**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C. 20549**

 

**FORM 10-Q**

 

**ý**** QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THESECURITIES EXCHANGE ACT OF 1934**

 

**For thequarterly period ended March 31, 2006**

 

**o**** TRANSITION REPORT UNDER SECTION 13 OR 15(d)OF THE EXCHANGE ACT**

 

**For thetransition period from           to**

 

**Commissionfile 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                                        |       | (I.R.S.  Employer Identification No.) |
| of  incorporation or organization)                                   |       |                                  |
|                                                                 |       |                                  |
| **11675  Great Oaks Way, Suite 120, Alpharetta, Georgia 30022** |
| (Address of  principal executive offices)                            |
|                                                                 |       |                                  |
| **(678)  808-1540**                                                  |
| (Registrant’s  telephone number, including area code)           |

 

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Indicate by checkmark whether the registrant (1) has filed all reports required to be filedby Section 13 or 15(d) of the Securities Exchange Act of 1934 duringthe preceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days.

Yes ý No o.

 

Indicate by check mark whether registrant is a large accelerated filer,an accelerated filer, or a non-accelerated filer. See definition of “acceleratedfiler and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Checkone):
| Large accelerated filer  ̈ | Accelerated filer  ̈ | Non-accelerated filer ý |
|--------------------------------|--------------------------|------------------------------|

 

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

 

Shares of the registrant’s common stock, par value $0.001 per share,outstanding as of May 10, 2006: 3,369,117.

 

 

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**TRI-SSECURITY CORPORATION**

**QUARTERLYREPORT ON FORM 10-Q FOR THE**

**QUARTERENDED MARCH 31, 2006**

**INDEX**

 
| ** **        | ** **                                                                                  | **Page No.** |
|-------------------|---------------------------------------------------------------------------------------------|-------------------|
|              |                                                                                        |              |
| **PART I.**  | **FINANCIAL INFORMATION**                                                                   |              |
|              |                                                                                        |              |
| ITEM 1.           | FINANCIAL STATEMENTS:                                                                       |              |
|              |                                                                                        |              |
|              | Consolidated Balance Sheets                                                                 |              |
|              | March 31, 2006 and December 31,  2005                                             | 2                 |
|              |                                                                                        |              |
|              | Consolidated Statements of Operations                                                       |              |
|              | Three Months ended March 31, 2006 and 2005                                             | 3                 |
|              |                                                                                        |              |
|              | Consolidated Statements of Cash Flows                                                       |              |
|              | Three months ended March 31, 2006 and 2005                                             | 4                 |
|              |                                                                                        |              |
|              | Notes to Consolidated Financial Statements                                                  | 5                 |
|              |                                                                                        |              |
| ITEM 2.           | MANAGEMENT’S  DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS | 13                |
|              |                                                                                        |              |
| ITEM 3.           | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                  | 17                |
|              |                                                                                        |              |
| ITEM 4.           | CONTROLS AND PROCEDURES                                                                     | 17                |
|              |                                                                                        |              |
| **PART II.** | **OTHER INFORMATION**                                                                       | 18                |
|              |                                                                                        |              |
| ITEM 1.           | LEGAL PROCEEDINGS                                                                           | 18                |
|              |                                                                                        |              |
| ITEM 1A.          | RISK  FACTORS                                                                               | 18                |
|              |                                                                                        |              |
| ITEM 3.           | DEFAULT UPON SENIOR  SECURITIES                                                             | 18                |
|              |                                                                                        |              |
| ITEM 4.           | SUBMISSION OF MATTERS TO  VOTE OF SECURITY HOLDERS                                          | 18                |
|              |                                                                                        |              |
| ITEM 5.           | OTHER INFORMATION                                                                           | 19                |
|              |                                                                                        |              |
| ITEM 6.           | EXHIBITS                                                                                    | 19                |
|              |                                                                                        |              |
|              | SIGNATURES                                                                                  | 20                |
|              |                                                                                        |              |
|              | EXHIBIT INDEX                                                                          | E-1               |

 

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**Tri-S Security Corporation and Subsidiaries**

 

**Consolidated Balance Sheets**

**Unaudited**

**(In thousands, except per share data)**

 
| ** **                                                                                                            | ** ** | **March 31, 2006** | ** ** | **December 31, 2005** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|----------------------------|------------|
| **Assets**                                                                                                            | ** ** | ** **              | ** ** | ** **                 | ** ** |
| Current assets:                                                                                                       |       |                    |       |                       |       |
| Cash and  cash equivalents                                                                                            |       | $                       | 245        |                       | $          | 463 |   |
| Trade  accounts receivable, net                                                                                       |       | 10,022                  |       | 10,988                     |       |
| Income taxes  receivable                                                                                              |       | 321                     |       | 20                         |       |
| Note  receivable – officer                                                                                       |       | 102                     |       | 102                        |       |
| Prepaid  expenses and other assets                                                                                    |       | 1,307                   |       | 982                        |       |
|                                                                                                                  |       |                    |       |                       |       |
| Total  current assets                                                                                                 |       | 11,997                  |       | 12,555                     |       |
|                                                                                                                  |       |                    |       |                       |       |
| Property and equipment, less accumulated  depreciation                                                                |       | 1,384                   |       | 1,467                      |       |
| Investment in joint venture                                                                                           |       | 8,974                   |       | 8,698                      |       |
| Goodwill                                                                                                              |       | 15,615                  |       | 15,615                     |       |
| Intangibles, net                                                                                                      |       |                    |       |                       |       |
| Customer  contracts                                                                                                   |       | 5,578                   |       | 5,990                      |       |
| Deferred  loan costs                                                                                                  |       | 1,639                   |       | 1,756                      |       |
| Other                                                                                                                 |       | 1,195                   |       | 1,264                      |       |
|                                                                                                                  |       |                    |       |                       |       |
| Total assets                                                                                                          |       | $                       | 46,382     |                       | $          | 47,345 |   |
|                                                                                                                  |       |                    |       |                       |       |
| **Liabilities  and Stockholders’ Equity**                                                                        | ** ** | ** **              | ** ** | ** **                 | ** ** |
| Current liabilities:                                                                                                  |       |                    |       |                       |       |
| Trade  accounts payable                                                                                               |       | $                       | 1,407      |                       | $          | 1,199 |   |
| Accrued  interest expense                                                                                             |       | 175                     |       | 100                        |       |
| Accrued  expenses                                                                                                     |       | 4,430                   |       | 5,690                      |       |
| Factoring  facility                                                                                                   |       | 9,008                   |       | 7,191                      |       |
| Series C  preferred stock subject to mandatory redemption                                                        |       | 6,000                   |       | —                     |       |
| Term loans                                                                                                            |       | 4,821                   |       | 275                        |       |
|                                                                                                                  |       |                    |       |                       |       |
| Total  current liabilities                                                                                            |       | 25,841                  |       | 14,455                     |       |
|                                                                                                                  |       |                    |       |                       |       |
| Other liabilities:                                                                                                    |       |                    |       |                       |       |
| 10%  convertible notes                                                                                                |       | 6,379                   |       | 6,300                      |       |
| Deferred  income taxes                                                                                                |       | 4,622                   |       | 5,069                      |       |
| Term loans                                                                                                            |       | —                  |       | 4,817                      |       |
| Long-term  debt                                                                                                       |       | 270                     |       | 270                        |       |
| Series C  preferred stock subject to mandatory redemption                                                        |       | —                  |       | 6,000                      |       |
| Total  liabilities                                                                                                    |       | 37,112                  |       | 36,911                     |       |
|                                                                                                                  |       |                    |       |                       |       |
| Stockholders’ equity:                                                                                            |       |                    |       |                       |       |
| Common stock,  $0.001 par value, 25,000,000 shares authorized, 3,369,117 and 3,338,700  shares issued and outstanding |       | 3                       |       | 3                          |       |
| Additional  paid-in capital                                                                                           |       | 13,850                  |       | 13,749                     |       |
| Deficit                                                                                                               |       | (4,583                  | )          | (3,318                     | )          |
|                                                                                                                  |       |                    |       |                       |       |
| Total  stockholders’ equity                                                                                      |       | 9,270                   |       | 10,434                     |       |
|                                                                                                                  |       |                    |       |                       |       |
| Total liabilities and stockholders’ equity                                                                       |       | $                       | 46,382     |                       | $          | 47,345 |   |

 

See accompanying notes to financial statements.

 

2

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**Tri-SSecurity Corporation and Subsidiaries**

 

**Consolidated Statements of Operations**

**Unaudited**

**(In thousands, except per share data)**

 
| ** **                                                  | ** ** | **Three Months  Ended  March 31, 2006** | ** ** | **Three Months  Ended  March 31, 2005** | ** ** |
|-------------------------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|
|                                                        |       |                                         |       |                                         |       |
| Revenues                                                    |       | $                                            | 17,373     |                                         | $          | 7,979 |   |
|                                                        |       |                                         |       |                                         |       |
| Cost of revenues:                                           |       |                                         |       |                                         |       |
| Direct labor                                                |       | 10,571                                       |       | 4,216                                        |       |
| Indirect  labor and other support costs                     |       | 4,391                                        |       | 3,320                                        |       |
| Amortization  of customer contracts                         |       | 412                                          |       | 95                                           |       |
|                                                        |       | 15,374                                       |       | 7,631                                        |       |
|                                                        |       |                                         |       |                                         |       |
| Gross profit                                                |       | 1,999                                        |       | 348                                          |       |
|                                                        |       |                                         |       |                                         |       |
| Selling, general and administrative                         |       | 2,990                                        |       | 678                                          |       |
| Amortization of intangible assets                           |       | 231                                          |       | —                                       |       |
|                                                        |       | 3,221                                        |       | 678                                          |       |
|                                                        |       |                                         |       |                                         |       |
| Operating  loss                                             |       | (1,222                                       | )          | (330                                         | )          |
|                                                        |       |                                         |       |                                         |       |
| Income from investment in Army Fleet  Support, LLC, net     |       | 276                                          |       | 634                                          |       |
|                                                        |       |                                         |       |                                         |       |
| Other income (expense):                                     |       |                                         |       |                                         |       |
| Interest  income                                            |       | 7                                            |       | 12                                           |       |
| Interest  expense                                           |       | (1,082                                       | )          | (315                                         | )          |
| Interest on Series C  redeemable preferred stock       |       | (75                                          | )          | (75                                          | )          |
| Other income                                                |       | 84                                           |       | —                                       |       |
|                                                        |       | (1,066                                       | )          | (378                                         | )          |
|                                                        |       |                                         |       |                                         |       |
| Loss before income taxes                                    |       | (2,012                                       | )          | (74                                          | )          |
|                                                        |       |                                         |       |                                         |       |
| Income tax benefit                                          |       | (747                                         | )          | (28                                          | )          |
|                                                        |       |                                         |       |                                         |       |
| Net loss                                                    |       | $                                            | (1,265     | )                                            | $          | (46 | ) |
|                                                        |       |                                         |       |                                         |       |
| Basic and diluted net loss per common share                 |       | $                                            | (0.38      | )                                            | $          | (0.02 | ) |
| Basic and diluted weighted average number  of common shares |       | 3,349                                        |       | 2,358                                        |       |

 

See accompanying notes to financial statements.

 

3

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**Tri-S Security Corporation and Subsidiaries**

 

**Consolidated Statements of Cash Flows**

**Unaudited**

**(In thousands)**

 
| ** **                                                                   | ** ** | **Three Months  Ended  March 31, 2006** | ** ** | **Three Months  Ended  March 31, 2005** | ** ** |
|------------------------------------------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|
|                                                                         |       |                                         |       |                                         |       |
| Cash flow from operating activities:                                         |       |                                         |       |                                         |       |
| Net loss                                                                     |       | $                                            | (1,265     | )                                            | $          | (46 | ) |
| Adjustments  to reconcile net loss to net cash used by operating activities: |       |                                         |       |                                         |       |
| Income from  investment in Army Fleet Support, LLC, net                      |       | (276                                         | )          | (634                                         | )          |
| Depreciation  and amortization                                               |       | 711                                          |       | 194                                          |       |
| Deferred  income tax benefits                                                |       | (447                                         | )          | (41                                          | )          |
| Non-cash  employee stock option expense                                      |       | 55                                           |       | —                                       |       |
| Non-cash  interest expense                                                   |       | 118                                          |       | —                                       |       |
| Changes in  operating assets and liabilities:                                |       |                                         |       |                                         |       |
| Trade  accounts receivable, net                                              |       | 966                                          |       | 530                                          |       |
| Prepaid  expenses and other assets                                           |       | (236                                         | )          | (796                                         | )          |
| Trade  accounts payable                                                      |       | 208                                          |       | (212                                         | )          |
| Accrued  liabilities                                                         |       | (1,185                                       | )          | 309                                          |       |
| Income taxes  payable                                                        |       | (301                                         | )          | 8                                            |       |
|                                                                         |       |                                         |       |                                         |       |
| Net cash  used by operating activities                                       |       | (1,652                                       | )          | (688                                         | )          |
|                                                                         |       |                                         |       |                                         |       |
| Cash flow from investing activities:                                         |       |                                         |       |                                         |       |
| Proceeds  from disposal of property and equipment                            |       | 16                                           |       | —                                       |       |
| Proceeds  from investment in Army Fleet Support, LLC                         |       | —                                       |       | 400                                          |       |
|                                                                         |       |                                         |       |                                         |       |
| Net cash  provided by investing activities                                   |       | 16                                           |       | 400                                          |       |
|                                                                         |       |                                         |       |                                         |       |
| Cash flow from financing activities:                                         |       |                                         |       |                                         |       |
| Net proceeds  of factoring facility                                          |       | 1,817                                        |       | —                                       |       |
| Repayments  of term loans                                                    |       | (271                                         | )          | —                                       |       |
| Deferred  financing costs                                                    |       | (46                                          | )          | —                                       |       |
| Proceeds  from initial public offering                                       |       | —                                       |       | 11,079                                       |       |
| Repayments  of short-term notes                                              |       | —                                       |       | (9,062                                       | )          |
| Repayments  of capital lease obligations                                     |       | —                                       |       | (24                                          | )          |
| Deferred  initial public offering costs                                      |       | (82                                          | )          | (165                                         | )          |
|                                                                         |       |                                         |       |                                         |       |
| Net cash  provided by financing activities                                   |       | 1,418                                        |       | 1,828                                        |       |
|                                                                         |       |                                         |       |                                         |       |
| Net increase (decrease) in cash and cash  equivalents                        |       | (218                                         | )          | 1,540                                        |       |
| Cash and cash equivalents at beginning of  period                            |       | 463                                          |       | 313                                          |       |
| Cash and cash equivalents at end of period                                   |       | $                                            | 245        |                                         | $          | 1,853 |   |
|                                                                         |       |                                         |       |                                         |       |
| Supplemental disclosures of cash flow  information:                          |       |                                         |       |                                         |       |
| Interest  paid                                                               |       | $                                            | 1,024      |                                         | $          | 931 |   |
| Income taxes  paid                                                           |       | $                                            | 3          |                                         | $          | 6 |   |

 

See accompanying notes to financial statements.

 

4

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**TRI-SSECURITY CORPORATION AND SUBSIDIARIES**

 

**NOTES TOCONSOLIDATED FINANCIAL STATEMENTS**

 

**March 31,2006**

 

**1.****                                      Organization**

 

Tri-S Security Corporation, a Georgiacorporation (“Tri-S”, the “Company” or “we”), was incorporated in October 2001under the name “Diversified Security Corporation.” We changed our name to “Tri-SSecurity Corporation” on August 16, 2004. We provide contract guardservices to (i) various Federal government agencies through oursubsidiary, Paragon Systems, Inc., an Alabama corporation with itsprincipal office located in Washington, DC (“Paragon Systems”); and (ii) commercialand state and local government customers through our subsidiary, The CornwallGroup, Inc. (“Cornwall”), a Florida corporation with its principal officeslocated in Miami, Florida.

 

In January 2006, Paragon Systems enteredinto a Joint Venture with Southeastern Protective Services to form SoutheasternParagon. Paragon Systems owns 49% and Southeastern Protective Services owns 51%of Southeastern Paragon. Southeastern Paragon was formed to bid on certaincontracts, and Paragon Systems will be the manager of the contracts awarded toSoutheastern Paragon. Tri-S will account for the joint venture under AccountingPrincipal Board Opinion No. 18, *TheEquity Method of Accounting for Investments in Common Stock,*and**FASBInterpretation No. 46(R), *Consolidationof Variable Interest Entities.*

 

We provide cost-effective solutions to ensurethe safety and security of the assets and personnel of our customers and tocontinually 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.

 

**2.****                                      Basisof Presentation**

 

The accompanying consolidated financialstatements have been prepared in accordance with generally accepted accountingprinciples in the United States (“GAAP”). The financial statements presentedare unaudited and have been prepared by our management in accordance with the rules andregulations of the Securities and Exchange Commission (the “SEC”). In theopinion of our management, all adjustments, consisting of normal recurringaccruals, necessary for the fair presentation of the financial position,results of operations and cash flows have been included. For furtherinformation, see our audited financial statements and footnotes theretoincluded in our Annual Report on Form 10-K for the year ended December 31,2005, as amended by Amendment No. 1 thereto, each as filed with the SEC,as amended (the “Annual Report”). Disclosure that substantially duplicates thedisclosure contained in the footnotes to the audited financial statementsincluded in the Annual Report has been omitted from these Notes.

 

5

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**3.****                                      Stock-basedCompensation**

 

Effective January 1, 2006, we adopted Statement of Financial Accounting Standards No. 123 (revised 2004), *Share-Based Payment* (“SFAS 123R”), using the modified-prospective-transition approach method. Under this transition method, compensation costs for in 2006 include costs for options granted prior to, but not vested at, December 31, 2005, and options vested in 2006. Therefore, results for prior periods have not been restated.

 

The adoption of SFAS 123R decreased net income by $55,000 for the three months ended March 31, 2006, compared to our previous method of accounting for share-based compensation under Accounting Principal Board Opinion No. 25, *Accounting for Stock Issued to Employees*. In the quarter ending March 31, 2005, there would not have been any pro-forma expenses under FAS 123R.

 

As of March 31, 2006, there was approximately $550,000 of unrecognized compensation cost related to unvested share-based compensation awards granted. We expect to recognize this cost over the next three years.

 

**4.****                                      InitialPublic Offering**

 

In February 2005, we completed anunderwritten initial public offering of 1,800,000 units (plus an additional270,000 units upon the exercise of the underwriters’ over-allotment option),with each unit consisting of one share of our common stock, par value $0.001per share, and a warrant to purchase one share of common stock, at an initialoffering price per unit of $6.00. The initial public offering closed withrespect to the initial 1,800,000 units on February 14, 2005 and withrespect to the additional 270,000 units on March 17, 2005. The aggregatenet proceeds to us from the initial public offering were approximately$10,885,000 after underwriting discounts and commissions, offering expenses andconsulting fees.

 

6

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**5.****                                      Acquisitionof Paragon Systems, Inc.**

 

On February 27, 2004, Tri-S acquired all ofthe outstanding capital stock of Paragon Systems (the “Paragon Acquisition”). Atthe closing of the Paragon Acquisition, we: (i) paid $10.0 million, ofwhich $2.3 million was paid in cash and $7.7 million was paid through theissuance of promissory notes (the “Paragon Notes”), to the former shareholdersof Paragon Systems; and (ii) issued 100 shares of our Series CRedeemable Preferred Stock, par value $1.00 per share, with an aggregateredemption value of $6.0 million. After the completion of the initial publicoffering, we repaid the outstanding principal of the Paragon Notes and paid allunpaid, accrued interest thereon. The Series C Redeemable Preferred isredeemable by the Company no later than February 27, 2007.

 

**6.****                                      Acquisitionof The Cornwall Group, Inc.**

 

On October 18, 2005, Tri-S acquired allof the outstanding capital stock of Cornwall (the “Cornwall Acquisition”). Atthe closing of the Cornwall Acquisition, we paid $13,500,000, of which$13,250,000 was paid in cash and $250,000 was paid through the issuance of apromissory note to the representative of the former shareholders of Cornwall.After adjusting for certain working capital items, the net purchase price forthe Cornwall Acquisition was $12,753,000.

 

**7.****                                      Commonand Preferred Stock**

 

OnFebruary 8, 2005, pursuant to an Exchange and Recapitalization Agreement,we effected an exchange and recapitalization of our outstanding common stock, Series AConvertible Preferred Stock and Series B Convertible Preferred Stock andrights to acquire our common stock. Pursuant to the Exchange andRecapitalization Agreement, all of our outstanding (i) common stock, Series AConvertible Preferred Stock and Series B Convertible Preferred Stock wasexchanged for an aggregate of 1,200,000 shares of common stock and (ii) rightsto acquire our common stock were exchanged for rights to purchase an aggregateof 113,269 shares of common stock. The recapitalization was given retroactivetreatment in the financial statements and related disclosures.

 

Asof March 31, 2006, we had 100 shares outstanding of Series CRedeemable Preferred Stock.

 

Holdersof the Series C Redeemable Preferred Stock have no voting rights, exceptthat a consent of a majority of the holders of the Series C RedeemablePreferred Stock, voting separately as a class, is required to increase ordecrease the number of authorized shares of Series C Redeemable PreferredStock and except as otherwise required by applicable law. The Series CRedeemable Preferred Stock does not have any preemptive, conversion or sinkingfund rights nor does it have any rights or preferences in the event of aliquidation, dissolution or winding-up of the Company.

 

7

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TheSeries C Redeemable Preferred Stock has a redemption value of $60,000 pershare. We may redeem the outstanding shares of Series C RedeemablePreferred Stock at any time, but must redeem all the outstanding shares of Series CRedeemable Preferred Stock no later than February 27, 2007. The holders ofthe Series C Redeemable Preferred Stock are entitled to receive cashdividends at a rate of 5% of the redemption value per annum (or $3,000 pershare per annum) which were accrued as interest expense for the three monthsended March 31, 2006.

 

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 of Tri-S. Tri-S has never paid any cashdividends on common stock.

 

Duringthree months ended March 31, 2006, we issued 20,000 shares of commonstock, at an average price of $4.45 per share, for services, which will berendered ratably during 2006. We recorded expense of approximately $22,000 forservices rendered during the first quarter of 2006.

 

Also,during the three months ended March 31, 2006, we issued 10,417 shares ofcommon stock upon conversion of a 10% convertible promissory note with an outstandingprincipal amount of $50,000 and a book value of $39,300.

 

**8.****                                      Investmentin Army Fleet Support, LLC**

 

In conjunction with the Paragon Acquisition,we acquired a 10% equity interest in Army Fleet Support, LLC (“Army Fleet”). Thevalue of our investment in Army Fleet o the date of the Paragon Acquisition was$8,102,000 as established by an independent appraisal. We amortize the cost ofthe investment in excess of the net book value thereof using a 10-year life,which approximates the anticipated life of Army Fleet.

 

We account for our investment in Army Fleetusing the equity method of accounting. Accordingly, our investment in ArmyFleet is increased by our share of Army Fleet’s earnings and reduced by theamortization of our investment in Army Fleet and the cash we receive from ArmyFleet with respect to our investment.

 

8

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Our investment in Army Fleet was affected bythe following transactions for the three months ended March 31, 2006 and2005:

 
| ** **                                     | ** ** | **Three Months  Ended  March 31, 2006** | ** ** | **Three Months  Ended  March 31, 2005** | ** ** |
|------------------------------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|
| Investment in Army Fleet – beginning      |       | $                                            | 8,698      |                                         | $          | 8,302 |   |
| Company’s share of earnings in Army Fleet |       | 482                                          |       | 840                                          |       |
| Amortization of the investment in Army  Fleet  |       | (206                                         | )          | (206                                         | )          |
| Cash received from Army Fleet                  |       |                                         |       | (400                                         | )          |
|                                           |       |                                         |       |                                         |       |
| Investment in Army Fleet – ending         |       | $                                            | 8,974      |                                         | $          | 8,536 |   |

 

Summarized unaudited balance sheetinformation for Army Fleet as of March 31, 2006 and December 31, 2005is as follows:

 
| ** **                   | ** ** | **March 31, 2006** | ** ** | **Dec. 31, 2005** | ** ** |
|------------------------------|------------|-------------------------|------------|------------------------|------------|
|                         |       |                    |       |                   |       |
| Total assets                 |       | $                       | 78,041     |                   | $          | 60,735 |   |
|                         |       |                    |       |                   |       |
| Total liabilities            |       | $                       | 56,213     |                   | $          | 42,761 |   |
| Equity                       |       | 21,828                  |       | 17,974                 |       |
|                         |       |                    |       |                   |       |
| Total liabilities and equity |       | $                       | 78,041     |                   | $          | 60,735 |   |

 

Summarized unaudited unconsolidated statementof operations information for Army Fleet for the three months ended March 31,2006 and 2005 is as follows:

 
| ** **        | ** ** | **Three Months  Ended  March 31, 2006** | ** ** | **Three Months  Ended  March 31, 2005** | ** ** |
|-------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|
|              |       |                                         |       |                                         |       |
| Contract revenues |       | $                                            | 76,917     |                                         | $          | 77,964 |   |
| Operating income  |       | 5,150                                        |       | 8,424                                        |       |
| Net earnings      |       | 4,817                                        |       | 8,401                                        |       |
|                   |            |                                              |            |                                              |            |  |  |

 

9

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**9.****                                      Debtand Other Obligations**

 

**Factoring Agreement**

 

OnOctober 18, 2005, we entered into a Credit Agreement (the “CreditAgreement”) with LSQ Funding Group, L.C. (“LSQ”) and BRE LLC (“BRE” and, togetherwith LSQ, our “lenders”), pursuant to which we borrowed $1,650,000 pursuant toa term loan with a maturity date of October 1, 2007 (“Term Loan A”) and$3,500,000 pursuant to a term loan with a maturity date of October 1, 2009(“Term Loan B” and, together with Term Loan A, the “Term Loans”).

 

Weshall pay to our lenders the principal amount of (i) Term Loan A in oneinstallment of $1.1 million payable on January 1, 2007 and equal quarterlyinstallments of $275,000 payable on the first day of each calendar quartercommencing on April 1, 2007; and (ii) Term Loan B in equal quarterlyinstallments of $296,000 payable on the first day of each calendar quartercommencing on January 1, 2007. Interest shall accrue under the Term Loansat the variable rate of interest published by The Wall Street Journal as itsprime rate (the “Prime Rate”) plus 4.0%, and Borrower shall pay Lender allinterest accrued under the Term Loans on the first day of each month. Allremaining unpaid principal under the Term Loans and accrued interest thereon ispayable no later than the respective maturity dates thereof.

 

Inconnection with the Credit Agreement, we entered into a Factoring and SecurityAgreement (the “Factoring Agreement”) with LSQ, pursuant to which LSQ willpurchase from us from time to time certain accounts receivable at a discount of0.7% and provide us with a professional accounts receivable management servicefor a funds usage fee of the Prime Rate plus 1.0% on the funds advanced on theoutstanding accounts receivable purchased. The Factoring Agreement has a$6,000,000 initial purchase limit and a four-year term which will automaticallyrenew unless we provide notice of our intent to terminate. The FactoringAgreement amends and restates this Factoring Agreement dated as of April 1,2005 between LSQ and Paragon Systems, pursuant to which LSQ purchased fromParagon Systems from time to time certain accounts receivable at a discount of0.7% under a factoring facility with a funds usage fee equal to the Prime Rateplus 1.00%, a $6,500,000 initial purchase limit and a one-year term subject toannual renewal.

 

Duringthe first quarter of 2006 and as of March 31, 2006, the funds advanced tous and outstanding under our Factoring Facility exceeded the maximumavailability under the factoring facility based on the collateral formula inthe Factoring Agreement with our lenders. This constitutes a default under theFactoring Agreement and, due to cross default provisions, under the CreditAgreement. On March 29, 2006, we entered into an Amendment and ForbearanceAgreement with our lenders pursuant to which our lenders waived this defaultand certain other specified defaults under Credit Agreement and agreed toforbear from exercising all remedies available to them in connection with suchdefaults until January 1, 2007. The agreement also amends the CreditAgreement, among other things, (i) to delay all principal payments underthe Term Loans until January 1, 2007; (ii) to revise the defaultinterest rate with respect to the Term Loans so that it equals the defaultinterest rate with respect to the Factoring Facility; (iii) to providethat the funds usage fee under the factoring facility from March 29, 2006through January 1, 2007, shall be increased to the Prime Rate plus 4.0%;and (iv) to defer certain fees until January 1, 2007.

 

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Pursuantto the Credit Agreement, we also entered into (i) a Guaranty Agreementpursuant to which we unconditionally and irrevocably guarantee to the lendersthe prompt payment and performance of all of our obligations, indebtedness andliabilities to the lenders, whether currently existing or subsequently arising(the “Obligations”); and (ii) a Security Agreement, pursuant to which wegranted to the lenders a security interest in substantially all of our assetsto secure all of the Obligations. Additionally, we have entered into a PledgeAgreement pursuant to which we have pledged to the lenders the capital stock ofParagon Systems to secure all of our obligations under the Credit Agreement andrelated documents.

 

**Convertible Notes**

 

DuringSeptember and October 2005, we issued in a private placementtransaction 10% convertible promissory notes with an aggregate principal amountof $8,015,000 and warrants to purchase 834,896 shares of common stock for anaggregate purchase price of $8,015,000. The 10% convertible promissory noteswere issued in four closings between September 2, 2005 and October 14,2005 at a discount and were priced to yield 26.1% per annum. The face value ofthe 10% convertible promissory notes is $8,015,000. Interest is payable monthlyon the face value of the 10% convertible promissory notes at a rate of 10% perannum. The gross proceeds from the offering of 10% convertible promissory notesand warrants was allocated to the notes and warrants in accordance withEmerging Issue Tax Force 98-5 “Accounting for Convertible Securities withBeneficial Conversion Features or Contingently Adjustable Conversion Ratios” (“EITF98-5”). In accordance with EITF 98-5, $6,107,000 of the gross proceeds wasallocated to the 10% convertible promissory notes and $1,908,000 was allocatedto Additional Paid in Capital related to the warrants. The $1,908,000 ofdiscount on the 10% convertible promissory notes relative to face value will beamortized over the three-year life of the 10% convertible promissory notes tointerest expense. The 10% convertible promissory notes mature three years afterissuance and may be prepaid at the option of the Company after one year afterthe issuance thereof subject to the satisfaction of certain conditions.

 

The10% convertible promissory notes are convertible by the holders at an initialconversion price of $4.80 per share at any time. The warrants issued have anexercise price of $4.80 and expire three years from the date of issuance. Duringthe three months ended March 31, 2006, 10,417 shares of common stock wereissued upon conversion of 10% convertible promissory note with an aggregateprincipal amount of $50,000.

 

**10.****                               NetLoss per Share**

 

Basic net loss per share is computed bydividing net loss available to common stockholders by the weighted averagenumber of common shares outstanding during the period. Diluted net loss pershare gives effect to all potentially dilutive securities. The effect of theCompany’s warrants and stock options were not included in the computation ofdiluted earnings per share as their effect was anti-dilutive.

 

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**11.****                               RelatedParty Transactions**

 

**Note Receivable** from Chief Executive Officer

** **

Pursuantto the employment agreement between Tri-S and Ronald G. Farrell, our ChiefExecutive Officer and President, Mr. Farrell was entitled to receiveduring 2004 an aggregate bonus of $435,000. However, in order to improve thefinancial position of the Company prior to our initial public offering, Mr. Farrellagreed to forfeit $290,000 of such bonus and accept a cash bonus of $145,000.At the time Mr. Farrell agreed to such change in his compensation, we hadalready paid to Mr. Farrell $245,000 with respect to his 2004 bonus.Accordingly, Mr. Farrell has agreed to repay to us $100,000 pursuant tothe terms of a promissory note issued by Mr. Farrell to us dated December 31,2004, which bears 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 bepaid, at the election of Mr. Farrell, in cash or shares of common stock orany combination thereof. The note is reflected as a $102,000 asset on ourbalance sheet as of March 31, 2006.

 

**Employment Agreement**

** **

Pursuantto the employment agreement between us and Mr. Farrell, Mr. Farrellhas agreed to serve as our Chief Executive Officer and President until December 31,2008. The agreement provides for (i) payment of a specified base salarywhich increases by 10% per year;  (ii) paymentof an annual incentive bonus equal to 5% of our operating income for such year(which income includes dividends and distributions made to us with respect toour interest in Army Fleet), provided that such bonus may not exceed 100%of Mr. Farrell’s base salary for such year; (iii) prohibitionsagainst Mr. Farrell’s disclosure of confidential information, solicitationof our employees and participation in a business competitive with our businessduring his employment and for a period of one year following the termination ofhis employment; (iv) payment of an acquisition bonus equal to 2% of thevalue of all acquisitions made by us; and (v) continuation of Mr. Farrell’scompensation and benefits for the remainder of the term of his employmentagreement if his employment is terminated by us without “cause” or by Mr. Farrellfor “good reason” or upon a “change of control” of the Company. Pursuant to Mr. Farrell’semployment agreement, we also provide certain other benefits and expensereimbursements to Mr. Farrell which are consistent with his position asour Chief Executive Officer. Mr. Farrell is also entitled to participatein any employee benefit plan, stock option plan and other fringe benefit planat the discretion of our board of directors.

 

**12.****                               Contingencies**

 

On March 2, 2006, InternationalMonitoring, Inc. (“IMI”), a wholly-owned subsidiary of Cornwall, enteredinto an agreement, as amended on April 10, 2006 (as so amended, the “SaleAgreement”), with Devcon Security Services Corporation (“Devcon”) pursuant towhich the IMI has agreed to assign all of its interest in its securitymonitoring contracts (the “Contracts”) and certain related equipment to Devconfor a purchase price to be calculated by Devcon based upon a multiple of themonthly revenue, net of certain expenses, generated by the Contracts which meetcertain criteria. The purchase price may be reduced for pre-paid revenuereceived by IMI prior to the closing for which IMI has not rendered services asof the closing.

 

If the closing does not occur on or before May 16,2006, then the Sale Agreement will terminate automatically. Devcon also has theright to terminate the Sale Agreement at any time for any reason. The SaleAgreement contains certain representations, warranties and agreements of IMIand requires IMI to indemnify Devcon for breaches of, or inaccuracies in, therepresentations and warranties set forth therein. The closing is subject to thesatisfaction or waiver of the closing conditions set forth in the SaleAgreement.

 

We do notanticipate the closing to occur by May 16, 2006. If the closing does not occurby May 16, 2006, we will attempt to extend the deadline with Devcon or begin toseek a new buyer.

 

InMarch 2006, we entered into an agreement to sell certain real property weown in Fort Lauderdale, Florida, for a purchase price of $775,000. Weanticipate the closing of the sale to occur during May 2006, however, theclosing is subject to the satisfaction or waiver of customary closingconditions, including, without limitation, satisfactory completion of duediligence by the buyer.

 

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**Item 2.  Management’s Discussion and Analysis ofFinancial Condition and Results of Operations.**

 

This Management’s Discussion and Analysis ofFinancial Condition and Results of Operations should be read in conjunctionwith the Management’s Discussion and Analysis of Financial Condition andResults of Operations contained in the Annual Report.

 

You should carefully review the informationcontained in this Quarterly Report on Form 10-Q for the quarter ended March 31,2006 (this “Quarterly Report”) and should particularly consider any risks andother factors that we set forth in this Quarterly Report and in other reportsor documents that we file from time to time with the SEC. Except for historicalinformation contained herein, this Quarterly Report contains forward-lookingstatements within the meaning of Section 27A of the Securities Act of1933, as amended, and Section 21E of the Securities Exchange Act of 1934,as amended (the “Exchange Act”), including statements of our expectations as tofuture events and our future financial performance. In some cases, you canidentify those so-called “forward-looking statements” by words such as “may,” “will,”“should,” “expects,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,”“potential,” or “continue” or the negative of those words and other comparablewords. You should be aware that those statements are only our predictions,which are being made as of the date hereof. Actual events or results may differmaterially. In evaluating those statements, you should specifically considervarious factors, including the risks outlined below. Those factors may causeour actual results to differ materially from any of our forward-lookingstatements. We undertake no obligation to update any forward-lookingstatements, whether as a result of new information, future events or otherwise.

 

**Overview**

 

We provide contract guard services togovernment and commercial customers. These guard services include providinguniformed and armed guards for access control, personnel protection, plantsecurity, theft prevention, surveillance, vehicular and foot patrol, crowdcontrol and prevention of sabotage, terrorist and criminal activities. Inconnection with providing these services, we assume responsibility for avariety of functions, including recruiting, hiring, training and supervisingsecurity guards deployed to the customers we serve as well as paying all guardsand providing them with uniforms, employee benefits and workers’ compensationinsurance. We are responsible for preventing the interruption of guard servicesas a consequence of illness, vacations or resignations.

 

**Critical Accounting Policies**

 

The following discussion and analysis of ourfinancial condition and results of operations is based upon our consolidatedfinancial statements, which have been prepared in accordance with GAAP. Thepreparation of these financial statements requires us to make judgmentsregarding estimates that affect the reported amounts of assets, liabilities,revenues and expenses, and related disclosures. We base our judgments onhistorical experience and on various assumptions that we believe are reasonableunder the circumstances. Actual results may differ from these estimatesunder different assumptions or conditions. We believe our judgments and relatedestimates regarding the following accounting policies are critical in thepreparation of our consolidated financial statements.

 

**Revenue Recognition.**Revenue is recorded****monthly asguard services are provided to our customers under contracts. We bill guardservices in arrears at hourly or monthly rates based on the number of hoursworked under some contracts and as fixed monthly amounts under other contracts.Hourly and monthly rates are based on contractual terms.

 

Theterms of our contracts are complex and may be subject to differinginterpretations. We make estimates and judgments about terms of the contractsin providing services and in billing and recording revenue. At times, ourFederal contracts require interpretations. Typically, differences ininterpretation are resolved on a mutual basis in discussions with the governmentagency involved. The resolution of differences may result in adetermination that amounts previously billed are not in accordance withcontract terms and adjustments of amounts initially recorded as revenue may bematerial.

 

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Contractswith Federal government agencies may be subject to cessation of funding.Cessation of funding may result in amounts billed and recorded as revenueas being uncollectible. We work with the appropriate government agency toresolve funding issues. When funding issues become known, we make estimates andjudgments about the extent of potential losses and adjust revenues accordingly.Amounts estimated could differ from amounts ultimately collected and theseamounts could be material. During 2004, 2005 and 2006, none of our contractshave been subject to cessation of funding.

 

**Cost of Revenues.**Costof revenues is primarily comprised of labor, related payroll taxes, employeebenefits, workers compensation, liability insurance, and the pro rata portionof the costs of customer contracts required.

 

We make estimates and judgments of amountsrecorded for accruals of labor related costs. Expenses most subject toestimation and judgment are accrued vacation and workers compensation costs.The terms of vacation policies may be complex and subject tointerpretation. Workers compensation insurance is subject to retroactive audit.Actual amounts could differ from the amounts initially recorded.

 

**Impairment of Long-lived Assets, Goodwill and IntangibleAssets**. We evaluateimpairment of long-lived assets, including property and equipment andintangible assets with finite lives, whenever events or changes incircumstances indicate that the carrying amount of such assets may not berecoverable. If the sum of the expected future undiscounted cash flows is lessthan the carrying amount of the asset, then an impairment loss is recognized.Measurement of an impairment loss for long-lived assets is based on discountedcash flows and the fair value of an asset.

 

**Investment in Army Fleet.**Weaccount for our 10% equity in Army Fleet, a joint venture which provideslogistics support for U.S. Army aviation training at Fort Rucker, Alabama,using the equity method of accounting. Accordingly, our investment in ArmyFleet is increased by our share of Army Fleet’s earnings and reduced by theamortization of our investment in Army Fleet and the cash we receive from ArmyFleet with respect to our investment.

 

**SFAS No. 123(R).**OnJanuary 1st, 2006, we adopted Statement of Financial AccountingStandards No. 123 (revised 2004), *Share-BasedPayment* (“SFAS 123R”), using the modified-prospective-transitionapproach method. The adoption increased our net loss by $55,000 in the quarterending March 31, 2006 compared to our previous method of accounting forshare-based compensation under Accounting Principal Board Opinion No. 25, *Accounting for Stock Issued to Employees*. Theadoption of SFAS 123(R) would have not have changed our net loss for thequarter ending March 31, 2005. We will incur approximately $550,000 ofexpense over a weighted average of 2.6 years for all unvested options.

 

**Results ofOperations - Three Months Ended March 31, 2006 Compared to Three MonthsEnded March 31, 2005.**

 

Revenue increased $9.4 million to $17.4million, or 118%, for the three months ended March 31, 2006, as comparedto revenue of $8.0 million for the three months ended March 31, 2005. Theincrease in revenue is primarily due to the Cornwall Acquisition, whichgenerated $10.0 of additional revenue in the first quarter 2006 offset by a$500,000 reduction in revenue at Paragon Systems as the result of two contractexpirations.

 

Cost of revenue increased $7.8 million to$15.4 million, or 101%, for the three months ended March 31, 2006, as comparedto cost of revenue of $7.6 million for the three months ended March 31,2005. Our cost of revenues increased primarily due to costs associated with theservice contracts acquired as part of the Cornwall acquisition.

 

Our gross profit increased by $1.7 million to$2.0 million for the three months ended March 31, 2006, as compared togross profit of $348,000 for the three months ended March 31, 2005. Ourgross margin percentage increased to 11.5% for the three months ended March 31,2006 compared to 4.4% for the three months ended March 31, 2005.

 

Selling, general and administrative expenses,which include payroll and related expenses for administrative personnel,occupancy costs at the office locations, consulting and professional fees, andother miscellaneous office and corporation expenses, increased $2.3 million to$3.0 million, or 341%, for the three months ended March 31, 2006, ascompared to $678,000 for the three months ended March 31, 2005. The $2.3million increase was due to $1.6 million of selling, general and administrativeexpenses incurred by Cornwall. The remainder of the increase was due to costsincurred to support our anticipated growth at Paragon Systems and due to theestablishment of a corporate headquarters as a result of our growth and initialpublic offering.

 

Income with respect to our equity interest inArmy Fleet decreased $358,000 for the three months ended March 31, 2006,as compared to the three months ended March 31, 2005. For the three monthsended March 31, 2006, we recognized $482,000 of net earnings with respectto our equity interest in Army Fleet less $206,000 of related amortizationexpense, for a net result of $276,000. For the three months ended March 31,2005, we recognized $840,000 of net earnings with respect to our equityinterest in Army Fleet less $206,000 of amortization expense, for a net resultof $634,000.

 

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Interest expense increased $767,000, or 197%,to $1,157,000 for the three months ended March 31, 2006, as compared tointerest expense of $390,000 for the three months ended March 31, 2005. Theincrease is due primarily to the interest associated with the 10% convertiblenotes and the term loans with LSQ, which did not exist in the quarter ending March 31,2005. Also increased borrowings on factoring facility with LSQ contributed tothe increase in interest expense.

 

Income taxes are provided at 37% of income(loss) before income taxes. Even though we have a net operating loss carryforward, we have recognized a deferred income tax benefit for the net operatingloss carry forward because we anticipate reporting income before income taxesin future periods.

 

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**Liquidity andCapital Resources**

 

Asof March 31, 2006, we had $245,000 of cash on hand. The funds advanced tous and outstanding under our Factoring Facility during the first quarter of2006 and as of March 31, 2006 exceeded the maximum availability under thefactoring facility based on the collateral formula in the Factoring Agreementwith our lenders. This constitutes a default under our Factoring Agreement and,due to cross default provisions, under our Credit Agreement. On March 29,2006, we entered into an Amendment and Forbearance Agreement with our lenderswhich waived this default and certain other specified defaults under the CreditAgreement and agreed to forbear from exercising all remedies available to thelenders in connection with such defaults until January 1, 2007. Theagreement also amends the Credit Agreement, among other things, (i) todelay all principal payments under the Term Loans until January 1, 2007; (ii) torevise the default interest rate with respect to the Term Loans so that itequals the default interest rate with respect to the Factoring Facility; (iii) toprovide that the funds usage fee under the factoring facility from March 29,2006 through January 1, 2007 shall be increased to the Prime Rate plus 4%;and (iv) to defer certain fees until January 1, 2007.

 

TheSeries C Redeemable Preferred Stock outstanding at December 31, 2005is redeemable on February 28, 2007 for an aggregate value of $6.0 million.All of the outstanding Series C Redeemable Preferred Stock was issued inconnection with the Paragon Acquisition and is held by the former shareholdersof Paragon Systems. On February 26, 2006, we filed a complaint against theformer shareholders of Paragon Systems alleging, among other things, that theformer shareholders breached certain representations set forth in the StockPurchase Agreement between the Company and the former shareholders dated as of February 23,2004 (the “Paragon Purchase Agreement”), pursuant to which the ParagonAcquisition was consummated on February 27, 2004, and that certain formershareholders committed fraud in connection with the Paragon Acquisition. In thecomplaint we seek, among other things, an award of damages against the formershareholders and a decree invalidating all of the outstanding shares of the Series CRedeemable Preferred Stock. Accordingly, we exercised our right of offset underthe Paragon Purchase Agreement and did not pay the $150,000 interest paymentwhich was otherwise due in respect of the Series C Redeemable PreferredStock on February 28, 2006.

 

Inorder to improve the liquidity position of the Company and to reduce theoutstanding debt under the Credit Agreement, we are planning to sell certainnon-core assets and to use the proceeds of such asset sales to repay ourlenders. We intend to sell the assets of IMI and use all of the proceeds fromthe sale to reduce our obligations under Term Loan A. In addition, we will needto sell additional assets and/or raise additional debt and/or equity capital orrenegotiate our existing debt agreements in order to improve our liquidity positionfor the remainder of 2006 and to satisfy our debt maturity obligations during2007. If we are unable to raise significant capital prior to January 1,2007, we anticipate that on such date we will be in default under our CreditAgreement.

 

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Cash out flow from operating activities was$1.7 million for the three months ended March 31, 2006. This resultedprimarily due to a net loss for the three months ended March 31, 2006 of$1.2 million and changes in working capital accounts.

 

Our liquidity position in the future will bedetermined by our ability to generate cash from operations, the cashdistributions received from Army Fleet, our borrowing availability under theFactoring Agreement and future financings.

 

**Item 3.  Quantitative andQualitative Disclosures about Market Risk**

 

Weare exposed to various market risks, including changes in interest rates.Market risk is the potential loss arising from adverse changes in market ratesand prices, such as interest rates and foreign currency exchange rates. We donot enter into derivatives or other financial instruments for trading orspeculative purposes. We have not entered into financial instruments to manageand reduce the impact of changes in interest rates and foreign currencyexchange rates, although we may enter into such transactions in thefuture.

 

Our10% convertible promissory notes carry interest rates which are fixed. TheFactoring Facility has a funds usage fee and the Term Loans have interest rateswhich vary with the Prime Rate. Accordingly, if we sell our accounts receivableto our lenders and such accounts remain unpaid, then any increase in the PrimeRate will increase the funds usage fee we owe on such unpaid accounts and,therefore, reduce our earnings.

 

**Item 4.  Controls and Procedures**

 

Our Chief Executive Officer and ChiefFinancial Officer have evaluated our disclosure controls and procedures (assuch term is defined in Rules 13a-15(e) or 15d-15(e) of theExchange Act), as of the end of the period covered by this Quarterly Report, asrequired by paragraph (b) of Rules 13a-15 or 15d-15 of the ExchangeAct. Based on such evaluation, such officers have concluded that, as of the endof the period covered by this Quarterly Report, our disclosure controls andprocedures are effective.

 

During the quarter ended March 31, 2006,there was not any change in our internal control over financial reportingidentified in connection with the evaluation required by paragraph (d) of Rules 13a-15or 15d-15 of the Exchange Act that has materially affected, or is reasonablylikely to materially affect, our internal control over financial reporting.

 

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**PART II- OTHER INFORMATION**

 

**Item 1.  Legal Proceedings.**

 

Exceptas set forth below and in our Annual Report, we believe that, based oncurrently known facts, there are no claims or litigation pending against us thedisposition of which would materially affect our financial position or futureoperating results, although we cannot be certain as to the ultimate outcome ofany such claim or litigation. In addition, exposure to litigation is inherentin our ongoing business and may harm our business in the future.

 

OnFebruary 27, 2006, we filed a complaint in the United States DistrictCourt, Northern District of Georgia, Atlanta Division (“Georgia Federal Court”),against Charles Keathley, Robert Luther, Harold Bright and John Wilson,the former shareholders of Paragon Systems, alleging, among other things, that:(i) the former shareholders breached certain representations set forth inthe Paragon Purchase Agreement; (ii) Messrs. Keathley and Lutherviolated Section 10(b) of the Exchange Act and Rule 10b-5promulgated thereunder in connection with the Paragon Acquisition; and (iii) Messrs. Keathleyand Luther committed fraud in connection with the Paragon Acquisition. In thecomplaint, we seek, among other things, (a) an award of damages againstthe former shareholders; (b) a decree invalidating all the outstandingshares of the Series C Redeemable Preferred Stock, which are held by theformer shareholders and were issued as part of the consideration for theParagon Acquisition; (c) a decree invalidating the Security Agreementsentered into between us and the former shareholders in connection with theParagon Acquisition, pursuant to which we have pledged an aggregate of 40% ofthe outstanding shares of Paragon Systems to secure our payment obligationsunder the Series C Redeemable Preferred Stock; (d) an award ofpunitive damages against Messrs. Keathley and Luther; and (e) anaward of attorneys’ fees and costs.

 

OnFebruary 28, 2006, we notified the former shareholders that, under Section 6.1(c) ofthe Paragon Purchase Agreement and all applicable common law rights of offset,we were exercising our rights of offset against the $150,000 dividend paymentotherwise payable by us on such date with respect to the Series CRedeemable Preferred Stock and that we would not make such dividend payment.

 

OnApril 28, 2006, Messrs. Bright and Wilson filed an answer andcounterclaim in Georgia Federal Court in response to the complaint we filedwith such court pursuant to which, among other things, they claim that wefailed to pay the February 28, 2006 dividend payment with respect to the Series CRedeemable Preferred Stock held by them and seek damages with respect thereto.

 

Onor about October 5, 2005, Messrs. Keathley and Luther filed acomplaint against Paragon Systems in the Circuit Court for Madison County,Alabama (“Alabama State Court”) claiming breach of contract and seekingrecovery of unspecified damages. Messrs. Keathley and Luther allege thatParagon Systems owes to them unpaid compensation for accrued, vested benefitsearned pursuant to their employment agreements with Paragon Systems and certainamounts as reimbursement for taxes incurred by them in 2003.

 

OnMay 8, 2006, Messrs. Keathley and Luther filed an answer and counterclaim inthe Georgia Federal Court in response to our complaint.  In their counterclaim, Messrs. Keathley andLuther assert, among other things, that we failed to pay the February 28, 2006dividend payment with respect to the Series C Redeemable Preferred Stock heldby them.  They assert that they areentitled to bring their counterclaims in Alabama State Court and that, ifnecessary, the Georgia Federal Court should dismiss the complaint filed byTri-S.  In the alternative, they seekdamages with respect to their counterclaim.

 

 

**Item 1A. Risk Factors.**

 

In addition to the other information set forth in this QuarterlyReport, you should carefully consider the factors discussed in Part I, “Item1A. Risk Factors” in the Annual Report, which could materially affect ourbusiness, financial condition or future results. The risks described in theAnnual Report are not the only risk factors facing us. Additional risks anduncertainties not currently known to us or we currently deem to be immaterialalso may materially adversely affect our business, financial conditionand/or operating results.

 

**Item3.  Defaults Upon Senior Securities.**

 

See Part I, “Item 2. Management’s Discussion and Analysis ofFinancial Condition and Results of Operations” and Part II, “Item 1. LegalProceedings” of this Quarterly Report for a discussion of our determination notto pay the $150,000 dividend payment with respect to our Series CRedeemable Preferred Stock due on February 28, 2006. Except for the February 28,2006 dividend payment, we have paid all other dividends due in respect of the Series CRedeemable Preferred Stock.

 

**Item4.  Submission of Matters to a Vote ofSecurity Holders.**

 

We held a Special Meeting of Shareholders ofTri-S on February 28, 2006, in Atlanta, Georgia (the “Meeting”). At theMeeting, our shareholders voted on proposals to: (i) approve the potentialissuance of more than 20% of the common stock upon the conversion of the 10%convertible promissory notes and exercise of warrants issued in the privateplacement financing in September and October 2005 for the purpose ofcomplying with the rules governing The Nasdaq Stock Market, Inc. (the“Nasdaq”) (“Proposal One”); and (ii) to approve the issuance of warrant toour lenders and the potential issuance of shares of common stock upon exercisethereof for purposes of complying with the Credit Agreement and the rules governingthe Nasdaq (“Proposal Two”). Each of the foregoing proposals was approved bythe Company’s shareholders at the Meeting.

 

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The results of the vote on Proposal One wereas follows: 1,663,427 votes **FOR**, 6,700votes **AGAINST**, and 3,395 votes **ABSTAINED**. There were 0 broker non-votes with respect toProposal One.

 

The results of the vote on Proposal Two wereas follows: 1,662,427 votes **FOR**, 6,700votes **AGAINST**, and 4,395 votes **ABSTAINED**. There were 0 broker non-votes with respect toProposal Two.

 

The foregoing proposals were set forth anddescribed in the Notice of Special Meeting of Shareholders and Proxy Statementof Tri-S dated January 30, 2006.

 

**Item 5.  Other Information.**

 

On January 17, 2006, Paragon Systemsentered into a Joint Venture Agreement with (the “Joint Venture Agreement”)Southeastern Protective Services, Inc. (“Southeastern”), pursuant to whichParagon Systems and Southeastern formed a joint venture for the purpose ofbidding on certain contracts specified in the Joint Venture Agreement andperforming the work required pursuant to such contracts, if such contracts areawarded to the joint venture.

 

On April 10, 2006, IMI entered into aletter agreement with Devcon which amended the Sale Agreement to extend theclosing date for the sale of IMI’s assets to Devcon until May 16, 2006. Ifthe closing does not occur on or before May 16, 2006, the Sale Agreementwill terminate automatically. Devcon also has the right to terminate the SaleAgreement at any time for any reason. We do not anticipate the closing to occurby May 16, 2006. If the closing does not occur by May 16, 2006, we will attemptto extend the deadline with Devcon or begin to seek a new buyer.

 

On May 10,2006, our board of directors amended the compensation arrangement for directorsto provide as follow: (i) we shall pay each director $10,000 per year forservice on our board plus $1,250 for each meeting of our board and each meetingof a committee of our board attended by such director; and (ii) we shallreimburse each director for all travel expenses incurred in connection withtravel to and from board and committee meetings.

 

**Item 6.  Exhibits.**

 

The exhibits required to be filed with thisQuarterly Report are set forth on the Exhibit Index included herein.

 

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**SIGNATURE**

 

Pursuant to the requirements of theSecurities Exchange Act of 1934 the registrant has duly caused this report tobe signed on its behalf by the undersigned thereunto duly authorized.

 
|                         | **TRI-S SECURITY CORPORATION**                     |
|------------------------------|----------------------------------------------------|
|                         |                                               |
|                         |                                               |
| Date: May 15, 2006 | /s/ Ronald G. Farrell                              |   |
|                         | Ronald G.  Farrell                                 |
|                         | Chairman of  the Board and Chief Executive Officer |
|                         | (duly  authorized signatory and                    |
|                         | Principal  Executive Officer)                      |

 

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**EXHIBIT INDEX**

 
| **Exhibit No.** | ** ** | **Description**                                                                                                                                   | ** ** | **Method of Filing**                                                                                                               |
|-----------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------|
| 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).              |
|            |       |                                                                                                                                              |       |                                                                                                                               |
| 10.1            |       | Agreement between  International Monitoring, Inc. and Devcon Security Services Corporation dated  March 2, 2006.                                  |       | Incorporated by reference  to Exhibit 99.1 to the Company’s Current Report on Form 8-K filed on March 8,  2006.               |
|            |       |                                                                                                                                              |       |                                                                                                                               |
| 10.2            |       | Amendment and Forbearance  Agreement dated as of March 29, 2006 by and among the Company, its  subsidiaries, LSQ Funding Group, L.C. and BRE LLC. |       | Incorporated by reference  to Exhibit 99.1 to the Company’s Current Report on Form 8-K filed on April 4,  2006.               |
|            |       |                                                                                                                                              |       |                                                                                                                               |
| 10.3            |       | Agreement to sell certain  real property located in Fort Lauderdale, Florida.                                                                     |       | Incorporated by reference  to Exhibit 10.92 to the Company’s Annual Report on Form 10-K for the year  ended December 31, 2005 |
|            |       |                                                                                                                                              |       |                                                                                                                               |
| 10.4            |       | Letter Agreement dated  April 10, 2006 between International Monitoring, Inc. and Devcon Security  Services Corporation.                          |       | Filed herewith.                                                                                                                    |
|            |       |                                                                                                                                              |       |                                                                                                                               |
| 10.5            |       | Joint Venture Agreement  dated January 17, 2006 between Paragon Systems, Inc. and Southeastern  Protective Services, Inc.                         |       | Filed herewith.                                                                                                                    |
|            |       |                                                                                                                                              |       |                                                                                                                               |
| 10.6            |       | Summary of Board  Compensation.                                                                                                                   |       | 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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