Edgar Filing: TRI-S SECURITY CORP

Form 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

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

For the quarterly period ended June 30, 2007

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

For the transition period from to

Commission file number 0-51148

TRI-S SECURITY CORPORATION

(Exact name of registrant as specified in its charter)

GEORGIA

30-0016962

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification No.)

11675 Great Oaks Way, Suite 120, Alpharetta, Georgia 30022

(Address of principal executive offices)

(678) 808-1540

(Registrant’s telephone number, including area code)

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

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

Large accelerated filer ¨ Accelerated filer ¨ Non-accelerated filer x

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

Shares of the registrant’s common stock, par value $0.001 per share, outstanding as of August 9, 2007: 3,538,280.

TRI-S SECURITY CORPORATION

QUARTERLY REPORT ON FORM 10-Q FOR THE

QUARTER ENDED JUNE 30, 2007

INDEX


		Page No.

PART I. FINANCIAL INFORMATION

ITEM 1.	FINANCIAL STATEMENTS:

	Consolidated Balance Sheets June 30, 2007 and December 31, 2006	3

	Consolidated Statements of Operations Three and Six Months Ended June 30, 2007 and 2006	4

	Consolidated Statements of Cash Flows Six Months Ended June 30, 2007 and 2006	5

	Notes to Consolidated Financial Statements	6

ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	12

ITEM 3	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	16

ITEM 4.	CONTROLS AND PROCEDURES	16

PART II. OTHER INFORMATION

ITEM 1.	LEGAL PROCEEDINGS	16

ITEM 1A.	RISK FACTORS	17

ITEM 3.	DEFAULTS UPON SENIOR SECURITIES	17

ITEM 6.	EXHIBITS	17

SIGNATURES		17

EXHIBIT INDEX		E-1

Tri-S Security Corporation and Subsidiaries

Consolidated Balance Sheets

Unaudited

(In thousands, except per share data)


	June 30, 2007			December 31, 2006
Assets
Current assets:
Cash and cash equivalents	$	151		$	66
Trade accounts receivable, net of allowance of $661 and $797, respectively		14,116			13,313
Prepaid expenses and other assets		849			649

Total current assets		15,116			14,028
Property and equipment, less accumulated depreciation		577			597
Goodwill		16,078			16,078
Intangibles, net
Customer contracts		3,455			4,264
Deferred loan costs		855			1,143
Other		1,013			991

Total assets	$	37,094		$	37,101

Liabilities and Stockholders’ Equity
Current liabilities:
Trade accounts payable	$	1,609		$	1,104
Accrued interest expense		550			400
Accrued expenses		4,819			4,467
Factoring facility and 2007 term loan		9,792			7,506
Income taxes payable		439			1,269
Series C preferred stock subject to mandatory redemption		6,000			6,000
Long-term debt - current portion		—			284

Total current liabilities		23,209			21,030
Other liabilities:
10% convertible notes		7,370			7,273
Deferred income taxes		1,692			1,974
Long-term debt		19			—

Total liabilities		32,290			30,277

Stockholders’ equity:
Common stock, $0.001 par value, 25,000,000 shares authorized; 3,583,704 shares issued and 3,538,280 shares outstanding at June 30, 2007 and December 31, 2006		3			3
Treasury stock – 45,424 shares at cost		(105	)		(105	)
Additional paid-in capital		14,358			14,109
Deficit		(9,452	)		(7,183	)

Total stockholders’ equity		4,804			6,824

Total liabilities and stockholders’ equity	$	37,094		$	37,101

See accompanying notes to financial statements.

Tri-S Security Corporation and Subsidiaries

Consolidated Statements of Operations

Unaudited

(In thousands, except per share data)


	Three Months Ended June 30,						Six Months Ended June 30,
	2007			2006			2007			2006
Revenues	$	21,426		$	17,704		$	41,631		$	35,077
Cost of revenues
Direct labor		13,612			11,144			26,307			21,715
Indirect labor and other support costs		6,134			4,342			11,385			8,733
Amortization of customer contracts		404			412			810			824

		20,150			15,898			38,502			31,272

Gross profit		1,276			1,806			3,129			3,805

Selling, general and administrative		2,906			2,798			5,522			5,788
Amortization of intangible assets		221			232			456			463

		3,127			3,030			5,978			6,251

Operating loss		(1,851	)		(1,224	)		(2,849	)		(2,446	)

Income from investment in Army Fleet Support, LLC, net		—			108			—			384

Other Income (expense):
Interest income		—			1						8
Interest expense		(472	)		(633	)		(930	)		(2335	)
Interest on Series C redeemable referred stock		(75	)		(75	)		(150	)		(150	)
Gain on sale of investment in Army Fleet Support, LLC		—			1,903			—			1,903
Other income		13			—			563			84

		(534	)		1,196			(517	)		(490	)

Income (loss) before income taxes		(2,385	)		80			(3,366	)		(2552	)
Income tax benefit		(792	)		139			(1,097	)		(844	)

Net Loss	$	(1,593	)	$	(59	)	$	(2,269	)	$	(1,708	)
Basic and diluted net loss per common share	$	(0.45	)	$	(0.02	)	$	(0.65	)	$	(0.51	)

Basic and diluted weighted average number of common shares		3,518			3,410			3,511			3,379

See accompanying notes to financial statements.

Tri-S Security Corporation and Subsidiaries

Consolidated Statements of Cash Flows

Unaudited

(In thousands)


	Six Months Ended June 30, 2007			Six Months Ended June 30, 2006
Cash flow from operating activities:
Net loss	$	(2,269	)	$	(1,708	)
Adjustments to reconcile net loss to net cash used by operating activities:
(Gain) on sale of investment in Army Fleet Support, LLC		—			(1,903	)
(Income) from investment in Army Fleet Support, LLC, net		—			(384	)
(Gain) on Cornwall settlement		(250	)		—
Stock issued for services		—			44
Depreciation and amortization		1,437			1,458
Deferred income tax benefits		(282	)		(3,134	)
Non-cash employee stock option expense		148			223
Non-cash interest expense		97			782
Changes in operating assets and liabilities:
Trade accounts receivable, net		(803	)		2,609
Income taxes receivable		—			20
Prepaid expenses and other assets		(200	)		(87	)
Trade accounts payable		505			(17	)
Accrued liabilities		502			(1,520	)
Income taxes payable		(830	)		2,270

Net cash used by operating activities		(1,945	)		(1,347	)

Cash flow from investing activities:
Cash distributions from investment in Army Fleet Support, LLC		—			175
Proceeds from sale of investment in Army Fleet Support, LLC		—			10,810
Proceeds from disposal of property and equipment		—			693
Purchase of property and equipment		(151	)		(59	)

Net cash provided (used) by investing activities		(151	)		11,619

Cash flow from financing activities:
Payment made for Paragon settlement		(50	)		—
Net (payments) proceeds on factoring facility		497			(5,217	)
Proceeds (repayments) of term loans		1,789			(5,092	)
Deferred financing costs		(40	)		(43	)
Repayments of capital lease obligations		(15	)		—
Deferred initial public offering costs		—			(111	)

Net cash provided (used) by financing activities		2,181			(10,463	)

Net increase (decrease) in cash and cash equivalents		85			(191	)
Cash and cash equivalents at beginning of period		66			463

Cash and cash equivalents at end of period	$	151		$	272

Supplemental disclosures of cash flow information:
Interest paid	$	833		$	1,545
Income taxes paid	$	14		$	3

See accompanying notes to financial statements.

TRI-S SECURITY CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2007

1. Organization

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

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

In January 2006, Paragon Systems entered into a Joint Venture Agreement with Southeastern Protective Services, Inc. (“Southeastern Protective Services”) to form Southeastern Paragon. Paragon Systems owns 49% and Southeastern Protective Services owns 51% of Southeastern Paragon. Southeastern Paragon was formed to bid on certain contracts, and Paragon Systems manages the contracts awarded to Southeastern Paragon. We account for the results of Southeastern Paragon in accordance with Accounting Principal Board Opinion No. 18, The Equity Method of Accounting for Investments in Common Stock, and Financial Accounting Standards Board (“FASB”) Interpretation No. 46(R), Consolidation of Variable Interest Entities.

2. Basis of Presentation

The accompanying consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States (“GAAP”). The financial statements presented are unaudited and have been prepared by our management in accordance with the rules and regulations of the Securities and Exchange Commission (the “SEC”). In the opinion of our management, all adjustments, consisting of normal recurring accruals, necessary for the fair presentation of the financial position, results of operations and cash flows have been included. For further information, see our audited financial statements and footnotes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2006 (the “Annual Report”) and our Quarterly Report on Form 10-Q for the quarter ended March 31, 2007, each filed with the SEC. Disclosure that substantially duplicates the disclosure contained in the footnotes to the audited financial statements included in the Annual Report has been omitted from these Notes.

3. Recent Accounting Pronouncement Implemented

We adopted the provisions of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109 (“FIN No. 48”) on January 1, 2007. FIN No. 48 prescribes a recognition threshold that a tax position is required to meet before being recognized in the financial statements and provides guidance on the de-recognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition issues. The adoption of FIN No. 48 resulted in the recognition of $32,104 of penalties which was recorded as an adjustment to the January 1, 2007 retained earnings. No adjustments were made in the quarter ended June 30, 2007 to the balance of unrecognized tax benefits and no material change is expected in the next twelve months. In addition, the following information required by FIN No. 48 is provided:

•

As noted above, as of January 1, 2007, we have accrued penalties in the amount of $32,104 related to uncertain tax positions. As of June 30, 2007, the total amount of interest and penalties accrued was $60,407. Accrued interest on tax deficiencies and tax penalties are recorded as a component of income tax expense.

•

The recognition of unrecognized tax benefits will not impact our effective tax rate.

•

Tri-S Security Corporation and its subsidiaries files federal income tax returns, as well as multiple state and local tax returns. The tax years of 2004 to 2006 for all jurisdictions remain open to examination.

4. Stock-based Compensation

Effective January 1, 2006, we adopted Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment (“SFAS No. 123R”), using the modified-prospective-transition approach method. Under this transition method, compensation costs for 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 No. 123R decreased net income by approximately $148,000 and $223,000 for the six months ended June 30, 2007 and 2006, respectively, compared to our previous method of accounting for share-based compensation under Accounting Principal Board Opinion No. 25, Accounting for Stock Issued to Employees.

As of June 30, 2007, there was approximately $560,000 of unrecognized compensation cost related to unvested share-based compensation awards granted. We expect to recognize this cost over the next 2.1 years.

5. Common and Preferred Stock

On February 8, 2005, pursuant to an Exchange and Recapitalization Agreement, we effected an exchange and recapitalization of our then outstanding common stock, Series A Convertible Preferred Stock and Series B Convertible Preferred Stock and rights to acquire our common stock. Pursuant to the Exchange and Recapitalization Agreement, all of our outstanding (i) common stock, Series A Convertible Preferred Stock and Series B Convertible Preferred Stock were exchanged for an aggregate of 1,200,000 shares of our common stock and (ii) rights to acquire our common stock were exchanged for rights to purchase an aggregate of 113,269 shares of our common stock. The recapitalization was given retroactive treatment in the financial statements and related disclosures.

As of June 30, 2007, we had 100 shares outstanding of Series C Redeemable Preferred Stock.

Holders of the Series C Redeemable Preferred Stock have no voting rights, except that a consent of a majority of the holders of the Series C Redeemable Preferred Stock, voting separately as a class, is required to increase or decrease the number of authorized shares of Series C Redeemable Preferred Stock and except as otherwise required by applicable law. The Series C Redeemable Preferred Stock does not have any preemptive, conversion or sinking fund rights nor does it have any rights or preferences in the event of a liquidation, dissolution or winding-up of the Company.

The Series C Redeemable Preferred Stock is classified as preferred stock subject to mandatory redemption in the financial statements and was redeemable by us on February 27, 2007. As of June 30, 2007 and 2006, the Company had accrued dividend expense with respect to the outstanding shares of Series C Redeemable Preferred Stock of $550,000 and $250,000, respectively. Dividends on the outstanding shares of Series C Redeemable Preferred Stock are payable semi-annually and accrue at an annual rate of 5% of the redemption value, which redemption value is an aggregate of $6.0 million. Our payment obligations under the Series C Redeemable Preferred Stock are secured by a pledge of 40% of the outstanding capital stock of Paragon Systems. On February 27, 2006, we filed a lawsuit against the former shareholders of Paragon Systems alleging, among other things, that they breached certain representations in the Stock Purchase Agreement between us and the former shareholders dated as of February 23, 2004 (the “Paragon Purchase Agreement”), pursuant to which we acquired Paragon Systems. In the complaint, we seek, among other things, an award of damages and a decree invalidating the Series C Redeemable Preferred Stock which was issued to the former shareholders as part of the purchase price for Paragon Systems and the security agreements pursuant to which we pledged 40% of the outstanding capital stock of Paragon Systems to secure our obligations under the Series C Redeemable Preferred Stock. Under the Paragon Purchase Agreement and all applicable common law, we are exercising our rights of offset against the dividend and redemption payments otherwise payable by us in respect of the Series C Redeemable Preferred Stock. Accordingly, we did not make dividend payments on the Series C Redeemable Preferred Stock on February 28, 2006, or at any point thereafter, and we have not redeemed the Series C Redeemable Preferred Stock, which has a redemption value of $6.0 million and was otherwise redeemable by us on February 27, 2007. If we do not settle the litigation with the former shareholders or prevail in the litigation, then we will be required to redeem the Series C Redeemable Preferred Stock and pay all accrued and unpaid dividends thereon. If we do not do so, then the former shareholders may be able to foreclose on the stock of Paragon Systems pledged to them. See Part II, Item 1 “Legal Proceedings” of this Quarterly Report for a discussion of the litigation with the former shareholders regarding the Series C Redeemable Preferred Stock.

If we are unable to satisfy or otherwise settle the claims with respect to the Series C Redeemable Preferred Stock by February 28, 2008, we will be in default under our credit facility with our lenders, which requires that the litigation with respect to the Series C Redeemable Preferred Stock be settled and that the lien on the 40% of the stock of Paragon Systems held by the former shareholders of Paragon Systems be eliminated by February 28, 2008. If the Series C Redeemable Preferred Stock or the lien remains

outstanding on February 28, 2008, we will be in violation of our credit facility and all indebtedness thereunder will become immediately due and payable. See Part II, Item 1 “Legal Proceedings” of this Quarterly Report for a discussion of the litigation with the former shareholder regarding the Series C Redeemable Preferred Stock.

We are authorized to issue 25 million shares of common stock with a par value of $0.001 per share. The holders of common stock are entitled to one vote per share on all matters. The common stock does not have cumulative voting rights and no conversion rights. Each share of common stock has an equal and ratable right to receive dividends to be paid from assets legally available when and if declared by our Board of Directors. We have never paid any cash dividends on common stock.

During the first quarter of 2006, we issued 20,000 shares of our common stock for services, at a price of $4.45 per share, which services will be rendered ratably during 2006. For the three and six months ended June 30, 2006, we recorded expense of approximately $22,000 and $44,000 for services rendered during that period.

6. Investment in Army Fleet Support, LLC

In conjunction with the purchase of all the outstanding capital stock of Paragon Systems (the “Paragon Acquisition”), we acquired a 10% equity interest in Army Fleet Support, LLC (“Army Fleet”). The value of our investment in Army Fleet on the date of the Paragon Acquisition was $8,102,000 as established by an independent appraisal. We amortize the cost of the 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 Fleet using the equity method of accounting. Accordingly, our investment in Army Fleet is increased by our share of Army Fleet’s earnings and reduced by the amortization of our investment in Army Fleet and the cash we receive from Army Fleet with respect to our investment.

During the second quarter of 2006, we sold our 10% equity interest in Army Fleet. The details of the transaction are as follows:


Cash received	$	10,810,000
Book value of investment		8,907,083

Gain on sale	$	1,902,917

Our investment in Army Fleet was affected by the following transactions:


	Three months ended June 30, 2006			Six months ended June 30, 2006
Investment in Army Fleet – beginning	$	8,974,000		$	8,698,000
Company’s share of earnings in Army Fleet		177,000			659,000
Amortization of the investment in Army Fleet		(69,000	)		(275,000	)
Cash received from Army Fleet		(175,000	)		(175,000	)
Sale of investment in Army Fleet		(8,907,000	)		(8,907,000	)

Investment in Army Fleet – ending	$	—		$	—

7. Debt and Other Obligations

Credit and Factoring Agreements

On October 18, 2005, we entered into a Credit Agreement (as amended from time to time, the “Credit Agreement”) with LSQ Funding Group, L.C. (“LSQ”) and BRE LLC (“BRE” and, together with LSQ, our “lenders”), pursuant to which we borrowed $1,650,000 pursuant to a 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”). During the second quarter of 2006, the Term Loans were paid in full.

In connection with the Credit Agreement, we entered into a Factoring and Security Agreement (the “Factoring Agreement”) with LSQ, pursuant to which LSQ will purchase from us from time to time certain accounts receivable at a discount of 0.7% and provide us with a professional accounts receivable management service for a funds usage fee of the prime rate plus 1.0% on the funds advanced on the outstanding accounts receivable purchased. The Factoring Agreement has a $6,000,000 initial purchase limit and a four-year term which will automatically renew unless we provide notice of our intent to terminate. The Factoring Agreement amends and restates the Factoring Agreement dated as of April 1, 2005 between LSQ and Paragon Systems, pursuant to which LSQ purchased from Paragon Systems from time to time certain accounts receivable at a discount of 0.7% under a factoring facility with a funds usage fee equal to the prime rate plus 1.00%, a $6,500,000 initial purchase limit and a one-year term subject to annual renewal.

Pursuant to the Credit Agreement, we also entered into (i) a Guaranty Agreement pursuant to which we unconditionally and irrevocably guarantee to the lenders the prompt payment and performance of all of our obligations, indebtedness and liabilities to the lenders, whether currently existing or subsequently arising (the “Obligations”); and (ii) a Security Agreement, pursuant to which we granted to the lenders a security interest in substantially all of our assets to secure all of the Obligations. Additionally, we have entered into a Pledge Agreement pursuant to which we have pledged to the lenders the capital stock of Paragon Systems to secure all of our obligations under the Credit Agreement and related documents.

On June 27, 2006, Paragon Systems executed a Guaranty of Joint Venture (the “JV Guaranty”) pursuant to which Paragon Systems unconditionally guarantees to LSQ the prompt payment and performance of all obligations, indebtedness and liabilities, whether currently existing or subsequently arising, of Southeastern Paragon (the “JV Obligations”). The JV Obligations include the obligations, indebtedness and liabilities of Southeastern Paragon to LSQ under that certain Factoring and Security Agreement between Southeastern Paragon and LSQ dated as of June 27, 2006 (the “JV Factoring Agreement”), pursuant to which LSQ will purchase from Southeastern Paragon from time to time certain accounts receivable at a discount of 0.7% and provide Southeastern Paragon with a professional accounts receivable management service for a funds usage fee equal to the prime rate plus 1.0% on the funds advanced on the outstanding accounts receivable purchased. The JV Factoring Agreement has a $1,000,000 initial purchase limit and a one-year term which will automatically renew unless Southeastern Paragon provides notice of its intent to terminate.

During March 2007, we entered into an Amendment and Forbearance Agreement with our lenders pursuant to which we amended the Credit Agreement and secured an additional $2.5 million term loan (the “2007 Term Loan”) with our lenders to provide additional financing as needed to provide the capital we estimate is necessary to continue to operate the business during 2007. Interest under the 2007 Term Loan is payable monthly at an annual interest rate of Prime plus 5.5%. The 2007 Term Loan matures on March 28, 2009. The 2007 Term Loan bears a 0.25% per month fee on the unused portion of the loan. The lenders were paid an origination fee of $40,000. The 2007 Term Loan requires us to pay a “Minimum Balance Fee”, as described in the Credit Agreement, if the 2007 Term Loan is repaid prior to maturity.

As of June 30, 2007, we had approximately $1,600,000 available under the credit facility and term loan. Additionally, we had $4,100,000 of unbilled accounts receivable of which the company can borrow up to $2,050,000 at the discretion of the lenders, giving the company and estimated availability of $3,650,000 as of June 30, 2007.

Convertible Notes

During September and October 2005, we issued in a private placement transaction 10% convertible promissory notes (“10% Notes”) with an aggregate principal amount of $8,015,000 and warrants to purchase 834,896 shares of our common stock for a total purchase price of $8,015,000. The 10% Notes and warrants were issued in four closings between September 2, 2005 and October 14, 2005. The face value of the 10% Notes is $8,015,000. Interest is payable monthly on the face value of the 10% Notes at a rate of 10% per annum. The gross proceeds from the offering of 10% Notes and warrants was allocated to the 10% Notes and warrants in accordance with Emerging Issue Tax Force 98-5, Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios (“EITF 98-5”). In accordance with EITF 98-5, $6,107,000 of the gross proceeds were allocated to the 10% Notes and $1,908,000 was allocated to additional paid in capital related to the warrants and the beneficial conversion feature. The conversion of the 10% Notes was restricted at the issue date because of the need for a shareholder vote to approve the conversion of the 10% Notes and the exercise of the warrants as well as certain other restrictions. In February 2006, the shareholders approved the shares issuable upon conversion of the 10% Notes and exercise of the warrants. Accordingly,

approximately $1.1 million of the in-the-money beneficial conversion feature was recorded to increase the book value of the 10% Notes. Of the $1.1 million of in-the-money beneficial conversion feature, approximately $700,000 was recorded as interest expense during the three months ended March 31, 2006, and approximately $400,000 was recorded as a reduction to additional paid in capital because of additional conversion restrictions associated with a certain portion of the 10% Notes. The remaining discount on the 10% Notes relative to face value will be amortized to interest expense over the remaining life of the 10% Notes. The 10% Notes mature three years after issuance and may be prepaid at the option of the Company after one year after the issuance thereof subject to the satisfaction of certain conditions.

The 10% Notes are convertible by the holders at an initial conversion price of $4.80 per share subject to certain restrictions. The warrants issued have an exercise price of $4.80 and expire three years from the date of issuance.

During the second quarter of 2006, 62,500 shares of our common stock were issued upon conversion of 10% Note with an aggregate principal amount of $300,000. During the first quarter of 2006, 10,417 shares of common stock were issued upon conversion of 10% Note with an aggregate principal amount of $50,000.

8. Income Tax

We adopted the provisions of FIN No. 48 on January 1, 2007. FIN No. 48 prescribes a recognition threshold that a tax position is required to meet before being recognized in the financial statements and provides guidance on the de-recognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition issues. The adoption of FIN No. 48 resulted in the recognition of $32,104 of penalties which was recorded as an adjustment to the January 1, 2007 retained earnings. No adjustments were made in the quarter ended June 30, 2007 to the balance of unrecognized tax benefits and no material change is expected in the next twelve months. In addition, the following information required by FIN No. 48 is provided:

•

The recognition of unrecognized tax benefits will not impact our effective tax rate.

•

Our effective tax rate for the three months ended June 30, 2007 and 2006 was 36.0%. The principal causes of the difference between the effective rate and the U.S. statutory rate of 34% were the state tax benefit and the reduction of book income resulting from a purchase price adjustment from our acquisition of Cornwall. The additional benefits are reduced by non-deductible stock option compensation expense and dividends paid on preferred stock.

As a result of the gain on the sale of the Company’s investment in Army Fleet Services, LLC a tax payment of approximately $1,300,000 is due in September 2007. The Company anticipates a refund in 2008 of similar magnitude due to anticipated losses in 2007.

9. Net Loss per Share

Basic net loss per share is computed by dividing net loss available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted net loss per share gives effect to all potentially dilutive securities. For the three and six months ended June 30, 2007 and 2006, the effect of our warrants and stock options were not included in the computation of diluted earnings per share as their effect was anti-dilutive.

10. Related Party Transactions

Note Receivable from Chief Executive Officer

Pursuant to the employment agreement between us and Ronald G. Farrell, our Chief Executive Officer and President, Mr. Farrell was entitled to receive during 2004 an aggregate bonus of $435,000. However, in order to improve the financial position of the Company prior to our initial public offering, Mr. Farrell agreed 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 had already paid to Mr. Farrell $245,000 with respect to his 2004 bonus. Accordingly, Mr. Farrell agreed to repay us $100,000 pursuant to the terms of a promissory note issued by Mr. Farrell to us dated December 31, 2004, which provided for interest at a rate of 2.48% per year and was payable on December 31, 2006. The note provided that it could be prepaid at any time without penalty and could be paid, at the election of Mr. Farrell, in cash

or shares of common stock or any combination thereof. During December 2006, Mr. Farrell repaid the loan balance and accrued interest with 45,424 shares of common stock. These shares are reflected as treasury stock on the accompanying balance sheet at a cost of $105,021.

Employment Agreement

Pursuant to the employment agreement, as amended, between us and Mr. Farrell, Mr. Farrell has agreed to serve as our Chief Executive Officer and President until June 30, 2010. The agreement provides for (i) payment of a specified base salary which increases by 10% per year; (ii) payment of an annual incentive bonus equal to 5% of our EBITDA, as defined, for such year, provided that such bonus may not exceed 100% of Mr. Farrell’s base salary for such year; (iii) prohibitions against Mr. Farrell’s disclosure of confidential information, solicitation of our employees and participation in a business competitive with our business during his employment and for a period of one year following the termination of his employment; and (iv) continuation of Mr. Farrell’s compensation and benefits for the remainder of the term of his employment agreement if his employment is terminated by us without “cause” or by Mr. Farrell for “good reason” or upon a “change of control” of the Company, provided that if a change of control occurs after June 30, 2008 and before July 1, 2010, Mr. Farrell is entitled to receive all monies which he would have been paid under the employment agreement had the term the agreement terminated on the second anniversary of such change of control rather than on June 30, 2010. Pursuant to Mr. Farrell’s employment agreement, we also provide certain other benefits and expense reimbursements to Mr. Farrell which are consistent with his position as our Chief Executive Officer. Mr. Farrell is also entitled to participate in any employee benefit plan, stock option plan and other fringe benefit plan at the discretion of our board of directors.

11. Cornwall Settlement

At the closing of our acquisition of Cornwall, we paid a total purchase price of $13,500,000 payable as follows: (i) payment of $12,825,000 in cash; (ii) delivery of a promissory note in principal amount of $250,000 payable to the former Cornwall shareholders (the “Cornwall Promissory Note”); and (iii) deposit of $425,000 with an escrow agent to secure the indemnification obligations of the former Cornwall shareholders under the Stock Purchase Agreement between us and the former Cornwall shareholders dated as of August 11, 2005 (the “Cornwall Purchase Agreement). After adjusting for certain working capital items, the net purchase price was $12,753,000. On January 26, 2007, we entered into a Settlement Agreement and General Release (the “Cornwall Settlement Agreement”) with David Shopay, on behalf of himself and the other former shareholders of Cornwall, in his capacity as the representative of such shareholders. Pursuant to the Cornwall Settlement Agreement (i) the parties waived and released each other from all claims and liabilities, with the exception of certain claims and liabilities specified in the Cornwall Settlement Agreement, arising from the Cornwall Purchase Agreement; (ii) the shareholder representative forgave and discharged all amounts owed by us to the former shareholders of Cornwall under the Cornwall Promissory Note; and (iii) the shareholder representative and the Company instructed the escrow agent administering the escrow fund to release $200,000 from such fund to us and the remaining balance of such fund to the former shareholders of Cornwall. We recognized a gain of $450,000 as other income on the accompanying statements of operations for the six months ended June 30, 2007.

12. Segment Reporting

Our two reportable segments are Cornwall and Paragon Systems/Southeastern Paragon. The accounting policies applicable to these reportable segments are the same as those described in the summary of significant accounting policies. The Cornwall segment focuses on contract guard services to commercial and state and local government customers. The Paragon Systems/Southeastern Paragon segment focuses on contract guard services to various Federal government agencies.

We considered our organization and reporting structure and the information used by our chief operating decision makers to make decisions about resource allocation and performance assessment and determined management evaluates the performance of the segments based primarily on revenues and operating income (loss). Revenues, operating income, and assets for each segment are as follows (in thousands):


	Total			Cornwall			Paragon Systems/SEP			Other
For the three months ended June 30, 2007
Revenues	$	21,426		$	10,039		$	11,387		$	—
Amortization and depreciation		718			430			122			166
Operating (loss)		(1,851	)		(755	)		(180	)		(916	)
Current assets		15,116			5,641			9,437			38
Goodwill		16,078			8,331			7,747			—
Other Intangibles		5,323			3,800			550			973
Total assets		37,094			18,056			17,965			1,073

	Total			Cornwall			Paragon Systems/SEP			Other
For the three months ended June 30, 2006
Revenues	$	17,704		$	10,091		$	7,613		$	—
Amortization and depreciation		727			463			97			167
Operating (loss)		(1,224	)		207			(386	)		(1,045	)
Current assets		9,867			4,902			4,628			337
Goodwill		15,692			7,945			7,747			—
Other Intangibles		7,765			5,391			902			1,472
Total assets		33,987			18,753			13,359			1,875

	Total			Cornwall			Paragon Systems/SEP			Other
For the six months ended June 30, 2007
Revenues	$	41,631		$	20,185		$	21,446		$	—
Amortization and depreciation		1,437			869			234			334
Operating (loss)		(2,849	)		(779	)		(185	)		(1,885	)
Current assets		15,116			5,641			9,437			38
Goodwill		16,078			8,331			7,747			—
Other Intangibles		5,323			3,800			550			973
Total assets		37,094			18,056			17,965			1,073

	Total			Cornwall			Paragon Systems/SEP			Other
For the six months ended June 30, 2006
Revenues	$	35,077		$	20,091		$	14,986		$	—
Amortization and depreciation		1,458			931			194			333
Operating (loss)		(2,446	)		(199	)		(434	)		(1,813	)
Current assets		9,867			4,902			4,628			337
Goodwill		15,692			7,945			7,747			—
Other Intangibles		7,765			5,391			902			1,472
Total assets		33,987			18,753			13,359			1,875

Item 2.

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

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

You should carefully review the information contained in this Quarterly Report and should particularly consider any risks and other factors that we set forth in this Quarterly Report and in other reports or documents that we file from time to time with the SEC. Except for historical information contained herein, this Quarterly Report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), including statements of our expectations as to future events and our future financial performance. In some cases, you can identify 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 comparable words. 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 differ materially. In evaluating those statements, you should specifically consider various factors, including those outlined below. Those factors may cause our actual results to differ materially from any of our forward-looking statements. We undertake no obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise.

Overview

We provide contract guard services to government and commercial customers. These guard services include providing uniformed and armed guards for access control, personnel protection, plant security, theft prevention, surveillance, vehicular and foot patrol, crowd control and prevention of sabotage, terrorist and criminal activities. In connection with providing these services, we assume responsibility for a variety of functions, including recruiting, hiring, training and supervising security guards deployed to the customers we serve as well as paying all guards and providing them with uniforms, employee benefits and workers’ compensation insurance. We are responsible for preventing the interruption of guard services as a consequence of illness, vacations or resignations.

Critical Accounting Policies

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

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

The terms of our contracts are complex and may be subject to differing interpretations. We make estimates and judgments about terms of the contracts in providing services and in billing and recording revenue. At times, our Federal contracts require interpretations. Typically, differences in interpretation are resolved on a mutual basis in discussions with the government agency involved. The resolution of differences may result in a determination that amounts previously billed are not in accordance with contract terms and adjustments of amounts initially recorded as revenue may be material.

Contracts with Federal government agencies may be subject to cessation of funding. Cessation of funding may result in amounts billed and recorded as revenue as being uncollectible. We work with the appropriate government agency to resolve funding issues. When funding issues become known, we make estimates and judgments about the extent of potential losses and adjust revenues accordingly. Amounts estimated could differ from amounts ultimately collected and these amounts could be material. During 2006 and 2007, none of our contracts have been subject to cessation of funding.

Cost of Revenues. Cost of revenues is primarily comprised of labor, related payroll taxes, employee benefits, workers compensation, liability insurance, and the pro rata portion of the costs of customer contracts acquired. We make estimates and judgments of amounts recorded for accruals of labor related costs. Expenses most subject to estimation and judgment are accrued vacation and workers compensation costs. The terms of vacation policies may be complex and subject to interpretation. Workers compensation insurance is subject to retroactive audit. Actual amounts could differ from the amounts initially recorded.

Impairment of Long-lived Assets, Goodwill and Intangible Assets. We evaluate impairment of long-lived assets, including property and equipment and intangible assets with finite lives, whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. If the sum of the expected future undiscounted cash flows is less than the carrying amount of the asset, then an impairment loss is recognized. Measurement of an impairment loss for long-lived assets is based on discounted cash flows and the fair value of an asset.

Investment in Army Fleet. We accounted for our 10% equity in Army Fleet, a joint venture which provides logistics support for U.S. Army aviation training at Fort Rucker, Alabama, using the equity method of accounting. Accordingly, our investment in Army Fleet is increased by our share of Army Fleet’s earnings and reduced by the amortization of our investment in Army Fleet and the cash we receive from Army Fleet with respect to our investment. During the second quarter of 2006, we sold our equity interest in Army Fleet.

SFAS No. 123(R). On January 1, 2006, we adopted SFAS No. 123R using the modified-prospective-transition approach method. The adoption increased our net loss by $148,000 and $223,000 for the six months ended June 30, 2007 and 2006, respectively, compared to our previous method of accounting for share-based compensation under Accounting Principal Board Opinion No. 25, Accounting for Stock Issued to Employees. We will incur approximately $560,000 of expense over a weighted average of 2.1 years for all unvested options.

Results of Operations - Three Months Ended June 30, 2007 Compared to Three Months Ended June 30, 2006

Revenue increased $3.7 million to $21.4 million, or 21.0%, for the three months ended June 30, 2007, as compared to revenue of $17.7 million for the three months ended June 30, 2006. The increase in revenue is primarily due to the increase in revenue at Paragon Systems and Southeastern Paragon related to new contracts initiated during 2006 and 2007.

Cost of revenue increased $4.3 million to $20.2 million, or 26.7%, for the three months ended June 30, 2007, as compared to cost of revenue of $15.9 million for the three months ended June 30, 2006. Our cost of revenues increased primarily due to the increase in cost of revenue at Paragon Systems and Southeastern Paragon related to new contracts initiated during 2006 and 2007, and an adjustment to reserves for self-insured workers compensation.

Our gross profit decreased by $0.5 million to $1.3 million for the three months ended June 30, 2007, as compared to gross profit of $1.8 million for the three months ended June 30, 2006. Our gross margin percentage decreased to 6.0% for the three months ended June 30, 2007, as compared to 10.2% for the three months ended June 30, 2006. This decrease is attributable to new contract start up costs and the adjustment to reserves for self-insured workers compensation.

Selling, general and administrative expenses, which include payroll and related expenses for administrative personnel, occupancy costs at the office locations, consulting and professional fees, and other miscellaneous office and corporation expenses, increased $108,000 to $2.9 million, or 3.9%, for the three months ended June 30, 2007, as compared to $2.8 million for the three months ended June 30, 2006. This increase is due to restructuring costs and an increase in bad debt expense.

Income with respect to our equity interest in Army Fleet was zero for the three months ended June 30, 2007, as compared to the three months ended June 30, 2006, as we sold our equity interest in Army Fleet during the second quarter of 2006. For the three months ended June 30, 2006, we recognized $177,000 of net earnings with respect to our equity interest in Army Fleet less $69,000 of amortization expense, for a net result of $108,000.

For the three months ended June 30, 2006, we recognized a gain of $1.9 million for the sale of investment in Army Fleet.

Interest expense decreased $161,000, or 25.4%, to $472,000 for the three months ended June 30, 2007, as compared to interest expense of $633,000 for the three months ended June 30, 2006. The decrease is primarily due to the repayment of two term loans during the second quarter of 2006.

For the three months ended June 30, 2007, we recognized other income of $13,000 primarily due to a contract settlement with the government for past services.

Loss before income taxes for the three months ended June 30, 2007 resulted in a tax benefit of $792,000, while the income before income taxes for the three months ended June 30, 2006 resulted in a tax expense of $139,000.

Results of Operations - Six Months Ended June 30, 2007 Compared to Six Months Ended June 30, 2006

Revenue increased $6.6 million to $41.6 million, or 18.7%, for the six months ended June 30, 2007, as compared to revenue of $35.1 million for the six months ended June 30, 2006. The increase in revenue is primarily due to the increase in revenue at Paragon Systems and Southeastern Paragon related to new contracts initiated during 2006 and 2007.

Cost of revenue increased $7.2 million to $38.5 million, or 23.1%, for the six months ended June 30, 2007, as compared to cost of revenue of $31.3 million for the six months ended June 30, 2006. Our cost of revenues increased primarily due to the increase in cost of revenue at Paragon Systems and Southeastern Paragon related to new contracts initiated during 2006 and 2007, and an adjustment to reserves for self-insured workers compensation.

Our gross profit decreased by $676,000 to $3.1 million for the six months ended June 30, 2007, as compared to gross profit of $3.8 million for the six months ended June 30, 2006. Our gross margin percentage decreased to 7.5% for the six months ended June 30, 2007, as compared to 10.8% for the three months ended June 30, 2006.

Selling, general and administrative expenses, which include payroll and related expenses for administrative personnel, occupancy costs at the office locations, consulting and professional fees, and other miscellaneous office and corporation expenses, decreased $266,000 to $5.5 million, or 4.6%, for the six months ended June 30, 2007, as compared to $5.8 million for the six months ended June 30, 2006. The decrease was primarily due to personnel related cost reductions.

Income with respect to our equity interest in Army Fleet decreased $384,000 for the six months ended June 30, 2007, as compared to the six months ended June 30, 2006, as we sold our equity interest in Army Fleet during the second quarter of 2006. For the six months ended June 30, 2006, we recognized $659,000 of net earnings with respect to our equity interest in Army Fleet less $275,000 of amortization expense, for a net result of $384,000.

For the six months ended June 30, 2006, we recognized a gain of $1.9 million for the sale of investment in Army Fleet.

Interest expense decreased $1.4 million, or 60.2%, to $930,000 for the six months ended June 30, 2007, as compared to interest expense of $2.3 million for the six months ended June 30, 2006. The decrease is primarily due to the repayment of two term loans during the second quarter of 2006. In addition, we paid default interest rates to our lender during the first quarter of 2006 because the amount outstanding under our factoring facility exceeded the maximum availability under the factoring facility based on the collateral formula in the Factoring Agreement with our lenders.

For the six months ended June 30, 2007, we recognized other income of $563,000 primarily due to the $450,000 gain recognized related to the settlement with the former shareholders of Cornwall pursuant to the Cornwall Settlement Agreement and a $113,000 settlement with the Department of Homeland Security for past services.

Loss before income taxes for the six months ended June 30, 2007 resulted in a tax benefit of $1.1 million, while the loss before income taxes for the six months ended June 30, 2006 resulted in a tax benefit of $844,000.

Liquidity and Capital Resources

As of June 30, 2007, we had $151,000 of cash on hand. Cash used by operating activities was $1.9 million for the six months ended June 30, 2007, which was due primarily to the net loss of $2.3 million. Cash provided by financing activities was $2.2 for the six months ended June 30, 2007, which was due primarily to the proceeds on term loans of $1.8 million.

The Series C Redeemable Preferred Stock outstanding at December 31, 2006 was redeemable on February 27, 2007 for an aggregate value of $6.0 million. All of the outstanding Series C Redeemable Preferred Stock was issued in connection with the Paragon Acquisition and is held by the former shareholders of Paragon Systems. On February 26, 2006, we filed a complaint against the former shareholders of Paragon Systems alleging, among other things, that the former shareholders breached certain representations set forth in the Paragon Purchase Agreement, pursuant to which the Paragon Acquisition was consummated on February 27, 2004, and that certain former shareholders committed fraud in connection with the Paragon Acquisition. In the complaint we seek, among other things, an award of damages against the former shareholders and a decree invalidating all of the outstanding shares of the Series C Redeemable Preferred Stock. Accordingly, we exercised our right of offset under the Paragon Purchase Agreement and applicable common law and have not paid the dividend payments which were otherwise due in respect of the Series C Redeemable Preferred Stock on February 28, 2006 or on any date thereafter. In addition, we did not pay the $6,000,000 redemption payment payable on February 27, 2007. In the event that we do not make the payment specified in the Mediation Settlement Agreement (see Part II, Item 1 “Legal Proceedings” of this Quarterly Report) and our complaint is unsuccessful and we are required to pay the dividend and redemption payments with respect to the Series C Redeemable Preferred Stock, we will need to raise additional debt and/or equity capital or sell assets to satisfy the obligation. See Part II, Item 1 “Legal Proceedings” of this Quarterly Report for a discussion of the litigation with the former shareholders regarding the Series C Redeemable Preferred Stock.

On March 23, 2007, we entered into an Amendment and Forbearance Agreement with our lenders pursuant to which they have waived certain defaults under our Credit Agreement relating to our litigation with the former shareholders of Paragon Systems and the Series C Redeemable Preferred Stock and have agreed to forbear from exercising any of the remedies available to them under the Credit Agreement in connection with such defaults until February 28, 2008. The Amendment and Forbearance Agreement also provides for the 2007 Term Loan, which makes available to us a $2.5 million term loan to be used for general corporate purposes. The interest rate on the term loan is prime plus 5.5% with maturity on February 28, 2009. We will be required to pay a prepayment fee of $50,000 per month for every month the term loan is prepaid prior to maturity.

As of June 30, 2007, we had approximately $1,600,000 available under the credit facility and term loan. Additionally, we had $4,100,000 of unbilled accounts receivable of which the company can borrow up to $2,050,000 at the discretion of the lenders, giving the company an estimated availability of $3,650,000 as of June 30, 2007.

Our liquidity position in the future will be determined by our ability to generate cash from operations and our borrowing availability under the Credit Agreement and Factoring Agreement with our lenders and future financings. If the Company does not have sufficient eligible accounts receivable to support the level of borrowings it may need, the Company may be unable to draw on the credit facility to the extent necessary without obtaining an amendment to the Credit Agreement or other forbearance.

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

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

Our 10% Notes carry interest rates which are fixed. The Factoring Agreement with our lenders has a funds usage fee which varies with the prime rate. Accordingly, if we sell our accounts receivable to our lenders and such accounts remain unpaid, then any increase in the prime rate 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 has evaluated our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) or 15d-15(e) of the Exchange Act), as of the end of the period covered by this Quarterly Report, as required by paragraph (b) of Rules 13a-15 or 15d-15 of the Exchange Act. Based on such evaluation, our Chief Executive Officer has concluded that, as of the end of the period covered by this Quarterly Report, our disclosure controls and procedures are effective. We do not currently have a person serving as the Company’s Chief Financial Officer.

During the quarter ended June 30, 2007, there was not any change in our internal control over financial reporting identified in connection with the evaluation required by paragraph (d) of Rules 13a-15 or 15d-15 of the Exchange Act that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II - OTHER INFORMATION

Item 1.

Legal Proceedings

Except as set forth in our Annual Report, our Quarterly Report on Form 10-Q for the quarter ended March 31, 2007, and as discussed below, we believe that, based on currently known facts, there are no claims or litigation pending against us the disposition of which would materially affect our financial position or future operating results, although we cannot be certain as to the ultimate outcome of any such claim or litigation. In addition, exposure to litigation is inherent in our ongoing business and may harm our business in the future.

On May 18, 2007, we entered into a Mediation Settlement Agreement (the “Mediation Settlement Agreement”) with Charles Keathley, Robert Luther, John Wilson and Harold Bright, the former shareholders of Paragon Systems (the “Selling Shareholders”), with respect to all of the pending litigation among us, Paragon Systems and the Selling Shareholders (collectively, the “Litigation”). Pursuant to the Mediation Settlement Agreement, we paid the Selling Shareholders an aggregate of $50,000 and issued to the Selling Shareholders an aggregate of 35,000 shares of our common stock, and the Company, Paragon and the Selling Shareholders sought to stay the Litigation for 120 days.

The Mediation Settlement Agreement provides that the settlement of the Litigation will occur no later than September 15, 2007, provided that the following closing conditions have been satisfied: (i) we have obtained acceptable financing for the additional $1,200,000 payment discussed below; (ii) the parties have reached agreement regarding the representation and indemnification of the Selling Shareholders in connection with the litigation concerning our initial public offering pending against us in the United States District Court for the Northern District of Georgia; and (iii) the courts and other venues in which the Litigation is currently pending have stayed the Litigation.

Pursuant to the Mediation Settlement Agreement, if the closing conditions discussed above are satisfied prior to September 15, 2007, then the Company, Paragon and the Selling Shareholders will execute mutual releases of all claims and obligations among them existing as of the settlement date, except for the obligations arising pursuant to the Mediation Settlement Agreement itself, and will dismiss all the Litigation with prejudice, in exchange for, among other things:

(i) payment by us to the Selling Shareholders of an additional $1,200,000 in cash;

(ii) issuance to the Selling Shareholders of an additional 665,000 shares of our common stock;

(iii) termination of the Selling Shareholders’ security interest in 40% of the outstanding shares of Paragon Systems;

(iv) reduction of the aggregate redemption value of our Series C Redeemable Preferred Stock from $6.0 million to $1.5 million, with such amount to be payable upon the earlier of five years from the settlement date or the sale of 70% or more of our assets in one or more transactions (unless the proceeds from the sale are reinvested in our business, used to retire debt or used for acquisitions or working capital purposes) and with the dividends with respect to such stock (which accrue at a rate of 5% of the redemption value per annum) to be payable quarterly;

(v) agreement by us not to amend the employment agreement between us and Ronald G. Farrell, our Chief Executive Officer, to increase or enhance the compensation or benefits payable to him thereunder during the one-year period after the settlement date;

(vi) agreement by us to issue to the Selling Shareholders an aggregate of 10% of the same equity securities issued to Mr. Farrell in the event Mr. Farrell is issued any equity securities during the one-year period commencing on May 18, 2007; and

(vii) a proxy granted by the Selling Shareholders to Mr. Farrell to vote all of the shares of Common Stock issued or to be issued to them pursuant to the Mediation Settlement Agreement.

Subsequent to the execution of the Mediation Settlement Agreement: (i) the portion of the Litigation pending in the Circuit Court for Madison County, Alabama has been stayed by such court until September 17, 2007 (the “Alabama Action”); (ii) the portion of the Litigation relating to the demand for arbitration and statement of claim pending before the American Arbitration Association has been placed in abeyance (the “Arbitration”); and (iii) the portion of the Litigation pending in the United States District Court, Northern District of Georgia, Atlanta Division was administratively closed by the court, subject to the reopening by the parties should they fail to settle the Litigation (the “Georgia Action”). For a full description of the Alabama Action, the Arbitration and the Georgia Action, see our Annual Report and our Form 10-Q for the quarter ended March 31, 2007.

Item 1A.

Risk Factors.

The risk factors included in our Annual Report have not materially changed.

Item 3.

Defaults Upon Senior Securities.

See Note 5 to Part I, “Item 1. Financial Statements” of this Quarterly Report for a discussion of our determination not to pay the dividend payments on the Series C Redeemable Preferred Stock due on February 28, 2006, or at any point thereafter and not to redeem the Series C Redeemable Preferred Stock, which has a redemption value of $6.0 million and was otherwise redeemable by us on February 27, 2007.

Item 6.

Exhibits.

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

SIGNATURE

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


				TRI-S SECURITY CORPORATION

Date: August 14, 2007				/s/ Ronald G. Farrell
				Ronald G. Farrell Chairman of the Board and Chief Executive Officer (duly authorized signatory and Principal Executive Officer)

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	Mediation Settlement Agreement dated as of May 18, 2007, among the Company, Paragon Systems, Inc., Charles Keathley, Robert Luther, Harold Bright and John Wilson.	Incorporated by reference to Exhibit 99.1 to the Company’s Current Report on Form 8-K filed on May 24, 2007.

31.1	Rule 13a-14(a)/15d-14(a) Certification by the Company’s Principal Executive Officer and acting Principal Financial Officer.	Filed herewith.

32.1	Section 1350 Certification by the Company’s Principal Executive Officer and acting Principal Financial Officer.	Filed herewith.

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