**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**Washington, D.C. 20549**

 

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**AMENDMENT NO. 1onFORM 10-K/A**

 
| **(Mark One)**                                                                                                                                                                               | ** **                                                                                    |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|-----------------------------------------------------------------------------------------------|
| ý                                                                                                                                                                                       | **ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934**     |
| ** **                                                                                                                                                                                   |
| **For the fiscal year ended  December 31, 2004**                                                                                                                                        |
| ** **                                                                                                                                                                                   |
| o                                                                                                                                                                                            | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF  THE SECURITIES EXCHANGE ACT OF 1934** |
| ** **                                                                                                                                                                                   |
| **For the transition period  from              to            ** |

 

**Commission File Number 0-51148**

 

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**Tri-S Security Corporation**

*(Exact Name of Registrant asSpecified in Its Charter)*

* *

| **Georgia**                        |       | **30-0016962**        |
|------------------------------------|------------|-----------------------|
| *(State or Other Jurisdiction  of* |       | *(I.R.S. Employer*    |
| *Incorporation or Organization)*   | ** ** | *Identification No.)* |

 

**Royal Centre One11675 Great Oak Way**

**Suite 120**

**Alpharetta, GA 30022**

*(Address of Principal ExecutiveOffices)*

** **

**(678) 808-1540**

*(Registrant’s Telephone Number,Including Area Code)*

 

**Securities registered pursuant toSection 12(b) of the Act: None**

 

**Securities registered pursuant toSection 12(g) of the Act: units (each unit consisting of one share ofcommon stock, par value $0.001 per share, and a warrant to purchase one shareof common stock); common stock, par value $0.001 per share; and warrants topurchase common stock, par value $0.001 per share**

 

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

 

                Indicateby check mark if disclosure of delinquent filers pursuant to Item 405 ofRegulation S-K is not contained herein, and will not be contained, to thebest of registrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-K or anyamendment to this Form 10-K. ý

 

                Indicateby check mark whether the registrant is an accelerated filer (as defined inExchange Act Rule 12b-2). Yes o  No ý

 

                Indicate by check mark whetherthe registrant is a shell company (as defined in Rule 12b-2 of theExchange Act). o Yes  ý No

 

                Asof June 30, 2004, there was no public market for the registrant’s commonequity.

 

                Asof March 25, 2005, 3,285,000 shares of common stock were outstanding.

 

**DOCUMENTS INCORPORATED BYREFERENCE: None.**

 

 

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**EXPLANATORYNOTE**

 

This Amendment No. 1 onForm 10-K/A (the “Amendment”) amends the Annual Report on Form 10-K for theyear ended December 31, 2004 (the “Original Report”) of Tri-S Security Corporation(the “Company”). As reported in the Current Report on Form 8-K filed by theCompany on November 2, 2005, the Audit Committee of the Company’s Board ofDirectors determined that the Company’s consolidated financial statementsincluded in the Original Report and the Company’s Quarterly Reports on Form10-Q for the quarters ended March 31, 2005 and June 30, 2005 should be restatedto account for the Company’s 10% equity interest in Army Fleet Support, LLC, ajoint venture which provides logistics support for U.S. Army aviation trainingat Fort Rucker, Alabama, using the equity method, rather than the cost method,of accounting as required by Account Principles Board Opinion No. 18, “*The Equity Method of Accounting for Investments inCommon Stock*” and Statement of Financial Accounting Standards No.94, “*Consolidation of All Majority-OwnedSubsidiaries*”.

 

The restated consolidatedfinancial statements for the year ended December 31, 2004 included in theAmendment (the “Restatement”) report a net loss of $627,000 as opposed to a netloss of $1,640,000 as reported in the Original Report. See Note 2 of the Notesto Financial Statements included in the Amendment. The Amendment amends andrestates Items 1, 6, 7, 8, 9A and 15 of the Original Report to the extent necessaryto reflect the effects of the Restatement. Except for such amendments, theAmendment continues to describe conditions as of the date of the OriginalReport, and the Company has not modified or updated other disclosures presentedin the Original Report affected by subsequent events. Accordingly, theAmendment should be read in conjunction with the Original Report and theCompany’s filings made with the Securities and Exchange Commission subsequentto the filing of the Original Report.

 

**PART I**

 

**Note Regarding Forward-LookingStatements**

 

**                Tri-SSecurity Corporation, a Georgia corporation (the “Company”, “Tri-S” or “we”),has made forward-looking statements in this Annual Report onForm 10-K/A for the year ended December 31, 2004 (the “Annual Report”),including, without limitation, in the sections herein titled “Management’sDiscussion and Analysis of Financial Condition and Results of Operations” and “Business,”that are based on our management’s beliefs and assumptions and on informationcurrently available to our management. Forward-looking statements includeinformation concerning our possible or assumed future results of operations,business strategies, financing plans, competitive position, potential growthopportunities, the effects of future regulation and the effects of competition.Forward-looking statements include all statements that are not historicalfacts. Words such as “believes,” “expects,” “anticipates,” “intends,” “seeks,” “could,”“will,” “predicts,” “potential,” “continue,” “may,” “plans,” “estimates” andsimilar expressions, or the negative of these and similar expressions, areintended to identify such forward-looking statements.**

 

**                Examplesof forward-looking statements in this Annual Report include statementsregarding: the impact of terrorist activity or breach of security on ourbusiness; our ability to retain and manage our guards; our plans for expansionand growth of our business; our ability to compete effectively in our industry;our expectations regarding the likelihood of introduction of new regulationsthat would adversely affect our business; our estimates of our capitalrequirements and needs for additional financing; risks related to Federalgovernment contracts; Federal government audits and cost adjustments;differences between authorized amounts and amounts received by us under Federalgovernment contracts; changes in Federal government (or other applicable)procurement laws, regulations, policies and budgets; our ability to retaincontracts during re-bidding processes; and the other factors that we describein this Annual Report under the section herein titled “Management’s Discussionand Analysis of Financial Condition and Results of Operations—Risk Factors.”Forward-looking statements involve risks, uncertainties and assumptions.Actual results may differ materially from those expressed in these forward-lookingstatements. You should not put undue reliance on any forward-lookingstatement. You should understand that many important factors, in addition tothose discussed in the sections herein titled “Management’s Discussion andAnalysis of Financial Condition and Results of Operations” and “Business” andelsewhere in this Annual Report, could cause our results to differ materiallyfrom those expressed in forward-looking statements.**

 

**                Allforward-looking statements attributable to us or persons acting on ourbehalf are expressly qualified in their entirety by the cautionary statementsset forth in this Annual Report. Forward-looking statements speak only asof the date they are made, and we undertake no obligation to update publiclyany of these statements in light of new information or future events.**

 

**Item 1. Business**

 

**Introduction and History**

 

                Throughour wholly-owned subsidiary, Paragon Systems, Inc., an Alabamacorporation (“Paragon Systems”), we provide contract guard services to variousFederal government agencies. We strive to provide cost-effective solutions toensure the safety and security of the assets and personnel of our customers andto continually improve the protection we provide for their personnel, programs,resources and facilities. Our goal is to provide demonstrably superior contractguard services with the highest degree of integrity and responsiveness.

 

                Wewere incorporated in Georgia in October 2001 under the name “DiversifiedSecurity Corporation.” We changed our name to “Tri-S Security Corporation” onAugust 16, 2004. Our principal executive offices are located at 3700Mansell Road, Suite 220, Alpharetta, Georgia 30022, and our telephone number atthat address is (770) 625-4945.

 

 

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                Wewere formed for the purpose of acquiring and consolidating electronic andphysical security companies in order to take advantage of the operatingefficiencies created by a larger company. We intend to pursue acquisitionopportunities in the contract guard services and system integration servicessegments of the security industry. We made our first acquisition (the “Acquisition”)on February 27, 2004 when we acquired Paragon Systems, a contract guardservices and logistics provider. At the closing of the Acquisition, we:(i) paid $10 million, of which $2.3 million was paid in cash and$7.7 million was paid through issuance of promissory notes (referred toherein as the “Paragon Notes”) to the former shareholders of Paragon Systems;and (ii) agreed to issue to the former shareholders an aggregate of 100shares of our Series C Redeemable Preferred Stock, par value $1.00 pershare (the “Series C Redeemable Preferred Stock”), with an aggregateredemption value of $6.0 million.

 

                OnFebruary 8, 2005, pursuant to an Exchange and Recapitalization Agreementbetween the Company and all the holders of our common stock, par value $0.001per share, Series A Convertible Preferred Stock, par value $1.00 per share(the “Series A Convertible Preferred Stock”), and Series BConvertible Preferred Stock, par value $1.00 per share (the “Series BConvertible Preferred Stock”), and all holders of rights to acquire our commonstock (the “Exchange and Recapitalization Agreement”), we effected an exchangeand recapitalization of our outstanding common stock, Series A ConvertiblePreferred Stock and Series B Convertible Preferred Stock and rights toacquire our common stock. Pursuant to the Exchange and RecapitalizationAgreement, all of our outstanding (i0 common stock, Series A ConvertiblePreferred Stock and Series B Convertible Preferred Stock was exchanged foran aggregate of 1,200,000 shares of common stock and (ii) rights toacquire our common stock were exchanged for rights to purchase an aggregate of113,269 shares of common stock. The transactions effected by the Exchange andRecapitalization agreement are referred to in this Annual Report as the “Exchangeand Recapitalization.”

 

                OnFebruary 9, 2005, we commenced an underwritten initial public offering of1,800,000 units (plus up to an additional 270,000 units subject to the exerciseof the underwriters’ over-allotment option), with each unit consisting of oneshare of our common stock and a warrant to purchase one share of our commonstock, at an initial offering price per unit of $6.00 (the “Initial PublicOffering”). In connection with the Initial Public Offering, our units commencedtrading on The Nasdaq SmallCap Stock Market under the symbol “TRISU” onFebruary 9, 2005. The Initial Public Offering closed with respect to theinitial 1,800,000 units on February 14, 2005 and with respect to theadditional 270,000 units on March 17, 2005. We filed a RegistrationStatement on Form S-1 (No. 333-119737) with the Securities andExchange Commission (the “SEC”) registering pursuant to the Securities Act of1933, as amended (the “Securities Act”), the securities to be sold in theInitial Public Offering (the “Registration Statement”). The SEC declared theRegistration Statement effective on February 8, 2005.

 

**Overview of Our Operations**

 

                Priorto the Acquisition, we had no operations. Currently, our operations consistonly of the operations of Paragon Systems. Paragon Systems was incorporated in1987 in Alabama and has provided contract guard services to Federal governmentagencies since 1994. Initially, Paragon Systems was established as anengineering company to service contracts with the Federal government agenciesand with the U.S. Army Missile Command in both space and defense related areasof business. Paragon Systems has participated in high level engineeringprojects for the U.S. Army, the National Aeronautics and Space Administration (“NASA”),other government agencies and local industry.

 

                Whileserving as an engineering company, Paragon Systems contracted with LockheedMartin to furnish assistance in Federal contract administration for LockheedMartin on a sub-contract for construction at the NASA missile plant located inIuka, Mississippi. Paragon Systems also provided engineering and technicalsupport for contract cost management to NASA’s Orbital Maneuvering Vehicleprogram, which developed an orbital vehicle that would be carried aloft by thespace shuttle and maintained in orbit to perform specific tasks for theInternational Space Station. Paragon Systems

 

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also performed a number of high level engineeringprojects for Control Dynamics Corporation, including conducting preliminarydesign tasks for development of a heavy launch lift vehicle, which was at thattime planned to be a robotic successor for the space shuttle.

 

                In1994, Paragon Systems applied its engineering expertise and management skillsto the security industry. Paragon Systems was awarded its first contract in1994 to provide security services for the U.S. Army Corps of Engineers. Sincesuch time, Paragon Systems has obtained contracts with various other Federalgovernment agencies and has provided high-level, expert security services.Paragon Systems has, through the utilization of its systems engineering skills,developed contract guard security services as its core business. ParagonSystems no longer provides engineering services.

 

                In1991, Paragon Systems applied to be certified as a small and disadvantagedbusiness (an “8(a) firm”) by the U.S. Small Business Administration (the “SBA”).In 1993, Paragon Systems was certified as an 8(a) firm and, in 1994, wasawarded its first guard contract to provide security guard services for theU.S. Army Corps of Engineers. Since such time, Paragon Systems has obtainedcontracts with various other Federal government agencies and has developedcontract guard security services as its core business. Paragon Systems’certification as an 8(a) firm expired in September 2002, and its revenuesfrom its security guard service business have grown to a level which makes itineligible to qualify once again for certification as an 8(a) firm. ParagonSystems is now expanding its security guard service business by bidding onlarger contracts than it was first awarded when certified as an 8(a) firm.

 

                ThroughParagon Systems, we employ over 700 persons in the course of providing contractguard services and maintain field offices located in Birmingham, Alabama,Mobile, Alabama, Montgomery, Alabama; Louisville, Kentucky; Baltimore,Maryland; Glynco, Georgia; Stennis Space Center, in Vicksburg, Mississippi; andGulfport, Mississippi. At our offices in Huntsville, Alabama we maintain a fullsupport staff to support all field operations, including human resources,accounting, payroll, quality control, logistics, computer services, training,and other supporting functions as needed.

 

                Inaddition to our core business of providing contract guard services, we have twonon-core business interests relating to logistics services. First, in 2000,Paragon Systems entered into a contract to provide logistics services bydeveloping and executing plans for improved logistics systems in support ofU.S. Army facilities located at Fort Bliss, Texas and Fort Sill, Oklahoma. Thiscontract will expire in September 2005, and we have not determined whetherwe will pursue any additional logistics contracts. Second, through ParagonSystems, we own a 10% equity interest in Army Fleet Support, LLC (“Army FleetSupport” or the “joint venture”), which provides logistics support for U.S.Army aviation training at Fort Rucker, Alabama.

 

                Wecurrently have a total of ten customers and thirteen Federal governmentcontracts. We provide contract guard services for eight of our customers and logisticsservices for the other two customers. Three of our contract guard customershave two contracts with us. The following table sets forth the number of ourFederal government contracts during the time periods and in the revenue rangesindicated:

 

| **Annual Revenues**                    | ** ** | **Year Ended  December 31,  2004** | ** ** | **Year Ended  December 31,  2003** | ** ** | **Year Ended  December 31,  2002** | ** ** |
|----------------------------------------|------------|------------------------------------|------------|------------------------------------|------------|------------------------------------|------------|
| Less than $1.0 Million per Contract    |       | 5                                  |       | 5                                  |       | 7                                  |       |
| $1.0 to $2.0 Million per Contract      |       | 3                                  |       | 6                                  |       | 4                                  |       |
| $2.0 to $3.0 Million per Contract      |       | 0                                  |       | 0                                  |       | 1                                  |       |
| Greater than $3.0 Million per Contract |       | 5                                  |       | 4                                  |       | 1                                  |       |

 

 

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**The Security Industry**

 

                Thesecurity industry encompasses a variety of high-tech and low-tech products andservices. The service segment of the security industry includes contract guardservices, armored car services, executive protection, fire suppression, alarmmonitoring, closed circuit television (“CCTV”), access control, biometric, homeautomation and system integration services.

 

                Theglobal security industry has grown largely due to an increasing fear of crimeand terrorism. In the United States, the demand for security related productsand central station monitoring services also has grown steadily. We believethat there is continued heightened attention to and demand for security due tothe events of September 11, 2001 and the ensuing threat, or perceivedthreat, of criminal and terrorist activities.

 

                Despitethe size and prospects for growth of the services segment of the securityindustry, the services segment, including the contract guard services andsystem integration services, remains highly fragmented. This high degree offragmentation in the security industry makes it a prime candidate for futureconsolidation.

 

*Contract Guard Service*

 

                The contractguard services segment of the security industry includes security and patrolservices, as well as various types of investigation services, includingbackground, undercover, insurance claims and financial fraud.

 

                Contractguard services are provided under contracts in which the guard company agreesto recruit, hire, train, supervise, schedule and pay security guards deployedto certain specified sites, as well as to provide firearms, uniforms andequipment. Typical functions for security guards include patrolling thepremises, checking identification for access control, staffing a securitycontrol center, monitoring activities on CCTV and responding to emergencyrequests for assistance.

 

                Contractguard services are customarily charged to the customer at an hourly or monthlyrate (which can be fixed or variable). A contract guard company’s profit isbased on the “spread” of the hourly or monthly rate over the cost of the guard.

 

                Demandfor guard services is dependent upon a number of factors, including demographictrends, general economic variables such as growth in the gross domesticproduct, unemployment rates, consumer spending levels, perceived and actualcrime rates, government legislation and technology.

 

                Althoughwe currently provide contract guard services only to Federal governmentagencies, the contract guard services segment of the security industry alsoincludes state government and private sectors, with customer sites includingresidential and office buildings, wholesale and retail businesses, warehouses,industrial facilities, hospitals and all state-run properties and facilities.The Federal government, state government and private sectors present diverseoperating environments and unique challenges for contract guard serviceproviders operating in such sectors. We intend to expand our operations in theFederal government sector and introduce operations in the state government andprivate sectors.

 

                TheFederal government awards substantially all contracts for contract guardservices through a competitive bidding process; however, certain agenciespermit negotiated contracting through the U.S. General Services Administration(“the “GSA”). Contracts awarded through a competitive bidding process generallyhave lower profit margins than negotiated contracts because in a competitivebidding process bidders compete predominantly on price. The Federal governmentis the largest procurer of products and services in the world, and the Federalcontract market provides significant business opportunities for contract guardservice providers approved to contract for the Federal government. Contractingwith the Federal government, however, poses certain risks including that theFederal

 

 

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government may terminate the contract at its discretion,that funds to pay awarded contracts may not be appropriated by Congress, andthat service providers to the Federal government may not be able to comply withcomplex procurement laws.

 

                Theprivate sector enterprises, however, generally do not obtain contract guardservices through a competitive bid process, but privately negotiate contractsfor such services, resulting in contracts with higher profit margins becauseprice is not always the primary basis for competition for such contracts. Theprivate sector provides an opportunity for contract guard service providers togrow through acquisitions.

 

*Security System Integration*

 

                Theterm “integrated systems” refers to security systems which combine the featuresof security products like CCTV and intrusion control. The critical concept insystem integration is that the components of the system communicate with oneanother in order to improve system performance. This communication among systemcomponents is accomplished through the use of specialized software. The mosthighly complex integrated systems utilize a common database, which is oftenmanaged and maintained by the systems integrator. Because of their complexityand reliance on software, integrated systems require a higher degree ofproficiency than ordinary add-on type systems like CCTV or access control.

 

                Wecurrently do not operate in the system integration segment of the securityindustry; however, we intend to expand our business by selectively pursuingacquisition opportunities in this segment. We intend to target for acquisitionexisting organizations with established reputations for quality customerservice. We will seek to identify and acquire organizations offeringcustomized, integrated systems in the high-end commercial and high-endresidential electronic security markets.

 

                Webelieve that offering system integration services will complement, and createsynergies with, the contract guard services we currently offer. In the courseof providing contract guard services under our current Federal governmentcontracts, for example, our security guards monitor and operate integratedsystems sold and installed by providers of integrated systems. If we are ableto sell integrated systems to our clients and install such systems for ourclients, in addition to monitoring and operating such systems, then we will beable to offer products and services which complement our contract guardservices. We also believe that offering system integration products andservices will increase our profitability because contracts for systemintegration products and services generally have higher profit margins thancontracts for guard services and the system integration segment is anticipatedto grow more rapidly than the contract guard segment.

 

**Our Strategy**

 

*Operations*

 

                Ourobjective is to increase our revenues, profitability and market position andthat of the businesses we may acquire in the future, while maintaining thehighest level of service to our customers. The key elements of our operationsstrategy include the following:

 

•                  managingpersonnel costs by minimizing turnover through effective recruitment, trainingand supervision of guards;

 

•                  retainingexisting customers and engaging new customers by servicing clients with the highestdegree of integrity and responsiveness;

 

•                  developingcost-effective solutions for the security needs of our customers; and

 

•                  capitalize onthe growing trend among businesses and Federal government agencies to outsourcenon-core functions such as security officer services.

 

 

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*Federal Government Contracts*

 

                Themajority of our current contracts for contract guard services were awarded bythe Federal government through a competitive bid process. We intend to grow ourbusiness by obtaining new Federal government contracts through the competitivebidding process and providing additional services under our current Federalgovernment contracts and by negotiated contracts. In March 2005, weengaged Proposal Solutions, Inc., a consulting firm located in theWashington, D.C. area, to assist us in preparing contract bids for contractguard services. We believe this consulting firm will provide valuableassistance to us in preparing our bids.

 

                Weintend to hire a full-time employee to provide business development andmarketing services for the Company. This person’s job responsibilities willfocus on identifying new contract opportunities with Federal governmentagencies and preparing and submitting bids for such contracts.

 

                Weintend to bid on Federal government contracts for contract guard servicesvalued between an aggregate of $500,000 and $50 million over a five-yearperiod. Our ability to bid on larger contracts is constrained because we do notcurrently have sufficient capital to cover the substantial start-up costs wewould incur if awarded a significant number of contracts with higher values.

 

*Acquisitions*

 

                Weintend to develop and expand our business by selectively pursuing acquisitionopportunities in the contract guard services and system integration servicessegments of the security industry. We intend to target for acquisition existingcompanies with established reputations for quality customer service.

 

                Inthe system integration market, we seek to identify and acquire organizationsoffering customized, integrated systems in the high-end commercial and high-endresidential electronic security markets.

 

                Inthe contract guard services market, we seek to acquire organizations whichprovide contract guard services to Federal government agencies and to theprivate sector. We are specifically looking to acquire larger organizationswhich provide contract guard services to Federal government agencies pursuantto negotiated contracts or which otherwise have contracts with higher profitmargins. We are also looking to acquire organizations which provide contractguard services to the private sector, including residential and commercialfacilities, and which have contracts with higher profit margins than our currentFederal government contracts. Although we intend our initial acquisitionactivities to be concentrated in the Southeast, Midwest and Atlantic coastalportions of the United States, we have not placed any geographic restrictionson our future acquisition strategy. We believe we will have significantly moreacquisition possibilities in the private sector than in the Federal governmentsector.

 

                Wefrequently evaluate acquisition opportunities and, at any given time, may be invarious stages of due diligence or preliminary discussions with respect to anumber of potential acquisitions. From time to time, we may enter intonon-binding letters of intent, but we are not currently subject to anydefinitive agreement with respect to any acquisition material to our operationsor otherwise so far advanced in any discussions as to make an acquisitionmaterial to our operations reasonably certain.

 

                Becausethe security industry is still very highly fragmented, we believe there will beno lack of opportunities for acquiring the type of companies that are the focusof our planned acquisition efforts. Both industry segments are marked byconcentration by several of the well known larger providers of securityservices, such as Tyco International Ltd. on the electronic side of thebusiness and Allied Security, Inc., Securitas Security Services USA andRentokil Initial plc on the physical security side. While there isconcentration among the larger providers, we believe there remains a host ofquality, sizable regional and local providers that are available foracquisition.

 

 

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**Our Contract Guard Services Operations**

 

                ThroughParagon Systems, we provide contract guard services to various Federalgovernment agencies. Our contract guard services include providing uniformedand armed guards for access control, plant security, personnel security, theftprevention, surveillance, vehicular and foot patrol, crowd control and theprevention of sabotage, terrorist and criminal activities. We provide guardsand other personnel who are, depending on the particular requirements of thecustomer, uniformed or plain-clothed, armed or unarmed, and who patrol inmarked radio cars or stand duty on the premises at stationary posts. Our guardsmaintain contact with headquarters or supervisors via car radio or hand-heldradios. In addition, our guards respond to emergency situations and report toappropriate authorities for fires, natural disasters, work accidents andmedical crises.

 

                Inconnection with providing these services, we assume responsibility for avariety of functions, including recruiting, hiring, training and supervisingthe guards deployed to the Federal agencies we serve, as well as paying allguards and providing them with firearms, uniforms, fringe benefits, workers’compensation insurance and any required bonding. We are responsible forpreventing the interruption of guard services as a consequence of illness,vacations or resignations.

 

                Westrive to provide cost-effective solutions to ensure the safety and security ofthe assets of our customers and to continually improve the protection weprovide for their personnel, programs, resources and facilities. Our goal is toprovide demonstrably superior contract guard services with the highest degreeof integrity and responsiveness.

 

**Our Logistics Contracts**

 

                In2000, Paragon Systems entered into a contract to provide logistics services bydeveloping and executing plans for improved logistics systems in support ofU.S. Army facilities located at Fort Bliss, Texas and Fort Sill, Oklahoma.Pursuant to this contract, Paragon Systems provides expertise in support of theU.S. Army’s Velocity Management initiatives, known as the Logistics Centers ofExcellence (“LCOE”) programs, by developing and executing plans for improvedlogistics systems in terms of readiness and cost reduction. Paragon Systemsdesigns and operates LCOEs at Fort Bliss, Texas and Fort Sill, Oklahoma tosupport the Army’s Material Command weapon programs. Paragon Systems providesthe essential and critical interfaces and lines of technical communicationsbetween the various U.S. Army Aviation and Missile Command Project Offices, theend user and the weapons prime contractors. This contract, includingextensions, expires pursuant to its terms in September 2005, and we havenot determined whether we will pursue any additional logistics contracts.

 

**Our Equity Interest in Army FleetSupport, LLC**

 

                ThroughParagon Systems, we own a 10% equity interest in Army Fleet Support, which providesall logistics support for U.S. Army aviation training at Fort Rucker, Alabama.In providing this support, the joint venture provides personnel, management,material parts, supplies, transportation and equipment to perform aviation unitmaintenance, aviation unit intermediate maintenance and approved depotmaintenance.

 

                L-3Communications Integrated Systems and Vertex Aerospace LLC collectively own themajority equity interest in Army Fleet Support. L-3 Communications IntegratedSystems provides comprehensive logistics support and services, includingextensive rotary-wing aircraft systems integration, modification andmaintenance. Vertex Aerospace LLC is an aviation and aerospace technicalservices company, managing and servicing rotary-wing air craft, as well asother equipment, primarily for government customers.

 

 

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                InDecember 2003, Paragon Systems made an initial capital contribution toArmy Fleet Support of $715,000. Since such time through December 31, 2004,Paragon Systems has received approximately $2.1 million in cashdistributions with respect to its equity interest in Army Fleet Support.

 

**Sales and Marketing**

 

                Oursales and marketing approach is designed to focus on Federal government agencies.We market our services through the offices of our subsidiary, Paragon Systems,located in Huntsville, Alabama. Currently, the executive officers of ParagonSystems conduct all of our sales and marketing efforts. We currently do nothave a separately designated sales and marketing staff but intend to establisha separate sales and marketing department to identify opportunities in theFederal government and private sectors and to negotiate and bid on Federalgovernment contracts. Our key marketing vehicles are our website, Federalgovernment bulletin board sites on the Internet, word of mouth and customerreferrals.

 

**Employees**

 

                Asof December 31, 2004, we employed approximately 760 individuals,consisting of more than 725 security guards, and 38 managerial andadministrative employees. Two of the former shareholders of Paragon Systemsserved as the President and Executive Vice President of Paragon Systems during2004 and were responsible for managing substantially all of Paragon Systems’operations relating to the provision of contract guard services. These twoindividuals were employed by Paragon Systems pursuant to employment agreementswhich expired in February 2005. We are currently conducting an executivesearch for a President of Paragon Systems.

 

                Ourbusiness is labor intensive and, as a result, is affected by the availabilityof qualified personnel and the cost of labor. Although the contract guardservices industry is characterized by high turnover, we believe our experiencecompares favorably with that of the industry. We have not experienced anymaterial difficulty in employing suitable numbers of qualified guards, althoughwhen labor has been in short supply, we have been required to pay higher wagesand incur overtime charges.

 

                Webelieve that the quality of our guards is essential to our ability to offereffective and reliable service, and we believe diligence in their selection andtraining produces the level of performance required to maintain customersatisfaction and internal growth. Our policy requires that all selectedapplicants for a guard position with us undergo a detailed pre-employmentinterview and a background investigation covering such areas as employment,education, military service, medical history and, subject to applicable statelaws and criminal record checks. Personnel are selected based upon physicalfitness, maturity, experience, personality, stability and reliability. We treatall employees and applicants for employment without unlawful discrimination asto race, creed, color, national origin, sex, age, disability, marital status orsexual orientation in all employment-related decisions. However, allFederal guard service contracts require that guards be a minimum of21 years of age.

 

                Ourcomprehensive training programs for our guards include pre-assignment training,on-the-job assignment training and refresher training. Pre-assignment trainingexplains the duties and powers of a guard, report preparation, emergencyprocedures, ethics and professionalism, grounds for discharge, general orders,uniforms and personal appearance, and basic post responsibilities. It alsoincludes jurisdiction and legal responsibilities, use of force, arrestauthority and procedures, search and seizure procedures, crime sceneprotection, rules of evidence, hostage situations, bomb threats and incidents,workplace violence, sabotage and espionage, terrorism/anti-terrorism, andweapons of mass destruction. On-the-job assignment training covers specificduties as required by the post and job orders. Ongoing refresher training isgiven on an annual basis as the need arises as determined by the local areasupervisor and manager, or quality control personnel.

 

 

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                Unionizedemployees account for approximately 60% of our employees and work undercollective bargaining agreements with the following unions: the United Union ofSecurity Guards; the Industrial, Technical and Professional Employees Union;and the Security Police and Fire Professionals of America. These collectivebargaining agreements do not permit work stoppages, and we have experienced nowork stoppages attributable to labor disputes. Our relations with our employeeshave generally been satisfactory. Guards and other personnel supplied by us toits customers are our employees, even though they may be stationed regularly atthe customer’s premises.

 

**Insurance**

 

                Wemaintain all appropriate forms of insurance, including comprehensive generalliability, performance and crime bonding, professional liability and automobilecoverage. Special coverage is sometimes added in response to unique customerrequirements. We also maintain compliance with all state workers’ compensationlaws. A certificate of insurance, which meets individual contract specifications,is made available to every customer.

 

                Generally,our Federal government contracts do not require that we obtain a performancebond; however, one of our current contracts does require a performance bond inthe amount equal to 20% of the current year’s contract price of$3.0 million or $600,000. The fee to obtain this bond is 1% of the bondamount. The bond does not cover losses incurred by our failure to perform dueto acts of terrorism.

 

**Customers**

 

                SinceFebruary 27, 2004, when we acquired Paragon Systems, we have provided ourcontract guard services to eight customers in eight states. We provide contractguard services for the following Federal government agencies (i) theDepartment of Homeland Security; (ii) the Social Security Administration;(iii) the Corps of Engineers; (iv) the U.S. Coast Guard; (v) theFederal Law Enforcement Training Center; (vi) the NASA John C. StennisSpace Center; (vii) the U.S. Food and Drug Administration; and(viii) the U.S. Army Armed Forces Retirement Home.

 

                Ourtypical customer contract may provide for an hourly or monthly billing rateused for all security guards at a site or variable hourly billing rates fordifferent guards. Our contracts are usually multi-year contracts with renewaloptions. For the twelve months ended December 31, 2004, five contractsrepresented more than 80% of our revenues.

 

                Forthe year ended December 31, 2004, our contracts with the Social SecurityAdministration, the Department of Homeland Security, the Federal LawEnforcement Training Center and the Stennis Space Center each accounted formore than 10% of our revenue.

 

**Competition in Contract Guard Services**

 

                Thecontract guard services segment of the security industry is highly competitivebut fragmented. Contract guard services generally compete with each other onprice and the quality of service provided; the scope of the services performed;name recognition; the extent and quality of the guard supervision, recruiting,selection and training; and the ability to handle multiple worksites nationwide.

 

                Weprovide contract guard services to Federal government agencies locatedexclusively in the southeastern United States. On any given contract for whichwe bid, there are generally five to ten other bidders. We compete primarily onprice, the quality of our service and our history of providing contract guardservices in the Southeast for over a decade.

 

                Ourlargest competitors in the contract guard services market include contractsecurity service providers such as Coastal International Security andWackenhut/Alletug. These competitors are much larger than we are and havesignificantly greater resources with which to target our markets, including

 

 

9

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name recognition. The guard industry also contains alarge number of smaller regional and local security service providers in theUnited States in addition to those listed above which also directly competewith us, including Alpha Protective Services and Security Consultants Group.

 

                Webelieve that we have highly skilled accounting and cost management personneland an excellent reputation for providing services to our customers on time andwithin budget. These competitive advantages contribute to our ability to obtainFederal government contracts through the competitive bidding process. Ourprimary competitive disadvantage results from our centralized management.Although we maintain field offices at certain contract sites, certain primarysupport functions for all of our contracts are provided out of our officelocated in Huntsville, Alabama, which is a competitive disadvantage when we arebidding for contracts against firms willing to establish full-blown supportoffices at the contract site.

 

                Becauseof the contract guard services industry’s low barriers to entry, othercompetitors are also likely to enter the industry. Furthermore, traditionalguard companies will increasingly compete with the electronics side of thesecurity industry, as customers increase their level of automation and replaceguards with more sophisticated electronic hardware.

 

**Government Regulation**

 

                Weare subject to city, county and state firearm and occupational licensing lawsthat apply to security guards and private investigators. In addition, manystates have laws or regulations requiring training and registration of securityguards, regulating the use of badges and uniforms, prescribing the use ofidentification cards or badges, and imposing minimum bond, surety or insurancestandards. We may be subjected to penalties or fines as the result of licensingirregularities or the misconduct of one of our guards from time to time in theordinary course of our business.

 

                Weare also subject to certain Federal regulations, including regulationsconcerning the use and distribution of firearms. Violations of theseregulations may result in criminal penalties. Furthermore, we are subject toFederal laws and regulations relating to the formation, administration andperformance of Federal government contracts, including the Federal AcquisitionRegulations and supplemental GSA regulations, the Truth in Negotiations Act andthe Cost Accounting Standards.

 

 

10

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**PART II**

 

**Item 6. Selected Financial Data**

 

                Wedid not have an operating business before our acquisition of Paragon Systems.The financial statements of Paragon Systems, as an operating entity, providethe more relevant information available for time periods prior to theAcquisition. Consequently, the selected financial data set forth below presentsthe selected financial data of Paragon Systems prior to the Acquisition and theconsolidated selected financial data of the Company for the year endedDecember 31, 2004, which includes the operations of Paragon Systems afterthe Acquisition. The historical results are not necessarily indicative offuture results.

 

                Basicincome (loss) per share is computed by dividing income (loss) available tocommon shareholders by the weighted average number of common shares outstandingfor the period after giving effect to the Exchange and Recapitalization.Diluted earnings per share reflects the potential dilution that would occur ifsecurities or other contracts to issue common stock were exercised or convertedinto common stock.

 

                ParagonSystems was formerly a subchapter S corporation and, consequently, pro formaincome tax expense, pro forma net income and pro forma income per share arepresented on the face of the summary of selected financial data for the periodspresented prior to February 27, 2004. The necessary adjustments includeonly taxes at a statutory rate of 38% for each period presented. The pro formaincome per share calculation of operations prior to February 27, 2004 isbased on the weighted average number of common shares outstanding of Tri-S.

 

                Tri-Swas incorporated during the fourth quarter of 2001. For purposes of calculatingthe weighted average shares outstanding for the pro forma income per sharecalculation for periods prior to the Acquisition, it is assumed that theCompany was incorporated on January 1, 2000.

 

                Theoperations of Tri-S prior to February 27, 2004 consisted primarily ofexpenditures relating to the identification and pursuit of acquisitionopportunities. For 2003, 2002 and 2001, such expenditures amounted to $347,000,$216,000 and $100,000, respectively. Tri-S recognized deferred income taxbenefits on these expenditures of $130,000, $80,000 and $40,000 for 2003, 2002and 2001, respectively. The loss per share (basic and diluted) for Tri-S for2003, 2002 and 2001 was $0.26, $0.16 and $0.08, respectively.

 

                Theselected financial data should be read in conjunction with our consolidatedfinancial statements, related notes and other financial information set forthin Item 15 hereof, and

 

 

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“Management’s Discussion and Analysis of FinancialCondition and Results of Operations,” set forth in Item 7 hereof.

 
| ** **                                           | ** ** | **Tri-S Security**      | ** ** | **Paragon Systems, Inc.**                  | ** ** |
|------------------------------------------------------|------------|-------------------------|------------|--------------------------------------------|------------|
| ** **                                           | ** ** | **Corporation**         | ** ** | **Jan. 1,**                                | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                           | ** ** | **and**                 | ** ** | **2004**                                   | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                           | ** ** | **Subsidiary**          | ** ** | **to**                                     | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                           | ** ** | **Consolidated**        | ** ** | **Feb. 27,**                               | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Selected Financial Data**                          | ** ** | **2004**                | ** ** | **2004**                                   | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
|                                                 |       | **(restated,  Note 2)** |       | **(In  thousands, except per share data)** |       |
| **Statement of Operations Data:**                    |       |                    |       |                                       |       |   |   |   |   |   |   |   |   |
| Revenues                                             |       | $                       | 25,425     |                                       | $          | 4,705 |   | $ | 29,395 |   | $ | 21,364 |   | $ | 16,491 |   | $ | 7,698 |   |
| Direct labor                                         |       | 13,810                  |       | 2,481                                      |       | 16,070 |   | 11,983 |   | 9,092 |   | 3,076 |   |
| % of revenues                                        |       | 54.32                   | %          | 52.73                                      | %          | 54.67 | % | 56.09 | % | 55.13 | % | 39.96 | % |
| Indirect labor and other contract support costs      |       | 10,223                  |       | 2,113                                      |       | 11,151 |   | 7,615 |   | 6,000 |   | 3,417 |   |
| % of revenues                                        |       | 40.21                   | %          | 44.91                                      | %          | 37.94 | % | 35.64 | % | 36.38 | % | 44.39 | % |
| Amortization of government contracts                 |       | 298                     |       | —                                     |       | — |   | — |   | — |   | — |   |
| % of revenues                                        |       | 1.17                    | %          | —                                     |       | — |   | — |   | — |   | — |   |
| Gross profit                                         |       | 1,094                   |       | 111                                        |       | 2,174 |   | 1,766 |   | 1,399 |   | 1,205 |   |
| % of revenues                                        |       | 4.30                    | %          | 2.36                                       | %          | 7.40 | % | 8.27 | % | 8.48 | % | 15.65 | % |
| Selling, general and administrative expenses         |       | 2,115                   |       | 230                                        |       | 1,466 |   | 1,179 |   | 896 |   | 652 |   |
| % of revenues                                        |       | 8.32                    | %          | 4.89                                       | %          | 4.99 | % | 5.52 | % | 5.43 | % | 8.47 | % |
| Amortization expense                                 |       | 462                     |       | —                                     |       | — |   | — |   | — |   | — |   |
| Operating income (loss)                              |       | (1,021                  | )          | (119                                       | )          | 708 |   | 587 |   | 503 |   | 553 |   |
| % of revenues                                        |       | -4.02                   | %          | -2.53                                      | %          | 2.41 | % | 2.74 | % | 3.05 | % | 7.18 | % |
| Income from investment in Joint Venture              |       | 1,637                   |       | —                                     |       | — |   | — |   | — |   | — |   |
| Depreciation expense                                 |       | 155                     |       | 28                                         |       | 175 |   | 68 |   | 88 |   | 62 |   |
| Interest income                                      |       | 3                       |       | —                                     |       | 12 |   | 23 |   | 28 |   | — |   |
| Interest expense                                     |       | (1,380                  | )          | (11                                        | )          | (30 | ) | (7 | ) | (11 | ) | (14 | ) |
| Interest on redeemable preferred stock               |       | (250                    | )          | —                                     |       | — |   | — |   | — |   | — |   |
| Income (loss) before income taxes                    |       | (1,011                  | )          | (130                                       | )          | 690 |   | 603 |   | 520 |   | 539 |   |
| Income tax expense (benefit)                         |       | (384                    | )          |                                       |       |   |   |   |   |   |   |   |   |
| Pro forma income tax expense (benefit)               |       |                    |       | (49                                        | )     | 262 |   | 229 |   | 198 |   | 205 |   |
| Net income (loss)                                    |       | (627                    | )          |                                       |       |   |   |   |   |   |   |   |   |
| Pro forma net income (loss)                          |       |                    |       | (81                                        | )     | 428 |   | 374 |   | 322 |   | 334 |   |
| Basic net income (loss) per common share             |       | (0.76                   | )          |                                       |       |   |   |   |   |   |   |   |   |
| Pro forma basic net income (loss) per common share   |       |                    |       | (0.10                                      | )     | 0.52 |   | 0.46 |   | 0.40 |   | 0.41 |   |
| Diluted net income (loss) per common share           |       | (0.76                   | )          |                                       |       |   |   |   |   |   |   |   |   |
| Pro forma diluted net income (loss) per common share |       |                    |       | (0.10                                      | )     | 0.39 |   | 0.40 |   | 0.40 |   | 0.41 |   |
| **Balance Sheet Data (at Period End):**              |       |                    |       |                                       |       |   |   |   |   |   |   |   |   |
| Cash                                                 |       | $                       | 313        |                                       | $          | 275 |   | $ | 846 |   | $ | 877 |   | $ | 647 |   | $ | 239 |   |
| Current assets                                       |       | 6,636                   |       | 6,803                                      |       | 5,713 |   | 5,911 |   | 5,003 |   | 3,005 |   |
| Total assets                                         |       | 24,618                  |       | 7,230                                      |       | 6,883 |   | 6,114 |   | 5,147 |   | 3,201 |   |
| Long term obligations                                |       | 10,446                  |       | 175                                        |       | 185 |   | — |   | — |   | — |   |
| Total liabilities                                    |       | 24,886                  |       | 3,720                                      |       | 3,243 |   | 3,124 |   | 2,760 |   | 1,207 |   |
| Cash dividends                                       |       | —                  |       | —                                     |       | — |   | — |   | — |   | — |   |

 

 

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

 

*                Theresults of operations set forth below are presented on a historical basis forthe Company. Historical amounts for the years ended December 31, 2004,2003 and 2002, are derived from audited financial statements for ParagonSystems and Tri-S and represent the mathematical addition of the results ofoperations for Paragon Systems and Tri-S for such years. The results ofoperations set forth below include the administrative expenses of Tri-S for allyears presented.*

 

*                ParagonSystems was formerly a subchapter S corporation and, consequently, pro formaincome tax expense and pro forma net income are presented on the face of thehistorical statements of operations for all periods presented. The adjustmentsinclude only taxes at a statutory rate of 38% for each period presented.*

 

*                Inaccordance with requirements of purchase accounting, the assets and liabilitiesof Paragon Systems were adjusted to their estimated fair values and theresulting goodwill computed for the Acquisition. The application of purchaseaccounting generally results in higher depreciation and amortization expense inperiods subsequent to the Acquisition. Accordingly, the results discussed forthe year ended December 31, 2004 are not comparable with prior years.*

 

**Overview**

 

                Weoperate in a single reportable segment offering contract guard services tovarious Federal government agencies pursuant to long-term contracts. Theseguard services include providing uniformed and armed guards for access control,personnel protection, plant security, theft prevention, surveillance, vehicularand foot patrol, crowd control and the prevention of sabotage, terrorist andcriminal activities. In connection with providing these services, we assumeresponsibility for a variety of functions, including recruiting, hiring,training, arming and supervising guards deployed to the Federal governmentagencies we serve as well as paying all guards and providing them withuniforms, fringe benefits and workers’ compensation insurance.

 

                Wewere incorporated in Georgia in October 2001 for the purpose of acquiringand consolidating electronic and physical security companies in order to takeadvantage of the operating efficiencies created by a larger company. Wecurrently intend to pursue acquisition opportunities in the contract guardservices and systems integration services segments of the security industry. Tothis end, we acquired Paragon Systems in February 2004. Paragon Systemshas been providing contract guard services to Federal government agencies since1994.

 

                Wefrequently evaluate acquisition opportunities and, at any given time, may be invarious stages of due diligence or preliminary discussions with respect to anumber of potential acquisitions. From time to time, we may enter intonon-binding letters of intent, but we are not currently subject to anydefinitive agreement with respect to any acquisition material to our operationsor otherwise so far advanced in any discussions as to make an acquisitionmaterial to our operations reasonably certain.

 

                Duringthe year ended December 31, 2004, the Federal government exercised optionrenewals for eleven of our existing contracts and a six month extension on oneof our contracts for providing contract guard and logistics services, whichcontracts generate aggregate annual revenue of approximately$30.0 million. Paragon Systems also obtained one new contract forproviding contract guard services, which contract generates annual revenue ofapproximately $250,000.

 

                Duringthe year ended December 31, 2003, the Federal government exercised optionrenewals for seven of our existing contracts for providing contract guard andlogistics services, which contracts generate aggregate annual revenue ofapproximately $9.8 million. Paragon Systems also obtained four newcontracts for providing contract guard services, which contracts generateaggregate annual revenue of approximately $17.7 million. One contract forproviding contract guard services which expired on December 31, 2002 wasrenewed for an additional five-year period and generates aggregate annualrevenue of approximately $1.3 million.

 

                During2005, all of our existing contracts which generate aggregate annual revenue ofapproximately $30.0 million will be subject to renewal or extension byvarious Federal government agencies under the option renewal clauses of suchcontracts. All of our contracts have been renewed or extended for some periodof time through the annual option renewal process. During 2005, Paragon Systemsintends to seek out and bid on additional contracts for providing contractguard services.

 

                Renewingand extending existing contracts and obtaining new contracts are crucial to ourability to generate revenue and manage cash flow. All of our contracts may beterminated at any time by the Federal government, or the Federal government maydetermine not to renew or extend any of our contracts upon their scheduledexpiration. We intend to seek additional contracts in the private sector

 

 

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in addition to pursuing contracts with Federal governmentagencies. We also intend to acquire one or more subsidiaries with operations inthe private sector and the Federal government sector.

 

                Wehave obtained substantially all of our current contracts through a competitivebidding process. During 2004, we engaged Proposal Solutions, Inc. toassist us in the preparation and presentation of contracts. We believe thatProposal Solutions, Inc. will effectively manage the competitive bidding processfor us. We are also evaluating the best method of identifying contractopportunities with Federal government agencies.

 

                TheSBA administers business assistance programs for small disadvantaged businesseswhich it certifies as 8(a) firms. Paragon Systems’ certification as an 8(a)firm expired in September 2002. We are unable to once again qualify forcertification as an 8(a) firm because our revenues have exceeded the maximumlevels accepted by the SBA for certification as an 8(a) firm. As a result, weare no longer eligible to bid on contracts designated specifically for 8(a)firms. Before September 2002, we bid on both contracts which could only beawarded to 8(a) firms, and on contracts not specifically designated for 8(a)firms. We believe that we are positioned to continue the growth of our businessby bidding on and obtaining larger contracts.

 

                Generally,our current contracts and the contracts on which we have bid and intend to bidhave a 3% or higher profit margin. To the extent we pursue Federal governmentcontracts through a competitive bidding process, we may find it difficult toachieve and maintain profitability. In addition to pursuing contracts through acompetitive bidding process, we also intend to pursue negotiated contracts withFederal government agencies and in the private sector. Until we are able toobtain negotiated contracts which generate significant revenue, we willcontinue to rely on the low-margin contracts obtained through the competitivebidding process for our revenue. Two of our contracts operated with negativemargins during 2004. We are currently working with the responsible Federalagency to provide for a 3% or higher profit margin on one of the contracts. Wewill begin work on the second contract shortly after completing our work on thefirst contract. Our goal is to insure that all of our contracts operateprofitably.

 

 

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**Results of Operations of the Company**

 

                Thefollowing table sets forth absolute dollar and percentage changes in ourselected financial data from period to period for the periods described below.The table below combines results of Paragon Systems with Tri-S for periodsprior to the Acquisition (dollars in thousands):

 
| ** **                                       | ** ** | **Change from  Year Ended  December 31,  2003 to Year  Ended  December 31,  2004** | ** ** | **Change from  Year Ended  December 31,  2002 to Year  Ended  December 31,  2003** | ** ** | **Change from  Year Ended  December 31,  2001 to Year  Ended  December 31,  2002** | ** ** |
|--------------------------------------------------|------------|----------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------|------------|
| ** **                                       | ** ** | **$**                                                                                        | ** ** | **%**                                                                              | ** ** | **$**                                                                                        | ** ** | **%** | ** ** | **$** | ** ** | **%** | ** ** |
| ** **                                       | ** ** | **(restated,  Note 2)**                                                                      | ** ** | ** **                                                                         | ** ** | ** **                                                                                   | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenues                                         |       | 735                                                                                          |       | 2.50                                                                               | %          | 8,031                                                                                        |       | 37.59 | % | 4,873 |   | 29.55 | % |
| Operating expenses:                              |       |                                                                                         |       |                                                                               |       |                                                                                         |       |   |   |   |   |   |   |
| Direct labor                                     |       | 221                                                                                          |       | 1.38                                                                               | %          | 4,087                                                                                        |       | 34.11 | % | 2,891 |   | 31.80 | % |
| Indirect labor and other contract support costs  |       | 1,185                                                                                        |       | 10.63                                                                              | %          | 3,536                                                                                        |       | 46.43 | % | 1,615 |   | 26.92 | % |
| Selling, general and administrative              |       | 879                                                                                          |       | 29.34                                                                              | %          | 418                                                                                          |       | 29.96 | % | 399 |   | 40.06 | % |
| Amortization of intangible assets                |       | 298                                                                                          |       |                                                                               |       |                                                                                         |       |   |   |   |   |   |   |
| Operating income (loss)                          |       | (1,848                                                                                       | )          | (415.79                                                                            | )%         | (10                                                                                          | )          | (2.70 | )% | (32 | ) | (7.94 | )% |
| Income from investment in Joint Venture          |       | 1,637                                                                                        |       | N/A                                                                                |       | —                                                                                       |       | — |   | — |   | — |   |
| Interest income                                  |       | (9                                                                                           | )          | (75.00                                                                             | )%         | (11                                                                                          | )          | (47.83 | )% | (5 | ) | (17.86 | )% |
| Interest expense                                 |       | (1,361                                                                                       | )          | (4,536.67                                                                          | )%         | (23                                                                                          | )          | 328.57 | % | 4 |   | (36.36 | )% |
| Interest on mandatory redeemable preferred stock |       | (250                                                                                         | )          |                                                                               |       |                                                                                         |       |   |   |   |   |   |   |
| Income (loss) before income taxes                |       | (1,831                                                                                       | )          | (265.96                                                                            | )%         | (87                                                                                          | )          | (14.42 | )% | (33 | ) | (7.86 | )% |

 

*Revenues*

 

                Theincrease in our revenues from period to period is directly attributable to thenumber and size of our contacts during successive periods. Generally, therevenue generated by a contract is dependent upon the number of labor hoursrequired to service such contract. Substantially all of our revenues aregenerated by Federal government contracts awarded to us through a competitivebidding process. Prior to 2001, we primarily bid on Federal governmentcontracts set aside for small, disadvantaged businesses certified as 8(a) firmsby the SBA. In 2001, we began bidding on larger contracts not specifically setaside for certified 8(a) firms. From December 31, 2001 toDecember 31, 2002, the net number of our Federal government contracts grewfrom nine to 13. We obtained four new Federal government contracts in 2002. In2003, five of our Federal government contracts expired, and we obtained fournew Federal government contracts for a net reduction of one contract betweenDecember 31, 2002 and December 31, 2003. Our revenues continued toincrease from 2002 to 2003 despite having one less contract because the averagerevenue from each of our contracts increased between 2002 and 2003. In 2004, weobtained one new contract in the fourth quarter returning the number of managedcontracts to thirteen. Revenue for 2004 increased by approximately $700,000over 2003 primarily because the new contracts obtained in 2003 were includedfor a full year in 2004. Revenue in 2004 from the new contracts obtained in2003 also more than offset the loss of two expired contracts in 2003. Also in2004, we accrued and invoiced $699,000 on two Federal contracts to recovercosts imposed on us in excess of our original bid that we fully expected torecover from one Federal agency based on meetings and negotiations with theFederal agency. Subsequent to December 31, 2004, the Federal agency deniedall of our claims to recover these costs. While we continue to believe that wewill ultimately prevail in recovery of these costs, we recorded a provision inthe amount of $434,000 against our 2004 revenue in anticipation that we may notsucceed with appeals that we plan to initiate.

 

 

15

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                Thefollowing table sets forth the number of our Federal government contractsduring the periods and in the revenue ranges indicated in the table:

 

| **Annual Revenues**                    | ** ** | **Year Ended  December 31,  2004** | ** ** | **Year Ended  December 31,  2003** | ** ** | **Year Ended  December 31,  2002** | ** ** |
|----------------------------------------|------------|------------------------------------|------------|------------------------------------|------------|------------------------------------|------------|
| Less than $1.0 Million per Contract    |       | 5                                  |       | 5                                  |       | 7                                  |       |
| $1.0 to $2.0 Million per Contract      |       | 3                                  |       | 6                                  |       | 4                                  |       |
| $2.0 to $3.0 Million per Contract      |       | 0                                  |       | 0                                  |       | 1                                  |       |
| Greater than $3.0 Million per Contract |       | 5                                  |       | 4                                  |       | 1                                  |       |

 

                Ofthe four contracts generating annual revenue greater than $3.0 million percontract in 2003, two were awarded near the end of 2002, one was a continuingcontract requiring substantially more service hours and one was modified from ametropolitan-area contract to a statewide contract. In 2005, the number of contractsgenerating revenue greater than $3.0 million increased to five from fourin 2004 due to one multiple location contract that was started inJuly 2003.

 

                Thefollowing table sets forth the expiration years of our contracts existing as ofDecember 31, 2004:

 

| **Number of  Contracts** | ** ** | **Year  Expiring** | ** ** |
|--------------------------|------------|--------------------|------------|
| 3                        |       | 2005               |       |
| 2                        |       | 2006               |       |
| 4                        |       | 2007               |       |
| 4                        |       | 2008               |       |

 

                Weexpect future revenues to increase as we continue to recognize revenues fromour existing contracts and to the extent we obtain new contracts.

 

*Costs of Revenues*

 

                Wecategorize our cost of revenues into three areas: (i) direct labor,(ii) indirect labor and other contract support costs, and(iii) amortization of government contracts.

 

*                DirectLabor.*  Directlabor is the most significant expense in providing guard services on anycontract. Direct labor was approximately 54% in 2004, 55% in 2003 and 56% for2002. When bidding on contracts, we must anticipate labor rates during thecontract term.

 

*                IndirectLabor and Other Contract Support Costs.*  This category of expenses consists primarilyof indirect labor (guard supervisors), our portion of payroll taxes, employeebenefit costs and other expenses, which are a relatively small portion of costsin this category. As with direct labor, when bidding on contracts, we must anticipatethe cost of providing supervisory oversight of the guards performing the actualguard services and the related payroll taxes and employee benefits that areprovided to both guards and to supervisors. Indirect labor and other contractsupport costs was approximately 41% in 2004, 38% in 2003 and 36% in 2002.

 

*                Directand Indirect Labor.*  Total wages and other payroll relatedexpenses are the most significant and dominant expenses. In 2004 wages andother payroll related expenses were approximately 94% of all operatingexpenses.

 

*                Amortizationof Government Contracts.*  Upon the Acquisition of Paragon Systems byTri-S, Paragon Systems’ existing contracts were valued in accordance withpurchase accounting rules and the resulting asset values are being amortizedover the remaining term of each contract proportionate to estimated futurediscounted cash flows based on an independent appraisal.

 

 

16

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*                General.*  Our ability to accuratelyanticipate the costs of providing guard services is critical to ourprofitability. Upon deciding to focus bidding on and obtaining larger contractsin 2001, we reduced our anticipated profit margins to be more competitive andto obtain more contracts. Thus, it is more important than ever that wecorrectly anticipate all of the above mentioned costs. When bidding oncontracts in 2002, we failed to accurately anticipate the cost of providingsupervisory oversight on two contracts which we subsequently obtained. Thecosts of providing the necessary oversight increased our indirect labor costsand reduced our profit margins in 2003 and 2004 with respect to these twocontracts. These two contracts were different from our other contracts in thatthey covered multiple locations over wide geographic areas. We are currentlynegotiating with the responsible Federal agency to reach profitability on oneof these contracts. In the third quarter of 2005, we will initiate negotiationsto reach profitability on the other contract.

 

                Ourcost of revenue was 96.0% in 2004, 92.6% in 2003 and 91.7% in 2002. Thisincrease in 2004 is primarily attributable to two factors: (i) we havereduced our profit margins in recent bids to be more competitive in the biddingprocess for larger contracts; and (ii) we failed to accurately anticipatethe costs of providing supervisory oversight on two existing contracts asdiscussed above. We believe that reducing our profit margins is one of thereasons we have been successful in obtaining several of our larger contracts. Weanticipate that we will continue to keep our profit margins low for theforeseeable future in order to obtain larger contracts and increase ourpresence in the contract guard market. As a result, we anticipate that our costof sales will be not less than 92% of our revenues for the next several years.

 

*Selling, General and AdministrativeExpenses*

 

                Selling,general and administrative expenses expressed as a percentage of revenue was7.8% in 2004, 6.2% in 2003 and 6.5% in 2002. Selling, general and administrativeexpenses consist primarily of payroll and related expenses for administrativepersonnel in Paragon Systems’ corporate office located in Huntsville, Alabamaand in the Tri-S corporate office located in Alpharetta, Georgia. It alsoincludes occupancy costs at the two locations, consulting and professionalfees, and certain miscellaneous office and corporation expenses. At ParagonSystems, selling, general and administrative expense has increased as a resultof increased salaries and employee benefits. Approximately, $92,000 of the 2003increase resulted from certain accounts receivable being written off as notcollectible. Since our customers are Federal government agencies, we do notprovide for bad debt allowances in the ordinary course of business. We writeoff account balances primarily for two reasons: (i) disagreements with agovernment agency relating to contract interpretations; and (ii) cessationof project funding at the end of a contract term. When there is a disagreementinvolving contract interpretation, the Company and the appropriate governmentagency mutually agree on resolution. When an account is not collected due tocessation of project funding, we work with the appropriate government agency toattempt resolution. If the agency cannot resolve the funding issue, then wemust write off the account balance. This only occurs at or near the expirationdate of contracts. During 2004, 2003 and 2002, corporate overhead consistedprimarily of salaries and professional fees totaling $947,000, $347,000, and$216,000, respectively.

 

*Joint Venture*

* *

                The Companyowns 10% of Army Fleet Support, LLC. We recognize as income 10% of the jointventure's net earnings or net loss less the amortization of the differencebetween our cost and our share of the net equity of the joint venture. In 2004,we recognized as income $2,324,000 less amortization of $687,000 for income of$1,637,000 from joint venture.

 

*Interest Income and Interest Expense*

 

                Priorto the Acquisition, Paragon Systems maintained a bank line of credit to meetits temporary cash flow needs. Paragon Systems invested cash exceeding itsshort term requirements on a temporary basis. Incident with the Acquisition,the line of credit was paid off and closed and a factoring arrangement wasestablished with LSQ Funding Group, L.L.C. (“LSQ”). In addition, Tri-S executed$7.7 million in promissory notes payable to the former shareholders ofParagon Systems and issued to them an aggregate of 100 shares of ourSeries C Redeemable Preferred Stock with an aggregate redemption value of$6.0 million with 5% annual interest thereon. The increase in interestexpense for

 

 

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2004 over 2003 is entirely the result of (i) theissuance to the former shareholders of Paragon Systems of the promissory notesand the shares of Series C Redeemable Preferred Stock in connection withthe Acquisition, and (ii) our factoring arrangement with LSQ.

 

*Pro Forma Income Tax Expense*

 

                Priorto the Acquisition, Paragon Systems only recognized income tax expense relatingto built in gain taxes for periods before its subchapter S election. Income taxexpense reported by Paragon Systems has been replaced with pro forma income taxexpense at 38% in all periods. This includes federal income taxes at 34% andstate income taxes at 4% which is net of the federal effect. For the year endedDecember 31, 2004, the results of operations of Tri-S consolidated withParagon Systems shows a loss before income taxes of $2.8 million and anincome tax benefit of $1.1 million. We will realize this benefit primarilybecause it is anticipated that future taxable distributions from ParagonSystems’ investment in Army Fleet Support will more than offset losses fromoperations.

 

**Critical Accounting Policies**

 

                Thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the United States requires us to make certain estimatesand judgments that affect the reported amounts of assets, liabilities,revenues, expenses and related disclosure of contingent assets and liabilities.We believe the following critical accounting policies affect our moresignificant estimates and judgments. Actual results may differ from theseestimates under different assumptions or conditions.

 

*                RevenueRecognition.*  We record revenue monthly as guard servicesare provided to our customers under contracts with Federal government agencies.We bill guard services in arrears at hourly or monthly rates based on thenumber of hours worked under some contracts and as fixed monthly amounts underother contracts. Hourly and monthly rates are determined as a result of ourbids submitted in response to formal specifications included in solicitationsfor bids from government agencies. Hourly and monthly billing rates aredeveloped by accumulating the estimated labor, general and administrativeexpenses, our profit objective and other costs to service a contract over afive-year period.

 

                Theterms of our contracts with Federal government agencies are complex and may besubject to differing interpretations. We make estimates and judgments aboutterms of the contracts in providing services and in billing and recordingrevenue. Differences in interpretation are generally resolved on a mutual basisin discussions with the government agency involved. The resolution ofdifferences may result in a determination that amounts previously billed arenot in accordance with contract terms and adjustments of amounts initiallyrecorded as revenue may be material.

 

                Contractswith Federal government agencies may be subject to cessation of funding.Cessation of funding may result in amounts billed and recorded as revenue asbeing uncollectible. We work with the appropriate government agency to resolvefunding issues. When funding issues become known, we make estimates andjudgments about the extent of potential losses and adjust revenues accordingly.Actual amounts estimated could differ from amounts ultimately collected andthese amounts could be material.

 

*                Costof Revenues.*  Cost of revenues is primarily comprised oflabor, related payroll taxes, employee benefits, workers compensation andliability insurance. Labor is recorded on an accrual basis. Direct and indirectlabor, related payroll taxes and employee benefits account for over 90% of allcost of revenues and over 90% of all operating expenses. In 2004, labor andrelated payroll taxes and employee benefits approximated 94% of our total costof revenues. The wages paid component of labor include regular pay, bonus,overtime, vacation, training, holiday and sick time. Total hours paid normallyexceed total hours billed mainly due to vacation, training, supervisory holidayand sick time, which is generally not billable. This non-billable time,however, is included in the development of the

 

 

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billable rate. Medical benefits and workers compensationcosts are based on premium-based plans and are expensed based on actualpremiums paid. One time expenses, such as extra training required on starting anew contract, are expensed when incurred.

 

                Wemake estimates and judgments of amounts recorded for accruals of labor relatedcosts. Expenses most subject to estimation and judgment are accrued vacationand workers compensation costs. For some contracts, we assume existingliabilities for accrued vacation. The terms of vacation policies may be complexand subject to interpretation. Workers compensation insurance is subject toretroactive audit. Actual amounts could differ from the amounts initiallyrecorded.

 

*                Goodwilland Other Intangible Assets.*  We account for goodwill and other intangibleassets in accordance with Statement of Financial Accounting Standards (“SFAS”)No. 142, *Goodwill and other IntangibleAssets* (“SFAS No. 142”), which requires goodwill and someintangible assets to no longer be amortized. Instead, goodwill will be subjectto an annual impairment test. The goodwill impairment test involves a two-stepapproach. The first step of the test is to compare the fair value of the reportingunit, which is the business of Paragon Systems, to its book value, includinggoodwill. The fair value of the reporting unit is measured using discountedprojected future cash flows. Cash flow estimates include projections ofrevenues from existing contracts with Federal government agencies, includingprojected renewals and extensions. The related costs of revenues are based onour historical costs. The projections are subject to the uncertainties ofrealizing contract renewals and extensions, the pricing of future contracts andreasonable estimates of future labor costs and other costs of revenues.

 

                Ifthe book value exceeds the fair value, then the second step of the goodwillimpairment test, used to measure the amount of impairment loss, compares the impliedfair value of the reporting unit goodwill with the book value of that goodwill.If the book value exceeds the implied fair value of that goodwill, then animpairment loss will be recognized to the extent of the excess. The impliedfair value of goodwill will be determined in the same manner as the amount ofgoodwill recognized in the Acquisition of Paragon Systems; that is, the fairvalue of the reporting unit will be allocated to all of the assets andliabilities of that unit as if the reporting unit had been acquired in abusiness combination and the fair value of the reporting unit was the pricepaid to acquire the reporting unit. The excess of the fair value of thereporting unit over the amounts assigned to its assets and liabilities is theimplied fair value of goodwill. We completed our first goodwill impairment testas of December 31, 2004 and determined that the reported value of goodwillwas not impaired.

 

                Goodwillwas valued at $7.7 million at the date of the Acquisition of ParagonSystems. Should an impairment test cause us to recognize an impairment loss,the book value of goodwill will be reduced by the amount of the impairmentloss. An equal charge to expense will be made reducing our results ofoperations.

 

                SFASNo. 142 also requires that intangible assets with definite lives beamortized over their estimated useful lives and reviewed for impairmentwhenever events or changes in circumstances indicate an asset’s carrying valuemay not be recoverable in accordance with SFAS No. 144, *Accounting for the Impairment of Long-Lived Assetsand for Long-Lived Assets to Be Disposed Of.* We are currentlyamortizing our acquired intangible assets with definite lives over periodsranging from five to nine years. Amortizable intangible assets consist ofgovernment contracts we acquired with the Acquisition of Paragon Systems andthe non-compete agreements with certain of Paragon Systems’ former owners. Webelieve that no events or changes in circumstances have occurred that wouldrequire an impairment test for these assets.

 

*                Investmentin Joint Venture.*  We account for our 10% interest in Army FleetSupport under the equity method. Accordingly, we increase the carrying amountof the joint venture asset for our share of the net earnings of the joint ventureand reduce the carrying amount for cash received from the joint venture andamortization of the difference between our cost and our share of the net equityof the joint venture. We record income from investment in joint venture equalto our share of the net earnings of the joint venture less amortization of thedifference between our cost and our share of the net equity of the jointventure. As part of the allocation of the purchase price for the Acquisition ofParagon Systems, fair value of the joint venture in excess of the net equity ofjoint venture was attributed to the value of the joint venture's contract withthe federal government and is being amortized over the life of the contract,which is 10 years. In December 2003, Paragon Systems made an investment of$715,000 in the joint venture. The carrying value of the investment in thejoint venture was increased to

 

 

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$8,102,000 as a result of the purchase accountingadjustments made in the Acquisition of Paragon Systems in February 2004.

 

                Ourportion of the net earnings, cash distributions received from the jointventure, and amortization of the excess of cost over our portion of the netequity of the joint venture during 2004 were as follows (in thousands):

 

 

 
| ** **          | ** ** | **Earnings** | ** ** | **Cash  Distributions** | ** ** | **Amortization** | ** ** |
|---------------------|------------|--------------|------------|-------------------------|------------|------------------|------------|
| First quarter 2004  |       | $            | 59,000     |                    | $          | 0                |       | $ | 69,000 |   |
| Second quarter 2004 |       | 311,000      |       | 145,000                 |       | 206,000          |       |
| Third quarter 2004  |       | 1,628,000    |       | 185,000                 |       | 206,000          |       |
| Fourth quarter 2004 |       | 326,000      |       | 1,107,000               |       | 206,000          |       |
|                |       | $            | 2,324,000  |                    | $          | 1,437,000        |       | $ | 687,000 |   |

 

                InJanuary 2005, we received $400,000 in cash distributions from the jointventure.

 

                Thetiming and amount of distributions received from the joint venture vary widelyand may not be predictable. These distributions may materially affect our cashflow.

 

**Liquidity and Capital Resources**

 

*Summary*

 

                Liquidityis the measurement of our ability to have adequate cash or access to cash atall times in order to meet financial obligations when due, as well as to fundcorporate development and expansion and other activities. Historically, we havemet our liquidity requirements through a combination of cash provided byoperations, cash provided by debt from third party lenders and issuances ofdebt and equity securities.

 

                Thefollowing table sets forth the changes in the major components of workingcapital between December 31, 2003 and December 31, 2004:

 

| ** **                                                                                | ** ** | **(in thousands)** | ** ** |
|-------------------------------------------------------------------------------------------|------------|--------------------|------------|
| Working capital at December 31, 2003                                                      |       | $                  | 2,754      |   |
| Acquisition related items:                                                                |       |               |       |
| Cash payment to former shareholders of Paragon Systems in February  2004                  |       | (2,300             | )          |
| Promissory notes payable to former shareholders of Paragon Systems  due February 15, 2005 |       | (6,200             | )          |
| Promissory notes payable to former shareholders of Paragon Systems  due February 28, 2005 |       | (1,500             | )          |
| Accrued interest on promissory notes payable to former shareholders  of Paragon Systems   |       | (316               | )          |
| Accrued interest on Series C Redeemable Preferred Stock                                   |       | (250               | )          |
| All other items, net                                                                      |       | 8                  |       |
| Working capital at December 31, 2004                                                      |       | $                  | (7,804     | ) |

 

                Nearlyall of the changes in working capital from December 31, 2003 toDecember 31, 2004 result from the Acquisition of Paragon Systems by Tri-S.Working capital of the operating business is relatively constant from period toperiod and generally fluctuates due to timing of cash disbursements andcollections of accounts receivable. We completed the Initial Public Offering inthe first quarter of 2005 and received proceeds of $11.1 million.

 

 

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*Cash Flow from Operations*

 

                Cashgenerated or used by operating activities of the operating business for theyears ended December 31, 2004, 2003 and 2002 is as follows:

 

| ** **                                              | ** ** | **Including  Interest** | ** ** | **Excluding  Interest** | ** ** |
|---------------------------------------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                                              | ** ** | **(in thousands)**      | ** ** |
| Year ended December 31, 2004 (Tri-S)                    |       | $                       | (1,156     | )                       | $          | 474 |   |
| Period January 1 to February 27, 2004 (Paragon Systems) |       | (867                    | )          | (856                    | )          |
| Year ended December 31, 2003 (Paragon Systems)          |       | 163                     |       | 181                     |       |
| Year ended December 31, 2002 (Paragon Systems)          |       | (97                     | )          | (81                     | )          |
|                                                         |            |                         |            |                         |            |  |  |

 

                Thetwo key cash flow drivers are payroll and collection of accounts receivable.Payroll includes wages, workers compensation insurance, medical insurance,union and other benefits. Payroll and related costs account for over 90% of alloperating expenses. The day of the week on which a month ends can dramaticallyaffect the timing of cash disbursements for these items. All accountsreceivable are billed near the end of each month. Processing delays can delaythe actual billing date, therefore extending collection by the number of daysdelayed. The above described conditions affecting cash flow timing aretemporary at any point in time.

 

                Ourcash receipts are nearly all received from Federal government agencies aspayment for security guard services provided by us. Payments are usuallyreceived by the invoice due date; however, payments may be received as much as45 days or more after the invoice due date due to factors beyond ourcontrol. When payments are received after the invoice due date, we adjustpayments to our vendors accordingly. Payments to our employees cannot bedelayed. As a result, there may be significant swings in cash flow from oneperiod compared to another comparable period. Our cash flows will continue tobe dependent upon the timing of cash receipts from our customers.

 

*Capital Expenditures and Investment*

 

                Expendituresfor vehicles and office equipment for the years ended December 31, 2004,2003 and 2002 are as follows:

 

| ** **                                               | ** ** | **(in thousands)** | ** ** |
|----------------------------------------------------------|------------|--------------------|------------|
| Year ended December 31,  2004 (Tri-S)                    |       | $                  | 67         |   |
| Period January 1 to  February 27, 2004 (Paragon Systems) |       | —             |       |
| Year ended December 31,  2003 (Paragon Systems)          |       | 427                |       |
| Year ended December 31,  2002 (Paragon Systems)          |       | 127                |       |
|                                                          |            |                    |            |  |

 

                Ourcapital requirements are driven by individual contract specifications andprimarily relate to our need for vehicles, firearms, uniforms, computers andcommunication devices for guards to service our contracts. We generally mustmake capital expenditures during the initial or start-up phase of newcontracts. Several new contracts we obtained in late 2002 necessitated expendituresin late 2002 and in 2003. In 2003, we expended $365,000 for vehicles to servicetwo contracts with wide geographic areas. Most of these vehicles were financedthrough vehicle leases.

 

                InDecember 2003, Paragon Systems invested $715,000 in the joint venture inexchange for a 10% equity interest therein. We received cash distributions fromthe joint venture of $715,000 in January through February 2004, $149,000in June 2004, $172,000 in September 2004 and $1,100,000 inDecember 2004. We received cash distributions from the joint venture of$400,000 in January 2005. We anticipate that cash distributions to us fromthe joint venture in 2005 will total approximately $1.1 million to$1.5 million, excluding the distribution we received in January 2005.

 

 

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*Contractual Obligations and CommercialCommitments*

 

                Thefollowing table summarizes our future contractual obligations for the yearsindicated:

 
| ** **                                                                                             | ** ** | **Payments Due by Year Commencing January 1, 2005** | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                             | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2007** | ** ** | **2008** | ** ** | **2009** | ** ** | **thereafter** | ** ** |
| ** **                                                                                             | ** ** | **($in thousands)**                                 | ** ** |
| Promissory notes—aggregate principal balance of $6.2 million                                 |       | $                                                   | 6,206      |   |   |   |   |   |   |   |   |   |   |   |
| Interest on promissory notes @ 7%                                                                      |       | 290                                                 |       |   |   |   |   |   |   |   |   |   |   |
| Promissory notes—aggregate principal balance of $1.5 million                                 |       | 1,500                                               |       |   |   |   |   |   |   |   |   |   |   |
| Interest on promissory notes @ 7%                                                                      |       | 105                                                 |       |   |   |   |   |   |   |   |   |   |   |
| Shares of Series C Redeemable Preferred Stock with an aggregate  redemption value of $6.0 million |       |                                                |       |   |   | $ | 6,000 |   |   |   |   |   |   |   |
| Interest on shares of Series C Redeemable Preferred Stock @ 5%                               |       | 450                                                 |       | $ | 300 |   | 150 |   |   |   |   |   |   |   |
| Operating leases                                                                                       |       | 101                                                 |       |   |   |   |   |   |   |   |   |   |   |
| Capital leases                                                                                         |       | 99                                                  |       | 106 |   |   |   |   |   |   |   |   |   |
| Income taxes payable from conversion of Paragon from S to C  corporation                               |       | 168                                                 |       | 352 |   | 352 |   | $ | 352 |   |   |   |   |   |
|                                                                                                   |       | $                                                   | 8,919      |   | $ | 758 |   | $ | 6,502 |   | $ | 352 |   |   |   |   |   |
|                                                                                                        |            |                                                     |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

*Sources of Cash*

 

                For2005, we expect that our primary sources of cash will be from cash on hand,cash received as distributions from the joint venture, cash generated byoperating activities and the net proceeds from our Initial Public Offeringafter repayment of all of the Paragon Notes in aggregate principal amount of$7.7 million and payment of all dividends due on our Series CRedeemable Preferred Stock. We believe that we will have sufficient liquidityfrom these sources to meet our current financial obligations during the next12 months.

 

                InJuly 2004, Paragon Systems entered into a modification of its factoringfacility with LSQ which was originally entered into in February 2004.Pursuant to the factoring facility, LSQ will, from time to time, purchasecertain accounts receivable from Paragon Systems at a discount of 1.25% (1.00%after February 9, 2005) and provide to Paragon Systems a professionalaccounts receivable management service for a funds usage fee of prime plus 2.00%on the outstanding funds advanced on the accounts receivable purchased. LSQalso charges us an invoice service fee of 1% depending on days outstanding ofour factored invoices. The factoring facility has a $5.0 million initialpurchase limit and a one-year term which will automatically renew unlessParagon Systems gives 60 days’ prior notice of its intent not to renew.For advances in excess of 85% (90% after July 27, 2004) of eligibleaccounts receivable, an over-advance charge of 0.75% applies. The discount feewas reduced to 1.00% as a result of our successful Initial Public Offering inFebruary 2005. At December 31, 2004, we owe approximately$3.1 million on the factoring agreement.

 

                InJuly 2004, Paragon Systems issued a promissory note to a lender whichallows Paragon Systems to receive cash advances up to $400,000. Paragon Systemsassigned a security interest in various assets of Paragon Systems, includingtwo receivable balances approximating $440,000 in the aggregate. OnDecember 29, 2004, Paragon Systems paid all indebtedness due under thepromissory note. Paragon Systems is not entitled to borrow such amounts in thefuture from the lender.

 

                Ourshort-term cash needs are for working capital, capital expenditures, remainingunpaid transaction costs and liabilities related to the Acquisition of ParagonSystems, which includes principal and interest payments as well as income taxpayments. At December 31, 2004, liabilities related to the Acquisition ofParagon Systems and other long-term debt obligations approximate$15.5 million. Over the next twelve months, we expect to pay outapproximately $8.7 million related to these obligations.

 

 

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                Ourlong-term cash needs are related to the costs of developing and expanding ourbusiness, including capital expenditures, working capital and additionalacquisitions. We expect to meet these cash needs through cash from operations,if any, cash on hand, the net proceeds of our Initial Public Offering after therepayment of all of the Paragon Notes in aggregate principal amount of$7.7 million and payment of all dividends due on our Series CRedeemable Preferred Stock and as well as through possible issuances of equityor debt securities. If we are otherwise unable to obtain additional capital orsell assets, then we may not be able to meet our obligations and growth plans.

 

*Competitive Bidding Process*

 

                Wegenerate substantially all of our revenue from Federal government contractsobtained through a competitive bidding process. We start the bidding processwith a detailed review of the specifications contained in the solicitation forbid. We expend considerable management time on this process. We incur minimalcost other than management time to complete our bid. The process is lengthy andwe may receive one or more revisions to contract specifications which may causeus to adjust our bid. There may also be considerable lapses of time betweenreceipt of initial specifications, receipt of revised specifications, submissionof our bid and contract award. It may take weeks or months after bids aresubmitted for a contract to be awarded. During this time, our only cost ismanagement’s time and out of pocket expenses.

 

                Oncea contract is awarded to us, we purchase uniforms, firearms, communications andother equipment needed to service the contract. For any number of reasons,including protest by our competitors, a contract may be rescinded. In 2003, oneof our contracts was rescinded. We had purchased approximately $80,000 infirearms for use on this contract. We have been able to use a portion of thesefirearms on other contracts. We are also servicing one contract where contractspecifications were changed by the government agency after the award wasapproved, requiring us to incur additional expenditures. Generally, whenadditional requirements are placed on the contractor by the government agency,the contractor is permitted to file a claim to recover these additionalexpenditures. In November and December 2004 we filed claims to recover inexcess of $400,000 of such expenses. In addition, we are currently negotiatingwith the contracting government agency to renew this contract on a profitablebasis. This process is lengthy and requires the use of our cash because we mustfund the expenses during this process in order to properly service thecontract. We have invoiced the agency to recover our cost associated with theforegoing. Because issues relating to our invoices to recover these costs willnot be resolved until some time in the future, we have established a reserve tocover potential non-recovery of these costs. Our contracts are subject toaudits and cost adjustments by the Federal government. We have never beenrequired to reimburse the Federal government for any funds in connection withits audit of our contracts.

 

*Twelve-Month Outlook*

 

                ParagonSystems historically funded its cash requirements during periods of negativecash flow by borrowing on a bank line of credit. The Acquisition of ParagonSystems by Tri-S created substantial cash requirements that we can not meetthrough our normal operations. We used approximately $7.8 million of thenet proceeds of our successful Initial Public Offering to repay all of theParagon Notes in aggregate principal amount of $7.7 million and pay alldividends due on our Series C Redeemable Preferred Stock.

 

                Wewill use a portion of the remaining proceeds from the Initial Public Offeringto pay down our borrowing from LSQ. As a result of paying down the borrowingfrom LSQ, we will avoid substantial fees relating to over-advances from LSQmentioned above.

 

 

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                Webelieve that the cash remaining from our Initial Public Offering combined withcash distributions from the joint venture and cash flow from our operationswill be sufficient to meet our obligations over the next twelve months.

 

**Recent Accounting Pronouncements**

 

                InJanuary 2003, the Financial Accounting Standards Board (“FASB”) issuedFASB Interpretation (“FIN”) 46*, Consolidationof Variable Interest Entities* (“FIN 46”). FIN 46 expands uponexisting accounting guidance that addresses when a company should include inits financial statements the assets, liabilities and activities of a variableinterest entity. The consolidation requirements of FIN 46 apply immediately tovariable interest entities created after January 31, 2003. Theconsolidation requirements apply to older entities in the first fiscal year orinterim period beginning after June 15, 2003. The adoption of FIN 46 didnot have any impact on our financial position or results of operations.

 

                InMay 2003, the FASB issued SFAS No. 150, *Accounting for Certain Financial Instruments with Characteristics ofBoth Liabilities and Equity* (“SFAS No. 150”). The Statementspecifies that instruments within its scope embody obligations of the issuerand that, therefore, the issuer must classify them as liabilities. SFASNo. 150 prohibits entities from restating financial statements for earlieryears presented. SFAS No. 150 became effective for the Company at thebeginning of the third quarter of 2003. We agreed to issue preferred sharessubject to mandatory redemption in conjunction with the Acquisition as morefully discussed in Note 2 to our audited financial statements included elsewherein this Annual Report. The preferred shares subject to mandatory redemption areaccounted for in accordance with SFAS No. 150.

 

                InDecember 2004, the FASB issued SFAS No. 123 (revised 2004), *Share-Based Payment* (“SFASNo. 123R”), which replaces SFAS No. 123, *Accounting for Stock-Based Compensation*, andsupersedes APB Opinion No. 25, *Accountingfor Stock Issued to Employees*. SFAS No. 123R requires all share-basedpayments to employees, including grants of employee stock options, to berecognized in the financial statements based on their fair values beginningwith the first interim or annual period after June 15, 2005, with earlyadoption encouraged. The pro forma disclosures previously permitted under SFASNo. 123 no longer will be an alternative to financial statementrecognition. The Company is required to adopt SFAS No. 123R in the thirdquarter of fiscal 2005, beginning July 1, 2005. Under SFAS 123R, theCompany must determine the appropriate fair value model to be used for valuingshare-based payments, the amortization method for compensation cost andthe transition method to be used at date of adoption. The transition methodsinclude prospective and retroactive adoption options. Under the retroactiveoption, prior periods may be restated either as of the beginning of the year ofadoption or for all periods presented. The prospective method requires thatcompensation expense be recorded for all unvested stock options and restrictedstock at the beginning of the first quarter of adoption of SFAS No. 123R,while the retroactive methods would record compensation expense for allunvested stock options and restricted stock beginning with the first periodrestated. The Company is evaluating the requirements of SFAS No. 123R andthe effect that the adoption of SFAS No. 123R will have on theconsolidated results of operations and earnings per share. The Company has notyet determined the method of adoption.

 

 

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**Risk Factors**

 

**Risks Related to Government Contracting**

 

***We derive allof our revenue from Federal government contracts which the government mayterminate at any time or determine not to extend after their scheduledexpiration. If we are unable to replace any contract which is not extended oris terminated, then our revenues will decline.***

 

                Duringthe twelve months ended December 31, 2004, we derived 100% of our revenuefrom Federal government contracts that typically span one or more base yearsand one or more option years. The option periods may cover more than half ofthe contract’s potential duration. Federal government agencies generally havethe right not to exercise these option periods. In addition, our contractstypically also contain provisions permitting a government customer to terminatethe contract for its convenience, as well as for our default. A decision by agovernment agency not to exercise option periods or to terminate contractscould result in significant revenue shortfalls.

 

                Ifthe government terminates a contract for convenience, then we may recover onlyour incurred or committed costs, settlement expenses and profit on workcompleted prior to the termination. We cannot recover anticipated profit onterminated work. If the government terminates a contract for default, then wemay not recover even those amounts, and instead may be liable for excess costsincurred by the government in procuring undelivered items and services fromanother source.

 

                Wecannot predict if the government will terminate or choose not to extend ourFederal government contracts. The government has never terminated any of ourcontracts; however, it may do so at any time.

 

                Wehave received a cure notice from the U.S. Department of Homeland Security inconnection with one of our contracts pursuant to which we provide contractguard services at various Federal government agencies. The cure notice statesthat we have not been fulfilling our obligations under this contract because wedid not submit certain personnel reports, we did not provide a sufficientnumber of armed guards, and we did not adequately supervise such guards. Webelieve we have taken all steps necessary to fulfill our obligations under thecontract to the satisfaction of the Department of Homeland Security, and onSeptember 24, 2004, the U.S. Department of Homeland Security notified usthat the contract which is the subject of the cure notice has been extendedthrough March 31, 2005. We anticipate that this contract will be furtherextended through September 30, 2005.

 

***Federalgovernment spending priorities may change away from contract guard services orthe Federal government agencies with which we contract may experience budgetcutbacks, either of which would cause the demand for our contract guardservices and our revenues to decline.***

 

                Ourbusiness and revenues depend significantly upon continued Federal governmentexpenditures on contract guard services. While spending authorizations forintelligence and defense related programs by the government have increased inrecent years, and in particular after the September 11, 2001 terroristattacks, future levels of expenditures and authorizations for those programsmay decrease, remain constant or shift to programs in areas where we do notcurrently provide services. Furthermore, the Federal government agencies withwhich we contract are subject to budgetary constraints and may experiencespending reductions or budget cutbacks. A significant decline in governmentexpenditures, a shift of expenditures away from programs for which we provideservices, or spending reductions or budget cutbacks at Federal governmentagencies with which we contract would cause the demand for our contract guardservices and our revenues to decline.

 

 

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***The Federalgovernment has rights and remedies under its contracts not typically found incommercial contracts that may reduce or eliminate our revenue under thesecontracts, as well as our ability to enter into other government contracts.***

 

                Federalgovernment contracts contain provisions and are subject to laws and regulationsthat give the government rights and remedies not typically found in commercialcontracts. As described above, the government may terminate its contracts forconvenience or decline to exercise an option to renew. The government may also:

 

•                  reduce or modifyits contracts or subcontracts;

 

•                  cancelmulti-year contracts and related orders if funds for contract performance forany subsequent year become unavailable; and

 

•                  suspend or debarus from doing business with the Federal government.

 

                Ifthe Federal government were to exercise any of these rights or remedies, thenour revenues would decline.

 

***Our failure tocomply with complex procurement laws and regulations could result in thetermination of our Federal government contracts or our failure to be awardedany new contracts, and changes in laws and regulations could impose added costson our business.***

 

                Wemust comply with and are affected by laws and regulations relating to theformation, administration and performance of Federal government contracts,which affect how we do business with our customers and may impose added costson our business. Among the most significant regulations are:

 

•                  the FederalAcquisition Regulations and other GSA and agency regulations supplemental tothe Federal Acquisition Regulations, which comprehensively regulate theformation, administration and performance of government contracts;

 

•                  the Truth inNegotiations Act, which requires certification and disclosure of all cost andpricing data in connection with contract negotiations;

 

•                  the CostAccounting Standards and Cost Principles, which impose accounting requirementsthat govern our right to reimbursement under certain cost-based governmentcontracts; and

 

•                  laws,regulations and executive orders restricting the use and dissemination ofinformation classified for national security purposes and the exportation ofcertain products and technical data.

 

                Moreover,we are subject to industrial security regulations of the Department of Defenseand other Federal agencies that are designed to safeguard against foreigners’access to classified information. If we were to come under foreign ownership,control or influence, then our Federal government customers could terminate ordecide not to renew our contracts, and it could impair our ability to obtainnew contracts.

 

                Ifwe do not comply with the procurement laws and regulations discussed above,then we may be fined, we may not be reimbursed for costs incurred by us inservicing our contracts, our contracts may be terminated and we may be unableto obtain new contracts, any of which would cause our revenues to decline.

 

***Our status as aGSA Federal Supply Schedule Contractor may be withdrawn, which would make usineligible to obtain certain Federal government contracts and would result in asignificant decrease in our revenues.***

 

                TheGSA secures the buildings, products, services, technology and other workplaceessentials which Federal agencies need to operate. GSA Federal Supply Schedulecontracts are contract vehicles under

 

 

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which Federal government agencies may purchaseprofessional services or products. Federal government agencies may choose toaward contracts only to GSA Federal Supply Schedule contractors to reduce thenumber of qualified bidders and to expedite the bidding process. ParagonSystems has been approved by the GSA as a GSA Federal Supply Schedulecontractor and, therefore, is able to bid on Federal government contracts awardedusing the GSA Federal Supply Schedule. The GSA imposes a 0.75% IndustrialFunding Fee that must be included in our proposed prices and paid to GSA on aquarterly basis upon award of a contract. Currently, four of our contracts withannual revenues of approximately $11.4 million have been procured underthe GSA Federal Supply Schedule. During the year ended December 31, 2004,the revenues on our contracts procured under the GSA Federal Supply Scheduletotaled approximately 37.4% of our consolidated revenues for such period.

 

                Ourstatus as a GSA Federal Supply Schedule contractor may be withdrawn if we donot comply with the complex procurement laws and regulations applicable to us.We continually review and monitor our compliance with these laws and regulationsas well as modifications to the GSA Federal Supply Schedule affecting ourbusiness. We believe that we are currently in material compliance with theselaws, regulations and modifications; however, if we are not in compliance andour status as a GSA Federal Supply Schedule contractor is withdrawn, then wemay not be able to obtain new contracts with Federal government agencies orrenew our existing contracts which have been procured under the GSA FederalSupply Schedule. If we are unable to obtain new Federal government contracts orrenew our existing contracts, then our revenues will decline significantly.

 

***All of ourcontracts are subject to audits and cost adjustments by the Federal governmentthat could result in decreased revenues and the imposition on us of civil orcriminal penalties or administrative remedies.***

 

                Wegenerate 100% of our revenue from Federal government contracts, each of whichis subject to audit by the Federal government. In these audits, the Federalgovernment audits and reviews our performance, pricing practices, coststructure and compliance with applicable laws, regulations and standards. Likemost government contractors, our direct and indirect contract costs are auditedand reviewed on a continual basis. Many of the audits for costs incurred orwork performed in recent years remain ongoing or have not yet commenced. Inaddition, non-audit reviews by the government may still be conducted on all ourgovernment contracts. An audit of our work, including an audit of work performedby companies we may acquire, could result in a substantial adjustment to ourrevenue because any costs found to be improperly allocated to a specificcontract will not be reimbursed and revenue we have already recognized may needto be refunded. Since 1997, we have not been required to reimburse the Federalgovernment agencies with which we contract any funds as a result of audits. Ifa government review or investigation uncovers improper or illegal activities,then we may be subject to civil and criminal penalties and administrativesanctions, including termination of contracts, forfeiture of claims andprofits, suspension of payments, treble damages, statutory penalties, fines andsuspension or debarment from doing business with Federal government agencies,any of which would cause a significant decline in our revenue.

 

***Restrictions onor other changes to the Federal government’s use of service contracts couldsignificantly reduce the demand for our services and cause our revenue todecline.***

 

                Thegovernment may face restrictions from new legislation, regulations orgovernment union pressures on the nature and amount of services the governmentmay obtain from private contractors. For example, the Truthfulness,Responsibility and Accountability in Contracting Act, proposed in 2001, wouldhave limited and severely delayed the government’s ability to use privateservice contractors.

 

                Althoughthis proposal was not enacted, it or similar legislation could be proposed atany time. Any reduction in the government’s use of private contractors toprovide services could significantly reduce the demand for our services andcause our revenues to decline.

 

 

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***Ourparticipation in the competitive bidding process, from which we derivesignificant revenue, presents a number of risks.***

 

                Duringthe year ended December 31, 2004, we derived substantially all of ourrevenue from Federal government contracts that were awarded through acompetitive bidding process. Most of the business that we expect to seek fromthe Federal government in the foreseeable future likely will be awarded throughcompetitive bidding. Competitive bidding presents a number of risks, includingthe:

 

•                  need to bid onprograms in advance of finalizing the services to be provided, which may resultin unforeseen difficulties and cost overruns;

 

•                  substantial costand managerial time and effort that we spend to prepare bids and proposals forcontracts that may not be awarded to us;

 

•                  need toaccurately estimate the resources and cost structure that will be required toservice any contract we are awarded; and

 

•                  expense anddelay that may arise if our competitors protest or challenge contract awardsmade to us pursuant to competitive bidding, which could result in theresubmission of bids on modified specifications or in termination, reduction ormodification of the awarded contract.

 

                TheFederal government rescinded one contract that was originally awarded to us forcontract guard services because the Department of Homeland Security had imposedadditional requirements for the contract with respect to the services to beprovided. We anticipate that the Federal government will re-solicit bids forthe contract, and we will likely incur costs and consume resources in resubmittingour bid. There is no guarantee that we will ultimately be awarded the contract.

 

                Ifwe are unable to win particular contracts that are awarded through thecompetitive bidding process, we may not be able to operate in the market forservices that are provided under those contracts for a number of years. If weare unable to consistently win new contract awards over any extended period,then we will not be able to grow our business, and our business, financialcondition and results of operations will be materially and aversely affected.

 

***Paragon Systemsis no longer certified as an 8(a) firm. As a result, we are no longer eligibleto bid on certain contracts, and it may be more difficult for us to wincontracts through the competitive bidding process.***

 

                TheSBA administers business assistance programs for small disadvantaged businesseswhich it certifies as “8(a) firms.” Firms certified as 8(a) firms havestreamlined contracting processes with certain Federal government agencies andotherwise enjoy certain competitive advantages in the competitive biddingprocess, one of which is that Federal acquisition policies encourage Federalgovernment agencies to award a certain percentage of their contracts to 8(a)firms. Certification as an 8(a) firm is valid for a period of nine years.Paragon Systems was certified as an 8(a) firm in September 1993, and suchcertification expired in September 2002. Consequently, we no longer enjoythe competitive advantages we once had as an 8(a) firm, we are no longer eligibleto bid on certain contracts, and it may be more difficult for us to wincontracts through the competitive bidding process.

 

***Our cash flowmay be reduced due to significant expenses we may incur in connection withattempting to obtain Federal government contracts.***

 

                Asignificant portion of Federal government contracts for contract guard servicesis awarded through a competitive bid process. As stated above, substantialcosts may be incurred in connection with preparing bids. In the past we havenot, and most likely in the future will not, be awarded all the contracts onwhich we bid. Furthermore, if and when we do obtain a contract, we aregenerally required to start providing services pursuant to such contract nolater than 30-45 days after the contract is awarded. As a result, we mayincur significant start-up expenses. The costs of bidding on contracts

 

 

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and the start-up costs associated with new contracts wemay obtain may significantly reduce our cash flow and liquidity.

 

***It may bedifficult for us to achieve and maintain profitability because our Federalgovernment contracts have low profit margins.***

 

                Allof our existing Federal government contracts have low profit margins becausethe competitive bidding process pursuant to which such contracts are awardedforces bidders for such contracts to compete primarily on price. Generally,larger contracts have even lower profit margins because they attract a greaternumber of bidders which, in turn, increases the price-based competition.If we underestimate our costs in performing the services under any of ourcontracts, especially our larger contracts, then our profit margin on suchcontract would be further reduced, which will make it more difficult for us toachieve and maintain profitability.

 

***The long salescycles of Federal government contracts make it difficult for us to predict ourfinancial results and cause us to expend a significant amount of effort andfunds in bidding on contracts that are not awarded to us.***

 

                Thesales cycle of a Federal government contract is often lengthy due to theprotracted bid and approval process. Typically, many months may elapse betweenthe time the Federal government solicits a bid for a contract and the time thecontract is awarded. The lengthy sales cycles of our contracts make forecastingthe volume and timing of contracts we may obtain difficult. During this period,we will generally expend substantial funds and management resources butrecognize no associated revenue.

 

***We may notreceive the full amount authorized under contracts into which we have entered;consequently, our backlog may not accurately estimate our revenue.***

 

                Themaximum contract value specified under a government contract that we enter intois not necessarily indicative of revenue that we will realize under thatcontract. In fact, even if we enter into a government contract, we will not bepaid for our services unless the Federal government has appropriated orbudgeted the funds for such contract. Congress often appropriates funds for aparticular program on a yearly basis, even though the contract may call forperformance that is expected to take a number of years. As a result, contractstypically are only partially funded at any point during their term, and all orsome of the work to be performed under the contracts may remain unfunded unlessand until Congress makes subsequent appropriations and the procuring agencyallocates funding to the contract. As described above, most of our existingcontracts are subject to modification and termination at the Federal government’sdiscretion. Moreover, there is no assurance that any contract included in ourestimated contract value that generates revenue will be profitable.Nevertheless, we look at these contract values, including values based on theassumed exercise of options relating to these contracts, in estimating theamount of our backlog. Because we may not receive the full amount we expectunder a contract, our backlog may not accurately estimate our revenue.

 

***If we areunable to obtain and maintain security clearances for our employees, then wewill not be able to satisfy existing contracts or obtain new contracts.***

 

                Manyof our Federal government contracts require our employees to maintain variouslevels of security clearances, and we are required to maintain certain facilitysecurity clearances complying with Federal government requirements. Obtainingand maintaining security clearances for employees involve a lengthy process,and it is difficult to identify, recruit and retain employees who already holdsecurity clearances. If our employees are unable to obtain or retain securityclearances or if our employees who hold security clearances terminateemployment with us, then the customer whose work requires cleared employeescould terminate the contract or decide not to renew it upon its expiration. Inaddition, we expect that many of the contracts on which we will bid willrequire us to demonstrate our ability to obtain facility security clearancesand perform work with employees who hold specified types of security

 

 

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clearances. To the extent we are not able to obtainfacility security clearances or engage employees with the required securityclearances for a particular contract, we may not be able to satisfy ourexisting contracts, bid on or win new contracts or effectively re-compete onexpiring contracts or follow-on task orders. To the extent we are unable to doany of the foregoing, our existing contracts may be terminated, we will not beable to grow our business and our revenues may decline.

 

**Risks Relating to our Business and theSecurity Industry**

 

***We depend onfactoring to meet our cash flow needs, which reduces our already low profitmargin.***

 

                Wehave entered into a factoring facility with LSQ pursuant to which LSQ, fromtime to time, purchases certain accounts receivable from us at a discount of1.25% with a funds usage fee of prime plus .75% on the outstanding fundsadvanced on the accounts receivable purchased. This discount and usage feefurther reduces the already low profit margins on our Federal governmentcontracts.

 

                Wecannot, however, cease factoring our receivables because the funds provided byLSQ are necessary to satisfy our cash flow needs. In fact, we generally utilizethe factoring arrangement to the maximum extent permitted by LSQ whichhistorically has allowed us to factor substantially all of our accountsreceivable. Since we entered into the factoring facility with LSQ, we haveborrowed approximately $31.9 million, repaid approximately$28.7 million through December 31, 2004 and owe at December 31,2004 approximately $3.2 million. Based on the operating activity generatedby our current contracts, we do not believe we will need any additional cash tocontinue our operations for the next 12 months. We believe that if LSQwere to cease to be our factor, then we would be required to replace LSQ withanother factor or lender in order to maintain our cash flow, which we believewe would be able to do upon commercially reasonable terms. Our obligations toLSQ are secured by a lien on all of our assets; consequently, if we areliquidated, then there may not be any assets available for distribution toshareholders or creditors other than LSQ.

 

***The amount ofcompensation paid to the executive officers of Tri-S and Paragon Systems issubstantial and decreases the funds available to operate and grow our business.***

 

                Forthe year ended December 31, 2004, we paid approximately $1.4 millionin compensation to the executive officers of Tri-S and Paragon Systems. See “ExecutiveCompensation.” Although (i) our chief executive officer has reduced hissalary from $254,000 in 2004 to $175,000 in 2005 and (ii) the employmentagreements we had with Paragon Systems’ President and Executive Vice President,who earned compensation in 2004 of $207,693 and $184,429, respectively, expiredin February 2005, we expect our compensation expenses to continue to besubstantial. These expenses decrease the funds available to operate and growour business.

 

***Declines in thefair values of intangible assets resulting from the Acquisition could result infuture impairment charges which could adversely affect the market value of oursecurities and our results of operations.***

 

                As aresult of the Acquisition, goodwill in the amount of $7.7 million andother intangible assets in the amount of $1.9 million have been created.We based these values on an independent appraisal of our intangible assets. Ifthe appraisal proves to be inaccurate, or if the fair values decline in thefuture, then ongoing reviews of the carrying values of such goodwill and otherintangible assets may indicate impairments which will require us to record animpairment charge in the period in which we identify the impairments. If we arerequired to record an impairment charge, then our expenses in the period inwhich we identify the impairments will increase in an amount equal to thereduction in carrying value of such goodwill and other intangible assets. Animpairment charge will not change our cash position; however, it couldmaterially increase our expenses, may cause the market value of our securitiesto decline and may harm our results of operations.

 

 

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***Because we havea highly concentrated customer base, the loss of any of our customers couldhave a significant effect on our revenues.***

 

                Wehave a total of ten customers and thirteen contracts. We provide contract guardservices for eight of our customers and logistics services for our other twocustomers. Two of our contract guard customers have two contracts with us.Furthermore, we derive 80% of our consolidated revenue from contracts with fiveof our customers. If any of our current customers determines not to renew orterminate its contract, then our revenues may significantly decline.

 

***If we areunable to obtain new contracts and renew existing contracts, then our revenueswill significantly decline.***

 

                ParagonSystems obtained a new contract in September 2004. Prior to such time,Paragon Systems had not obtained a new contract since October 2003 andhistorically has generated revenue by renewing existing contracts. We havehired a consulting firm to assist us in identifying new contracts with Federalgovernment agencies available for bid or otherwise open to negotiatedcontracting. Failure to obtain new contracts or renew existing contracts willcause our revenues to decline significantly.

 

***If we cannotsuccessfully compete with new or existing contract security service providers,then our business will suffer and our revenues will decline.***

 

                Thesecurity industry is highly competitive. Certain of our competitors, such asCoastal International Security and Wackenhut/Alletug, are significantly largerthan we are and have significantly greater financial and marketing resourcesand name recognition than we do. Additionally, certain of our smallercompetitors, such as Alpha Protective Services and Security Consultants Group,are focusing on market opportunities similar to market opportunities on whichwe focus. Although we believe that, especially with respect to certain markets,we enjoy a favorable competitive position because of our emphasis on customerservice, supervision and training and that are able to compete on the basis ofthe quality of our service, personal relationships with customers andreputation, we may not be able to maintain a competitive position in theindustry. If we cannot successfully compete with new or existing contract guardservice providers, then our business will suffer and our revenues will decline.

 

***Terroristactivity at facilities at which we provide guard services could expose us toliability for the results of such activity.***

 

                Ifany of the facilities at which we provide guard services is attacked byterrorists in the future, liabilities imposed upon us for death or damagesresulting from our negligence or breach of contract in connection with suchattacks could, to the extent not covered by insurance, have a material adverse effecton our business, financial condition and results of operations. We currentlymaintain insurance with coverage limits of $1.0 million per occurrence and$5.0 million in the aggregate.

 

***We may beunable to obtain liability insurance at a reasonable cost, which would increaseour exposure to catastrophic claims.***

 

                Insurancepremiums have increased substantially since the terrorist attacks onSeptember 11, 2001. If certain coverages are unavailable at premiumsdeemed reasonable by management, our exposure for catastrophic claims would beincreased.

 

***If we areunable to recruit, retain and manage security guards, then our business willsuffer because we will not be able to service our contracts or get newcontracts.***

 

                Ourbusiness involves the delivery of contract guard services and is labor-intensive.As of December 31, 2004, we employed over 725 guards. Our futureperformance depends in large part upon our ability to recruit, train and retainguards.

 

 

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                Qualifiedguards are in demand, particularly after the terrorist activity which occurredon September 11, 2001, and there is significant competition for theseindividuals from other security firms, government agencies and other similarenterprises. As a result, we may not be able to recruit and retain sufficientnumbers of these individuals in the future. Turnover of contract guards issignificant. The loss of the services of, or the failure to recruit, asignificant number of skilled guards would materially and adversely affect ourbusiness, financial condition and results of operations, including our abilityto secure and complete service contracts. Furthermore, if we do notsuccessfully manage our existing guards, then they may not be able to achievethe anticipated billing rates, engagement quality, level of overtime and otherperformance measures that are important to our business.

 

***Our securityguards may conduct improper searches and seizures of third persons or mayotherwise engage in misconduct or other improper activities that would cause usto incur liability and to pay significant judgments or settlements.***

 

                Oursecurity guards in the scope of their employment may stop and search thirdpersons and may or may not have justification to do so, which may also resultin harm or injury to such third parties or otherwise cause us to incur damagesor liability. Additionally, we are exposed to the risk that employee fraud orother misconduct could occur. Misconduct by employees could include intentionalfailures to comply with government procurement regulations and failure todisclose unauthorized activities to us. Employee misconduct could also involvethe improper use of our customers’ sensitive or classified information, whichcould result in regulatory sanctions and cause serious harm to our reputation.Although we believe that we hire security guards with the relevant experience,appropriate background and the intellectual, emotional and physicalcapabilities necessary to provide quality guard services and that wesufficiently train them to provide such services, our screening and hiringprocesses may be inadequate or flawed. It is not always possible to identifyand deter employee misconduct, and the precautions we take to detect andprevent this activity may not be effective in controlling unknown or unmanagedrisks or losses.

 

                Ifour security guards improperly discharge their firearms, engage in impropersearches and seizures or otherwise engage in misconduct or other improperactivities, then we may be liable for the resulting harm or damage and may berequired to pay significant judgments or settlements.

 

***Our costs mayincrease and we may not be able to pass the increase on to our customers in atimely fashion which would reduce our liquidity and cash flow.***

 

                Ourlargest expense is wages. The majority of our contracts provide for payments ofeither fixed fees or fees that increase by only small amounts during theirterms. Competitive pressures also prevent us from raising our fees whencontracts are renewed. Even in situations where we can raise our fees, the timeat which we are able to raise and subsequently collect such additional feeswill most likely lag behind the time we are forced to increase wages andsalaries. If, due to inflation or other causes, we must increase the wages andsalaries of our employees at rates faster than we can increase the fees chargedunder such contracts, then our liquidity and cash flow would be reduced.

 

***We are subjectto government regulation, and our failure or inability to comply with theseregulations could materially restrict our operations and subject us tosubstantial penalties.***

 

                Weare subject to a significant number of city, county and state occupationallicensing laws that apply to security services. Most states have laws requiringqualification, training and registration of security officers, regulating theuse of identification cards, badges and uniforms and imposing minimum bondsurety or insurance standards. While we believe that we are currently inmaterial compliance with all such laws, we may not be able to maintain suchcompliance. Furthermore, governmental entities may amend or change such laws ina manner which is detrimental to us. Any liability we may have from our failureto comply with these laws may materially and adversely affect our business byrestricting our operations and subjecting us to substantial penalties. In addition,our current and future

 

 

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operations may be subject to additional regulation as aresult of, among other factors, new statutes and regulations and changes in themanner in which existing statutes and regulations are or may be interpreted.

 

***We may not beable to develop and expand our business through the implementation of our acquisitionstrategy as we intend because such strategy involves certain risks.***

 

                Weintend to develop and expand our business through selective acquisitions ofsecurity system integrators, guard companies and other complementarybusinesses. We may not be able to identify, acquire or profitably manageadditional companies or assets or successfully integrate such additionalcompanies or assets without substantial costs, delays or other problems. Inaddition, companies we may acquire may not be profitable at the time of theiracquisition or may not achieve levels of profitability that would justify ourinvestment. Acquisitions may involve a number of special risks, includingadverse short-term effects on our reported operating results, diversion ofmanagement’s attention, dependence on retaining, hiring and training keypersonnel, risks associated with unanticipated problems or legal liabilitiesand amortization of acquired intangible assets, some or all of which could harmour results of operations.

 

***We may nothave, or be able to obtain, sufficient capital to implement our acquisitionstrategy.***

 

                Ouracquisition strategy will require substantial capital. Such capital may beobtained by borrowings under credit facilities, through the issuance oflong-term or short-term indebtedness or through the issuance of equitysecurities in private or public transactions. This could result in dilution ofexisting equity positions and increased interest expense. We may not be able toobtain financing for future acquisitions on suitable terms, if at all.

 

                Furthermore,executing our acquisition strategy may be more expensive than we anticipatebecause the purchase price for acquisition targets may increase due to recentmergers and other transactions recently completed in the security industry andthe growing interest in future mergers and consolidations. If the purchaseprice for acquisition targets we find appealing increases, then we will needmore capital than we anticipate to execute our acquisition strategy or we maynot be able to execute our acquisition strategy at all.

 

***We may not beable to obtain additional financing that may be necessary to fund or expand ouroperations.***

 

                Inorder to fund and expand our operations, increase revenues and acquire certaincompanies in connection with our acquisition strategy, additional financingwill be required, which additional financing may not be available to us oncommercially reasonable terms, if at all. We may not be successful in raisingadditional capital, and the proceeds of any future financings may not besufficient to meet our future capital needs. We may need to seek additionalfinancing sooner than we anticipate as a result of any of the followingfactors:

 

•                  changes inoperating plans;

 

•                  acceleration ofour expansion plans;

 

•                  lower thananticipated sales;

 

•                  increased costsof expansion;

 

•                  increasedoperating costs; or

 

•                  potentialacquisitions.

 

 

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***Our financialresults could be adversely affected by changes in accounting rules governingthe recognition of stock-based compensation expense, which would reduceour income or increase our losses.***

 

                Ourfinancial results could be affected by changes in the accounting rulesgoverning the recognition of stock-based compensation expense. We measurecompensation expense for our employee stock options in accordance with theprovisions of Accounting Principles Board Opinion No. 25, “*Accounting for Stock Issued to Employees*.”We measure stock-based compensation expense as the excess of the marketprice on date of grant over the amount of the grant. Since we grant all stock-basedcompensation at the market price on the date of grant, no compensation expenseis recognized. As permitted, we have elected to adopt only the disclosure provisionsof SFAS No. 123, *Accounting for Stock-BasedCompensation.*

 

                Wehave determined pro forma amounts as if the fair value method required by SFASNo. 123, *Accounting for Stock-BasedCompensation*, had been applied to its stock-basedcompensation. The fair value of stock options was estimated on the date ofgrant using the Black-Scholes option pricing model. Had we accounted forour compensation expense under the fair value method of accounting prescribedby SFAS No. 123, we would have had to record a charge of $2,000 in 2002and $1,000 in 2003. The pro forma effect on the net loss of the Company for theyear ended December 31, 2004 and for the net loss of Tri-S, the SuccessorCompany, for the years ended December 31, 2003 as if the fair value ofstock-based compensation had been recognized as compensation expense on astraight-line basis over the vesting period of the stock option or purchaseright was as follows:

 

| ** **                                                                 | ** ** | **2004**               | ** ** | **2003** | ** ** | **2002** | ** ** |
|----------------------------------------------------------------------------|------------|------------------------|------------|----------|------------|----------|------------|
|                                                                       |       | **(restated, Note 2)** |       |     |       |     |       |
| Net loss attributable to common shareholders:                              |       |                   |       |     |       |     |       |
| As reported                                                                |       | $                      | (627       | )        | $          | (217     | )          | $ | (136 | ) |
| Pro forma                                                                  |       | $                      | (627       | )        | $          | (218     | )          | $ | (138 | ) |
| Basic and diluted net loss per share attributable to common  shareholders: |       |                   |       |     |       |     |       |
| As reported                                                                |       | $                      | (0.76      | )        | $          | (0.26    | )          | $ | (0.17 | ) |
| Pro forma                                                                  |       | $                      | (0.76      | )        | $          | (0.26    | )          | $ | (0.17 | ) |

 

                Theweighted-average estimated fair value of options granted during 2002 was$0.03 per share. For purposes of computing the pro forma amount above, theminimum value of the options was calculated using a volatility factor of zero,an estimated option life of seven years and a risk-free interest rateassumption of 4.84%.

 

***Compliance withthe new corporate governance requirements to which we are now subject as apublic company will cause us to incur significant costs, and the failure tocomply with such requirements will expose us to investigations and sanctions byregulatory authorities.***

 

                Weface new corporate governance requirements under the Sarbanes-Oxley Actof 2002 (“Sarbanes-Oxley”), as well as new rules and regulationssubsequently adopted by the SEC, the Public Company Accounting Oversight Boardand The Nasdaq Stock Market. These laws, rules and regulations continue toevolve and may become increasingly stringent in the future.

 

                Inparticular, we will be required to include the management and auditor reportson internal control as part of our annual report for the year endingDecember 31, 2006 pursuant to Section 404 of Sarbanes-Oxley.Although we believe we have adequate internal control procedures in place, weare in the process of evaluating our internal controls systems in order(i) to allow management to report on, and our independent auditors toattest to, our internal controls, as required by these laws, rules andregulations, (ii) to provide reasonable assurance that our public disclosurewill be accurate and complete, and (iii) to help ensure that we will beable to comply with the other provisions of Section 404 of Sarbanes-Oxley.We cannot be certain as to the timing of the completion of our evaluation,testing and remediation actions or the impact of the same on our operations. Ifwe are not

 

 

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able to implement the requirements relating to internalcontrols and all other provisions of Section 404 in a timely fashion orotherwise achieve adequate compliance with such requirements, then we might besubject to sanctions or investigation by regulatory authorities, such as theSEC or The Nasdaq Stock Market. Any such action may materially adversely affectour reputation, financial condition and the value of our securities, includingour common stock. In addition, we expect that these laws, rules and regulationswill increase our legal and financial compliance costs and make certaincorporate governance activities more difficult, time-consuming and costly. Wealso expect that these new requirements will make it more difficult andexpensive for us to obtain director and officer liability insurance.

 

***If ourprofessional reputation is harmed, then we will have difficulty obtaining newcustomers and retaining existing customers, either of which would adverselyaffect our revenues.***

 

                Wedepend upon our reputation and the individual reputations of our seniorprofessionals to obtain new customers and retain existing customers. Any factorthat diminishes our reputation or the individual reputations of our seniorprofessionals, including an ineffective response to terrorist activity orbreach of security at any location we service, will make it more difficult forus to compete successfully for new customers or to retain existing customersand, therefore, would adversely affect our revenues.

 

***Economicdownturns or recessions may dampen the demand for our services, which willreduce our revenues.***

 

                Duringeconomic declines, some decisions to implement security programs and installsystems may be deferred or cancelled. In other cases, customers may increasetheir purchases of security systems because they fear more inventory shrinkageand theft will occur due to increasing economic need. We are not able accuratelyto predict to what extent an economic slowdown will decrease the demand for ourservices. If demand for our services decreases, then our revenues will decline.

 

***Our business ofproviding contract guard services exposes us to liability resulting from actsor omissions of our contract guards.***

 

                Ifwe fail to screen for and recruit qualified security guards or if we fail tosufficiently train our security guards, then such failures could result in ourinability to provide the services we have been contracted to provide or in oursecurity guards causing harm to third parties through improper use or dischargeof firearms, improper search and seizure, or other misconduct, which wouldexpose us to liability. Agreements to provide security products and servicestypically contain provisions which limit liability to customers in an attemptto reduce this risk. However, in the event of litigation with respect to suchmatters, there is no assurance that these limitations will be enforced, and thecosts of such litigation could have a material adverse effect on our operatingresults. We also maintain insurance coverage that we believe is appropriate forour liability risks. We have never had a judgment issued against us inconnection with acts or omissions of our employees, and we have never paid anysettlement in connection with any such acts or omissions in excess of $20,000.Nonetheless, claims or lawsuits brought against us could allege substantialdamages that, if awarded and ultimately paid, could increase our expenses andadversely affect our operating results.

 

***Our ownershipand use of firearms exposes us to liability and criminal penalties.***

 

                Ourbusiness requires that we own firearms and that these firearms be used by ourcontract guards. If our security guards improperly discharge or otherwiseimproperly handle their firearms in the scope or outside the scope of theiremployment, harm or injury to third parties may result. We may be held liablefor such harm or injury and this could materially and adversely affect ourbusiness, financial condition and results of operations. Furthermore, we maylose our license as a firearm distributor and may be exposed to criminalpenalties.

 

 

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                Weare subject to Federal laws and regulations relating to the distribution anduse of firearms. We must maintain procedures to ensure that we comply withthese laws and regulations. As discussed previously, a firearm was stolen fromone of our security guards servicing one of our contracts and the U.S.Department of Homeland Security has asserted that we did not comply withappropriate procedures in connection with such theft. If we are unable tomaintain and create procedures with respect to our distribution and use offirearms which comply with applicable Federal laws and regulations, then wewill not be able to fulfill our contracts with Federal agencies and may bebanned from obtaining or renewing Federal government contracts, and ourrevenues would decline significantly.

 

**Risks Relating to Our Securities**

 

***Managementbeneficially owns a significant percentage of our common stock and has theability to influence all matters requiring the approval of our board ofdirectors and our shareholders.***

 

                Managementowns shares of our common stock which represents approximately 25% of thecombined voting power of our outstanding capital stock. Management has thepower to influence the election of our directors and all decisions made by ourshareholders and, in general, to influence the outcome of any corporatetransaction or other matter submitted to the shareholders for approval,including mergers, consolidations and the sale of all or substantially all ofour assets. The interests of management may conflict with the interests of ourother shareholders.

 

***Provisions ofour articles of incorporation and Georgia law may have anti-takeover effectsthat could prevent a change in control which the shareholders considerfavorable and could negatively affect your investment.***

 

                Provisionsin our articles of incorporation and our bylaws could delay or prevent a changeof control of the Company or a change in our management that would provideshareholders with a premium to the market price of their common stock. Ourarticles of incorporation currently authorize the issuance of 10,000,000 sharesof our preferred stock. Our board of directors has the power to issue any orall of these additional shares without shareholder approval, and such sharescan be issued with such rights, preferences and limitations as may bedetermined by our board of directors. The rights of the holders of common stockwill be subject to, and may be adversely affected by, the rights of any holdersof preferred stock that may be issued in the future. We presently have nocommitments or contracts to issue any shares of preferred stock. Authorized andunissued preferred stock could delay, discourage, hinder or preclude anunsolicited acquisition of the Company, could make it less likely thatshareholders receive a premium for their shares as a result of any such attemptand could adversely affect the market price of, and the voting and otherrights, of the holders of outstanding shares of common stock. Currently, wehave outstanding 100 shares of our Series C Redeemable Preferred Stock.Our articles of incorporation and bylaws also contain provisions that:

 

•                  create aclassified board of directors that prevents a majority of the board from beingelected at one time;

 

•                  prohibitcumulative voting in the election of directors, which would otherwise allowless than a majority of shareholders to elect director candidates;

 

•                  limit theability of shareholders to call special meetings of shareholders; and

 

•                  establishadvance notice requirements for nominations for election to the board ofdirectors or for proposing matters that can be acted upon by shareholders atshareholder meetings.

 

***We mayexperience significant volatility in the price of our common stock even if ourbusiness is doing well, which could cause you to lose all or part of your investment.***

 

                Thestock markets have experienced extreme price and volume fluctuations that haveaffected and continue to affect the market prices of equity securities of manycompanies. These fluctuations often have been unrelated or disproportionate tothe operating performance of those companies. The market

 

 

36

----

 

price of our common stock may also fluctuate as a resultof variations in our operating results. In addition, because there has been nomarket for our common stock prior to this Initial Public Offering, we cannotpredict the extent to which investor interest in our common stock will lead tothe development of an active trading market or how liquid that market mightbecome. If the trading volume of our common stock is low, then the fluctuationsin the overall stock market could be exaggerated in the price of our commonstock. In addition, due to the nature of our business, the market price of ourcommon stock may fall in response to a number of factors, some of which arebeyond our control, including:

 

•                  announcements ofcompetitive developments by us or others;

 

•                  changes inestimates of our financial performance or changes in recommendations bysecurities analysts;

 

•                  any loss by usof a major customer;

 

•                  additions ordepartures of key management or other personnel;

 

•                  our failure tomeet financial analysts’ performance expectations or

 

•                  guidance weprovide;

 

•                  future sales ofour common stock or preferred stock;

 

•                  volumefluctuations;

 

•                  acquisitions orstrategic alliances by us or our competitors;

 

•                  our historicaland anticipated operating results;

 

•                  quarterlyfluctuations in our financial and operating results;

 

•                  changes inmarket valuations of other companies that operate in our

 

•                  business marketsor in our industry;

 

•                  lack of adequatetrading liquidity as a public company; and

 

•                  general marketand economic conditions.

 

                Accordingly,market fluctuations, as well as general economic, political and marketconditions such as recessions and interest rate changes, may negatively impactthe market price of our common stock, and you may not be able to sell yourshares without incurring a loss.

 

***We do notintend to pay dividends on our common stock, and you may not experience areturn on investment without selling your securities.***

 

                Wehave never declared or paid, nor do we intend in the foreseeable future todeclare or pay, any cash dividends on our common stock. Because we intend toretain all future earnings to finance the operation and growth of our business,you will likely need to sell your securities in order to realize a return onyour investment, if any. We are obligated to pay dividends on our outstandingshares of Series C Redeemable Preferred Stock equal to 5% of theredemption value per annum (or $300,000 per year on 100 shares of Series CRedeemable Preferred Stock).

 

 

37

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**Item 8. Financial Statements andSupplementary Data**

 

                Thefinancial statements required to be filed with this Annual Report are filedunder Item 15 hereof and are listed on the “Index to Financial Statements” onpage F-1 hereof.

 

                Thesupplementary financial data required to be included in this Annual Report isincluded in Note 14 of the Notes to Financial Statements, which are listedon the “Index to Financial Statements” on page F-1 hereof.

 

**Item 9A. Controls and Procedures**

 

In theOriginal Report, our Chief Executive Officer and Chief Financial Officerconcluded that, as of the end of the period covered by the Annual Report, ourdisclosure controls and procedures (as such term is defined in Rules 13a-15(e)or 15d-15(e) of the Exchange Act) were effective. This conclusion was reachedafter our Chief Executive Officer and Chief Financial Officer evaluated ourdisclosure controls and procedures as of the end of the period covered by theAnnual Report, as required by paragraph (b) of Rules 13a-15 or 15d-15 ofthe Exchange Act.

 

Inconnection with preparing the restated consolidated financial statementsincluded in the Amendment, our Chief Executive Officer and Chief FinancialOfficer further evaluated our disclosure controls and procedures as of the endof the period covered by the Annual Report and concluded that such disclosurecontrols and procedures were ineffective because in the Original Report weaccounted for our 10% equity interest in Army Fleet Support in accordance withcost method of accounting rather than the equity method of accounting.

 

During the quarter ended December 31, 2004, there wasnot any change in our internal control over financial reporting identified inconnection with the evaluation required by paragraph (d) of Rules 13a-15 or15d-15 of the Exchange Act that has materially affected, or is reasonablylikely to materially affect, our internal control over financial reporting.

 

**PART III**

 

**Item 15. Exhibits, Financial StatementSchedules and Reports on Form 8-K**

 

                (a)*           Listsof certain documents filed herewith as part of this Annual Report may be foundas follows:*

 

                                                                (1)           A list of the consolidated financialstatements required to be filed as a part of this Annual Report is shown in the“Index to Consolidated Financial Statements “on page F-1.

 

                                                                (2)           A list of the exhibits required byItem 601 of Regulation S-K to be filed as a part of this Annual Report isshown on the “Exhibit Index” filed herewith.

 

                (b)*           Reportson Form 8-K.*

 

                Duringthe quarter ended December 31, 2004, the Company was not subject to therequirements of the Exchange Act and, consequently, did not file any CurrentReports on Form 8-K.

 

 

38

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**INDEX TO FINANCIAL STATEMENTS**

 
| ** **                                                    | ** ** | ** ** | ** ** |
|---------------------------------------------------------------|------------|------------|------------|
| **Tri-S Security  Corporation and Subsidiary:**               |       |       |       |
| **Reports  of Independent Registered Public Accounting Firm** |       |       |       |
| **Financial Statements:**                                     |       |       |       |
| Balance Sheets                                                |       |       |       |
| Statements  of Operations                                     |       |       |       |
| Statements of Shareholders’ Equity                       |       |       |       |
| Statements  of Cash Flows                                     |       |       |       |
| **Notes to  Financial Statements**                            |       |       |       |

 

 

F-1

----

 

**Report of Independent RegisteredPublic Accounting Firm**

 

**To the Board of Directors andStockholders**

**Tri-S Security Corporation**

 

                Wehave audited the accompanying consolidated balance sheet of Tri-S SecurityCorporation and subsidiary as of December 31, 2004 and the relatedstatements of operations, shareholders’ equity and cash flows for the year thenended. These financial statements are the responsibility of the Company’smanagement. Our responsibility is to express an opinion on these financialstatements based on our audit.

 

                Weconducted our audit in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Those standards require that weplan and perform the audit to obtain reasonable assurance about whether thefinancial statements are free of material misstatement. An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements. An audit also includes assessing the accountingprinciples used and significant estimates made by management, as well asevaluating the overall financial statement presentation. We believe that ouraudit provides a reasonable basis for our opinion.

 

                Inour opinion, the financial statements referred to above present fairly, in allmaterial respects, the consolidated financial position of Tri-S SecurityCorporation and subsidiary of December 31, 2004, and the results of theiroperations and their cash flows for year then ended in conformity withaccounting principles generally accepted in the United States.

 

                As discussed inNote 2 to the financial statements, the accompanying 2004 consolidatedfinancial statements have been restated.

 

/s/ Miller Ray Houser & Stewart LLP

 

Atlanta, Georgia

March 15, 2005 (except for Note 2, as to whichthe date is November 15, 2005)

 

 

F-2

----

 

**Report of Independent RegisteredPublic Accounting Firm**

 

**To the Board of Directors andStockholders**

**Tri-S Security Corporation**

 

                Wehave audited the accompanying balance sheet of Paragon Systems, Inc.(predecessor company to Tri-S Security Corporation) as of December 31,2003 and the related statements of operations, shareholders’ equity and cashflows for each of the two years in the period ended December 31, 2003 andthe statements of operations, shareholders’ equity and cash flows for theperiod from January 1, 2004 to February 27, 2004. These financialstatements are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these financial statements based onour audits.

 

                Weconducted our audits in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Those standards require that we planand perform the audit to obtain reasonable assurance about whether thefinancial statements are free of material misstatement. An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements. An audit also includes assessing the accountingprinciples used and significant estimates made by management, as well asevaluating the overall financial statement presentation. We believe that ouraudits provide a reasonable basis for our opinion.

 

                Inour opinion, the financial statements referred to above present fairly, in allmaterial respects, the financial position of Paragon Systems, Inc, as ofDecember 31, 2003, and the results of its operations and its cash flowsfor each of the two years in the period ended December 31, 2003 and theperiod from January 1, 2004 to February 27, 2004 and in conformitywith accounting principles generally accepted in the United States.

 

/s/ Miller Ray Houser & Stewart LLP

 

Atlanta, Georgia

March 15, 2005

 

 

F-3

----

 

**Tri-S Security Corporationand Subsidiary**

**Balance Sheets**

**(In thousands, except per sharedata)**

 
| ** **                                                                                           | ** ** | ** **                               | ** ** | **Predecessor Basis**                             | ** ** |
|------------------------------------------------------------------------------------------------------|------------|------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                                           | ** ** | **Consolidated  December 31, 2004** | ** ** | **Paragon Systems, Inc.  December 31, 2003** | ** ** |
| ** **                                                                                           | ** ** | **(restated, Note 2)**                   | ** ** | ** **                                        | ** ** |
| **Assets**                                                                                      |       |
| Current assets:                                                                                      |       |                                     |       |                                              |       |
| Cash and cash equivalents                                                                            |       | $                                        | 313        |                                              | $          | 846 |   |
| Trade accounts receivable, net                                                                       |       | 5,312                                    |       | 4,695                                             |       |
| Deferred initial public offering costs                                                               |       | 633                                      |       | —                                            |       |
| Deferred income taxes                                                                                |       | 200                                      |       | —                                            |       |
| Prepaid expenses and other assets                                                                    |       | 178                                      |       | 172                                               |       |
| Total current assets                                                                                 |       | 6,636                                    |       | 5,713                                             |       |
| Property and equipment, less accumulated depreciation                                                |       | 325                                      |       | 455                                               |       |
| Note receivable—officer                                                                         |       | 100                                      |       | —                                            |       |
| Investment in joint venture                                                                          |       | 8,302                                    |       | 715                                               |       |
| Investment in government contracts, net                                                              |       | 1,172                                    |       | —                                            |       |
| Non-compete agreements, net                                                                          |       | 318                                      |       | —                                            |       |
| Deferred loan costs, net                                                                             |       | 18                                       |       | —                                            |       |
| Goodwill                                                                                             |       | 7,747                                    |       | —                                            |       |
| Total assets                                                                                         |       | $                                        | 24,618     |                                              | $          | 6,883 |   |
|                                                                                                 |       |                                     |       |                                              |       |
| **Liabilities and Stockholders’  Equity (Deficit)**                                             |       |
| Current liabilities:                                                                                 |       |                                     |       |                                              |       |
| Trade accounts payable                                                                               |       | $                                        | 351        |                                              | $          | 29 |   |
| Accrued salaries                                                                                     |       | 774                                      |       | 726                                               |       |
| Payroll withholding                                                                                  |       | 347                                      |       | 184                                               |       |
| Accrued vacation                                                                                     |       | 612                                      |       | 524                                               |       |
| Accrued interest expense                                                                             |       | 316                                      |       | —                                            |       |
| Accrued interest on preferred stock subject to mandatory redemption                                  |       | 250                                      |       | —                                            |       |
| Other accrued expenses                                                                               |       | 689                                      |       | 226                                               |       |
| Income taxes payable                                                                                 |       | 212                                      |       | 152                                               |       |
| Short-term notes payable                                                                             |       | 10,798                                   |       | 1,130                                             |       |
| Current portion of capital lease obligations                                                         |       | 91                                       |       | 87                                                |       |
| Total current liabilities                                                                            |       | 14,440                                   |       | 3,058                                             |       |
| Other liabilities:                                                                                   |       |                                     |       |                                              |       |
| Capital lease obligations, less current portion                                                      |       | 103                                      |       | 185                                               |       |
| Income taxes payable                                                                                 |       | 1,056                                    |       | —                                            |       |
| Deferred income taxes                                                                                |       | 3,287                                    |       | —                                            |       |
| Series C preferred stock subject to mandatory redemption                                             |       | 6,000                                    |       | —                                            |       |
| Total liabilities                                                                                    |       | 24,886                                   |       | 3,243                                             |       |
| Stockholders’ equity (deficit):                                                                 |       |                                     |       |                                              |       |
| Preferred stock, $1.00 par value, 10,000,000 shares authorized                                       |       |                                     |       |                                              |       |
| Series A convertible preferred stock 100,000 shares issued and  outstanding                     |       | 460                                      |       | —                                            |       |
| Series B convertible preferred stock, 40,000 shares issued and  outstanding                          |       | 196                                      |       | —                                            |       |
| Common stock, $1.00 par value, 1,000 shares authorized, 940 shares  issued and outstanding           |       | —                                   |       | 1                                                 |       |
| Common stock, $0.001 par value, 25,000,000 shares authorized, 827,832  shares issued and outstanding |       | 1                                        |       | —                                            |       |
| Additional paid-in capital                                                                           |       | 115                                      |       | —                                            |       |
| Retained earnings (deficit)                                                                          |       | (1,040                                   | )          | 3,639                                             |       |
|                                                                                                 |       | (268                                     | )     | 3,640                                             |       |
| Less treasury stock acquired (60 shares of Paragon Systems, Inc. at  December 31, 2003)              |       | —                                   |       | —                                            |       |
| Total stockholders’ equity (deficit)                                                            |       | (268                                     | )          | 3,640                                             |       |
| Total liabilities and stockholders’ equity (deficit)                                            |       | $                                        | 24,618     |                                              | $          | 6,883 |   |

 

See accompanying notes to financial statements.

 

 

F-4

----

 

**Tri-SSecurity Corporation and Subsidiary**

**Statements of Operations**

**(Inthousands, except per share data)**

 
| ** **                                                  | ** ** | ** **                                      | ** ** | **Predecessor Basis—Paragon Systems, Inc.** | ** ** |
|-------------------------------------------------------------|------------|-------------------------------------------------|------------|--------------------------------------------------|------------|
| ** **                                                  | ** ** | **Consolidated  Year ended  December 31, 2004** | ** ** | **January 1, 2004  to  February 27, 2004**       | ** ** | **Year ended  December 31,  2003** | ** ** | **Year ended  December 31,  2002** | ** ** |
| ** **                                                  | ** ** | **(restated, Note 2)**                          | ** ** | ** **                                       | ** ** | ** ** | ** ** | ** ** | ** ** |
| Revenues                                                    |       | $                                               | 25,425     |                                             | $          | 4,705 |   | $ | 29,395 |   | $ | 21,364 |   |
| Cost of revenues:                                           |       |                                            |       |                                             |       |   |   |   |   |
| Direct labor                                                |       | 13,810                                          |       | 2,481                                            |       | 16,070 |   | 11,983 |   |
| Indirect labor and other contract support costs             |       | 10,223                                          |       | 2,113                                            |       | 11,151 |   | 7,615 |   |
| Amortization of government contracts                        |       | 298                                             |       | —                                           |       | — |   | — |   |
|                                                        |       | 24,331                                          |       | 4,594                                            |       | 27,221 |   | 19,598 |   |
| Gross profit                                                |       | 1,094                                           |       | 111                                              |       | 2,174 |   | 1,766 |   |
| Selling, general and administrative                         |       | 2,115                                           |       | 230                                              |       | 1,466 |   | 1,179 |   |
| Operating income (loss)                                     |       | (1,021                                          | )          | (119                                             | )          | 708 |   | 587 |   |
| Income from investment in joint venture                     |       | 1,637                                           |       | —                                           |       | — |   | — |   |
| Other income (expense):                                     |       |                                            |       |                                             |       |   |   |   |   |
| Interest income                                             |       | 3                                               |       | —                                           |       | 12 |   | 23 |   |
| Interest expense                                            |       | (1,380                                          | )          | (11                                              | )          | (30 | ) | (7 | ) |
| Interest on preferred stock subject to mandatory redemption |       | (250                                            | )          | —                                           |       |   |   |   |   |
|                                                        |       | (1,627                                          | )          | (11                                              | )          | (18 | )  | 16 |   |
| Income (loss) before income taxes                           |       | (1,011                                          | )          | (130                                             | )          | 690 |   | 603 |   |
| Income tax expense (benefit)                                |       | (384                                            | )          | —                                           |       | 40 |   | — |   |
| Net income (loss)                                           |       | $                                               | (627       | )                                                | $          | (130 | ) | $ | 650 |   | $ | 603 |   |
| Pro forma income tax expense (benefit)                      |       |                                            |       | (49                                              | )     | 262 |   | 229 |   |
| Proforma net income (loss)                                  |       |                                            |       | $                                                | (81        | )  | $ | 428 |   | $ | 374 |   |
| Basic net income (loss) per common share                    |       | $                                               | (0.76      | )                                                |       |   |   |   |   |   |
| Diluted net income (loss) per common share                  |       | $                                               | (0.76      | )                                                |       |   |   |   |   |   |
| Basic weighted average number of common shares              |       | 828                                             |       |                                             |       |   |   |   |   |
| Diluted weighted average number of common shares            |       | 1,269                                           |       |                                             |       |   |   |   |   |

 

See accompanying notes to financial statements.

 

 

F-5

----

 

**Tri-S Security Corporationand Subsidiary**

**Statements of Shareholders’Equity (Deficit)**

**(In thousands)**

 

| ** **                                                         | ** ** | **Predecessor  Basis  Paragon Systems, Inc.** | ** ** | **Successor  Basis Tri-S Security Corporation** | ** ** | ** **        | ** ** | ** **                            | ** ** |
|--------------------------------------------------------------------|------------|-----------------------------------------------|------------|-------------------------------------------------|------------|-------------------|------------|---------------------------------------|------------|
| ** **                                                         | ** ** | ** **                                    | ** ** | ** **                                      | ** ** | **Series A** | ** ** | **Series B**                     | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| ** **                                                         | ** ** | **Common  Stock**                             | ** ** | **Treasury**                                    | ** ** | **Common  Stock** | ** ** | **Convertible  Preferred Stock** | ** ** | **Convertible  Preferred Stock** | ** ** | **Additional  Paid-In** | ** ** | **Retained  Earnings** | ** ** | ** ** | ** ** |
| ** **                                                         | ** ** | **Shares**                                    | ** ** | **Cost**                                        | ** ** | **Stock**         | ** ** | **Shares**                            | ** ** | **Cost** | ** ** | **Shares** | ** ** | **Cost** | ** ** | **Shares** | ** ** | **Cost** | ** ** | **Captial** | ** ** | **(Deficit)** | ** ** | **Total** | ** ** |
| **Predecessor  Basis**                                             |       |                                          |       |                                            |       |              |       |                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Balance at  December 31, 2001                                 |       | 940                                           |       | $                                               | 1          |              | $          | —                                |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   | $ | 2,386 |   | $ | 2,387 |   |
| Net income                                                         |       | —                                        |       | —                                          |       | —            |       |                                  |       |   |   |   |   |   |   |   |   |   |   |   |   | 603 |   | 603 |   |
| Balance at  December 31, 2002                                 |       | 940                                           |       | 1                                               |       | —            |       |                                  |       |   |   |   |   |   |   |   |   |   |   |   |   | 2,989 |   | 2,990 |   |
| Net income                                                         |       | —                                        |       | —                                          |       | —            |       |                                  |       |   |   |   |   |   |   |   |   |   |   |   |   | 650 |   | 650 |   |
| Balance at  December 31, 2003                                 |       | 940                                           |       | 1                                               |       | —            |       |                                  |       |   |   |   |   |   |   |   |   |   |   |   |   | 3,639 |   | 3,640 |   |
| Net income (loss)                                                  |       | —                                        |       | —                                          |       | —            |       |                                  |       |   |   |   |   |   |   |   |   |   |   |   |   | (130 | )  | (130 | )  |
| Balance at  February 27, 2004                                 |       | 940                                           |       | $                                               | 1          |              | $          | —                                |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   | $ | 3,509 |   | $ | 3,510 |   |
| ** **                                                         |       |                                          |       |                                            |       |              |       |                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| **Successor  Basis**                                               |       |                                          |       |                                            |       |              |       |                                  |       |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Balance at  February 27, 2004                                      |       | 940                                           |       | $                                               | 1          |              | —     |                                  |       |   | $ | — |   | — |   | $ | — |   | — |   | $ | — |   | $ | — |   | $ | 3,509 |   | $ | 3,510 |   |
| Reverse capital  structure of predecessor                          |       | (940                                          | )          | (1                                              | )          | —            |       |                                  |       | — |   | — |   | — |   | — |   | — |   | — |   | (3,509 | ) | (3,510 | )  |
| Capital structure  of successor at December 31, 2003          |       | —                                        |       | —                                          |       |              |       | 828                                   |       | 1 |   | 100 |   | 460 |   | 40 |   | 196 |   | 115 |   | (413 | )  | 359 |   |
| Net loss for year  ended December 31, 2004 (restated, Note 2) |       | —                                        |       | —                                          |       |              |       | —                                |       | — |   | — |   | — |   | — |   | — |   | — |   | (627 | ) | (627 | )  |
| Balance at  December 31, 2004 (restated, Note 2)              |       | —                                        |       | $                                               | —     |              |       |                                  | 828        |   | $ | 1 |   | 100 |   | $ | 460 |   | 40 |   | $ | 196 |   | $ | 115 |   | $ | (1,040 | ) | $ | (268 | )  |
|                                                                    |            |                                               |            |                                                 |            |                   |            |                                       |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

See accompanying notes to financial statements.

 

 

F-6

----

**Tri-SSecurity Corporation and Subsidiary**

**Statements of Cash Flows**

**(Inthousands)**

 
| ** **                                                                                        | ** ** | ** **                                           | ** ** | **Predecessor Basis—Paragon Systems, Inc.**               | ** ** |
|---------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|----------------------------------------------------------------|------------|
| ** **                                                                                        | ** ** | **Consolidated  Year ended  December 31, 2004** | ** ** | **For the period  January 1, 2004 to  February 27, 2004** | ** ** | **Year ended  December 31,  2003** | ** ** | **Year ended  December 31,  2002** | ** ** |
| ** **                                                                                        | ** ** | **(restated, Note 2)**                               | ** ** | ** **                                                     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Cash flow from  operating activities:                                                             |       |                                                 |       |                                                           |       |   |   |   |   |
| Net income (loss)                                                                                 |       | $                                                    | (627       | )                                                              | $          | (130 | ) | $ | 650 |   | $ | 603 |   |
| Adjustments to  reconcile net income (loss) to net cash provided (used) by operating  activities: |       |                                                 |       |                                                           |       |   |   |   |   |
| Income from  investment in joint venture                                                          |       | (1,637                                               | )          |                                                           |       |   |   |   |   |
| Depreciation and  amortization                                                                    |       | 617                                                  |       | 28                                                             |       | 175 |   | 68 |   |
| Deferred income  tax benefits                                                                     |       | (414                                                 | )          | —                                                         |       | — |   | — |   |
| Changes in  operating assets and liabilities:                                                     |       |                                                 |       |                                                           |       |   |   |   |   |
| Trade accounts  receivable, net                                                                   |       | 544                                                  |       | (1,161                                                         | )          | 157 |   | (673 | ) |
| Prepaid expenses  and other assets                                                                |       | 393                                                  |       | (499                                                           | )          | 10 |   | (5 | ) |
| Trade accounts  payable                                                                           |       | (262                                                 | )          | 62                                                             |       | (872 | ) | (313 | ) |
| Accrued salaries                                                                                  |       | 107                                                  |       | (59                                                            | )          | (162 | ) | 259 |   |
| Payroll  withholding                                                                              |       | (63                                                  | )          | 226                                                            |       | (47 | ) | 67 |   |
| Accrued vacation                                                                                  |       | 2                                                    |       | 85                                                             |       | 181 |   | 155 |   |
| Accrued interest  expense                                                                         |       | 316                                                  |       | —                                                         |       | — |   | — |   |
| Accrued interest  on redeemable preferred stock                                                   |       | 250                                                  |       | —                                                         |       | — |   | — |   |
| Other accrued  expenses                                                                           |       | (175                                                 | )          | 692                                                            |       | (81 | ) | (131 | ) |
| Income taxes payable                                                                              |       | (207                                                 | )          | (111                                                           | )          | 152 |   | (127 | ) |
| Net cash provided  (used) by operating activities                                                 |       | (1,156                                               | )          | (867                                                           | )          | 163 |   | (97 | ) |
| Cash flow from  investing activities:                                                             |       |                                                 |       |                                                           |       |   |   |   |   |
| Acquisition of  subsidiary                                                                        |       | (2,300                                               | )          | —                                                         |       | — |   | — |   |
| Investment in  joint venture                                                                      |       | —                                               |       | —                                                         |       | (715 | ) | — |   |
| Proceeds from  investment in joint venture                                                        |       | 1,437                                                |       | 715                                                            |       | — |   | — |   |
| Proceeds from  sale of property and equipment                                                     |       | 14                                                   |       | —                                                         |       | — |   | — |   |
| Purchase of  property and equipment                                                               |       | (67                                                  | )          | —                                                         |       | (427 | ) | (127 | ) |
| Net cash provided  (used) by investing activities                                                 |       | (916                                                 | )          | 715                                                            |       | (1,142 | ) | (127 | ) |
| Cash flow from  financing activities:                                                             |       |                                                 |       |                                                           |       |   |   |   |   |
| Proceeds  (repayments) of short-term notes                                                        |       | 3,067                                                |       | (405                                                           | )          | 676 |   | 454 |   |
| Proceeds  (repayments) of capital lease obligations                                               |       | (65                                                  | )          | (13                                                            | )          | 272 |   | — |   |
| Deferred initial  public offering costs                                                           |       | (599                                                 | )          | —                                                         |       | — |   | — |   |
| Loan costs                                                                                        |       | (120                                                 | )          | —                                                         |       | — |   | — |   |
| Net cash provided  (used) by financing activities                                                 |       | 2,283                                                |       | (418                                                           | )          | 948 |   | 454 |   |
| Net increase  (decrease) in cash and cash equivalents                                             |       | 211                                                  |       | (570                                                           | )          | (31 | ) | 230 |   |
| Cash and cash  equivalents at beginning of period                                                 |       | 102                                                  |       | 846                                                            |       | 877 |   | 647 |   |
| Cash and cash  equivalents at end of period                                                       |       | $                                                    | 313        |                                                           | $          | 276 |   | $ | 846 |   | $ | 877 |   |
| Supplemental  disclosures of cash flow information:                                               |       |                                                 |       |                                                           |       |   |   |   |   |
| Interest paid                                                                                     |       | $                                                    | 931        |                                                           | $          | 6 |   | $ | 30 |   | $ | 7 |   |
| Income taxes paid                                                                                 |       | $                                                    | 224        |                                                           | $          | — |   | $ | — |   | $ | 127 |   |
| Issuance of notes  and preferred stock in business acquisition                                    |       | $                                                    | 13,706     |                                                           | $          | — |   | $ | — |   | $ | — |   |

 

See accompanying notes to financial statements.

 

 

F-7

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**Tri-S Security Corporation andSubsidiary**

**Notes to Financial Statements**

 

**(dollars in thousands, except pershare data)**

 

**1.             Summaryof Significant Accounting Policies**

 

**                Basisof Presentation**

 

                Tri-Swas formed in October 2001 for the purpose of acquiring and consolidatingelectronic and physical security companies in order to take advantage of theoperating efficiencies created by a large company. Tri-S has and currentlyintends to continue to pursue acquisition opportunities in the contract guardservices and system integration services segments of the security industry.

 

                OnFebruary 27, 2004, Tri-S Security Corporation (“Tri-S” or the “Company”)completed the acquisition (the “Acquisition”) of Paragon Systems, Inc. (“Paragon”).Tri-S acquired all of the outstanding capital stock of Paragon for a total purchaseprice of $16,006 payable in cash, redeemable preferred stock, and notespayable.

 

                Forperiods subsequent to the Acquisition, the accompanying financial statementsrepresent the consolidated statements of Tri-S and its wholly owned subsidiary,Paragon. All intercompany transactions and balances have been eliminated inconsolidation.

 

                Tri-Sdid not have any operating businesses prior to the Acquisition. Expensesconsisted primarily of services performed and fees incurred associated with thecreation and capitalization of the Company and the pursuit of acquisitionopportunities. The financial statements of Paragon, as an operating entity, arethe more relevant information available prior to the Acquisition of Paragon byTri-S. Consequently, the accompanying financial statements present thefinancial statements of Paragon as the “Predecessor” prior to the Acquisitionand the consolidated financial statements of Tri-S as the “Successor”subsequent to the Acquisition.

 

**                Natureof Operations**

 

                TheCompany provides contract guard services to various Federal governmentagencies. These guard services include providing uniformed and armed guards foraccess control, personnel protection, plant security, theft prevention,surveillance, vehicular and foot patrol, crowd control and the prevention ofsabotage, terrorist and criminal activities. In connection with providing theseservices, Paragon assumes responsibility for a variety of functions, includingrecruiting, hiring, training and supervising security guards deployed to theFederal agencies served as well as paying all guards and providing them withuniforms, employee benefits and workers’ compensation insurance. Paragon isresponsible for preventing the interruption of guard services as a consequenceof illness, vacations or resignations.

 

**                RevenueRecognition**

 

                Revenueis recognized as guard services are provided under contracts with Federalgovernment agencies. Guard services are billed in arrears at hourly or monthlyrates based on the number of hours worked under some contracts and as fixedmonthly amounts under other contracts. Hourly and monthly rates are determinedas a result of bids submitted in response to formal specifications included insolicitations for bids from government agencies. Hourly and monthly billingrates are developed by accumulating the estimated labor, general andadministrative expenses, profit objective and other costs to service a contractover a five year period.

 

                Directlabor includes the regular wages of direct personnel as defined under thecontracts and is recorded on an actual basis as it is incurred. Indirect costsinclude other wages, payroll taxes, union

 

 

F-8

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benefits, employee benefits, workers compensationinsurance, liability insurance and other costs associated with specificcontracts. The wages component of indirect labor includes vacation, training,holiday and sick time. Initial one-time expenses, such as extra training coststo start a new contract, are expensed as incurred.

 

**                Useof Estimates**

 

                Thepreparation of financial statements in conformity with generally acceptedaccounting principles requires management to make estimates and assumptionsthat affect the reported amounts of assets and liabilities and disclosure ofcontingencies at the date of the financial statements and the reported amountsof expenses during the reporting period. Actual amounts could differ from thoseestimates.

 

**                Concentrationsof Credit Risk**

 

                Financialinstruments that potentially subject the Company to significant concentrationsof credit risk consist principally of cash and accounts receivable. The Companymaintains cash and cash equivalents with various financial institutions. TheCompany’s policy is to maintain balances with high credit quality financialinstitutions. The Company has not sustained material credit losses frominstruments held at financial institutions. The Company provides services undercontracts with various Federal agencies. The Company maintained an allowancefor doubtful accounts of $536 and $50 at December 31, 2004 and 2003,respectively, as a reserve against potential billing adjustments.

 

**                StockBased Compensation**

 

                Inaccordance with the provisions of Accounting Principles Board Opinion No. 25,*Accounting for Stock Issued to Employees*,the Company measures stock-based compensation expense as the excess ofthe market price on date of grant over the amount of the grant. Since theCompany grants all stock-based compensation at the market price on thedate of grant, no compensation expense is recognized. As permitted, the Companyhas elected to adopt only the disclosure provisions of SFAS No. 123, *Accounting for Stock-based Compensation*.

 

                TheCompany has determined pro forma amounts as if the fair value method required bySFAS No. 123, *Accounting for Stock-BasedCompensation*, had been applied to its stock-basedcompensation. See Note 11 for descriptions of the Company’s stock-basedcompensation plans. The fair value of stock options was estimated on the dateof grant using the Black-Scholes option pricing model. The pro formaeffect on the net loss of the Company for the year ended December 31, 2004and for the net loss of Tri-S, the Successor Company, for the years endedDecember 31, 2003 and 2002 as if the fair

 

 

F-9

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value of stock-based compensation had beenrecognized as compensation expense on a straight-line basis over the vestingperiod of the stock option or purchase right was as follows:

 

| ** **                                                                 | ** ** | **2004**               | ** ** | **2003**   | ** ** | **2002**   | ** ** |
|----------------------------------------------------------------------------|------------|------------------------|------------|------------|------------|------------|------------|
| ** **                                                                 | ** ** | **(restated, Note 2)** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net loss attributable to common shareholders:                              |       |                   |       |       |       |       |       |
| As reported                                                                |       | $                      | (627       | )          | $          | (217       | )          | $ | (136 | ) |
| Pro forma                                                                  |       | $                      | (627       | )          | $          | (218       | )          | $ | (138 | ) |
| Basic and diluted net loss per share attributable to common  shareholders: |       |                   |       |       |       |       |       |
| As reported                                                                |       | $                      | (0.76      | )          | $          | (0.26      | )          | $ | (0.17 | ) |
| Pro forma                                                                  |       | $                      | (0.76      | )          | $          | (0.26      | )          | $ | (0.17 | ) |

 

                Theweighted-average estimated fair value of options granted during 2002 was$0.03 per share. For purposes of computing the pro forma amount above, theminimum value of the options was calculated using a volatility factor of zero,an estimated option life of seven years and a risk-free interest rateassumption of 4.84%.

 

**                FairValue of Financial Instruments**

 

                Thecarrying amounts of the Company’s financial instruments, including cash andcash equivalents, accounts receivable, accounts payable and accruedliabilities, approximate fair value because of their short maturities. Thecarrying amounts of the Company’s short-term loans and capital leaseobligations approximate fair value of these obligations based upon management’sbest estimates of interest rates that would be available for similar debtobligations at December 31, 2004 and 2003.

 

**                RetirementPlan**

 

                Substantiallyall of Paragon’s employees are eligible to participate in a 401(k) definedcontribution plan. Under the terms of the plan, employees may elect to defer upto ten percent of their compensation subject to Internal Revenue Servicelimitations. Paragon provides discretionary matching contributions on thesedeferrals each year based upon determinations by the board of directors.Paragon did not make any matching contributions for 2004, 2003 and 2002.

 

**                CashEquivalents**

 

                TheCompany considers all highly liquid investments with original maturities ofthree months or less to be cash equivalents.

 

**                Investmentin Joint Venture**

 

                InDecember 2003, Paragon acquired a 10% interest in Army Fleet Support, LLC.The investment is accounted for under the equity method. The cost of theinvestment was determined as part of the allocation of the purchase price ofParagon (see Note 2). The cost of the joint venture in excess of the netequity of the joint venture is attributed to the value of the joint venture'scontract with the federal government and is being amortized over the life ofthe contract, which is 10 years. The company records income from the investmentequal to the Company’s share of the net earnings of the joint venture less amortizationof the difference between the cost of the joint venture and The Company's shareof the net equity of the joint venture. The joint venture asset is increased bythe Company’s share of the net earnings of the joint venture and decreased bycash received from the joint venture and amortization of the difference betweenthe cost of the joint venture and The Company's share of the net equity of thejoint venture. During 2004, subsequent to the Acquisition, the Company received

 

 

F-10

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distributions of $1,437 from Army Fleet Support, LLC.

 

**                Propertyand Equipment**

 

                Propertyand equipment are recorded at cost and depreciated over their estimated usefullives using the double-declining balance method. Property and equipmentheld under capital leases are amortized over the shorter of the lease term orthe estimated useful life of the related asset. Upon retirement or sale, thecost of the assets disposed of and the related accumulated depreciation areremoved from the accounts and any resulting gain or loss is credited or chargedto income. Repairs and maintenance costs are expensed as incurred.

 

**                Long-livedAssets Including Goodwill and Other Acquired Intangible Assets**

 

                TheCompany reviews property and equipment and certain identifiable intangibles,excluding goodwill, for impairment whenever events or changes in circumstancesindicate the carrying amount of an asset may not be recoverable. Recoverabilityof these assets is measured by comparison of its carrying amounts to futureundiscounted cash flows the assets are expected to generate. If property andequipment and certain identifiable intangibles are considered to be impaired,the impairment to be recognized equals the amount by which the carrying valueof the asset exceeds its fair market value. The Company has made no adjustmentsto its long-lived assets in any of the periods presented.

 

                TheCompany has adopted SFAS No. 142, *Goodwilland Other Intangible Assets*. SFAS No. 142 requires thatgoodwill and intangible assets with indefinite useful lives no longer beamortized, but instead be tested for impairment at least annually or soonerwhenever events or changes in circumstances indicate that they may be impaired.

 

                SFASNo. 142 also requires that intangible assets with definite lives beamortized over their estimated useful lives and reviewed for impairmentwhenever events or changes in circumstances indicate an asset’s carrying valuemay not be recoverable in accordance with SFAS No. 144, *Accounting for the Impairment of Long-Lived Assetsand for Long-Lived Assets to Be Disposed Of.* The Company iscurrently amortizing its acquired intangible assets with definite lives overperiods ranging from five to nine years. The Company believes no events orchanges in circumstances have occurred that would require an impairment testfor these assets.

 

**                PreferredStock Subject to Mandatory Redemption**

 

                PreferredStock subject to mandatory redemption is accounted for in accordance with SFAS No. 150,*Accounting for Certain Financial Instrumentswith Characteristics of both Liabilities and Equity*, as freestandingfinancial instruments having characteristics of both liabilities and equityand, as such, are classified as liabilities in the financial statements. Thedividend requirement is recorded as interest expense. Payments and accruals forthe dividend requirements are presented in the income statement and the cashflows statement separately from payments and interest due to other creditors.

 

 

F-11

----

 

**                IncomeTaxes**

 

                Beginningwith its S corporation election on January 1, 1999, and prior to itsacquisition by Tri-S on February 27, 2004, Paragon was taxed as asubchapter S corporation. All income and losses of Paragon were allocated tothe shareholders for inclusion in their respective income tax returns. Prior toits election as a subchapter S corporation, Paragon was taxed as a Ccorporation and was subject to taxes on income earned prior to its election asan S corporation. Upon election as an S Corporation, Paragon becamesubject to built in gain taxes which relate to differences between the fairmarket value and the tax basis of assets as of the date a C corporation electsS status. These taxes paid by the S corporation are deductible by shareholders.The provision for income taxes of Paragon as the Predecessor consists of built-ingains taxes. Paragon’s S election was automatically terminated upon itsacquisition by Tri-S.

 

                Paragonused the cash basis of accounting for income taxes prior to its acquisition, atwhich time it was required to change its tax method to the accrual basis.Effective February 28, 2004, the Company will file a consolidatedincome tax return that includes the accounts of Tri-S and Paragon.

 

                TheCompany determines its deferred tax provision using the liability method. Underthe liability method, deferred income tax assets and liabilities are determinedbased on differences between financial reporting and income tax bases of assetsand liabilities and are measured using the tax rates and laws in effect at thetime of such determination. The measurement of deferred tax assets is adjustedby a valuation allowance, if necessary, to recognize the extent to which, basedon available evidence, the future tax benefits more likely than not will not berealized.

 

                Theaccompanying financial statements present the financial statements of Paragonas the Predecessor prior to the Acquisition and the consolidated financialstatements of Tri-S as the Successor subsequent to the Acquisition. ThePredecessor company was a subchapter S corporation; consequently, pro forma taxexpense and pro forma net income per share are presented on the face of thehistorical statements of operations for the periods presented as thePredecessor.

 

**                RecentlyIssued Accounting Pronouncements**

 

                InJanuary 2003, the FASB issued FASB Interpretation (“FIN”) 46*, Consolidation of Variable Interest Entities*.FIN 46 expands upon existing accounting guidance that addresses when a companyshould include in its financial statements the assets, liabilities andactivities of a variable interest entity. The consolidation requirements of FIN46 apply immediately to variable interest entities created afterJanuary 31, 2003. The consolidation requirements apply to older entitiesin the first fiscal year or interim period beginning after June 15, 2003.The adoption of FIN 46 did not have any impact on the Company’s financialposition or results of operations.

 

                InMay 2003, the FASB issued SFAS No. 150, *Accounting for Certain Financial Instruments with Characteristics ofBoth Liabilities and Equity*. The Statement specifies thatinstruments within its scope embody obligations of the issuer and that,therefore, the issuer must classify them as liabilities. SFAS No. 150prohibits entities from restating financial statements for earlier yearspresented. SFAS No. 150 became effective for the Company at the beginningof the third quarter of 2003. The Company agreed to issue preferred sharessubject to mandatory redemption in conjunction with the acquisition as more

 

 

F-12

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fully discussed in Note 3. The preferred sharessubject to mandatory redemption are accounted for in accordance with SFAS No. 150.

 

                InDecember 2004, the FASB issued SFAS No. 123 (revised 2004), *Share-Based Payment* (“SFAS 123R”)which replaces SFAS No. 123, *Accountingfor Stock-Based Compensation*, and supersedes APB Opinion No. 25,*Accounting for Stock Issued to Employees*.SFAS 123R requires all share-based payments to employees, includinggrants of employee stock options, to be recognized in the financial statementsbased on their fair values beginning with the first interim or annual periodafter June 15, 2005, with early adoption encouraged. The pro formadisclosures previously permitted under SFAS 123 no longer will be analternative to financial statement recognition. The Company is required toadopt SFAS 123R in the third quarter of fiscal 2005, beginningJuly 1, 2005. Under SFAS 123R, the Company must determine theappropriate fair value model to be used for valuing share-based payments,the amortization method for compensation cost and the transition method to beused at date of adoption. The Company is evaluating the requirements ofSFAS 123R and the effect that the adoption of SFAS 123R will have onthe consolidated results of operations and earnings per share. The Company hasnot yet determined the method of adoption.

 

**2.****             Restatement**

** **

                On October 27, 2005, the Audit Committeedetermined the Company's consolidated financial statements for the year endedDecember 31, 2004 should be restated. The restatement is required for theCompany's 10% equity interest in Army Fleet Support, LLC, to use the equitymethod of accounting as required by Account Principles Board OpinionNo. 18, "*The Equity Method ofAccounting for Investments in Common Stock*'' and Statement ofFinancial Accounting Standards No. 94, "*Consolidationof All Majority-Owned Subsidiaries*".

 

                Thefollowing tables present the effect of the restatement on the originallyreported financial position and results of operations as of and for the yearended December 31, 2004. The originally reported cash flows fromoperating, investing, and financing activities were not affected.

 
| ** **                                  | ** ** | **December 31, 2004  As Originally Reported** | ** ** | **December 31, 2004  Restated** | ** ** |
|---------------------------------------------|------------|----------------------------------------------------|------------|--------------------------------------|------------|
|                                        |       |                                               |       |                                 |       |
| **Balance Sheet:**                          |       |                                               |       |                                 |       |
|                                        |       |                                               |       |                                 |       |
| Current assets                              |       | $                                                  | 6,636      |                                 | $          | 6,636 |   |
| Investment in joint venture                 |       | 6,665                                              |       | 8,302                                |       |
| Other non-current assets                    |       | 9,680                                              |       | 9,680                                |       |
|                                        |       |                                               |       |                                 |       |
| Total assets                                |       | $                                                  | 22,981     |                                 | $          | 24,618 |   |
|                                        |       |                                               |       |                                 |       |
| Current liabilities                         |       | $                                                  | 14,440     |                                 | $          | 14,440 |   |
| Other non-current  liabilities              |       | 9,822                                              |       | 10,446                               |       |
| Stockholders' equity  (deficit)             |       | (1,281                                             | )          | (268                                 | )          |
|                                        |       |                                               |       |                                 |       |
| Total liabilities and stockholders'  equity |       | $                                                  | 22,981     |                                 | $          | 24,618 |   |
|                                        |       |                                               |       |                                 |       |
| **Statement of Operations:**                |       |                                               |       |                                 |       |
|                                        |       |                                               |       |                                 |       |
| Revenues                                    |       | $                                                  | 25,425     |                                 | $          | 25,425 |   |
| Cost of revenues                            |       | 24,331                                             |       | 24,331                               |       |
|                                        |       |                                               |       |                                 |       |
| Selling, general and  administrative        |       | 2,115                                              |       | 2,115                                |       |
| Income from joint venture                   |       | 0                                                  |       | 1,637                                |       |
| Other income (expense)                      |       | (1627                                              | )          | (1627                                | )          |
|                                        |       |                                               |       |                                 |       |
| Net income (loss) before income  taxes      |       | (2,648                                             | )          | (1,011                               | )          |
|                                        |       |                                               |       |                                 |       |
| Income tax expense  (benefit)               |       | (1,008                                             | )          | (384                                 | )          |
|                                        |       |                                               |       |                                 |       |
| Net income (Loss)                           |       | $                                                  | (1,640     | )                                    | $          | (627 | ) |
|                                        |       |                                               |       |                                 |       |
| Basic net income (loss) per  share          |       | $                                                  | (1.98      | )                                    | $          | (0.76 | ) |
| Diluted net income (loss) per  share        |       | $                                                  | (1.98      | )                                    | $          | (0.76 | ) |
|                                             |            |                                                    |            |                                      |            |  |  |  |  |

 

Notes3, 8, 10, 12 and 16 have been updated to reflect this restatement. 

 

**3.             Acquisitionof Paragon Systems, Inc.**

 

                OnFebruary 27, 2004, Tri-S completed the Acquisition of Paragon, an Alabamacorporation with offices located in Huntsville, Alabama. Tri-S acquired all theoutstanding capital stock of Paragon for a total of $16,006, payable in cash,preferred shares subject to mandatory redemption and notes as set forth below.The Acquisition has been accounted for as a purchase transaction in accordancewith SFAS No. 141, *BusinessCombinations*. At the closing of the Acquisition, Tri-S:

 

•                  paid $2,300 incash to the former shareholders of Paragon;

 

•                  issuedpromissory notes to the former shareholders of Paragon in an aggregateprincipal amount of $7,706 with an annual rate of 7.0%; and

 

•                  agreed to issueto the former shareholders of Paragon preferred stock subject to mandatoryredemptions, with an aggregate redemption value of $6,000 with an annual rateof 5.0%.

 

                Simultaneouswith the closing of the Acquisition, Paragon sold $4,295 in receivables to LSQFunding, L.L.C., an unaffiliated company which factors receivables (“LSQ”). Theproceeds of the transaction were utilized as follows:

 

| Cash payment to sellers of Paragon                               |   | $     | 2,300  |   |
|------------------------------------------------------------------|--------|-------|--------|--------|
| Pay off outstanding  borrowings under the Paragon line-of-credit |   | 1,175 |   |
| Additional cash for  working capital at Paragon                  |   | 700   |   |
| Fees and interest costs                                          |   | 120   |   |
|                                                             |   | $     | 4,295  |   |
|                                                                  |        |       |        |        |  |

 

                Thepurchase price was allocated among tangible and intangible assets acquired andliabilities assumed based on an independent appraisal of fair values at thetransaction date. Amounts previously estimated and reported have been adjustedto give effect to the independent appraisal. The change in

 

 

F-13

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valuation of the assets acquired did not have any effecton the results of operations previously reported. The following represents theallocation of the purchase price at the time of the acquisition:

 

| Book value of net assets acquired |   | $      | 3,511  |   |
|-----------------------------------|--------|--------|--------|--------|
| Investment in joint  venture      |   | 8,102  |   |
| Federal contracts                 |   | 1,470  |   |
| Non compete agreements            |   | 380    |   |
| Income tax liabilities            |   | (1,423 | )      |
| Deferred income tax  liabilities  |   | (3,751 | )      |
| Goodwill                          |   | 7,717  |   |
| Allocated purchase price          |   | $      | 16,006 |   |
|                                   |        |        |        |        |  |

 

                Theinvestment in the joint venture was valued based on the expected futuredistributions from the investment. The joint venture is accounted for inaccordance with the equity method of accounting. Federal contracts will beamortized over a period of nine years and non-compete agreements will beamortized over five years. The $7,717 excess of the purchase price over the estimatedfair values of the net tangible assets and separately identifiable intangibleassets was recorded as goodwill.

 

                Paragonused the cash basis of accounting for income taxes prior to its acquisition, atwhich time Paragon was required to change its method to the accrual basis.Income taxes as a result of the change in method became due in four annualinstallments and were recorded as an adjustment of $1,423 to the purchase priceof Paragon in accordance with business combination purchase accounting.

 

                As aresult of the acquisition of Paragon, the Company recorded a net deferred taxliability of $3,751. This deferred tax liability results from the differencebetween financial reporting and income tax bases of assets and liabilitiespurchased.

 

                Thefollowing combined pro forma financial information presents the results ofoperations of the Company as if the Acquisition had occurred at the beginningof each of the periods presented. Adjustments to the combined financialinformation related to the Acquisition that affect the results of operationsinclude the interest expense associated with the debt and redeemable preferredshares issued in conjunction with the Acquisition and amortization of the fairvalue of intangible assets. This

 

 

F-14

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pro forma information does not purport to be indicativeof what would have occurred had the Acquisition occurred as of January 1or of results of operations that may occur in the future.

 

| ** **                     | ** ** | **Combined Pro Forma  Statements of Operations** | ** ** |
|--------------------------------|------------|--------------------------------------------------|------------|
| ** **                     | ** ** | **For the year  ended  December 31,  2004** | ** ** | **For the year  ended  December 31,  2003** | ** ** |
| ** **                     | ** ** | **(restated)**                                   | ** ** | ** ** | ** ** |
| Revenues                       |       | $                                                | 30,130     |   | $ | 29,395 |   |
| Operating loss                 |       | $                                                | (1,209     | ) | $ | (71 | ) |
| Net loss                       |       | $                                                | (843       | ) | $ | (576 | ) |
| Basic loss per common  share   |       | $                                                | (1.02      | ) | $ | (0.70 | ) |
| Diluted loss per common  share |       | $                                                | (1.02      | ) | $ | (0.70 | ) |
|                                |            |                                                  |            |  |  |  |  |  |

 

                Tri-Sdid not have an operating business prior to the Acquisition. Expenses consistedprimarily of services performed and fees incurred associated with the creationand capitalization of the Company and the pursuit of acquisition opportunities.The financial statements of Paragon, as an operating entity, are the morerelevant information available prior to the acquisition of Paragon by Tri-S.Consequently, the combined pro forma financial information represents thefinancial statements of Paragon as the Predecessor Company prior to theacquisition date of February 27, 2004 combined with the expenses of Tri-Sprior to the acquisition date of February 27, 2004.

 

                Tri-Soperations for 2003 and 2002 consisted of $347 and $216 of expenses,respectively, associated with the creation and capitalization of the Companyand the pursuit of acquisition opportunities. The Company recognized deferredincome tax benefits related to these expenditures of $130 and $80 for 2003 and2002, respectively.

 

**4.             Salesto Major Customers**

 

                TheCompany’s principal operation is to provide contract guard services to variousFederal agencies. Substantially all of the Company’s revenues are derived fromten customers. Contracts with five Federal agencies account for approximately80% of the Company’s revenue.

 

**5.             RelatedParty Transactions**

 

**                EmploymentAgreements**

 

                Uponcompletion of the Acquisition of Paragon, Tri-S entered into employmentagreements with six key employees of Paragon, with agreement terms between oneand three years and non-compete terms for an additional four years fortwo of the employees. The terms and conditions of the agreements weresubstantially the same as that which the employees were entitled prior to theAcquisition.

 

                OnJanuary 1, 2002, Tri-S entered into an employment agreement withMr. Farrell pursuant to which Mr. Farrell has agreed to serve asChief Executive Officer and President of the Company until December 31,2005, which term has been subsequently extended until December 31, 2008.The agreement provides for (i) payment of a specified base salary whichincreases by 5% per year;

 

 

F-15

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(ii) payment of an annual bonus equal to 5% of theCompany’s income before income taxes for such year plus cash distributions fromthe joint venture, provided that such bonus may not exceed 150% ofMr. Farrell’s base salary for such year; (iii) prohibition againstMr. Farrell’s disclosure of confidential information for a period of oneyear following the termination of his employment; and (iv) continuation ofMr. Farrell’s compensation and benefits for the remainder of the term ofthe employment agreement if his employment is terminated by the Company withoutcause or by Mr. Farrell for “good reason”. For the year endingDecember 31, 2004, Mr. Farrell’s salary under his employmentagreement is $254,000.

 

**                Indebtednessof Management**

 

                Pursuantto Mr. Farrell’s employment agreement with the Company, Mr. Farrell,Chief Executive Officer and President of the Company, would have otherwise beenentitled to receive during 2004 an aggregate bonus of $435,000; however, inorder to improve the financial position of the Company, he agreed to forfeit$290,000 thereof and accept a cash bonus of $145,000 and a loan for $100,000.In connection with the loan, Mr. Farrell issued a promissory note to theCompany dated December 31, 2004 in the principal amount of $100,000, whichbears interest at a rate of 2.48% per year and is payable on December 31,2006. The note may be prepaid at any time without penalty and may be paid, atthe election of Mr. Farrell, in cash or shares of the Company’s commonstock or any combination thereof.

 

**6.             Propertyand Equipment**

 

                Propertyand equipment are comprised of the following:

 
| ** **                                      | ** ** | ** **                 | ** ** | **December 31,**          | ** ** |
|-------------------------------------------------|------------|----------------------------|------------|---------------------------|------------|
| ** **                                      | ** ** | **Estimated  Useful Life** | ** ** | **Tri-S  Security  2004** | ** ** | **Paragon  Systems 2003** | ** ** |
| Computer equipment and  software                |       | 3-5  years                 |       | $                         | 595        |   | $ | 212 |   |
| Vehicles                                        |       | 5  years                   |       | 236                       |       | 644 |   |
| Furniture and fixtures                          |       | 5-7  years                 |       | 179                       |       | 134 |   |
|                                            |       |                       |       | 1,010                     |       | 990 |   |
| Less accumulated  depreciation and amortization |       |                       |       | (685                      | )          | (535 | )  |
| Property and equipment,  net                    |       |                       |       | $                         | 325        |   | $ | 455 |   |

 

                Depreciationexpense for Tri-S was $155 for the year ended December 31, 2004.Depreciation expense was $28 for the two months ended February 27, 2004and $175 and $68, respectively, for the years ended December 31, 2003 and2002.

 

 

F-16

----

 

**7.             Goodwilland Other Intangible Assets**

 

                Thechanges in the carrying amount of goodwill for the year ended December 31,2004, are as follows:

 

| Balance as of January 1, 2004   |   | $     | — |   |
|--------------------------------------|--------|-------|--------|--------|
| Acquisition costs                    |   | 30    |   |
| Goodwill acquired during  the period |   | 7,717 |   |
| Balance as of December 31,  2004     |   | $     | 7,747  |   |

 

                Informationregarding the Company’s intangible assets that are being amortized is asfollows:

 

| ** **              | ** ** | **As of December 31, 2004** | ** ** |
|-------------------------|------------|----------------------------------|------------|
| ** **              | ** ** | **Gross  Carrying  Amount**      | ** ** | **Accumulated  Amortization** | ** ** | **Net Carrying  Value** | ** ** |
| Federal contracts       |       | $                                | 1,470      |   | $ | 298 |   | $ | 1,172 |   |
| Non-compete  agreements |       | 380                              |       | 62 |   | 318 |   |
| Loan costs              |       | 120                              |       | 102 |   | 18 |   |
| Total                   |       | $                                | 1,970      |   | $ | 462 |   | $ | 1,508 |   |

 

                Federalcontracts represent the aggregate value of the contracts with Federal agenciespurchased in the Acquisition in February 2004 and are being amortized inproportion to expected cash flows over the expected life of the contracts,which is estimated to be nine years.

 

                Non-competeagreements represent the aggregate value of the non-compete agreements enteredinto with the certain of the prior owners of Paragon and are being amortized ona straight-line basis over the term of the agreements, which is fiveyears.

 

                Loancosts are the upfront fees paid by the Company to arrange and complete thefactoring arrangement with LSQ in February 2004. The fees were capitalizedand are being amortized over the 12 month life of the factoring agreement.The amortization of loan costs is reflected as interest expense in theconsolidated financial statements of the Company.

 

                Amortizationexpense of acquisition-related intangible assets for the year endedDecember 31, 2004 was $462.

 

                Estimatedfuture amortization expense for acquisition-related intangible assets onthe Company’s December 31, 2004 consolidated balance sheet for the fiscalyears ending December 31, is as follows:

 

| 2005       |   | $   | 471    |   |
|------------|--------|-----|--------|--------|
| 2006       |   | 382 |   |
| 2007       |   | 328 |   |
| 2008       |   | 199 |   |
| 2009       |   | 58  |   |
| Thereafter |   | 70  |   |
|       |   | $   | 1,508  |   |

 

 

F-17

----

 

**8.             Investment in UnconsolidatedAffiliate**

 

                In conjunction with the ParagonSystems, Inc. acquisition on February 27, 2004, the Company acquired a 10%interest in the Army Fleet Service joint venture (see Note 1 andNote 3). The value of the investment in the joint venture at theacquisition date was $8,102 as established through an independent appraisal. Thecost of the joint venture in excess of the net equity of the joint venture isattributed to the value of the joint venture's contract with the federalgovernment and is being amortized straight-line over the life of the contract,which is 10 years.

 

                The Company accounts for itsinvestment in the joint venture using the equity method. Accordingly, theinvestment in the joint venture is increased by the Company’s share of thejoint venture’s earnings and reduced by the cash received from the jointventure and amortization of the difference between the cost of the jointventure and the Company's share of the net equity of the joint venture.

 

                The investment in the jointventure was affected by the following transactions for the 10 months endedDecember 31, 2004:

 

| Investment in joint venture—February 27, 2004   |   | $      | 8,102  |   |
|-----------------------------------------------------------|--------|--------|--------|--------|
| Company’s interest in  earnings of the joint venture |   | 2,324  |   |
| Amortization of the  investment in the joint venture      |   | (687   | )      |
| Cash received form the  joint venture                     |   | (1,437 | )      |
| Investment in joint  venture—December 31, 2004  |   | $      | 8,302  |   |
|                                                           |        |        |        |        |  |

 

                Summarized unaudited balance sheet information forthe joint venture as of December 31, 2004 is as follows:

 

| Total assets                 |   | $      | 39,189 |   |
|------------------------------|--------|--------|--------|--------|
|                         |   |   |   |
| Total liabilities            |   | $      | 28,200 |   |
| Equity                       |   | 10,989 |   |
| Total liabilities and equity |   | $      | 39,189 |   |

 

                Summarized unaudited statement of operationsinformation for the unconsolidated joint venture for the 10 months endedDecember 31, 2004 is as follows:

 

| Contract revenues |   | $      | 221,132 |   |
|-------------------|--------|--------|---------|--------|
| Operating income  |   | 24,805 |    |
| Net earnings      |   | 23,237 |    |

 

 

F-18

----

 

**9.             Debtand Other Obligations**

 

                Inconjunction with the closing of the Acquisition in February 2004, theCompany:

 

•                  issued 7%promissory notes to the former shareholders of Paragon in aggregate principalamounts of $6,206 and $1,500;

 

•                  issued to theformer shareholders of Paragon an aggregate of 100 shares of Series Credeemable preferred stock, with a 5% dividend and an aggregate redemptionvalue of $6,000; and

 

•                  repaidoutstanding borrowings under the line-of-credit and terminated the line of creditagreement.

 

                InFebruary 2004, Paragon entered into a factoring arrangement and began tosell certain of its accounts receivable to LSQ Funding, LLC (“LSQ”). LSQprovides advances of up to 85% (90% after July 27, 2004) of eligibleaccounts receivable in exchange for a funds usage rate equal to prime plus 2.0%on the outstanding funds advanced plus a factoring commission. The factoringcommission is equal to a discount of 1.25% (1.00% after February 9, 2005)of gross factored sales plus an invoice service fee of 1.0% depending on daysoutstanding on factored invoices. For advances in excess of 85% (90% afterJuly 27, 2004) of eligible accounts receivable, an over-advance charge of0.75% applies. LSQ may require Paragon to repurchase factored receivables forvarious reasons including uncollectibility or delinquency as defined in theagreement. Because LSQ has recourse to Paragon on factored receivables,accounts receivable are shown gross on the balance sheet and advances are shownas short-term notes payable. The Company’s obligations to LSQ are secured by alien on all of the Company’s assets.

 

                Debtand other obligations are summarized as follows:

 

| ** **                                                              | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------------------|------------|------------------|------------|
| ** **                                                              | ** ** | **Successor**    | ** ** | **Predecessor** | ** ** |
| ** **                                                              | ** ** | **2004**         | ** ** | **2003** | ** ** |
| Current:                                                                |       |             |       |   |   |
| Short-term borrowings under line-of-credit                              |       | $                | —     |   | $ | 1,130 |   |
| Amounts payable under factoring facility                                |       | 3,092            |       | — |   |
| Promissory notes payable, 7.0% due February 15, 2005                    |       | 6,206            |       | — |   |
| Promissory notes payable, 7.0% due February 28, 2005                    |       | 1,500            |       | — |   |
|                                                                    |       | $                | 10,798     |   | $ | 1,130 |   |
| Long-term:                                                              |       |             |       |   |   |
| Preferred shares subject to mandatory redemption due February 27,  2007 |       | $                | 6,000      |   | $ | — |   |

 

                Thepromissory notes with an outstanding principal balance of $6,206 wereoriginally due $5,500 on May 31, 2004 and $706 on June 10, 2004. Theterms of these notes were amended and restated and were paid in full onFebruary 15, 2005 with the proceeds from an initial public offering of theCompany’s shares.

 

                Thepromissory notes with an outstanding principal balance of $1,500 were paid infull on February 28, 2005.

 

 

F-19

----

 

                Theaverage amount of borrowings under the factoring facility was $2,599 during2004 and under the line of credit was $933, $636, and $126 for the two monthsended February 27, 2004 and the years ended December 31, 2003 and2002, respectively.

 

                TheSeries C redeemable preferred stock is classified as preferred sharessubject to mandatory redemption in the financial statements. The shares may beredeemed by the Company at any time but must be redeemed no later thanFebruary 27, 2007. As of December 31, 2004 the Company has accruedinterest expense of $250 on these shares. The payment of interest is requiredsemi-annually.

 

                Paragon’spayment obligations under the promissory notes issued to the formershareholders of Paragon and the redemption and dividend obligations under thepreferred shares subject to mandatory redemption are secured by a pledge to theformer shareholders of Paragon of approximately 55% of the capital stock ofParagon.

 

                InJuly 2004, Paragon entered into a credit agreement with an unaffiliatedfinance source which allowed Paragon to receive cash advances of $400. Paragonassigned a security interest in various assets of Paragon, including tworeceivable balances approximating $440 in the aggregate. Borrowings under thisagreement were paid in December 2004 and the agreement was terminated.Pursuant to the credit agreement, interest expense at an annualized rate of 12%on the outstanding borrowings was paid on a monthly basis. In addition to theabove, Tri-S issued 16,181 warrants to the finance source for the purchase ofcommon stock, at $3.09 per share.

 

                Priorto the Acquisition, Paragon had a line of credit guaranteed by two corporateshareholders allowing draws up to the lesser of $6,000, or 80% of accountsreceivable. The line was secured by all accounts receivable and contractrights. Interest was payable on all draws monthly. The amount due as ofDecember 31, 2003 was $1,130. Simultaneous with the closing of the Acquisition,Paragon paid off outstanding borrowings under the line-of-credit and terminatedthe line-of-credit agreement.

 

**10.          IncomeTaxes**

 

                Theincome tax provision for Paragon, the Predecessor Company, consists of built-ingain taxes. The income tax provision for Tri-S, the Successor Company, consistsof deferred federal and state tax benefits of $414 and current Alabama stateincome tax expense of $30 for the year ended December 31, 2004.

 

                Thefollowing is a reconciliation of income taxes for Tri-S for the year endedDecember 31, 2004 at statutory rates to the provision for income taxes:

 

| Federal tax benefits computed at the statutory rate |   | $   | (344 | ) |
|-----------------------------------------------------|--------|-----|------|---|
| State tax benefits, net of  federal deduction       |   | (40 | )    |
| Provision for income taxes                          |   | $   | (384 | ) |
|                                                     |        |     |      |   |  |

 

 

F-20

----

 

                Netdeferred tax liabilities at December 31, 2004 for Tri-S results fromtemporary differences associated with the following:

 

| ** **                     | ** ** | **December 31,  2004** | ** ** |
|--------------------------------|------------|------------------------|------------|
| Deferred tax assets:           |       |                   |       |
| Accounts receivable            |       | 200                    |       |
| Total deferred tax assets      |       | 200                    |       |
| Deferred tax liabilities:      |       |                   |       |
| Investment in joint venture    |       | (2,688                 | )          |
| Intangible assets              |       | (566                   | )          |
| Depreciation                   |       | (33                    | )          |
| Total deferred tax liabilities |       | (3,287                 | )          |
| Net deferred tax  liabilities  |       | $                      | (3,087     | ) |
|                                |            |                        |            |  |

 

                Paragonused the cash basis of accounting for income taxes prior its acquisition, atwhich time Paragon was required to change its method to the accrual basis.Income taxes as a result of the change in method became due in four annualinstallments and were recorded as an adjustment of $1,423 to the purchase priceof Paragon in accordance with business combination purchase accounting.

 

**11.          LeaseObligations**

 

                Paragonleases real property under operating leases. The leases all terminate in lessthan one year. Rental expense for Tri-S consolidated was $108 for 2004. Rentalexpense for Paragon was $21 for the two months ended February 27, 2004,$112 for 2003 and $79 for 2002. Included in rental expense is $1 per month paidto two officers for rental of a building. Rental obligations to the two officersceases on February 28, 2005. The future minimum amounts due underoperating leases are $100 for 2005.

 

                During2003, Paragon entered into several capital leases for vehicles. The grossamount of assets capitalized under these leases and accumulated depreciation asof December 31, 2004 is $364 and $194, respectively. Depreciation expenseof Tri-S consolidated for these assets during 2004 was $95. Depreciationexpense for the two months ended February 27, 2004 was $19. Depreciationexpense charged for these assets during 2003 was $80.

 

 

F-21

----

 

                Thetotal lease obligation as of December 31, 2004 for the capitalized leasesand the future minimum lease payments under these leases are as follows:

 

| **Year Ending December 31,**  | ** ** | ** ** | ** ** |
|------------------------------------|------------|------------|------------|
| 2005                               |       | $          | 99         |   |
| 2006                               |       | 106        |       |
| Total minimum lease  payments      |       | 205        |       |
| Less amount representing  interest |       | (11        | )          |
| Capital lease obligations          |       | 194        |       |
| Less current portion               |       | (91        | )          |
| Long term portion                  |       | $          | 103        |   |
|                                    |            |            |            |  |  |

 

**12.          Commonand Preferred Stock**

 

**                Tri-SSecurity Corporation (Successor Company)**

 

                Immediatelyprior to the initial public offering of its common stock on February 9,2005, Tri-S entered into an exchange and recapitalization agreement with all ofthe holders of common stock, convertible preferred stock and holders of rightsto acquire common stock. Pursuant to the agreement the Company implemented areverse stock split of all the outstanding shares of its common stock and stockoptions and exchanged common stock for all convertible preferred stock. The recapitalizationwas given retroactive treatment in the financial statements and relateddisclosures.

 

                Asof December 31, 2004, Tri-S is authorized to issue 10 million sharesof preferred stock with a par value of $1.00 per share. The board of directorsof Tri-S is authorized, without further shareholder action, to divide any orall shares of authorized preferred stock into series and to fix and determinethe designations, preferences and relative participating, optional or otherspecial rights, and qualifications, limitations or restrictions thereon, of anyseries so established, including voting powers, dividend rights, liquidationpreferences, redemption rights and conversion or exchange privileges.

 

                Asof December 31, 2004, Tri-S had 100,000 shares outstanding ofSeries A Convertible Preferred Stock, 40,000 shares outstanding ofSeries B Convertible Preferred Stock and 100 shares outstanding ofSeries C Redeemable Preferred Stock.

 

                Holdersof the Series A Convertible Preferred Stock have no voting rights, exceptas otherwise required by applicable law, and no preemptive, dividend or sinkingfund rights. These shares were converted into an aggregate of 242,718 shares ofcommon stock immediately prior to the initial public offering onFebruary 9, 2005.

 

                Holdersof the Series B Convertible Preferred Stock have no voting rights, exceptas otherwise required by applicable law, and no preemptive, dividend or sinkingfund rights. These shares were converted into an aggregate of 129,450 shares ofcommon stock immediately prior to the initial public offering onFebruary 9, 2005.

 

                Holdersof Series C Mandatory Redeemable Preferred Stock have no voting rights,except as otherwise required by applicable law. Holders of Series CMandatory Redeemable Preferred Stock have

 

 

F-22

----

 

no preemptive, conversion or sinking fund rights. In theevent of a liquidation, dissolution or winding up of the Company, holders ofthe Series C Preferred Shares are entitled to a liquidation preference andholders of common shares have a secondary liquidation right to the assets ofthe Company.

 

                TheSeries C Mandatory Redeemable Preferred Stock has a redemption value of$60,000 per share. The Company may redeem the outstanding shares ofSeries C Preferred Stock at any time, but must redeem all the outstandingshares of Series C Mandatory Redeemable Preferred Stock no later thanFebruary 27, 2007. The holders of the Series C Mandatory RedeemablePreferred Stock are entitled to receive cumulative cash dividends at a rate of5% of the redemption value per annum (or $3,000 per share per annum).

 

                Tri-Sis authorized to issue 25 million shares of common stock with a par valueof $0.001 per share. The holders of common stock are entitled to one vote pershare on all matters. The common stock does not have cumulative voting rightsand no conversion rights. Each share of common stock has an equal and ratableright to receive dividends to be paid from assets legally available when and ifdeclared by the Board of Directors. Tri-S has not paid any cash dividends sincethe inception of the Company.

 

**                ParagonSystems, Inc. (Predecessor Company)**

 

                Asof December 31, 2003, Paragon is authorized to issue 1,000 shares ofcommon stock with a par value of $1.00 per share. At December 31, 2003,940 shares were issued and outstanding and 60 shares, which were reacquired ina previous year, are presented as treasury stock in the accompanying financialstatements for the Predecessor Company.

 

**                Income(Loss) Per Share**

 

                Basicincome (loss) per share is computed by dividing income (loss) available tocommon shareholders by the weighted average number of common shares outstandingfor the period. Diluted earnings per share reflects the potential dilution thatwould occur if securities or other contracts to issue common stock wereexercised or converted into common stock.

 

 

F-23

----

 

                Thefollowing table sets forth the computation of the basic and diluted net income(loss) per share (share amounts in thousands):

 

| ** **                                         | ** ** | **Year ended  December 31,  2004** | ** ** |
|----------------------------------------------------|------------|-----------------------------------------|------------|
| ** **                                         | ** ** | **(restated, Note 2)**                  | ** ** |
| Numerator:                                         |       |                                    |       |
| Net income (loss)                                  |       | $                                       | (627       | ) |
| Denominator:                                       |       |                                    |       |
| Weighted average common shares outstanding         |       | 828                                     |       |
| Denominator for basic calculation                  |       | 828                                     |       |
| Effect of dilutive securities:                     |       |                                    |       |
| Conversion of Series A Convertible Preferred Stock |       | 243                                     |       |
| Conversion of Series B Convertible Preferred Stock |       | 129                                     |       |
| Common stock options                               |       | 65                                      |       |
| Common stock warrants                              |       | 4                                       |       |
| Denominator for diluted calculation                |       | 1,269                                   |       |
| Basic net income (loss)  per common share          |       | $                                       | (0.76      | ) |
| Diluted net income (loss)  per common share        |       | $                                       | (0.76      | ) |

 

                Thediluted net loss per common share is anti-dilutive, consequently the dilutednet loss per common share as presented on the face of the financial statementsis the same as the basic net loss per common share.

 

**13.          StockOptions and Warrants**

 

                Non-qualifiedstock options for 97,087 shares of the common stock of Tri-S were granted onJanuary 1, 2002 with an exercise price of $0.12 per share. These optionsvest 32,362 shares each on December 31, 2004, 2003 and 2002 and expire inOctober 2011. As of December 31, 2004 there have been no otheroptions granted and there have been no options forfeited. At December 31,2004, options for 97,087 shares were outstanding, of which all options wereexercisable.

 

                Warrantsfor 16,181 shares of common stock were issued on July 27, 2004 with anexercise price of $3.09 per share. These warrants were outstanding atDecember 31, 2004 and will expire on February 9, 2006.

 

                The2004 Stock Incentive Plan (“Stock Incentive Plan”) was approved and adopted bythe board of directors and shareholders on October 13, 2004. The StockIncentive Plan is administered by the compensation committee of the board ofdirectors in accordance with and subject to the provisions of the StockIncentive Plan. The committee has the authority to determine all provisions ofincentive awards as the committee may deem necessary or desirable and asconsistent with the terms of the Stock Incentive Plan. The maximum number ofshares of common stock that are available for issuance under the StockIncentive Plan is 500,000 all of which are available for future grant. TheStock Incentive Plan will terminate at midnight no later than October 13,2014, unless terminated earlier by action of the board of directors.

 

 

F-24

----

 

                TheStock Incentive Plan provides for the grants of incentive awards to eligibleparticipants, including employees, officers, directors, consultants and independentcontractors. These awards include options to purchase shares of common stockthat qualify as incentive stock options within the meaning of the InternalRevenue Code, non-qualified options, restricted stock awards, and stockbonuses.

 

                Theper share price to be paid by a participant upon exercise of an option isdetermined by the committee at the time of the option grant, provided that theexercise price for incentive stock options must be equal to the fair marketvalue of common stock on the date of grant and 110% of the fair market valueif, at the time the incentive stock option is granted, the participant owns,directly or indirectly, more than 10% of the total combined voting power of allclasses of stock of the Company or any parent or subsidiary corporation of theCompany. An option will become exercisable at such times and in suchinstallments as may be determined by the committee in its sole discretion atthe time of grant, provided that no option may be exercisable after10 years from its date of grant.

 

                Restrictedstock awards are awards of common stock granted to a recipient which aresubject to restrictions on transferability and the risk of forfeiture. Thecommittee may impose such restrictions or conditions to the vesting ofrestricted stock awards, including that the participant remain in thecontinuous employ or service of the Company for a specified period of time orthat the participant or the Company satisfy specified performance goals orcriteria.

 

                Stockbonuses are awards of common stock that are not subject to any restrictionsother than, if imposed by the committee, restrictions on transferability. Stockbonuses are subject to such terms and conditions as may be determined by thecommittee.

 

**14.          Contingencies**

 

                TheCompany is involved in various legal proceedings, including employeediscrimination suits, from time to time in the normal course of business. Inmanagement’s opinion, the Company is not currently involved in any legalproceedings, individually or in the aggregate, which could have a materialeffect on the financial condition, results of operations or cash flows of theCompany.

 

**15.          SubsequentEvents**

 

                OnFebruary 9, 2005, the Company completed an initial public offering of1,800,000 units, consisting of one share of common stock and one warrant topurchase one share of common stock. After underwriting fees and before othercosts of the public offering, the Company received proceeds of $9,592. As ofDecember 31, 2004, the Company had accrued or paid $633 in costs for thepublic offering. Additionally, the Company incurred approximately $125 ofpublic offering costs subsequent to December 31, 2004. On March 17,2005, the underwriters exercised their option to purchase 270,000 additionalunits. After underwriting fees, the Company received proceeds of $1,487 fromthe additional units.

 

                Incidentwith the public offering, holders of the Company’s existing common stock beforethe public offering, Series A Convertible Preferred Stock andSeries B Convertible Preferred Stock exchanged their shares for a total of1,200,000 shares of the Company’s common stock. Also, 15,000 shares of theCompany’s common stock were issued to a current shareholder of the Company and20,000 shares of the Company’s common stock were issued to former shareholdersof Paragon Systems.

 

 

F-25

----

 

After the initial public offering, 3,305,000 shares ofthe Company’s common stock were issued and outstanding.

 

**16.          SelectedQuarterly Financial Data (Unaudited)**

 

                The followingtable sets forth, for each quarter in the last two fiscal years, selected datafrom our statements of operations. The operations of Tri-S prior toFebruary 27, 2004 are combined with the operations of Paragon for allperiods presented. Paragon was an S corporation and not subject to income taxesprior to the Acquisition. Pro forma income taxes are provided for Paragon at38% of income or loss before income taxes for periods prior to the Acquisition.

 
| ** **                                                          | ** ** | **First  Quarter** | ** ** | **Second  Quarter** | ** ** | **Third  Quarter** | ** ** | **Fourth  Quarter** | ** ** |
|---------------------------------------------------------------------|------------|--------------------|------------|---------------------|------------|--------------------|------------|---------------------|------------|
| ** **                                                          | ** ** | **(restated)**     | ** ** | **(restated)**      | ** ** | **(restated)**     | ** ** | **(restated)**      | ** ** |
| **2004**                                                            |       |               |       |                |       |               |       |                |       |
| Revenue                                                             |       | $                  | 7,283      |                | $          | 7,468              |       | $                   | 7,682      |   | $ | 7,697 |   |
| Gross profit (loss)                                                 |       | $                  | 565        |                | $          | 321                |       | $                   | 446        |   | $ | (127 | ) |
| Net income attributable to  common shareholders                     |       | $                  | (62        | )                   | $          | (338               | )          | $                   | 571        |   | $ | (879 | ) |
| Diluted net earnings per  share attributable to common shareholders |       | $                  | (0.07      | )                   | $          | (0.41              | )          | $                   | 0.44       |   | $ | (1.07 | ) |
| **2003**                                                            |       |               |       |                |       |               |       |                |       |
| Revenue                                                             |       | $                  | 7,223      |                | $          | 6,790              |       | $                   | 7,753      |   | $ | 7,629 |   |
| Gross profit                                                        |       | $                  | 679        |                | $          | 559                |       | $                   | 519        |   | $ | 417 |   |
| Net income attributable to  common shareholders                     |       | $                  | 198        |                | $          | 125                |       | $                   | 24         |   | $ | (136 | ) |
| Diluted net earnings per  share attributable to common shareholders |       | $                  | 0.19       |                | $          | 0.12               |       | $                   | 0.02       |   | $ | (0.16 | ) |
|                                                                     |            |                    |            |                     |            |                    |            |                     |            |  |  |  |  |  |  |  |  |  |

 

 

F-26

----

 

**SIGNATURES**

 

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

 
| ** ** | **TRI-S SECURITY CORPORATION** |
|------------|--------------------------------|
| ** ** | ** **                     | ** ** |
|       | By:                            | /s/ Ronald G. Farrell |
|       |                           | Ronald G. Farrell*Chairman of the Board  and**Chief Executive  Officer* |
|       |                           |   |
|       | Date:                          | November 17, 2005 |

 

 

----

 

 

**EXHIBIT INDEX**

 
| **Exhibit No.** | ** ** | **Description**                                                                                                                                | ** ** | **Method of Filing**                                                                                                       |
|-----------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------------------------------------------------------------------------|
| 1.1             |       | Form of Underwriting Agreement entered into in  connection with the Initial Public Offering.                                                   |       | Incorporated by reference to Exhibit 1.1 to the Company’s  Registration Statement on Form S-1 (No. 333-119737).  |
| 2.1             |       | Stock Purchase Agreement dated February 23, 2004,  among the Company and Charles Keathley, Robert Luther, Harold Bright and John  Wilson. |       | Incorporated by reference to Exhibit 2.1 to the Company’s  Registration Statement on Form S-1 (No. 333-119737).  |
| 3.1             |       | Amended and Restated Articles of Incorporation.                                                                                                |       | Incorporated by reference to Exhibit 3.1 to the Company’s  Registration Statement on Form S-1 (No. 333-119737).  |
| 3.2             |       | Amended and Restated Bylaws.                                                                                                                   |       | Incorporated by reference to Exhibit 3.2 to the Company’s  Registration Statement on Form S-1 (No. 333-119737).  |
| 4.1             |       | Form of Representative’s Option for the Purchase of  Warrants.                                                                            |       | Incorporated by reference to Exhibit 4.1 to the Company’s  Registration Statement on Form S-1 (No. 333-119737).  |
| 4.2             |       | Form of Representative’s Option for the Purchase of  Common Stock.                                                                        |       | Incorporated by reference to Exhibit 4.2 to the Company’s  Registration Statement on Form S-1 (No. 333-119737).  |
| 4.3             |       | Specimen Common Stock Certificate.                                                                                                             |       | Incorporated by reference to Exhibit 4.3 to the Company’s  Registration Statement on Form S-1 (No. 333-119737).  |
| 4.4             |       | Form of Warrant Agreement.                                                                                                                     |       | Incorporated by reference to Exhibit 4.4 to the Company’s  Registration Statement on Form S-1 (No. 333-119737).  |
| 4.5             |       | Form of Warrant Issuable to Underwriters Upon Exercise  of Option.                                                                             |       | Incorporated by reference to Exhibit 4.5 to the Company’s  Registration Statement on Form S-1 (No. 333-119737).  |
| 4.6             |       | Specimen Warrant Certificate.                                                                                                                  |       | Incorporated by reference to Exhibit 4.6 to the Company’s  Registration Statement on Form S-1 (No. 333-119737).  |
| 4.7             |       | Specimen Unit Certificate.                                                                                                                     |       | Incorporated by reference to Exhibit 4.7 to the Company’s  Registration Statement on Form S-1 (No. 333-119737).  |
| 10.1            |       | Factoring and Security Agreement dated as of February  27, 2004, between Paragon Systems, Inc. and LSQ Funding Group, L.L.C.                   |       | Incorporated by reference to Exhibit 10.1 to the  Company’s Registration Statement on Form S-1 (No. 333-119737). |
| 10.2            |       | Assignment of Contract Proceeds dated as of  February 27, 2004, between Paragon Systems, Inc. and LSQ Funding Group,  L.L.C.              |       | Incorporated by reference to Exhibit 10.2 to the  Company’s Registration Statement on Form S-1 (No. 333-119737). |
| 10.3            |       | Assignment of Factoring Credit Balances dated as of  July 27, 2004, among Paragon Systems, Inc., LSQ Funding Group, L.L.C. and BRE  LLC.       |       | Incorporated by reference to Exhibit 10.3 to the  Company’s Registration Statement on Form S-1 (No. 333-119737). |

 

 

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| 10.4  |   | Promissory Note dated July 27, 2004, made by Paragon  Systems, Inc. in favor of BRE LLC in principal amount of $400,000.                                                                                                                        |   | Incorporated by reference to Exhibit 10.4 to the  Company’s Registration Statement on Form S-1 (No. 333-119737).  |
|-------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------------------------------------------------------------|
| 10.5  |   | Security Agreement dated July 27, 2004, between Paragon  Systems, Inc. and BRE LLC.                                                                                                                                                             |   | Incorporated by reference to Exhibit 10.5 to the  Company’s Registration Statement on Form S-1 (No. 333-119737).  |
| 10.6  |   | Agreement Regarding Notes and Preferred Shares dated as  of September 29, 2004, among the Company, Paragon Systems, Inc., Harold  Bright, Charles Keathley, Robert Luther and John Wilson.                                                      |   | Incorporated by reference to Exhibit 10.6 to the  Company’s Registration Statement on Form S-1 (No. 333-119737).  |
| 10.7  |   | Letter Agreement dated October 6, 2004, between the  Company, Paragon Systems, Inc., Charles Keathley and Robert Luther.                                                                                                                        |   | Incorporated by reference to Exhibit 10.7 to the  Company’s Registration Statement on Form S-1 (No. 333-119737).  |
| 10.8  |   | Consent Agreement to Extend Promissory Notes dated as  of September 7, 2004 among the Company, Paragon Systems, Inc., Harold Bright  and John Wilson.                                                                                           |   | Incorporated by reference to Exhibit 10.8 to the  Company’s Registration Statement on Form S-1 (No. 333-119737).  |
| 10.9  |   | Promissory Note dated February 24, 2004, made by the  Company in favor of Harold Bright in the principal amount of $526,900.                                                                                                                    |   | Incorporated by reference to Exhibit 10.9 to the  Company’s Registration Statement on Form S-1 (No. 333-119737).  |
| 10.10 |   | Amended and Restated Promissory Note dated September  29, 2004, made by the Company in favor of Charles Keathley in principal  amount of $2,983,750.                                                                                            |   | Incorporated by reference to Exhibit 10.10 to the  Company’s Registration Statement on Form S-1 (No. 333-119737). |
| 10.11 |   | Amended and Restated Promissory Note dated September  29, 2004, made by the Company in favor of Robert Luther in principal amount  of $1,462,450.                                                                                               |   | Incorporated by reference to Exhibit 10.11 to the  Company’s Registration Statement on Form S-1 (No. 333-119737). |
| 10.12 |   | Promissory Note dated February 24, 2004, made by the  Company in favor of Tom Wilson in the principal amount of $526,900                                                                                                                        |   | Incorporated by reference to Exhibit 10.12 to the  Company’s Registration Statement on Form S-1 (No. 333-119737). |
| 10.13 |   | Amended and Restated Promissory Note dated September  29, 2004, made by Paragon Systems, Inc. in favor of Charles Keathley, both  individually and as agent for Robert Luther, Harold Bright and John Wilson,  in principal amount of $706,507. |   | Incorporated by reference to Exhibit 10.13 to the  Company’s Registration Statement on Form S-1 (No. 333-119737). |
| 10.14 |   | Pledge and Assignment of Stock and Security Agreement  dated September 29, 2004, between the Company and Charles Keathley.                                                                                                                      |   | Incorporated by reference to Exhibit 10.14 to the  Company’s Registration Statement on Form S-1 (No. 333-119737). |
| 10.15 |   | Pledge and Assignment of Stock and Security Agreement  dated September 29, 2004, between the Company and Robert Luther.                                                                                                                         |   | Incorporated by reference to Exhibit 10.15 to the Company’s  Registration Statement on Form S-1 (No. 333-119737). |
| 10.16 |   | Promissory Note dated February 24, 2004, made by the  Company in favor of Harold Bright in principal amount of $143,700.                                                                                                                        |   | Incorporated by reference to Exhibit 10.16 to the  Company’s Registration Statement on Form S-1 (No. 333-119737). |

 

 

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| 10.17 |   | Promissory Note dated February 24, 2004, made by the  Company in favor of Charles Keathley in principal amount of $813,750.                                     |   | Incorporated by reference to Exhibit 10.17 to the  Company’s Registration Statement on Form S-1 (No. 333-119737). |
|-------|--------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------------------------------------------------------------|
| 10.18 |   | Promissory Note dated February 24, 2004, made by the  Company in favor of Robert Luther Bright in principal amount of $398,850.                                 |   | Incorporated by reference to Exhibit 10.18 to the  Company’s Registration Statement on Form S-1 (No. 333-119737). |
| 10.19 |   | Promissory Note dated February 24, 2004, made by the  Company in favor of John Wilson in principal amount of $143,700.                                          |   | Incorporated by reference to Exhibit 10.19 to the  Company’s Registration Statement on Form S-1 (No. 333-119737). |
| 10.20 |   | Security Agreement dated February 24, 2004, between the  Company and Harold Bright.                                                                             |   | Incorporated by reference to Exhibit 10.20 to the  Company’s Registration Statement on Form S-1 (No. 333-119737). |
| 10.21 |   | Security Agreement dated February 24, 2004, between the  Company and Charles Keathley.                                                                          |   | Incorporated by reference to Exhibit 10.21 to the  Company’s Registration Statement on Form S-1 (No. 333-119737). |
| 10.22 |   | Security Agreement dated February 24, 2004, between the  Company and Robert Luther.                                                                             |   | Incorporated by reference to Exhibit 10.22 to the  Company’s Registration Statement on Form S-1 (No. 333-119737). |
| 10.23 |   | Security Agreement dated February 24, 2004, between the  Company and John Wilson.                                                                               |   | Incorporated by reference to Exhibit 10.23 to the  Company’s Registration Statement on Form S-1 (No. 333-119737). |
| 10.24 |   | Employment Agreement dated January 1, 2002, between the  Company and Ronald G. Farrell. Represents an executive compensation plan or  arrangement.              |   | Incorporated by reference to Exhibit 10.24 to the  Company’s Registration Statement on Form S-1 (No. 333-119737). |
| 10.25 |   | Employment Agreement dated February 24, 2004, between  Paragon Systems, Inc. and Charles Allbritten. Represents an executive  compensation plan or arrangement. |   | Incorporated by reference to Exhibit 10.25 to the  Company’s Registration Statement on Form S-1 (No. 333-119737). |
| 10.26 |   | Employment Agreement dated February 24, 2004, between  Paragon Systems, Inc. and Harold Bright. Represents an executive compensation  plan or arrangement.      |   | Incorporated by reference to Exhibit 10.26 to the  Company’s Registration Statement on Form S-1 (No. 333-119737). |
| 10.27 |   | Employment Agreement dated February 24, 2004, between  Paragon Systems, Inc. and Carla J. Cilyok. Represents an executive compensation  plan or arrangement.    |   | Incorporated by reference to Exhibit 10.27 to the  Company’s Registration Statement on Form S-1 (No. 333-119737). |
| 10.28 |   | Employment Agreement dated February 24, 2004, between  Paragon Systems, Inc. and Charles Keathley. Represents an executive  compensation plan or arrangement.   |   | Incorporated by reference to Exhibit 10.28 to the  Company’s Registration Statement on Form S-1 (No. 333-119737). |
| 10.29 |   | Employment Agreement dated February 24, 2004, between  Paragon Systems, Inc. and Robert N. Luther. Represents an executive  compensation plan or arrangement.   |   | Incorporated by reference to Exhibit 10.29 to the  Company’s Registration Statement on Form S-1 (No. 333-119737). |
| 10.30 |   | Employment Agreement dated February 24, 2004, between  Paragon Systems, Inc. and John T. Wilson. Represents an executive  compensation plan or arrangement.     |   | Incorporated by reference to Exhibit 10.30 to the  Company’s Registration Statement on Form S-1 (No. 333-119737). |

 

 

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| 10.31 |   | Form of Exchange and Recapitalization Agreement among  the Company and the holders of the Company’s outstanding common stock, Series  A Convertible Preferred Stock and Series B Convertible Preferred Stock. |   | Incorporated by reference to Exhibit 10.31 to the  Company’s Registration Statement on Form S-1 (No. 333-119737). |
|-------|--------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------------------------------------------------------------|
| 10.32 |   | Office Lease Agreement dated November 2003, between  Paragon Systems, Inc. and Southpark Office Centre.                                                                                                            |   | Incorporated by reference to Exhibit 10.32 to the  Company’s Registration Statement on Form S-1 (No. 333-119737). |
| 10.33 |   | Lease Agreement dated October 7, 2003, between Paragon  Systems, Inc. and Gwen Reed for 2319 Market Place, Huntsville, Alabama.                                                                                    |   | Incorporated by reference to Exhibit 10.33 to the  Company’s Registration Statement on Form S-1 (No. 333-119737). |
| 10.34 |   | Lease Agreement dated October 7, 2003, between Paragon  Systems, Inc. and Gwen Reed for 3317 Triana Boulevard, Huntsville, Alabama.                                                                                |   | Incorporated by reference to Exhibit 10.34 to the  Company’s Registration Statement on Form S-1 (No. 333-119737). |
| 10.35 |   | Office Services Agreement, between the Company and  Interactive Offices Mansell, LLC.                                                                                                                              |   | Incorporated by reference to Exhibit 10.35 to the  Company’s Registration Statement on Form S-1 (No. 333-119737). |
| 10.36 |   | Building Lease Agreement dated June 29, 1996, between  Paragon Systems, Inc. and Charles Keathley and Robert Luther.                                                                                               |   | Incorporated by reference to Exhibit 10.36 to the  Company’s Registration Statement on Form S-1 (No. 333-119737). |
| 10.37 |   | Agreement dated May 5, 2003, among Paragon Systems,  Inc. and International Union of Security, Police and Fire Professionals of  America.                                                                          |   | Incorporated by reference to Exhibit 10.37 to the  Company’s Registration Statement on Form S-1 (No. 333-119737). |
| 10.38 |   | Agreement dated December 16, 2003 among Paragon Systems  Inc. and International Union, Security, Police, and Fire Professionals of  America.                                                                       |   | Incorporated by reference to Exhibit 10.38 to the  Company’s Registration Statement on Form S-1 (No. 333-119737). |
| 10.39 |   | Agreement dated March 1, 2002, between Paragon Systems,  Inc. and International Technical and Professional Employees Union, AFL-  CIO.                                                                             |   | Incorporated by reference to Exhibit 10.39 to the  Company’s Registration Statement on Form S-1 (No. 333-119737). |
| 10.40 |   | Agreement dated December 1, 2003 between Paragon  Systems, Inc. and United Union of Security Guards.                                                                                                               |   | Incorporated by reference to Exhibit 10.40 to the  Company’s Registration Statement on Form S-1 (No. 333-119737). |
| 10.41 |   | Joint Venture limited Liability Company Agreement for  Army Fleet Support, LLC.                                                                                                                                    |   | Incorporated by reference to Exhibit 10.41 to the  Company’s Registration Statement on Form S-1 (No. 333-119737). |
| 10.42 |   | 2004 Stock Incentive Plan.                                                                                                                                                                                         |   | Incorporated by reference to Exhibit 10.42 to the  Company’s Registration Statement on Form S-1 (No. 333-119737). |
| 10.43 |   | Form of Indemnification Agreement.                                                                                                                                                                                 |   | Incorporated by reference to Exhibit 10.43 to the  Company’s Registration Statement on Form S-1 (No. 333-119737). |
| 10.44 |   | Paragon Systems, Inc. 401(k) Profit Sharing Plan, as  amended.                                                                                                                                                     |   | Incorporated by reference to Exhibit 10.44 to the  Company’s Registration Statement on Form S-1 (No. 333-119737). |

 

 

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| 10.45 |   | Federal Government Contract #DAAH01-00-C-0057.                                   |   | Incorporated by reference to Exhibit 10.45 to the  Company’s Registration Statement on Form S-1 (No. 333-119737). |
|-------|--------|----------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------------------------------------------------------------|
| 10.46 |   | Federal Government Contract #TFTC-00-22, as  amended.                            |   | Incorporated by reference to Exhibit 10.46 to the  Company’s Registration Statement on Form S-1 (No. 333-119737). |
| 10.47 |   | Federal Government Contract #DTCG-84-01-N-AA8002,  as amended.                   |   | Incorporated by reference to Exhibit 10.47 to the  Company’s Registration Statement on Form S-1 (No. 333-119737). |
| 10.48 |   | Federal Government SubContract #DASG60.                                          |   | Incorporated by reference to Exhibit 10.48 to the  Company’s Registration Statement on Form S-1 (No. 333-119737). |
| 10.49 |   | Federal Government Contract ####-##-####,  as amended.                           |   | Incorporated by reference to Exhibit 10.49 to the  Company’s Registration Statement on Form S-1 (No. 333-119737). |
| 10.50 |   | Federal Government Contract #DTCG84-03-F-3N4005.                                 |   | Incorporated by reference to Exhibit 10.50 to the  Company’s Registration Statement on Form S-1 (No. 333-119737). |
| 10.51 |   | Federal Government Contract #NS-7790.                                            |   | Incorporated by reference to Exhibit 10.51 to the  Company’s Registration Statement on Form S-1 (No. 333-119737). |
| 10.52 |   | Federal Government Contract #600-00-60012.                                       |   | Incorporated by reference to Exhibit 10.52 to the  Company’s Registration Statement on Form S-1 (No. 333-119737). |
| 10.53 |   | Federal Government Contract #0600-03-60006.                                      |   | Incorporated by reference to Exhibit 10.53 to the  Company’s Registration Statement on Form S-1 (No. 333-119737). |
| 10.54 |   | Federal Government Contract #DACW38-03-D-0002.                                   |   | Incorporated by reference to Exhibit 10.54 to the  Company’s Registration Statement on Form S-1 (No. 333-119737). |
| 10.55 |   | Federal Government Contract #GS-07F-0418K,  as amended.                          |   | Incorporated by reference to Exhibit 10.55 to the  Company’s Registration Statement on Form S-1 (No. 333-119737). |
| 10.56 |   | Federal Government Contract #GS-07F-0418K,  as amended.                          |   | Incorporated by reference to Exhibit 10.56 to the  Company’s Registration Statement on Form S-1 (No. 333-119737). |
| 10.57 |   | Federal Government Contract#AFR-RHG-05-C-001.                                    |   | Incorporated by reference to Exhibit 10.57 to the  Company’s Registration Statement on Form S-1 (No. 333-119737). |
| 10.58 |   | Form of Market Stand-Off Agreement.                                              |   | Incorporated by reference to Exhibit 10.58 to the  Company’s Registration Statement on Form S-1 (No. 333-119737). |
| 10.59 |   | Consulting Agreement dated March 25, 2002 between the  Company and Douglas Ball. |   | Incorporated by reference to Exhibit 10.59 to the  Company’s Registration Statement on Form S-1 (No. 333-119737). |
| 10.60 |   | Employment Agreement dated March 25, 2002 between the  Company and Douglas Ball. |   | Incorporated by reference to Exhibit 10.60 to the  Company’s Registration Statement on Form S-1 (No. 333-119737). |

 

 

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| 10.61 |   | Letter Agreement dated December 7, 2004 between the  Company and Douglas Ball.                                                                    |   | Incorporated by reference to Exhibit 10.61 to the  Company’s Registration Statement on Form S-1 (No. 333-119737). |
|-------|--------|---------------------------------------------------------------------------------------------------------------------------------------------------|--------|-----------------------------------------------------------------------------------------------------------------------------|
| 10.62 |   | Letter Agreement dated November 30, 2004 among the  Company, Charles Keathley and Robert Luther.                                                  |   | Incorporated by reference to Exhibit 10.62 to the  Company’s Registration Statement on Form S-1 (No. 333-119737). |
| 10.63 |   | Letter Agreement dated December 14, 2004 among the  Company, Harold Bright and John Wilson.                                                       |   | Incorporated by reference to Exhibit 10.63 to the  Company’s Registration Statement on Form S-1 (No. 333-119737). |
| 10.64 |   | Amendment No. 1 to Employment Agreement between  the Company and Ronald G. Farrell. Represents an executive compensation plan  of agreement. |   | Incorporated by reference to Exhibit 10.64 to the  Company’s Registration Statement on Form S-1 (No. 333-119737). |
| 10.65 |   | Form of Consulting Agreement among the Company, Capital  Growth Financial, LLC and Bathgate Capital Partners LLC.                                 |   | Incorporated by reference to Exhibit 10.65 to the  Company’s Registration Statement on Form S-1 (No. 333-119737). |
| 10.66 |   | Promissory Note made by Ronald G. Farrell in favor of  the Company dated December 31, 2004.                                                  |   | Incorporated by reference to Exhibit 10.66 to the  Company’s Registration Statement on Form S-1 (No. 333-119737). |
| 21.1  |   | Subsidiaries of the Company.                                                                                                                      |   | Incorporated by reference to Exhibit 21.1 to the  Company’s Registration Statement on Form S-1 (No. 333-119737).  |
| 23.1  |   | Consent of Miller Ray & Houser LLP (Tri-S  Security Corporation).                                                                             |   | Filed herewith.                                                                                                             |
| 23.2  |   | Consent of Miller Ray & Houser LLP (Paragon  Systems, Inc.).                                                                                  |   | Filed herewith.                                                                                                             |
| 31.1  |   | Rule 13a-14(a)/15d-14(a) Certification of  the Company’s Chief Executive Officer.                                                            |   | Filed herewith.                                                                                                             |
| 31.2  |   | Rule 13a-14(a)/15d-14(a) Certification of  the Company’s Chief Financial Officer.                                                            |   | Filed herewith.                                                                                                             |
| 32.1  |   | Section 1350 Certification of the Company’s Chief  Executive Officer.                                                                        |   | Filed herewith.                                                                                                             |
| 32.2  |   | Section 1350 Certification of the Company’s Chief  Financial Officer.                                                                        |   | Filed herewith.                                                                                                             |

 

 

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