents at medical facilities operated by the DOD and the VA.

The purchase price paid to InPhyNet was subject to increase or decrease on
a dollar-for-dollar basis by an amount equal to the amount by which EMSA's
working capital, as defined, and as reflected on its balance sheet as of January
25, 1999 (the "Closing Date Balance Sheet"), was in excess of or was less than
$27.6 million. The Closing Date Balance Sheet reflected working capital, as
defined, of $24.0 million. Accordingly, the Company received $3.6 million in
March 1999 as part of the purchase price adjustment. The Company will account
for the EMSA acquisition using the purchase method of accounting.

In connection with the EMSA acquisition: (i) the Company and all of its
subsidiaries, including EMSA, EMSA Military and EMSA Correctional, entered into
an Amended and Restated Credit Agreement, dated as of January 26, 1999, with
NationsBank, N.A., as Administrative Agent and Issuing Bank ("NationsBank"),
which provides for a revolving credit facility of up to $52.0 million (the
"Credit Facility") and (ii) the Company entered into a Securities Purchase
Agreement, dated as of January 26, 1999 (the "Securities Purchase Agreement")
with Health Care Capital Partners L.P. ("Capital Partners") and Health Care
Executive Partners L.P. ("Executive Partners"), investment funds managed by
Ferrer Freeman Thompson & Co. (collectively, with Capital Partners and Executive
Partners, "FFT"). On January 26, 1999, pursuant to the Securities Purchase
Agreement, the Company issued to Capital Partners and Executive Partners (i)
$15.0 million aggregate principal amount of the Company's 12% Subordinated
Convertible Bridge Notes due January 26, 2000 (the "Notes") with detachable
warrants (the "Warrants") to purchase an aggregate 135,000 shares of the
Company's common stock, par value $0.01 per share (the "Common Stock"), and (ii)
50,000 shares of the Company's Series A Convertible Preferred Stock, par value
$0.01 per share (the "Preferred Stock"), for $5.0 million. The Notes, Warrants
and Preferred Stock are referred to collectively as the "Convertible
Securities."

The Company used $47.0 million in borrowings under the Credit Facility and
the aggregate $20 million in proceeds received from its issuance of the
Convertible Securities to Capital Partners and Executive Partners to finance, in
part, the EMSA acquisition.

The Company has obtained an independent valuation computation of the fair
values of the Warrants ($4.88 per Warrant). Significant assumptions used in the
fair value calculation include: risk-free interest rate (4.79%); expiration
period (7 years); volatility (49%); and dividend per share (zero). The proceeds
from the sale of the Notes and Warrants were allocated in January 1999 based on
the relative fair values of the Warrants and Notes, with the fair value of the
Warrants being accounted for as an addition to paid-in capital. The resulting
discount on the Notes is accounted for as such and is being accreted and charged
to interest expense over the one year life of the Notes.

At a meeting of the Emerging Issues Task Force, the Securities and Exchange
Commission (the "SEC") recommended an accounting treatment for securities
similar to the Company's Series A Convertible Preferred Stock (the "Convertible
Preferred Stock") that have "beneficial conversion" feature. The Emerging Issues
Task Force issued clarifying guidance, effective for transactions consummated
after May 20, 1999, indicating that whether a beneficial conversion feature
exists with respect to a convertible security should be determined at the date
the issuer enters into a commitment to issue the security and that, if a
beneficial conversion feature exists, it should be recorded upon the issuance of
the security. The Company originally accounted for the issuance of the
Convertible Preferred Stock in January 1999 following the Emerging Issues Task
Force's guidance requiring that the existence of a beneficial conversion feature
be determined at the date of the commitment to issue the security. The SEC
concluded, during a review of the recently concluded EMSA transaction, that the
Company should have accounted for the issuance of the Convertible Preferred
Stock under the accounting interpretations that applied to transactions
consummated prior to May 20, 1999. As a result, the Company will be required to
restate its results for the first quarter ended March 31, 1999. An adjustment of
$1.9 million, which increases paid-in capital, represents a $3.68 non-cash,
nonrecurring dividend

F-10
<PAGE> 41
AMERICA SERVICE GROUP INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

on each outstanding share of Convertible Preferred Stock. The dividend equals
the increase in the fair market value of a share of the Company's Common Stock
from the date the Company entered into a commitment to issue the Convertible
Preferred Stock ($9.45 per share) to the Company's issuance of the Convertible
Preferred Stock on January 26, 1999 ($13.125 per share). If the acquisition of
EMSA had occurred subsequent to May 20, 1999, restatement of the Company's first
quarter financial statements would not be required. The restatement is a
historical event and will have no impact on earnings per share in future
periods. The restatement of the first quarter resulted in a reduction of fully
diluted earnings per share of $0.54.

4. RELEASE AND SETTLEMENT AGREEMENT

On October 1, 1997, the Company entered into a Plan and Agreement of Merger
(the "Merger Agreement") with MedPartners, Inc., a Delaware corporation
("MedPartners"), and a wholly owned subsidiary of MedPartners, pursuant to which
the Company would have been acquired by MedPartners (the "Merger").

On February 26, 1998, the Company announced the termination of the Merger
Agreement and the execution of a Release and Settlement Agreement (the
"Settlement Agreement") with MedPartners relating to the Merger Agreement.
Pursuant to the Settlement Agreement, MedPartners agreed to pay the Company
approximately $3.5 million in cash and to assume certain other base and employee
healthcare benefit costs incurred by the Company of approximately $1.5 million.
Approximately $1,000,000 of these payments reimbursed the Company for costs
directly associated with the terminated merger that were included in prepaid
expenses and other current assets at December 31, 1997. The resulting $4,047,000
is reported in 1998 as the MedPartners settlement gain.

In connection with the anticipated merger, all of the UniSource employees
were informed of the Company's intent to cease operations and sell or dispose of
all of UniSource's operating assets. Costs of approximately $0.6 million
associated with the disposal of UniSource, including $397,000 of unamortized
cost in excess of net assets acquired, severance and other miscellaneous
expenses are included in selling, general and administrative expenses. Also in
connection with the MedPartners transaction, the Company incurred employee stay
bonuses and severance costs of $0.7 million, which is included in selling
general and administrative expenses.

5. CORPORATE HEADQUARTERS, COMPENSATION AND GEORGIA CONTRACT CHARGES

During the fourth quarter of 1996, the Company commenced the move of its
corporate headquarters from New Castle, Delaware to Brentwood, Tennessee.
Related costs accrued were $1,055,000 relating to corporate employee severance
costs, which is included in selling, general and administrative expenses in the
accompanying statement of operations.

In April 1996, the Company entered into an agreement to grant the former
Chief Executive Officer 175,000 stock options at the fair market value of the
shares on March 28, 1996. The options were granted in May 1996 upon approval by
the Shareholders, pursuant to an amendment to the Incentive Stock Plan in May
1996. The options contained accelerated vesting provisions, based upon the
Company's stock achieving certain targeted price levels. During 1996, these
price levels were obtained and a $2,034,000 noncash compensation charge was
recognized, based upon the difference between the exercise price agreed upon in
March 1996 and the fair market value on the date of grant. The former Chief
Executive Officer was also awarded 40,000 redeemable common shares which
resulted in a $350,000 compensation charge based upon the fair market value of
the shares on the date of award. These compensation charges are included in
selling, general and administrative expenses in the accompanying statement of
operations.

The Company increased its 1996 second quarter $1,000,000 loss estimate
relating to the State of Georgia Department of Corrections contract by
$2,802,000 in the fourth quarter of 1996, included in healthcare

F-11
<PAGE> 42
AMERICA SERVICE GROUP INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

expenses in the accompanying statement of operations. The additional accrual for
losses in the fourth quarter was the result of the following factors: 1) higher
than anticipated pharmacy and laboratory costs, 2) the Company was forced to use
more expensive offsite services due to the unavailability of the state
infirmary, 3) certain patterns of practice by the state were changed that
negatively impacted the Company's ability to control costs, and 4) critical
company employees were extended offers by the state, negatively impacting the
Company's ability to manage the contract. The fourth quarter loss estimate
included $1.9 million in anticipated operating losses under the contract,
$150,000 for certain unreimbursed mental health costs, $350,000 for certain
fines and penalties, and a $450,000 write-down of equipment, which the State of
Georgia agreed to purchase for $2,900,000. The contract with the State of
Georgia which commenced October 1995, represented $30.9 million or 23.9% of
revenue and $56.7 or 37.2% of revenue for the years ended December 31, 1997 and
1996, respectively.

6. RESTRICTED INVESTMENTS

Restricted investments represent required funding for Harbour, the captive
insurance subsidiary, and accordingly, were intended to be held to maturity. All
restricted investments are stated at cost, adjusted for amortization of premiums
and accretion of discounts, which are recognized as adjustments to interest
income.

The amortized cost and approximate market value of restricted investments
are as follows:

<TABLE>
<CAPTION>
DECEMBER 31, 1997
--------------------------------------------------
UNREALIZED AMOUNTS
------------------
AMORTIZED COST GAINS LOSSES MARKET VALUE
-------------- ------- -------- ------------
<S> <C> <C> <C> <C>
U.S. Treasury and governmental agency
obligations............................ $1,723,000 $15,000 $ -- $1,738,000
Corporate bonds.......................... 3,262,000 25,000 (93,000) 3,194,000
Mortgage backed securities............... 654,000 2,000 (2,000) 654,000
---------- ------- -------- ----------
$5,639,000 $42,000 $(95,000) $5,586,000
========== ======= ======== ==========
</TABLE>

In October 1998, the Company completed a portfolio transfer of all
outstanding medical malpractice claims covered under Harbour related to the
period December 1, 1997 and prior through the execution of a Novation Agreement,
which transferred the risk of all reported claims to a third party. Subsequent
to all restrictions being removed on the investments, the Company dissolved
Harbour in November 1998.

7. PROPERTY AND EQUIPMENT

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

<TABLE>
<CAPTION>
DECEMBER 31,
------------------------- ESTIMATED
1998 1997 USEFUL LIVES
----------- ----------- ---------------
<S> <C> <C> <C>
Building and improvements.................... $ 41,000 $ 604,000 10 - 31.5 years
Equipment and furniture...................... 3,326,000 3,988,000 5 - 10 years
Medical equipment............................ 366,000 344,000 5 - 7 years
Automobile................................... 12,000 14,000 3 - 5 years
----------- ----------- ---------------
3,745,000 4,950,000
Less: Accumulated depreciation............... (1,859,000) (2,482,000)
----------- -----------
$ 1,886,000 $ 2,468,000
=========== ===========
</TABLE>

Depreciation expense for the years ended December 31, 1998, 1997 and 1996
was $788,000, $1,072,000 and $1,490,000, respectively.

F-12
<PAGE> 43
AMERICA SERVICE GROUP INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

8. ACCRUED EXPENSES

Accrued expenses consist of the following:

<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------
1998 1997
----------- -----------
<S> <C> <C>
Salaries and employee benefits.............................. $ 5,937,000 $ 4,345,000
Medical claims.............................................. 4,243,000 6,047,000
Liability claims............................................ 2,408,000 4,494,000
Legal....................................................... 190,000 429,000
Severance................................................... 19,000 290,000
Merger costs................................................ -- 247,000
Accrued loss on Georgia contract............................ -- 200,000
Other....................................................... 349,000 408,000
----------- -----------
13,146,000 16,460,000
Less: Noncurrent portion of liability claims................ (1,300,000) (3,624,000)
----------- -----------
$11,846,000 $12,836,000
=========== ===========
</TABLE>

9. BANKING ARRANGEMENTS

On March 28, 1997, the Company entered into a $20,000,000 line of credit
facility expiring September 2000 for general corporate purposes including
working capital, the issuance of letters of credit for performance bonds and the
funding of acquisitions. The interest rate was based on LIBOR or prime rates
subject to the quarterly operating performance of the Company, as defined in
such facility. The line of credit was collateralized by all assets of the
Company and its operating subsidiaries and is also subject to certain quarterly
financial covenants of which the Company was in compliance with throughout 1998.
No borrowings were outstanding under the lines of credit at December 31, 1998
and 1997. Such credit facility was replaced by the Credit Facility.

PHS had open letters of credit of $503,000 and $3,641,000 at December 31,
1998 and 1997, respectively, supporting performance guaranteed on specific
contracts. Subsequent to December 31, 1998, the Company had the remaining
$503,000 letters of credit returned.

10. INCOME TAXES

The Company's provision (benefit) for income taxes consists of the
following:

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------
1998 1997 1996
--------- -------- -----------
<S> <C> <C> <C>
Current income taxes:
Federal........................................... $ 50,000 $ -- $(1,110,000)
State............................................. 87,000 -- (137,000)
--------- -------- -----------
137,000 -- (1,247,000)
Deferred taxes:
Federal........................................... (682,000) -- --
State............................................. (80,000) 101,000 --
--------- -------- -----------
(762,000) 101,000 --
--------- -------- -----------
Income taxes (benefits)............................. $(625,000) $101,000 $(1,247,000)
========= ======== ===========
</TABLE>

F-13
<PAGE> 44
AMERICA SERVICE GROUP INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Deferred tax assets (liabilities) are comprised of the following at
December 31:

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------
1998 1997
---------- -----------
<S> <C> <C>
Net operating loss carryforwards............................ $2,161,000 $ 2,835,000
Executive stock options..................................... 773,000 773,000
Self-insurance reserves..................................... 733,000 1,714,000
Accrued vacation............................................ 421,000 299,000
Bad debt allowance.......................................... 59,000 146,000
Depreciation................................................ 48,000 (461,000)
Accrued legal............................................... (134,000) 140,000
Accrued severance........................................... 6,000 109,000
Accrued merger costs........................................ -- 247,000
Accrued loss on Georgia contract............................ -- 76,000
Other....................................................... 4,000 96,000
---------- -----------
4,071,000 5,974,000
Valuation allowance......................................... -- (2,665,000)
---------- -----------
$4,071,000 $ 3,309,000
========== ===========
</TABLE>

The valuation allowance for deferred tax assets has been eliminated at
December 31, 1998 as it is more likely than not that the deferred tax assets
will be realized through the future reversion of existing taxable temporary
differences and the generation of future taxable income. As of December 31,
1998, the Company had federal and state net operating loss carryforwards of
$5,686,000 expiring in 2005 through 2006.

A reconciliation of the federal statutory rate to the effective tax rate is
as follows:

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------
1998 1997 1996
----- ----- -----
<S> <C> <C> <C>
Federal tax................................................. 34.0% 34.0% (34.0)%
State income taxes.......................................... 4.0 5.7 (1.4)
Alternative minimum tax..................................... 1.0 -- --
Other....................................................... 1.0 1.0 --
Increase (decrease) in valuation allowance.................. (52.3) (35.0) 22.8
----- ----- -----
(12.3)% 5.7% (12.6)%
===== ===== =====
</TABLE>

11. MANDATORY REDEEMABLE COMMON STOCK

During 1996, the Company sold 146,000 shares of mandatory redeemable common
stock (purchased shares) and awarded 40,000 shares (awarded shares) of mandatory
redeemable common stock to its then Chief Executive Officer. The 146,000 shares
were sold at the then current fair market value of $8.75 per share. The vesting
of the awarded shares could be, and was accelerated under the terms of the award
and a compensation charge of $8.75 per share was recorded representing the fair
market value of the shares on the date of issuance. As of March 31, 1997, the
redemption price was fixed at $9.90 per share, through an amendment to the
employment agreement. Changes in the redemption value of the purchased and
awarded shares were recorded as adjustments to retained earnings and
compensation expense, respectively. During 1997, the Company decreased the
redemption value of the purchased and awarded shares, respectively, by $57,000
and $17,000, and during 1996 increased the redemption value by $226,000 and
$62,000. The impact on basic earnings per share for the purchased and awarded
shares was an increase of $0.02 per share and $0.00 per share, respectively, for
1997 and a decrease of $0.07 per share and $0.02 per share, respectively, for
1996. At December 31, 1998, the Company or the former Chief Executive Officer
was permitted to redeem the common stock at $9.90 per share.

F-14
<PAGE> 45
AMERICA SERVICE GROUP INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

12. NET INCOME (LOSS) PER SHARE

The table below sets forth the computation of basic and diluted earnings
per share as required by FASB Statement No. 128 for the three years in the
period ended December 31, 1998.

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------------------
1998 1997 1996
---------- ---------- -----------
<S> <C> <C> <C>
NUMERATOR:
Net Income (loss)................................. $5,724,000 $1,685,000 $(8,686,000)
Redeemable Common Stock........................... -- 57,000 (226,000)
---------- ---------- -----------
Numerator for basic and diluted earnings per
share -- income (loss) available to common
stockholders.................................... $5,724,000 $1,742,000 $(8,912,000)
========== ========== ===========
DENOMINATOR:
Denominator for basic earnings per
share -- weighted average shares................ 3,554,000 3,480,000 3,171,000
Effect of dilutive securities:
Employee stock options.......................... 99,000 177,000 --
---------- ---------- -----------
Denominator for diluted earnings per
share -- adjusted weighted average shares and
assumed conversions............................. 3,653,000 3,657,000 3,171,000
========== ========== ===========
Basic earnings per share.......................... $ 1.61 $ .50 $ (2.81)
========== ========== ===========
Diluted earnings per share........................ $ 1.57 $ .48 $ (2.81)
========== ========== ===========
</TABLE>

During any given quarter for the years ended December 31, 1998, 1997, and
1996 there were no more than 388,000, 175,100 and 762,000 options, respectively,
to purchase common stock with weighted average exercise prices of $12.04, $12.84
and $8.60, respectively, not included in the computation of diluted earnings per
share because the options' exercise price was greater than the average market
price for the period of the common shares or there was a loss for the year and,
therefore, the effect would be antidilutive.

In addition, during any given quarter for the year ended December 31, 1998
and 1997 there were no more than 186,000 shares of common stock which the
Company is required to repurchase upon termination of the former Chief Executive
Officer, as part of the written put option included in the employment agreement,
which were not included in the computation of diluted earnings per share because
the exercise (redemption) price was less than the average market price of the
common shares for the period or there was a loss for the year and, therefore,
the effect would be antidilutive.

13. STOCK OPTION PLANS

The Company has an Incentive Stock Plan, which provides for the granting of
options, stock awards and stock appreciation rights to officers, key employees
and non-employee directors for up to 1,483,000 shares of the Company's common
stock. Awards and vesting periods under the plan are discretionary and are
administered by a committee of the Board of Directors. The exercise price of the
options can not be less than the fair market value at the date of grant. Options
and other benefits expire at such times as the committee determines at the time
of grant, but no later than ten years from the grant date.

F-15
<PAGE> 46
AMERICA SERVICE GROUP INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The following is a summary of stock option activity under the plan:

<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
OPTIONS PRICE RANGE EXERCISE PRICE
-------- --------------- --------------
<S> <C> <C> <C>
Outstanding, December 31, 1995............... 668,000 $2.33 -- $11.19 $ 5.00
Granted.................................... 402,000 6.93 -- 13.13 10.53
Exercised.................................. (325,000) 2.33 -- 6.50 3.39
Stock award vested......................... (40,000) 8.75 -- 8.75 8.75
Canceled................................... (19,000) 4.50 -- 13.12 12.16
-------- --------------- ------
Outstanding, December, 1996.................. 686,000 2.67 -- 13.12 8.66
Granted.................................... 97,000 10.19 -- 14.44 12.98
Exercised.................................. (147,000) 2.67 -- 13.13 3.45
Canceled................................... (42,000) 4.50 -- 13.88 11.91
-------- --------------- ------
Outstanding, December 31, 1997............... 594,000 4.50 -- 14.44 10.41
Granted.................................... 186,000 8.69 -- 13.56 9.89
Exercised.................................. (6,000) 6.50 -- 10.63 9.19
Canceled................................... (91,000) 6.31 -- 14.44 11.33
-------- --------------- ------
Outstanding, December 31, 1998............... 683,000 $4.50 -- $14.44 $10.12
======== =============== ======
</TABLE>

Total options available for future grants at December 31, 1998 and 1997,
were 280,000 and 76,000, respectively. Under separate plans and as part of the
recruitment of the Chief Operating Officer and Vice President of Marketing, the
Company granted 75,000 options and 60,000 options, respectively, at fair market
value during 1998.

In April 1996, the Company granted the former Chief Executive Officer
175,000 stock options pursuant to an amendment to the Incentive Stock Plan in
May 1996 which resulted in a $2,034,000 noncash compensation charge.

As of December 31, 1998, 439,000 options were exercisable under all plans.
The Company has reserved 1,483,000 shares of common stock for options
outstanding and for options which may be granted in the future.

<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
- ------------------------------------------------------------------------- -------------------------------------
WEIGHTED AVERAGE
RANGE OF OUTSTANDING REMAINING WEIGHTED AVERAGE NUMBER EXERCISABLE WEIGHTED AVERAGE
EXERCISE PRICES AT 12/31/98 CONTRACTUAL LIVE EXERCISE PRICE AT 12/31/98 EXERCISE PRICE
- --------------- ----------- ---------------- ---------------- ------------------ ----------------
<S> <C> <C> <C> <C> <C>
$4.50 -- 6.50........ 63,000 5.91 $5.69 63,000 $5.69
8.69 -- 11.19........ 574,000 9.49 9.52 274,000 9.45
13.13 -- 14.44........ 181,000 8.87 13.58 102,000 13.44
- ---------------------- ------- -------
$4.50 -- 14.14........ 818,000 439,000
====================== ======= =======
</TABLE>

Options exercisable at December 31, 1998 had a weighted average exercise of
$9.84.

F-16
<PAGE> 47
AMERICA SERVICE GROUP INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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

<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
--------------
1998 1997
---- ----
<S> <C> <C>
Volatility................................................ 0.6 0.7
Interest rate............................................. 5.0% 5.8%
Expected life (years)..................................... 3 3
Dividend yields........................................... 0.0% 0.0%
</TABLE>

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

For purposes of pro forma disclosures, the estimated fair value of the
options is amortized to expense over the options' vesting period. The Company's
pro forma information for the years ended December 31, 1998, 1997 and 1996 are
as follows:

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------------------------
1998 1997 1996
----------------- ----------------- ------------------
AS PRO AS PRO AS PRO
REPORTED FORMA REPORTED FORMA REPORTED FORMA
-------- ------ -------- ------ -------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C>
Net income (loss).................. $5,724 $5,231 $1,685 $1,029 $(8,686) $(7,190)
Income per common share:
Basic............................ $ 1.61 $ 1.47 $ .50 $ .30 $ (2.81) $ (2.04)
Diluted.......................... $ 1.57 $ 1.44 $ .48 $ .28 $ (2.81) $ (2.04)
</TABLE>

The resulting pro forma disclosures may not be representative of that to be
expected in future years. The weighted average fair value of options granted
during 1998, 1997 and 1996 is $4.26, $5.41 and $4.93, respectively.

14. EMPLOYEE BENEFIT PLAN

The Company has a 401(k) Retirement Savings Plan (the Plan) covering
substantially all employees who have completed one year and 1,000 hours of
service. The Plan permits eligible employees to defer and contribute to the plan
a portion of their compensation. The Company matches such employee contributions
to the Plan ranging from 1% to 3% depending on their years of participation. The
Company recorded an expense of $316,000, $266,000 and $299,000 for the years
ended December 31, 1998, 1997 and 1996, respectively, related to the matching
contributions of the Plan.

The Company instituted an Employee Stock Purchase Plan during 1996. The
Employee Stock Purchase Plan allows an employee who has completed one year of
service with the Company to elect to purchase shares of Common Stock through
voluntary automatic payroll deductions of up to 10% of his or her annual salary.
Purchases of stock under the plan are made at the end of two six month offering
periods each year, one

F-17
<PAGE> 48
AMERICA SERVICE GROUP INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

beginning on January 1 and one beginning on July 1. At the end of each six month
period, the employee's contributions during that six month period are used to
purchase shares of Common Stock from the Company at 85% of the fair market value
of the Common Stock on the first day of that six month period. The employee may
elect to discontinue participation in the plan for future periods at the end of
any six month period.

The Company's announcement of the termination of its proposed merger with
MedPartners in December 1997 resulted in the price of the Common Stock falling
below the amount of the discounted purchase price at which stock would have been
sold to employees participating in the plan for the offering period from July 1,
1997 through December 31, 1998. Consequently the Board of Directors offered
employees then participating in the plan the opportunity to rescind their
scheduled purchase of Common Stock for that offering period and to receive a
refund of their payroll deductions for that offering period. At December 31,
1997, the Company had recorded $136,000, included in accrued expenses, related
to this one-time opportunity for employees to rescind the purchase of common
stock under the plan.

15. PROFESSIONAL AND GENERAL LIABILITY INSURANCE

Subsequent to December 1, 1997, the Company has maintained third party
commercial insurance on a claims-made basis with primary limits of $1,000,000
each occurrence and $3,000,000 in the aggregate. In addition, the Company has
maintained excess liability insurance of $15,000,000 for each claim and
$15,000,000 annual aggregate. For the period prior to December 1, 1997, Harbour
Insurance, Inc., a wholly-owned captive insurance company incorporated under the
laws of the State of Delaware, provided professional and general liability
coverage to PHS with limits of $1,000,000 per claim and various aggregate limits
per policy year. The aggregate limit for policy years ended 1997 and 1996 was
$3,500,000 and $3,250,000, respectively.

Possible claims in excess of the individual and aggregate claims per policy
year up to a maximum of $15,000,000 for 1997 and $5,000,000 for 1996 are covered
by third-party insurance policies on a claims-made basis.

Any liabilities in excess of the third-party insurance limits are assumed
by the Company. The Harbour policy relative to the contract with the Georgia
Department of Corrections, which terminated on June 30, 1997, is an
occurrence-based policy with similar levels of self-insured retention.

The Company records a liability for reported and unreported professional
and general liability claims based upon an actuarial estimate of the cost of
settling losses and loss adjustment expenses discounted at 7% in 1998 and 6% in
1997. Amounts accrued were $2,408,000 and $4,494,000 at December 31, 1998 and
1997, respectively, and are included in accrued expenses and non-current portion
of accrued expenses. Changes in estimates of losses resulting from the
continuous review process and differences between estimates and loss payments
are recognized in the period in which the estimates are changed or payments are
made. Reserves for medical malpractice exposures are subject to fluctuations in
frequency and severity. Given the inherent degree of variability in any such
estimates, the reserves reported at December 31, 1998, represent management's
best estimate of the amounts necessary to discharge the Company's obligations.

In exchange for a one time premium to a third party insurance company, all
of the liabilities and obligations associated with the insurance policies
written by Harbour Insurance, a wholly owned captive insurance company of the
Company, open as of August 31, 1998 and relating to the periods as of December
1, 1997, were transferred to a third party insurance company. Harbour ceased
writing policies as of December 1, 1997. The Company has no continuing liability
for open cases disclosed on the loss run of Harbour as of August 31, 1998. The
Company's dissolution of Harbour resulted in no significant gain or loss to the
Company.

F-18
<PAGE> 49
AMERICA SERVICE GROUP INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

16. COMMITMENTS AND CONTINGENCIES

Operating Leases

The Company leases office space and equipment through October 2003 under
certain noncancelable operating leases.

The Company has a sublease agreement with a third party for its former
corporate office space in New Castle, Delaware. The sublease is for the period
May 1, 1997 through April 30, 2000. The original lease term expires July 31,
2000.

In connection with the MedPartners Settlement Agreement, the Company closed
its regional offices in Atlanta, Georgia, and Newark, Delaware and assigned
future lease payments to MedPartners.

Future minimum annual lease payments at December 31, 1998 are as follows:

<TABLE>
<CAPTION>
YEAR ENDING DECEMBER 31:
- ------------------------
<S> <C>
1999...................................................... $ 725,000
2000...................................................... 605,000
2001...................................................... 349,000
2002...................................................... 290,000
2003...................................................... 254,000
Thereafter................................................ 19,000
----------
2,242,000
Sublease receipts........................................... (499,000)
----------
$1,743,000
==========
</TABLE>

Rental expense under operating leases was $394,000, $516,000, and $564,000
for the years ended December 1998, 1997 and 1996, respectively.

Catastrophic Limits

Many of the Company's contracts require reimbursement to the Company for
all treatment costs or, in some cases, only out-of-pocket treatment costs
related to certain catastrophic events, and/or for AIDS or AIDS-related
illnesses. Certain contracts do not contain such limits. The Company attempts to
compensate for the increased financial risk when pricing contracts that do not
contain individual, catastrophic or AIDS-related limits. However, the occurrence
of severe individual cases, AIDS-related 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. The Company maintains insurance from an unaffiliated insurer for
contracts, which do not contain catastrophic protection for hospitalization
amounts in excess of $125,000 per inmate through September 1998 and $200,000 per
inmate thereafter. The Company believes this insurance significantly mitigates
its exposure to unanticipated expenses of catastrophic hospitalization.

Catastrophic insurance premiums and recoveries, neither of which are
significant, are included in healthcare expenses. Receivables for insurance
recoveries, which are not significant, are included in accounts receivable.

Litigation and Claims

The Company is a party to various legal proceedings incidental to its
business. Certain claims, suits and complaints arising in the ordinary course of
business have been filed or are pending against the Company. An estimate of the
amounts payable on existing claims for which the liability of the Company is
probable is

F-19
<PAGE> 50
AMERICA SERVICE GROUP INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

included in accrued expenses at December 31, 1998 and 1997. The Company is not
aware of any material unasserted claims and, based on its past experience, would
not anticipate that potential future claims would have a material adverse effect
on its consolidated financial position or results of operations.

17. MAJOR CUSTOMERS AND GEOGRAPHICAL CONCENTRATIONS

The Company generally views its operating segments on a managed healthcare
contract basis. The Company considers its managed healthcare services contract
business to be one reportable segment under Financial Accounting Standards Board
Statement No. 131, Disclosures about Segments of an Enterprise and Related
Information, as the economic characteristics, the nature of the services, and
type and class of customers for the services and the methods used to provide the
services are similar. Consequently, other than the following enterprise-wide
disclosures relating to major customers and geographic concentrations,
reportable segment information is not applicable. The following is a summary of
revenues from major customers:

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------------------------------
1998 1997 1996
----------------- ----------------- -----------------
REVENUE PERCENT REVENUE PERCENT REVENUE PERCENT
------- ------- ------- ------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
State of Indiana......... $23,968 21.2% $ 7,688 5.9% $ -- --%
State of Kansas.......... 19,223 17.0 18,095 14.0 17,096 11.2
City of Philadelphia..... 17,966 15.9 17,865 13.8 16,034 10.5
County of Alameda........ 12,122 10.7 11,601 9.0 11,619 7.6
State of Georgia......... 291 .02 30,854 23.9 56,662 37.2
State of Maryland........ -- -- 6,022 4.6 15,479 10.2
</TABLE>

Estimated credit losses associated with the receivables are provided for in
the consolidated financial statements. The contract with the State of Georgia
expired June 30, 1997.

18. FOURTH QUARTER ADJUSTMENTS

The Company made a year end adjustment in 1997 resulting from a change in
estimate relating to medical malpractice reserves. The adjustment, which was
based on facts and circumstances obtained or occurring during the fourth quarter
of 1997, resulted from improvements in the Company's utilization management
processes, reducing the Company's claims exposure, favorable 1997 claim payment
experience, and a significant reduction in the total inmate population primarily
as a result of the termination of the Georgia Department of Corrections contract
at June 30, 1997. The adjustment of $1,400,000 increased basic and diluted
earnings per share by $.40 and $.39, respectively.

The Company made a year end adjustment in 1998 resulting from a change in
estimate relating to the valuation allowance for deferred tax assets. The
adjustment of $763,000 increased basic and diluted earnings per share by $.21.

19. AMENDMENT TO PREVIOUSLY FILED FINANCIAL STATEMENTS

The Company has made revisions to its previously filed financial statements
to modify display of the MedPartners settlement gain and make other display and
disclosure enhancements and accordingly, has filed an amended Form 10-K/A.

F-20
<PAGE> 51

SCHEDULE II

AMERICA SERVICE GROUP INC.

VALUATION AND QUALIFYING ACCOUNTS AND RESERVES

<TABLE>
<CAPTION>
ADDITIONS
BALANCE AT CHARGED TO BALANCE AT
BEGINNING OF COSTS AND END OF
PERIOD EXPENSES DEDUCTIONS PERIOD
------------ ---------- ---------- ----------
<S> <C> <C> <C> <C>
DECEMBER 31, 1998
Allowance for doubtful accounts................. $ 384,000 $ -- $ 364,000 $ 20,000
Valuation allowance for deferred tax asset...... 2,665,000 -- 2,665,000 --
========== ========== ========== ==========
$3,049,000 $ -- $3,029,000 $ 20,000
========== ========== ========== ==========
DECEMBER 31, 1997
Allowance for doubtful accounts................. $2,016,000 $ 841,000 $2,473,000 $ 384,000
Valuation allowance for deferred tax asset...... 3,009,000 -- 344,000 2,665,000
========== ========== ========== ==========
$5,025,000 $ 841,000 $2,817,000 $3,049,000
========== ========== ========== ==========
DECEMBER 31, 1996
Allowance for doubtful accounts................. $ 840,000 $1,822,000 $ 646,000 $2,016,000
Valuation allowance for deferred tax asset...... -- 3,009,000 -- 3,009,000
========== ========== ========== ==========
$ 840,000 $4,831,000 $ 646,000 $5,025,000
========== ========== ========== ==========
</TABLE>

F-21

<PAGE> 1
EXHIBIT 2.4

EXECUTION COPY

AMENDMENT
TO
SECURITIES PURCHASE AGREEMENT

THIS AMENDMENT, dated June 17, 1999 (this "Amendment") to that certain
Securities Purchase Agreement, dated January 26, 1999 (the "Agreement"), by and
among America Service Group Inc. ("ASG"), Health Care Capital Partners L.P.
("HCCP") and Health Care Executive Partners, L.P. ("HCEP," and together with
HCCP, the "Purchasers"), is entered into by and among ASG and the Purchasers.
The capitalized terms used herein and not otherwise defined shall have the
meanings assigned to them in the Agreement.

WITNESSETH:

WHEREAS, ASG intends to redeem $7.5 million of the Notes on or before
July 9, 1999, pursuant to Section 9.1 of the Agreement;

WHEREAS, the Purchasers agree to waive ASG's obligation to provide
notice of such redemption in accordance with Section 9.3(a) of the Agreement;
and

WHEREAS, ASG and the Purchasers desire to amend the Agreement as set
forth below;

NOW, THEREFORE, in consideration of good and valuable consideration,
the receipt and sufficiency of which are acknowledged hereby, ASG and the
Purchasers hereby agree as follows:

1. Redemption of Notes. ASG hereby agrees to redeem $7.5 million
aggregate principal amount of the Notes on July 2, 1999 by paying $7,660,000,
which the parties agree is the "Redemption Price" specified in Section 9.1 of
the Agreement, to the Purchasers prior to 2:00 p.m. on such date. The Redemption
Price shall be paid by wire transfer of immediately available funds to the
Purchasers as follows: (i) $7,355,643 shall be paid to HCCP by wire transfer to
Account No. 00-353-017 at Bankers Trust Company (ABA No. 021001033) and (ii)
$304,357 shall be paid to HCEP by wire transfer to Account No.
00-358-096 at Bankers Trust Company (ABA No.021001033).

Simultaneously with the payment of the Redemption Price, ASG and the
Purchasers shall execute and deliver amended and restated Warrant Certificates
reflecting the amendments set forth in Exhibit "A" to this Amendment.

<PAGE> 2

Purchasers hereby waive the receipt of notice of redemption of the
Notes pursuant to Section 9.3(a) of the Agreement.

ASG hereby agrees that it will not take action to redeem any Notes and
that no other Notes shall be redeemable at the option of the Company, other than
the principal amount of the Notes to be redeemed pursuant to this Amendment,
except in the event that (a) the Company shall have duly convened the
Stockholders Meeting and (b) the Company shall then be entitled to defer the
payment of penalty interest pursuant to the proviso of Section 8.3(b) of the
Agreement.

2. Amendments to the Agreement. The Agreement is hereby amended as
follows:

(a) Section 6.12 - Board Membership. Section 6.12 shall be amended
and restated to read as follows:

For as long as the Purchasers and their Affiliates and Affiliates
of the general partner of the Purchasers own the percentage of the
aggregate Face Value of Preferred Stock issued hereunder or Common
Stock issuable upon conversion of such Preferred Stock specified in
the table below, the Company shall fix and maintain the number of
directors as specified in such table and shall take all necessary
action to cause the appointment of the number of nominees of the
Purchasers specified in such table as members of the Board. If the
Purchasers own 25% or less of the aggregate Face Value of Preferred
Stock issued hereunder or Common Stock issuable upon conversion of
such Preferred Stock, the Purchasers shall not be entitled to any
representation on the Board. The percentage of the aggregate Face
Value of Preferred Stock issued hereunder or Common Stock issuable
upon conversion of such Preferred Stock shall be computed based on
200,000 shares of Preferred Stock, which represents the 150,000 shares
of Preferred Stock issuable upon conversion of the Notes and the
50,000 shares of Preferred Stock issued hereunder. The Purchasers
agree that their nominees shall be persons reasonably acceptable to
the Company.

<TABLE>
<CAPTION>
- ----------------------------------------------------------------------------------
Percentage Size of Number of Purchasers'
of Stock Board Directors
- ----------------------------------------------------------------------------------
<S> <C> <C>
>62.5% 9 3
-
- ----------------------------------------------------------------------------------
<62.5%, but 8 2
>33-1/3%
- ----------------------------------------------------------------------------------
<33-1/3%, but 7 1
-
>25%
- ----------------------------------------------------------------------------------
</TABLE>

<PAGE> 3

So long as the Purchasers are entitled to designate directors pursuant
to this Section 6.12, the Company shall cause the Board to appoint at least
one Director designated by the Purchasers to the executive, audit and
compensation committees of the Board and each other committee established
by the Board. At each subsequent annual meeting for the election of
directors, the Purchasers will be entitled to propose (and the Company will
nominate and recommend) such persons nominated by the Purchasers as members
of the Board. In the event of any vacancy arising by reason of the
resignation, death, removal or inability to serve as the Purchasers'
nominee, the Purchasers shall be entitled to designate a successor to fill
each vacancy until the next annual meeting for the election of directors.
The Company agrees that if such nominee or nominees is not elected, (i) the
Purchasers will be entitled to have observational rights at all meetings of
the Board of Directors and the Purchasers shall have the same access to
information concerning the business and operations of the Company and its
Subsidiaries at the same time as the directors of the Company and shall be
entitled to participate in discussions and consult with the Board, without
voting, and (ii) the Company will nominate and recommend such person or
persons proposed by the Purchasers at each subsequent annual meeting until
the nominee or nominees of the Purchasers has been elected to the Board.

(b) Section 6A. The phrase "one-third (unless a greater percentage is
required below) of shares of Preferred Stock issued or issuable hereunder" in
Section 6A shall be amended by inserting at the end of such phrase "based on
200,000 shares of Preferred Stock, which represents the 150,000 shares of
Preferred Stock issuable upon conversion of the Notes and the 50,000 shares of
Preferred Stock issued hereunder."

(c) Section 6C. The phrase "at least 25% of the aggregate Face Value
of Preferred Stock issued pursuant to this Agreement" in Section 6C shall be
amended by inserting at the end of such phrase "based on 200,000 shares of
Preferred Stock, which represents the 150,000 shares of Preferred Stock issuable
upon conversion of the Notes and the 50,000 shares of Preferred Stock issued
hereunder."

(d) Section 6.3. The phrase "So long as the Purchasers hold Issuable
Preferred Stock" in the first sentence of Section 6.3 shall be deleted and the
phrase "So long as the Purchasers hold any shares of Preferred Stock issued
hereunder or any shares of Common Stock issued upon conversion of the Preferred
Stock issued hereunder" shall be inserted in lieu thereof.

(e) Section 6.19. The reference to "no later than six months from the
Closing Date" at the end of Section 6.19 shall be deleted and "no later than
August 31, 1999" shall be inserted in lieu thereof.

(f) Section 8.3. The reference to "July 26, 1999" in clauses (b)(ii)
and (b)(iii) of Section 8.3 shall be deleted and "August 31, 1999" shall be
inserted in lieu thereof.

<PAGE> 4

3. Entire Agreement. The Agreement, as amended by this Amendment, sets
forth the entire understanding of the parties with respect to the transaction
contemplated hereby.

4. Effect of Amendment. On or after the date hereof, each reference in the
Agreement to "this Agreement," "hereunder," "hereof," "herein," or words of like
import, and each reference in any other documents entered into in connection
with the Agreement, shall mean and be a reference to the Agreement, as amended
hereby.

5. Ratification of Agreement. Except as specifically amended above, the
Agreement shall remain in full force and effect and is hereby ratified and
confirmed.

6. Governing Law. This Amendment shall be governed by and construed and
enforced in accordance with the laws of the State of New York.

7. Counterparts. This Agreement may be executed in two or more
counterparts, each of which shall be deemed an original, but all of which
together shall constitute one and the same instrument.

[Signatures Appear on Following Page]

<PAGE> 5

IN WITNESS WHEREOF, ASG and the Purchasers have caused this Amendment
to be executed and delivered by their respective officers thereunto duly
authorized.

AMERICA SERVICE GROUP INC.

By: _________________________________
Bruce A. Teal
Senior Vice President and
Chief Financial Officer

HEALTH CARE CAPITAL PARTNERS L.P.

By: FERRER FREEMAN THOMPSON
& CO., its General Partner

By: __________________________
David A. Freeman
Member

HEALTH CARE EXECUTIVE PARTNERS L.P.

By: FERRER FREEMAN THOMPSON
& CO., its General Partner

By: __________________________
David A. Freeman
Member

<PAGE> 1
EXHIBIT 23.1
CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS

We consent to the incorporation by reference in the America Service Group Inc.
Registration Statements on Form S-8 (Registrations Nos. 33-48231, 333-03010,
333-04903, 333-04895, 333-26903, 333-26905, 333-50161, 333-50171, 333-58093),
of our report dated February 12, 1999, except for Note 3 and Note 19, as to
which the date is July 22, 1999, with respect to the consolidated financial
statements and schedule of America Service Group Inc. included in the Annual
Report (Form 10-K/A) for the year ended December 31, 1998.

/s/ Ernst & Young LLP

Nashville, Tennessee
July 23, 1999

<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
FINANCIAL STATEMENTS OF AMERICAN SERVICE CORP. FOR THE YEAR ENDED DECEMBER 31,
1998 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>

<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 7,211,000
<SECURITIES> 0
<RECEIVABLES> 13,780,000
<ALLOWANCES> (20,000)
<INVENTORY> 329,000
<CURRENT-ASSETS> 24,799,000
<PP&E> 3,745,000
<DEPRECIATION> (1,859,000)
<TOTAL-ASSETS> 28,375,000
<CURRENT-LIABILITIES> 14,284,000
<BONDS> 0
1,842,000
0
<COMMON> 36,000
<OTHER-SE> 10,913,000
<TOTAL-LIABILITY-AND-EQUITY> 28,375,000
<SALES> 113,287,000
<TOTAL-REVENUES> 113,887,000
<CGS> 102,119,000
<TOTAL-COSTS> 112,835,000
<OTHER-EXPENSES> (4,047,000)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 0
<INCOME-PRETAX> 5,099,000
<INCOME-TAX> (625,000)
<INCOME-CONTINUING> 5,724,000
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 5,724,000
<EPS-BASIC> 1.61
<EPS-DILUTED> 1.57

</TABLE>