If holders of 765,009 or more of the shares of Argyle’s common stock purchased in Argyle’s initial public offering (which number represents 20% or more of the common stock sold in Argyle’s initial public offering and private placement) decide to vote against the acquisition and opt to convert their shares to cash, Argyle may be forced to dissolve and liquidate, stockholders may receive less than $8.00 per share, and Argyle’s warrants may expire worthless.

 

Under the terms of Argyle’s Amended and Restated Certificate of Incorporation, if holders of 765,009 or more of the shares of Argyle’s common stock purchased in Argyle’s initial public offering (which number represents 20% or more of the common stock issued in its initial public offering and private placement) decide to vote against the acquisition and opt to convert their shares to cash, Argyle may ultimately be forced to dissolve and liquidate. Although Argyle will continue to search to acquire an operating company in the security sector, Argyle’s certificate of incorporation requires Argyle to liquidate if it does not complete a business combination by July 30, 2007, or January 30, 2008 if Argyle enters into a letter of intent, an agreement in principle or a definitive agreement to complete a business combination prior to July 30, 2007, but is unable to complete such business combination by such date. Argyle signed a definitive agreement with ISI on December 8, 2006, and therefore has until January 30, 2008 to complete the acquisition. If Argyle does not consummate the acquisition of ISI by that time, it will be forced to dissolve and liquidate in accordance with the provisions of Delaware law.

 

In any liquidation, the net proceeds of Argyle’s initial public offering and private placement and the deferred underwriting compensation held in the trust account, plus any interest earned thereon (net of taxes payable and $600,000 of interest earned on the trust account that was released to fund Argyle’s working capital), will be distributed on a pro rata basis to the holders of Argyle’s common stock issued in Argyle’s initial public offering. As of September 30, 2006, and assuming Argyle expended all of the funds not in the trust account, the per share liquidation price would be approximately $7.84, or $0.16 less than the price ($8.00 per unit) that Argyle sold each unit for in its initial public offering (The liquidation amount of $7.84 is greater than the original amount of $7.76 indicated in the prospectus relating to our initial public offering due to interest accrued on the amounts in the trust account). The proceeds deposited in the trust account could, however, become subject to the claims of Argyle’s creditors which could be prior to the claims of Argyle’s public stockholders. Argyle cannot assure you that the actual per share liquidation price will not be less than $7.84, plus interest (net of taxes payable), due to claims of creditors. Furthermore, there will be no distribution with respect to Argyle’s outstanding warrants and, accordingly, the warrants will expire worthless.

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Under Delaware law, Argyle’s dissolution requires the approval of the holders of a majority of its outstanding stock, without which Argyle will not be able to dissolve and liquidate and distribute Argyle’s assets to its public stockholders.

 

Pursuant to Delaware law, Argyle’s dissolution requires the affirmative vote of stockholders owning a majority of Argyle’s then outstanding common stock. Soliciting the vote of Argyle’s stockholders will require the preparation of preliminary and definitive proxy statements, which will need to be filed with the Securities and Exchange Commission and could be subject to its review. This process could take a substantial amount of time, ranging from 40 days to several months.

 

 

Argyle’s stockholders may be held liable for claims by third parties against Argyle to the extent of distributions received by them.

 

Under the Delaware General Corporation Law, stockholders may be held liable for claims by third parties against a corporation to the extent of distributions received by them in a dissolution. If Argyle complied with certain procedures set forth in Section 280 of the Delaware General Corporation Law intended to ensure that Argyle makes reasonable provision for all claims against it, including a 60-day notice period during which any third-party claims can be brought against Argyle, a 90-day period during which Argyle may reject any claims brought, and an additional 150-day waiting period before any liquidating distributions are made to stockholders, any liability of a stockholder with respect to a liquidating distribution would be limited to the lesser of such stockholder’s pro rata share of the claim or the amount distributed to the stockholder, and any liability of the stockholder would be barred after the third anniversary of the dissolution. However, it is Argyle’s intention to make liquidating distributions to its stockholders as soon as reasonably possible after dissolution, should it occur, and, therefore, Argyle does not intend to comply with those procedures. As such, Argyle’s stockholders could potentially be liable for any claims to the extent of distributions received by them in a dissolution and any such liability of Argyle’s stockholders will likely extend beyond the third anniversary of such dissolution. Accordingly, Argyle cannot assure you that third parties will not seek to recover from its public stockholders amounts owed to them by Argyle.

 

If third parties bring claims against Argyle, the proceeds held in the trust account could be reduced and the per share liquidation price received by stockholders could be less than $7.84 per share.

 

Although Argyle intends to pay amounts owed to creditors from amounts not held in trust, Argyle cannot assure you that those funds will be sufficient to cover such claims and obligations. Although Argyle has sought to have vendors, potential target businesses, consultants or other entities with which Argyle does business execute valid and enforceable agreements waiving any right, title, interest or claim of any kind in or to any monies held in the trust account for the benefit of Argyle’s public stockholders, not all have executed such agreements. Those parties who have not entered into such agreements may have claims they will attempt to assert, and those who have may claim that the waiver is unenforceable or assert claims based on fraudulent inducement, breach of fiduciary responsibility or other similar claims.

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As of December 31, 2006, Argyle has not received a waiver letter from the State of Delaware, its independent auditor and certain miscellaneous service providers, with aggregate claims in the amount of approximately ________. To the extent that creditors, even those who have executed a waiver of claims against the trust account, or ISI, bring a claim and attempt to have it satisfied out of the trust account, the proceeds available to Argyle’s stockholders from the trust account could be reduced.

 

 

Additionally, if Argyle is forced to file a bankruptcy case or an involuntary bankruptcy case is filed against Argyle which is not dismissed, the proceeds held in the trust account could be subject to applicable bankruptcy law, and may be included in Argyle’s bankruptcy estate and subject to the claims of third parties with priority over the claims of Argyle’s stockholders. To the extent any bankruptcy claims deplete the trust account, Argyle cannot assure you that it will be able to return to Argyle’s public stockholders at least $7.84 per share.

 

Argyle’s Board of Directors has had Limited Ability to Evaluate the Target Business’ Management.

 

Although Argyle closely examined the management of ISI, Argyle cannot assure you that its assessment of ISI’s management will prove to be correct, or that future management will have the necessary skills, qualifications or abilities to manage its business successfully. Essentially, all of the serving management of ISI will be involved with the management of the Merger Subsidiary, will remain with the combined company, and will for the most part run its day to day operations. Argyle’s current Board of Directors will remain directors of Argyle subsequent to the acquisition.

Argyle does not have an Audit Committee composed solely of independent directors and therefore Argyle’s financial statements have not been subject to independent review.

Argyle does not have an audit committee. Pursuant to SEC regulations, the entire Board of Directors of a company without an audit committee acts as the audit committee. Two of the members of Argyle’s Board of Directors are also officers of Argyle and therefore not independent. Therefore, Argyle does not have solely independent directors reviewing its financial statements, making it more difficult for Argyle to discover if there was any fraud in connection with the preparation of its financial statements.

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		Nine Months Ended September 30, 2006 (unaudited)			Period from June 22, 2005 (inception) to September 30, 2005 (unaudited)			Period from June 22, 2005 (inception) to Year Ended December 31, 2005			Period from June 22, 2005 (inception) to September 30, 2006 (unaudited)
Revenues		$	-		$	-		$	-		$	-
Interest income on trust account			952,609			-			-			952,609
Net income/(loss)			71,066			(4,358	)		(7,743	)		63,323
Net loss allocable to holders of non-redeemable common stock			(81,875	)		(4,358	)		(7,743	)		(89,618	)
Net income/(loss) per share - basic and diluted		$	0.02		$	(0.00	)	$	(0.01	)	$	0.02
Weighted average number of shares outstanding - basic and diluted			4,375,600			937,500			937,500			2,951,666
Net income/(loss) per share exclusive of shares and related interest subject to possible redemption - basic and diluted		$	(0.02	)	$	(0.00	)	$	(0.01	)	$	(0.04	)
Weighted average number of shares outstanding exclusive of shares subject to possible redemption - basic and diluted			3,692,197			937,500			937,500			2,551,303

 

		At December 31, 2005			At September 30, 2006 (unaudited)
Total assets (including cash deposited in trust account in 2006)		$	304,353		$	30,063,620
Total liabilities			287,096			1,660,807
Common stock and deferred interest subject to possible redemption			-			5,612,376
Stockholders’ equity			17,257			22,790,437

 

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SELECTED UNAUDITED PRO FORMA COMBINED FINANCIAL INFORMATION

 

The following selected unaudited pro forma financial information combines Argyle’s historical balance sheet and that of ISI as of September 30, 2006, giving effect to the transactions described in the purchase agreement as if they had occurred on September 30, 2006. Additionally, the financial information combines (i) Argyle’s historical statement of operations from inception (June 22, 2005) to December 31, 2005 with those of ISI for the year ended December 31, 2005 and (ii) Argyle’s historical statement of operations for the nine months ended September 30, 2006 with those of ISI, in each case giving effect to the acquisition as if it had occurred on January 1, 2005. The following selected unaudited pro forma condensed combined financial information is intended to provide you with a picture of what Argyle’s business might have looked like had the acquisition been completed on or as of the dates specified above. The combined financial information may have been different had the acquisition actually been completed on or as of those dates. You should not rely on the selected unaudited pro forma condensed combined financial information as being indicative of the historical results that would have occurred had the acquisition occurred or the future results that may be achieved after the acquisition. The following selected unaudited pro forma condensed combined financial information has been derived from, and should be read in conjunction with, the Unaudited Pro Forma Condensed Consolidated Financial Statements and related notes thereto starting on page 67.

 

The following unaudited pro forma condensed financial information has been prepared using two different levels of approval of the acquisition by Argyle’s stockholders, as follows:

 

·	Assuming No Redemption of Shares: This presentation assumes that no stockholders exercised their redemption rights; and
·	Assuming Redemption of 19.99% of Shares: This presentation assumes that holders of only 19.99% of Argyle’s outstanding common stock exercise their redemption rights.

 

(in thousands, except per share data)		At September 30, 2006
		Assuming No Redemption of Shares			Assuming Redemption of 19.99% of Shares
Total assets		$	74,226		$	68,613
Line of credit		$	4,663		$	4,663
Long-term debt		$	6,088		$	6,088
Stockholders’ equity		$	37,080		$	31,468

 

(in thousands, except per share data)		For the Year Ended December 31, 2005						For the Nine Months Ended September 30, 2006
		Assuming No Redemption of Shares			Assuming Redemption of 19.99% of Shares			Assuming No Redemption of Shares			Assuming Redemption of 19.99% of Shares
Revenue		$	39,234		$	39,234		$	41,234		$	41,234
Operating income/(loss)		$	(1,063	)	$	(1,063	)	$	454		$	454
Net loss		$	(1,394	)	$	(1,394	)	$	(153	)	$	(267	)
Net loss per share:
Basic		$	(0.23	)	$	(0.27	)	$	(0.03	)	$	(0.05	)
Diluted		$	(0.23	)	$	(0.27	)	$	(0.03	)	$	(0.05	)

 

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  COMPARATIVE PER SHARE INFORMATION

 

The following table sets forth selected historical per share information and unaudited pro forma combined information as of September 30, 2006 and for the nine months then ended for Argyle and ISI giving effect to the acquisition as if it had occurred on September 30, 2006. Argyle is providing this information to aid you in your analysis of the financial aspects of the acquisition. The unaudited pro forma combined share information should be read in conjunction with the historical financial statements of Argyle and ISI and the related notes thereto included elsewhere in this proxy statement/prospectus.

 

The unaudited pro forma combined per share information does not purport to represent what the actual results of operations of Argyle and ISI would have been had the acquisition taken place on the dates noted, or to project Argyle’s or ISI’s results of operations that may be achieved after the acquisition.

		In thousands, except per share data
								Pro Forma Combined
		ISI			Argyle			Company
Weighted average shares of common stock outstanding:
Assuming no redemptions
Basic			.10491			4,376			5,961
Diluted			.10491			4,376			6,917
Assuming maximum redemptions
Basic			-			3,692			5,197
Diluted			-			3,692			6,152
Book value—assuming no redemptions		$	(12,708	)	$	28,403		$	37,080
Book value—assuming maximum redemptions			-			22,790			31,468
Book value per share—assuming no redemptions
Basic		$	(121,132	)	$	6.49		$	6.22
Diluted			(121,132	)		6.49			5.36
Book value per share—assuming maximum redemptions
Basic			-		$	6.17		$	6.06
Diluted			-			6.17			5.12
Earnings/(loss) per share—assuming no redemptions
Basic		$	(3,606	)	$	0.02		$	(0.03	)
Diluted			(3,606	)		0.02			(0.03	)
Earnings/(loss) per share—assuming maximum redemptions
Basic		$	-		$	(0.02	)	$	(0.05	)
Diluted			-			(0.02	)		(0.05	)

 

PRICE RANGE OF SECURITIES AND DIVIDENDS 

 

Argyle

 

Argyle’s common stock, warrants and units are quoted on the OTC Bulletin Board under the symbols ARGL, ARGLW and ARGLU, respectively. The closing price for these securities on December 13, 2006, the last trading day before announcement of the acquisition, was $7.41, $1.36 and $8.75, respectively. The closing price for the securities on _______ __, 2007, the most recent trading day practicable before the date of this proxy statement/prospectus, was $___, $___ and $___, respectively

 

Argyle units commenced public trading on January 30, 2006, and common stock and warrants commenced public trading on March 2, 2006. The table below sets forth, for the calendar quarters indicated, the high and low bid prices for the securities as reported on the OTC Bulletin Board in U.S. dollars. These quotations reflect inter-dealer prices, without markup, markdown or commissions, and may not represent actual transactions.

 

		Common Stock						Warrants (US$)						Units
		High			Low			High			Low			High			Low
2006
First Quarter			7.55			7.25			1.35			0.93			8.85			7.90
Second Quarter			7.45			7.22			1.56			1.02			8.86			8.00
Third Quarter			7.30			7.14			1.08			0.88			8.30			8.00
Fourth Quarter			7.45			7.15			1.55			0.75			8.80			7.94

 

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Holders of Argyle common stock, warrants and units should obtain current market quotations for their securities. The market price of these securities could vary at any time before the acquisition is completed.

 

Argyle anticipates that its securities will continue to be quoted on the OTC Bulletin Board post acquisition. There can be no assurance that a trading market will develop for these securities.

 

Holders of Argyle. As of November 30, 2006, there were of record six holders of common stock, four of warrants, and one of units. Argyle believes the number of beneficial holders of each of these securities is significantly greater than the number of record holders.

 

Dividends. Argyle has not paid any dividends on its common stock to date and does not intend to pay dividends prior to the completion of a business combination.

 

ISI

 

ISI securities are not publicly traded.

 

Holders. As of November 30, 2006, there were of record three holders of ISI common stock, and one holder of warrants. Immediately prior to the consummation of the merger between ISI and the Merger Subsidiary (assuming the merger is approved by Argyle’s stockholders), $10,000,000 of ISI’s debt will be converted into ISI preferred stock, the holder of which will then receive a portion of the cash consideration to be paid to the ISI stockholders in the merger.

 

Dividends. As part of a recapitalization transaction in October 2004, ISI distributed $16,935,340 to its stockholders. ISI does not intend to pay any other dividends in the foreseeable future.

 

Post Acquisition

 

The payment of dividends by the combined company in the future will be contingent upon revenues and earnings, if any, capital requirements and general financial condition subsequent to completion of the acquisition. The payment of any dividends subsequent to that time will be within the discretion of the Board of Directors serving at that time. It is the present intention of the Board to retain all earnings, if any, for use in business operations and, accordingly, it does not anticipate declaring any dividends in the foreseeable future. Loans or credit facilities may also limit the combined company’s ability to pay dividends.

 

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THE ARGYLE SPECIAL MEETING

 

Argyle is furnishing this proxy statement/prospectus to its stockholders as part of the solicitation of proxies by the Board of Directors for use at the special meeting in connection with the proposed acquisition of ISI. This document provides you with the information you need to know to be able to vote or instruct your vote to be cast at the special meeting.

 

Date, Time and Place. Argyle will hold the special meeting at 10:00 a.m., San Antonio, Texas, time, on ____ __, 2007, at Concord Plaza, San Antonio, TX 78216 to vote on the proposals.

 

Purpose. At the special meeting, holders of Argyle common stock will be asked to approve:

 

·	The proposed merger of a wholly-owned subsidiary of Argyle into ISI, resulting in ISI becoming a wholly-owned subsidiary of Argyle;

 

·	The adoption of Argyle’s 2007 Omnibus Securities and Incentive Plan, which provides for the grant of up to 1,000,000 shares of Argyle’s common stock or cash equivalents to directors, officers, employees and/or consultants of Argyle and its subsidiaries;

 

·	Amending Argyle’s Second Amended and Restated Certificate of Incorporation to change Argyle’s corporate name to Argyle Security, Inc.; and

 

·	Amending Argyle’s Second Amended and Restated Certificate of Incorporation to remove certain provisions containing procedural and approval requirements applicable to Argyle prior to the combination of a business combination that will no longer be operative upon consummation of the merger.

 

·	The approval of any adjournment or postponement of the special meeting for the purpose of soliciting additional proxies.

 

Pursuant to Argyle’s Second Amended and Restated Certificate of Incorporation, Argyle is required to obtain stockholder approval of the acquisition of ISI. Pursuant to the merger agreement entered into by Argyle, Argyle’s wholly-owned subsidiary, and ISI, it is a condition to the obligation of ISI to consummate the merger that the 2007 Omnibus Securities and Incentive Plan be approved by Argyle’s stockholders. ISI will have no options outstanding upon the closing of the merger and, therefore, Argyle is not assuming any options. ISI requested that the approval of the 2007 Omnibus Securities and Incentive Plan be a condition to the merger because, although Argyle is under no obligation to issue any options under the 2007 Omnibus Securities and Incentive Plan , Argyle should have the ability to reward its employees with equity compensation post merger, as might be determined by Argyle’s Board of Directors or its Compensation Committee. If the proposal relating to the 2007 Omnibus Securities and Incentive Plan is not approved, and if ISI’s Board of Directors chooses not to waive that condition to the merger, Argyle will not be able to go forward with the acquisition of ISI even if the proposal to approve the merger has been approved.

 

Argyle’s Board of Directors determined that the acquisition of ISI, the adoption of the 2007 Omnibus Securities and Incentive Plan, the amendment to Argyle’s Second Amended and Restated Certificate of Incorporation to change of Argyle’s name to Argyle Security, Inc. and the amendment to Argyle’s Second Amended and Restated Certificate of Incorporation to remove certain provisions containing procedural and approval requirements applicable to Argyle prior to the combination of a business combination are fair to and in the best interests of Argyle and its stockholders, approved and declared each of them advisable, and recommends that Argyle stockholders vote “FOR” the acquisition, the adoption of the 2007 Omnibus Securities and Incentive Plan, the amendment to the Second Amended and Restated Certificate of Incorporation to change Argyle’s name and the amendment to the Second Amended and Restated Certificate of Incorporation to remove certain provisions which will no longer be applicable after the acquisition is complete. The Board of Directors has also determined that the fair market value of ISI is at least 80% of Argyle’s net assets, which is necessary to satisfy the provisions of its certificate of incorporation enabling it to consummate the acquisition.

 

The special meeting has been called only to consider approval of the acquisition, the approval of the 2007 Omnibus Securities and Incentive Plan, the amendment to Argyle’s certificate of incorporation to change Argyle’s name and the amendment to Argyle’s certificate of incorporation to remove certain provisions which will no longer be applicable upon consummation of the acquisition. Under Delaware law and Argyle’s bylaws, no other business may be transacted at the special meeting.

 

Record Date; Who is Entitled to Vote. The “record date” for the special meeting is ____ __, 2007. Record holders of Argyle common stock at the close of business on the record date are entitled to vote or have their votes cast at the special meeting. On the record date, there were 4,781,307 outstanding shares of Argyle common stock, of which 3,700,046 shares were sold to the public in Argyle’s initial public offering. Each common share is entitled to one vote per proposal at the special meeting. Argyle’s warrants do not have voting rights.

 

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Pursuant to letter agreements with Argyle, Argyle’s initial stockholders have agreed to vote 956,261 of their shares in accordance with the holders of a majority of the public shares voting in person or by proxy at the meeting and have agreed to vote the 125,000 of their shares purchased in the private placement immediately prior to Argyle’s initial public offering and all shares acquired after such initial public offering in favor of all the proposals. If holders of a majority of the public shares cast at the meeting vote for or against, or abstain with respect to, a proposal, the initial stockholders will cast the 956,261 shares in the same manner as such majority votes on such proposal. No initial stockholders will demand redemption of any shares owned by them. The 125,000 shares that Argyle’s initial stockholders will vote in favor of the proposals presented in this prospectus represent 2.6% of Argyle’s outstanding shares of common stock. By voting these shares for the merger, Argyle’s initial stockholders increase the number of shares held by Argyle’s public stockholders that must be voted against the merger proposal to reject the proposal.

 

Vote Required. Approval of the acquisition requires the affirmative vote of a majority of the votes cast special meeting. The proposal to adopt the 2007 Omnibus Securities and Incentive Plan and to adjourn or postpone the special meeting will require the affirmative vote of a majority of the shares represented in person or by proxy and entitled to vote at the meeting, and the change in Argyle’s name and the amendment to the certificate of incorporation will require the affirmative vote of holders of a majority of Argyle’s outstanding common stock. If the stockholders approve the acquisition , the acquisition will only proceed if holders of shares purchased in Argyle’s initial public offering, representing no more than 20% of the total shares sold in the initial public offering and the private placement, exercise their redemption rights. Argyle’s Board of Directors will abandon the acquisition if holders of 765,009 or more of the shares of common stock issued in Argyle’s initial public offering (which number represents 20% of the total shares sold in Argyle’s initial public offering and private placement) vote against the acquisition and exercise their right to cause Argyle to redeem their shares into a pro-rata portion of the trust account established at the time of Argyle’s initial public offering. In addition, pursuant to the merger agreement entered into by Argyle, Argyle’s wholly-owned subsidiary and ISI, it is a condition to the obligation of ISI to consummate the merger that the 2007 Omnibus Securities and Incentive Plan be approved by Argyle’s stockholders. If the proposal relating to the 2007 Omnibus Securities and Incentive Plan is not approved, and if ISI’s Board of Directors chooses not to waive that condition to the merger, Argyle will not be able to go forward with the acquisition of ISI.

 

Abstaining from voting or not voting on a proposal (including broker non-votes), either in person or by proxy or voting instruction, will not have an effect on the vote relating to the merger since our Second Amendment and Restated Certificate of Incorporation provides that only votes cast at the meeting will count towards the vote on the merger. With respect to the proposal relating to the 2007 Omnibus Securities and Incentive Plan an abstention will have the same effect as a vote against the proposal; however, a broken non-vote will have no impact on the vote on the proposal. Abstention and broker non-votes will have the same effect as a vote against adoption of the proposals relating to the amendments to Argyle’s Second Amended and Restated Certificate of Incorporation to change Argyle’s name and to remove certain provisions containing procedural and approval requirements applicable to Argyle prior to the consummation of a business combination that will no longer be operative upon consummation of the merger and the adjournment proposal. An abstention will not count toward the 20% “against and redeeming” vote that would result in the acquisition’s abandonment, and you would be unable to exercise any redemption rights upon approval of the acquisition. If the proposal relating to the 2007 Omnibus Securities and Incentive Plan is not approved, and if ISI’s Board of Directors chooses not to waive the condition to the merger relating to the approval of the plan by Argyle’s stockholders, Argyle will not be able to go forward with the acquisition of ISI.

 

Voting Your Shares. Each share of common stock that you own in your name entitles you to one vote per proposal. Your proxy card shows the number of shares you own.

 

There are three ways to vote your shares at the special meeting:

 

·

By signing and returning the enclosed proxy card. If you vote by proxy card, your “proxy,” whose names are listed on the proxy card, will vote your shares as you instruct on the card. If you sign and return the proxy card, but do not give instructions on how to vote your shares, your shares will be voted as recommended by the Argyle Board “for” approval of each proposal.

 

·	By telephone or on the Internet. You can vote this way by following the telephone or Internet voting instructions included with your proxy card. If you do, you should not return the proxy card.

 

·

You can attend the special meeting and vote in person. We will give you a ballot when you arrive. If your shares are held in the name of your broker, bank or another nominee, however, you must get a proxy from the broker, bank or other nominee. That is the only way we can be sure that the broker, bank or nominee has not already voted your shares.

 

 

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Redemption Rights. Any holder of shares that were purchased in Argyle’s initial public offering who votes against the acquisition may, at the same time, demand that Argyle redeem his or her shares into a pro rata portion of the funds in the trust account. If so demanded and the acquisition is consummated, Argyle will redeem the shares. If the holders of 765,009 or more shares issued in Argyle’s initial public offering vote against the acquisition and demand redemption of their shares, Argyle will not have authority to consummate the acquisition. You will only be entitled to receive cash for these shares if you continue to hold them through the closing of the acquisition and then tender your stock certificate(s) to Argyle. If you exercise your redemption rights, then you will be exchanging your shares for cash and will no longer own these shares. Do not send your stock certificate(s) with your proxy.

 

The closing price of Argyle’s common stock on December 29, 2006 was $7.43, and the amount of cash held in the IPO trust account on September 30, 2006 was approximately $29.1 million. If a public stockholder would have elected to exercise redemption rights on such date, he or she would have been entitled to receive approximately $7.20 per share.

 

Questions About Voting. If you have any questions about how to vote or direct a vote in respect of your Argyle common stock, you may call Bob Marbut or Ron Chaimovski of Argyle, at (210) 828-1700. You may also want to consult your financial and other advisors about the vote.

 

Revoking Your Proxy and Changing Your Vote. If you give a proxy, you may revoke it or change your voting instructions at any time before it is exercised by:

 

·	If you sent in a proxy, by sending another proxy card with a later date;

 

·	If you voted by telephone, by calling the same number and following the instructions;

 

·	If you voted by internet, by going to the same internet website and following the instructions;

 

·	Notifying 200 Concord Plaza, Suite 700, San Antonio, TX 78216, Attention: Bob Marbut, in writing before the special meeting that you have revoked your proxy; or

 

·	Attending the special meeting, revoking your proxy and voting in person.

 

·	If your shares are held in “street name,” consult your broker for instructions on how to revoke your proxy or change your vote.

 

Broker Non-Votes. If your broker holds your shares in its name and you do not give the broker voting instructions, National Association of Securities Dealers, Inc. (NASD) rules prohibit your broker from voting your shares on any of the proposals to which this proxy statement/prospectus relates. This is known as a “broker non-vote.”

 

Solicitation Costs. Argyle is soliciting proxies on behalf of the Argyle Board of Directors. This solicitation is being made by mail, but also may be made in person or by telephone or other electronic means. Argyle and its respective directors, officers, employees and consultants may also solicit proxies in person or by mail, telephone or other electronic means. In addition, ISI stockholders, officers and directors may solicit proxies in person or by mail, telephone or other electronic means on Argyle’s behalf. These persons will not be paid for doing this.

 

Argyle has not hired a firm to assist in the proxy solicitation process but may do so if it deems this assistance necessary. Argyle will pay all fees and expenses related to the retention of any proxy solicitation firm.

 

Argyle will ask banks, brokers and other institutions, nominees and fiduciaries to forward its proxy materials to their principals and to obtain their authority to execute proxies and voting instructions. Argyle will reimburse them for their reasonable expenses.

 

Stock Ownership. Information concerning the holdings of certain Argyle stockholders is set forth above in the Summary and below under “Beneficial Ownership of Securities.”

 

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PROPOSAL TO ACQUIRE ISI

 

General

 

Pursuant to the merger agreement entered into by and among Argyle, the Merger Subsidiary and ISI, the Merger Subsidiary will, if and as soon as practicable after stockholders approve the acquisition, merge with and into ISI, with ISI being the surviving corporation and ISI being a wholly-owned subsidiary of Argyle.

 

On December 8, 2006, Argyle, Argyle’s wholly-owned subsidiary ISI Security Group, Inc. (referred to in this document as the Merger Subsidiary) and ISI entered into a merger agreement pursuant to which the Merger Subsidiary will merge into ISI, and ISI will become a wholly-owned subsidiary of Argyle. Pursuant to the merger agreement, Argyle will pay ISI’s security holders an aggregate of $16,300,000 and 1,180,000 shares of Argyle’s common stock (valued at $8,673,000, based on the closing price of the common stock on January 30, 2007). In the event that ISI’s earnings before interest, taxes, depreciation and amortization (EBITDA) for the year ended December 31, 2006 are greater than $4,500,000 and its backlog of orders at February 28, 2007 is greater than $80,000,000 (including inter-company amounts), Argyle will pay the stockholders of ISI an additional $1,900,000. The calculations of EBITDA and 2/28 backlog will be initially calculated by ISI and such calculations will be presented to Argyle. Argyle will verify the calculations, and if they are not accurate, object to the calculations. Pursuant to the merger agreement, if there is a dispute over the calculation of (i) EBITDA that cannot be resolved between the parties, the parties will engage a third party accountant to resolve the dispute, and (ii) 2/28 backlog, the ISI and Argyle must negotiate a resolution to the dispute among themselves. The calculation of ISI’s EBITDA is subject to an adjustment of $900,000 relating to certain events that Argyle and ISI agreed should not reduce the EBITDA calculation. For the nine months ended September 30, 2006, ISI’s adjusted EBITDA was approximately $4.1 million and the backlog (including inter-company amounts) was approximately $75.8 million. The final purchase price is dependent upon the actual EBITDA results for 2006 and the backlog (including inter-company amounts) as of February 28, 2007.

 

The merger agreement contains representations by Argyle and ISI and representations to be made by ISI’s stockholders upon closing. Argyle’s representations include representations relating to litigation, the issuance of Argyle’s common stock in the merger, fees to be paid upon consummation of the merger, the accuracy of Argyle’s financial statements and money laundering laws. With respect to the Merger Subsidiary, Argyle makes certain representations including representations relating to its formation and ownership. ISI’s representations include representations relating to capitalization and ownership, the accuracy of financial statements, accounts receivable, the accuracy of books and records, the absence of certain changes in ISI’s business since the last audit, property owned, intellectual property, relationships with customers and suppliers, litigation, material agreements, licenses with permits, compliance with labor laws, the filing of tax returns, fees to be paid in connection with the merger and money laundering laws. At the closing of the merger, ISI’s stockholders will make certain representations, including representations relating to the ownership of their securities in ISI, litigation, investment intent in Argyle’s securities, and the assumption of risk of acquiring Argyle’s securities. ISI also makes certain covenants relating to the conduct of its business between the time the merger agreement was signed and the consummation of the merger, including that it will not take certain actions without the permission of Argyle and that Argyle will have access to ISI’s records. The parties to the merger agreement also make covenants relating to confidentiality, non-solicitation and non-competition.

Argyle approved certain transactions that ISI engaged in or would engage in before or after the signing of the merger agreement, including:

·	The payment of up to a $310,000 brokerage fee to James Raines;

·	The leases for all the properties owned by Green Wing Management, Ltd., an affiliate of Sam Youngblood and Don Carr, used by ISI as office space in San Antonio, Texas; and

·	A new lease for a property owned by Green Wing Management, Ltd. on the same terms and conditions as prior leases.

 

In connection with the merger, immediately prior to the merger, William Blair Mezzanine Capital Fund III, L.P. will convert $10,000,000 of long term debt into shares of ISI preferred stock. Additionally, ISI will remain obligated to William Blair Mezzanine Capital Fund III, L.P. for approximately $6,000,000. Upon consummation of the merger, the surviving corporation will be obligated for all of ISI’s outstanding liabilities, including the $6,000,000 of long-term debt described above, up to $9,000,000 that may be outstanding pursuant to a revolving credit line, and any capitalized leases. As of December 31, 2006 there was approximately ________ outstanding under the credit line.

The $6,000,000 obligation to William Blair Mezzanine Capital Fund III, L.P. will be evidenced by a promissory note to be executed by ISI at the closing of the merger. The promissory note will bear interest after closing at the rate of 11.58% per annum. In the event of a default, interest will accrue at the additional rate of 2% per annum after the occurrence and during the continuance of an event of default. The obligations evidenced in the promissory note are to be subordinate to the obligations owed by ISI to the holders of all notes issued pursuant to the revolving credit line. Interest accruing on the principal balance will be paid quarterly, and the outstanding principal balance shall become due at the conclusion of the 18-month term of the promissory note. No payment of principal is required during the 18-month term of the promissory note. Quarterly payments will be of current interest only; providing for a balloon payment of the full outstanding principal amount along with any additional accrued interest on the maturity date. There will be no prepayment penalty or fee.

Immediately prior to the merger, certain rights to acquire shares of ISI’s common stock held by certain employees of ISI will vest and such employees will receive a portion of the consideration paid to ISI’s security holders. No additional consideration will be paid by Argyle in connection with these rights and Argyle will not issue any securities in exchange for these rights.

 

Upon consummation of the merger, the former holders of ISI securities will own 19.8% of Argyle’s issued and outstanding common stock (assuming none of Argyle’s public stockholders exercise redemption rights with respect to the acquisition).

 

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At the closing of the merger, each of the security holders of ISI will enter into a lock-up agreement with Argyle with respect to the shares that they acquire pursuant to the merger so that they will not be able to sell the shares (except to family members or affiliates) until the specified times expire. William Blair Mezzanine Capital Fund III, L.P. will acquire 440,288 shares in connection with the merger and will not be able to sell such shares until the earlier of six months after the closing of the acquisition or November 1, 2007, whichever is earlier. The remaining 739,712 shares that will be issued to Sam Youngblood and Don Carr, each an officer and director of ISI, Mark McDonald, the officer of a subsidiary of ISI and the Youngblood Trust, a trust for the benefit of Mr. Youngblood’s family will not be able to be sold until January 24, 2009.

 

The merger agreement provides that Argyle will, within 30 days after the closing of the merger, file a registration statement relating to the resale of the shares of Argyle’s common stock acquired by the stockholders of ISI, and that Argyle will use its commercially reasonable best efforts to have the registration statement declared effective by the SEC within 150 days after the closing of the merger.

 

The closing of the merger is subject to certain conditions, including the approval of the transaction by Argyle’s stockholders and holders of fewer than 765,009 of the shares of Argyle’s common stock sold in Argyle’s initial public offering exercising their right to redeem their shares of common stock for cash. The stockholders of ISI will also be entitled to indemnification from Argyle if certain events occur, as described in the merger agreement. In the event that the merger is not consummated by July 1, 2007, either party may terminate the merger agreement without reason.

Following the merger, Argyle has agreed that it will negotiate employment agreements with Sam Youngblood, Don Carr, Mark McDonald and Tim Moxon. Other than the agreement that the term of the employment agreements will be five years for Mark McDonald and two years for the others, and that Sam Youngblood and Don Carr must be directors of ISI post merger, the agreements have not yet been negotiated, meaning that the employment agreements currently in place with those parties will remain in full force and effect until the new agreements take effect.

 

We sometimes refer to the Merger Subsidiary and ISI together, after giving effect to completion of the acquisition, as the “combined company.”

Argyle anticipates that it will incur total transaction costs of approximately $1.3 million. Such costs do not include transaction costs of approximately $1.0 million anticipated to be incurred by ISI. Of the $1.3 million of Argyle anticipated transaction costs, approximately $.4 million relate to certain Giuliani Capital Advisors advisory fees which are contingent upon the closing of the transaction. Approximately $.5 million of the $.9 million in non-contingent anticipated costs has been incurred and recorded as of December 31, 2006. The $.9 million primarily relates to Loeb & Loeb legal expenses, Giuliani Capital Advisors, fairness opinion, accountants and valuation consultants’ fees, road show expenses, printer fees and other miscellaneous expenses. Argyle’s cash outside the trust and accrued expenses as of December 31, 2006 was approximately $.7 million and $.6 million, respectively. Argyle expects to incur the remaining anticipated non-contingent transaction costs of $.4 million over the first two quarters of 2007. Additionally, recurring monthly operating expenses of approximately $75,000 per month have continued to accrue after December 31, 2006 and, in January 2007, Argyle renewed its directors and officers insurance policy which had a premium of $88,000.

As a result of the foregoing, Argyle anticipates that the costs to consummate the acquisition will greatly exceed its available cash outside of the trust, and that Argyle will not be able to consummate the merger without receiving additional funds and/or reaching agreements with Argyle’s service providers to defer their fees and expenses. Argyle expects that these expenses would ultimately be borne by the combined company from the funds held in trust if the proposed ISI acquisition is completed. If it is not, they would be subject to the potential indemnification obligations of Argyle’s officers and directors to the trust account related to expenses incurred for vendors or service providers. If these obligations are not performed or are inadequate, it is possible that vendors or service providers could seek to recover these expenses from the trust account, which could ultimately reduce the amounts in the trust account and reduce a stockholder’s current pro rata portion of the trust account upon liquidation. As of January 31, 2007, Argyle has not entered into any formal arrangements with its professional service providers to defer their fees. However, they anticipate that certain providers may be agreeable to such deferral. Additionally, the officers of Argyle are considering various potential funding mechanisms; however, as of January 31, 2007, no additional financing has been provided or agreements reached.

 

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Background

 

Argyle Security Acquisition Corporation is a Delaware corporation incorporated on June 22, 2005 in order to serve as a vehicle for the acquisition of an operating business through a merger, capital stock exchange, asset acquisition or other similar business combination. On January 24, 2006, Argyle completed a private placement and received net proceeds of approximately $900,000. On January 30, 2006, Argyle consummated its initial public offering and received net proceeds of approximately $27.3 million. Argyle’s management has broad discretion with respect to the specific application of the net proceeds of the private placement and the public offering, although substantially all of the net proceeds of the offerings are intended to be generally applied toward consummating a business combination. Of the proceeds from the offerings, approximately $28.7 million was deposited into a trust account. The amount in the trust account includes approximately $1.4 million of contingent underwriting compensation and $45,000 of contingent private placement fees which will be paid to Rodman & Renshaw LLC if a business combination is consummated, but which will be forfeited if a business combination is not consummated.

 

If Argyle does not consummate the business combination with ISI, it will continue to seek another target business until it is required to liquidate and dissolve pursuant to its certificate of incorporation. As provided in its certificate of incorporation, Argyle is required, by July 30, 2007, to consummate a business combination or enter a letter of intent, agreement in principle or definitive agreement relating to a business combination, in which case Argyle would be allowed an additional six months to complete the transactions contemplated by such agreement. Under its certificate of incorporation as currently in effect, if Argyle does not acquire at least majority control of a target business by at latest January 30, 2008, Argyle will dissolve and distribute to its public stockholders the amount in the trust account plus any remaining net assets.

 

Shortly after Argyle’s initial public offering in January 2006, it actively started to seek a target business for a business combination. In the months after Argyle’s initial public offering, Argyle’s management reviewed information on over 150 companies in its search for a target business. On June 29, 2006, Argyle engaged Giuliani Capital Advisors as its financial advisor to assist Argyle. In the months following Argyle’s initial public offering, Argyle’s management engaged in an intensive process to seek a target business for a business combination. Messrs. Marbut and Chaimovski were assisted by Mr. Alan Wachtel, who was engaged in Februrary 2006 as a consultant to coordinate the research effort, and Mr. Mark Mellin, who was engaged in February 2006 to coordinate the financial aspects of the process. The focus of this effort was to find a suitable acquisition candidate that was engaged in one or more of the following segments of the physical security industry that had been targeted by Argyle: video surveillance, perimeter/outdoor protection, access control and intrusion protection, and that met most of the criteria established by Argyle.

 

 The scope of Giuliani Capital Advisors’ engagement as financial advisor to Argyle included:

 

·

Gathering market intelligence on the security industry;

·

Analyzing relative valuations and appropriate bid amounts;

·

Structuring the offer and letter of intent, and assisting in negotiating the definitive agreement;

·

Analyzing the terms of the agreement; and

·

Participating in drafting of the Company’s filings with the SEC relating to the merger.

In addition, in its capacity as financial advisor, Giuliani Capital Advisors sought to identify potential acquisition targets for Argyle’s consideration. Giuliani Capital Advisors identified and presented numerous potential acquisition targets to Argyle’s officers and directors, and selected for follow up those businesses that they believe had the most potential as an acquisition. Giuliani Capital Advisors approached various acquisition targets on behalf of Argyle. Argyle submitted an expression of interest to two companies identified and introduced to Argyle by Giuliani Capital Advisors. One of these was U.S.-based. Giuliani Capital Advisors assisted Argyle in protracted negotiations before a letter of intent was finalized with the other company, but Argyle ultimately decided to abort continued negotiations. Giuliani Capital Advisors did not identify or introduce ISI to Argyle.

Giuliani Capital Advisors, role as financial advisor to Argyle was independent from its role to provide a fairness opinion of the proposed merger. The Board of Directors of Argyle determined that Giuliani Capital Advisors’ role as financial advisor in the negotiation of the merger with ISI, would not compromise its ability to remain independent in rendering the fairness opinion. Giuliani Capital Advisors is owed a fee of $200,000 for its services in connection with providing its fairness opinion. The fee for the fairness opinion was negotiated by Argyle and Giuliani Capital Advisors. The amount of this fee is consistent with industry custom and practice for the preparation of a fairness opinion, is not contingent upon consummation of the proposed merger and can not be credited against the success fee payable to Giuliani Capital Advisors upon consummation of the proposed merger.

During February 2006, after the Argyle initial public offering was completed, Argyle management developed a list of 15 criteria to be used in screening and evaluating target companies for Argyle to acquire. These criteria were approved by the Argyle Board at its March 6, 2006 meeting and were utilized during the ensuing months by the Argyle team in the search and evaluation process. While management felt it would not have been possible to find a target company that fully met all of the criteria, the team sought to identify those companies with characteristics that were in close alignment with the criteria.

 

Following is a summary of the criteria used by the Argyle team in the process:

1.	Business Sectors Served: Highest priority given to video surveillance, access control and perimeter/outdoor.

2.	Markets Served: Highest priority given to U.S. and European companies.

3.	Channels Served: Highest priority given to security IT/IP integrators and security value added resellers.

4.	Products Offered to Include One or More of the Following: Part of a solutions strategy, competitively positioned, scalable, favorable obsolescence factor, strong brand equity.

5.	Annual Sales: At least $20 million.

6.	Gross Margin: If video or access control - 50%, if perimeter/outdoor, or, if intrusion protection - 40%.

7.	Operating Margin: 10% or more, or the potential to reach 10% in the next 12-18 months.

8.	Annual Cash Flow: At least $1.5 million.

9.	Relative Competitive Advantage: Clear competitive advantage in at least one key area.

10.	R&D Capability: Ability to continuously integrate into company’s other offerings, ability to add value to Argyle’s other targeted sectors and companies, in-house R&D leadership or management capability.

11.	Management Capabilities: Strong in at least one key functional area.

12.	Location: Located so as to be cost effective in interacting/communicating with Argyle management.

13.	Relative Attractiveness: To investors and to other targeted companies.

14.	Opportunities/Potential: For revenue growth, for improving margin percentages, for synergies with other target sectors/companies, to improve/expand offerings, for channel expansion.

15.	Target Company’s Culture: Senior management supportive of Argyle vision and strategy, customer focused, senior management familiar with and supportive of a solutions strategy.

Also during February 2006, Argyle management prepared a roadmap for the startup of Argyle and presented it to the Board for approval at its March 6, 2006 meeting.

 

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The roadmap included key goals for the first quarter and an action plan with activities to be performed. The goals, as stated in the roadmap, were in the following areas:

 

1.	Organizational, including the roles of management and consultants.

2.	Logistical, including facilities, equipment and supplies.

3.	Communication, including corporate identity and external communications.

4.	Acquiring necessary outside legal, accounting and financial support.

5.	Strategic analysis of markets and evaluation of possible target companies within those markets.

6.	Initial implementation of the target company search and evaluation process.

7.	Compliance with all accounting, regulatory and legal requirements for a public SPAC company.

The target company search and evaluation process, which identified, investigated and analyzed companies in North America, Europe, Israel, Australia and India, included: reviews of industry research, published trade and corporate information, attendance at trade shows in North America and Europe; contacting bankers, investors, lawyers, accountants, brokers and executives who were familiar with companies in Argyle’s targeted segments; engaging (in March 2006) Graham Wallis in a consulting capacity to broaden the search.

Mr. Wallis had been introduced to Messrs. Marbut and Chaimovski in 2004 by Mr. Wachtel, who had known him for over 15 years. Beginning in March 2006, Mr. Wallis worked closely with Mr. Wachtel and Argyle management in sourcing and analyzing possible target companies for Argyle. Periodically, they produced updated reports that summarized the findings of their research, with specific information on the most promising targeted companies.

Walter Bailey and Paul Talley, who together head the Security & Defense Investment Banking Practice for Giuliani Capital Advisors, had been known to Messrs. Marbut and Chaimovski since 2004. Argyle management had several informal discussions with Messrs. Bailey and Talley during the spring of 2006 concerning Argyle’s strategy and acquisition criteria. On June 29, 2006, Argyle management formally engaged Giuliani Capital Advisors as a financial advisor to work with the Argyle team in locating potential target businesses. In addition, Giuliani Capital Advisors was asked to perform research, analysis, economic modeling, introductions and due diligence for selected target companies. From the end of June through September of 2006, Giuliani Capital Advisors provided Argyle with both written and oral updates of their work, as well as introductions to several possible targets. They also accompanied Argyle management to several meetings with target companies and drafted letters of intent for two. Some of Giuliani Capital Advisors’ work was independent of the efforts of other Argyle consultants; some of it was in conjunction with the work of Messrs. Wachtel and Wallis.

Argyle management was also in frequent contact with representatives from Rodman & Renshaw, the representative of the underwriters in Argyle’s initial public offering, including Edward Kovalik, Terrence M. Murphy and Edward Ching, to discuss possible acquisitions. This resulted in Argyle’s pursing one opportunity that later was abandoned for lack of mutual interest before any due diligence had occurred or a letter of intent has been drafted.

The Argyle Board was apprised of the team’s progress throughout this period of investigation, and reviewed and approved management’s proposed roadmap and acquisition criteria at its meeting on March 6, 2006. At subsequent meetings on May 31 and July 13, the Board (with the assistance of Argyle’s consultants) reviewed progress and discussed in detail the highest priority target companies. Beginning in April and continuing through September, Mr. Marbut and Mr. Chaimovski had several meetings with Gen. Clark and Mr. Smith, individually, to provide updates and enlist their help in contacting a particular target company or getting more information about a company. In addition, Gen. Clark and Mr. Smith each attended meetings with representatives of several of the highest priority target companies during this time.

The research effort cumulatively identified over 150 possible target companies and accumulated meaningful information on over 100 of them. During the period beginning in March 2006 and until October (excluding ISI), the process had narrowed down the number of priority targets to about 15 companies, representing all of Argyle’s target market segments - one in Europe, two in Israel, one in Australia, one in India and the rest in North America. Some of these companies were found by Argyle consultants Wachtel and Wallis, some by Argyle management, one by Rodman & Renshaw and others by Giuliani Capital Advisors.

Discussions were held with principals and/or representatives from all of the top priority companies. Giuliani Capital Advisors and/or Messrs. Wachtel, Wallis and Mellin were intimately involved, along with Argyle management, in the analysis of these companies and preparation of materials for review by the Argyle board of Directors. Confidentiality agreements were signed, and preliminary due diligence was begun with 11 of these companies. Board-approved proposals were made to acquire three of these companies, but none reached the stage of a formal letter of intent or merger agreement. All of this occurred before Argyle management had made any contact with ISI, or had any knowledge of the possibility of a transaction with ISI.

On October 3, 2006, James M. Raines left a message for Mr. Marbut at the Argyle corporate office in San Antonio. Mr. Marbut, who was traveling and unable to return the call until October 4, was an acquaintance of Mr. Raines. They had met socially in San Antonio in the early 1990’s. They had never been engaged together in any business relationships and, until the telephone conversation on October 4, had not seen one another for at least five years.

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On October 4, 2006, during their initial conversation, Mr. Raines told Mr. Marbut that, during the previous week, he had been at a San Antonio restaurant where he saw and talked with Mr. Youngblood. Although they had not seen one another for a number of months, Mr. Raines had known Mr. Youngblood for over 20 years and, from time to time, Mr. Raines had introduced Mr. Youngblood to various investment opportunities and also had acted as advisor to ISI.

In the October 4 conversation with Mr. Marbut, Mr. Raines explained that Mr. Youngblood had informed Mr. Raines that ISI was in the process of exploring alternatives that would provide financial and other support to facilitate ISI’s growth strategy. Mr. Raines had previously been told by a mutual friend of Mr. Raines and Mr. Marbut (Randy Cain), while playing golf with him during September 2006, that Mr. Marbut was engaged in trying to buy a company in the security industry. This prompted Mr. Raines to tell Mr. Youngblood of Argyle’s search for an appropriate company to acquire and to ask Mr. Youngblood’s permission to contact Mr. Marbut and inquire if there were any interest on Argyle’s part to explore the possibility of a transaction with ISI.

During this conversation, Mr. Marbut indicated an interest in discussing the possibility that Argyle’s strategy and ISI’s strategy might be sufficiently compatible to allow an acquisition of ISI by Argyle.

Mr. Marbut had known Mr. Youngblood for over 17 years, although they had neither seen nor spoken to one another since seeing each other at a basketball game in San Antonio over four years prior to the time Mr. Raines contacted Mr. Marbut. Neither had, prior to the telephone conversation between senior executives of ISI and Argyle on October 5, any contact with members of management, affiliates or board members of the other’s company.

 

A follow-up conference call was held the following day, October 5, 2006. The call included Mr. Raines, Mr. Marbut, Ron Chaimovski (Vice Chairman and Co-Chief Executive Officer of Argyle), and Mark Mellin and Alan Wachtel, both consultants to Argyle. As a result of this telephonic meeting, Mr. Marbut expressed an interest to Mr. Raines in meeting with Mr. Youngblood.

On October 6, 2006 Messrs. Youngblood, Marbut, Raines, and Mellin met at the ISI corporate office in San Antonio. Other members of ISI’s senior management later joined the meeting, which lasted four hours. As a result, Messrs. Marbut and Youngblood agreed to pursue the possibility of Argyle’s acquiring ISI in order to determine expeditiously whether or not this was mutually feasible for both companies. At the October 6 meeting, Messrs. Youngblood and Marbut acknowledged to Mr. Raines that, should an agreement be reached between ISI and Argyle, Mr. Raines would receive a fee, contingent on the transaction being closed.

 

On October 10, 2006, a non-disclosure agreement was then signed by Argyle and ISI. In the subsequent weeks, preliminary information on ISI and its business was shared with Argyle. Both Argyle and ISI then engaged legal counsel (Loeb & Loeb LLP for Argyle and Hughes Luce for ISI), and information was provided to the respective independent auditors of Argyle and ISI (Ernst & Young for Argyle and Padgett, Stratemann & Co. for ISI).

During the week of October 9, 2006, Messrs. Marbut and Youngblood communicated frequently via telephone and e-mail. They, along with Mr. Chaimovski, had face-to-face meetings on October 16 and 17, 2006 in San Antonio.

Argyle continued to perform preliminary due diligence between October 9, 2006 and October 31, 2006. During this time, a letter of intent was also being negotiated by the parties.

 

On October 12, 2006, Mr. Youngblood met with David Jones of William Blair Mezzanine Capital Fund III, L.P., a significant debt holder in ISI. At that meeting, Mr. Youngblood explained the basic outline of possible merger with Argyle to Mr. Jones.

On October 15, 2006, Mr. Raines met with Mr. Jones and the general terms of the merger were discussed.

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Between October 12 and October 30 there were many phone calls between Mr. Jones and Mr. Youngblood regarding a potential merger between ISI and Argyle. During these discussions, Mr. Jones, on behalf of William Blair Mezzanine Capital Fund III, L.P., provided input from the perspective of a stockholder in ISI, a potential post merger lender to ISI, and as a member of the board of directors of ISI. These discussions involved various terms and conditions of a possible merger as well as review and comments on the various drafts of the letter of intent being negotiated between ISI and Argyle. There were no discussions, either in person or by telephone between William Blair Mezzanine Capital Fund III, L.P. and Argyle until Jones arrived in New York City for the October 30, 2006 meeting, attended by Argyle representatives, at which the letter of intent regarding the merger was signed by all parties. After October 12, 2006, Mr. Jones had numerous conversations with William Blair Mezzanine Capital Fund III, L.P.’s counsel regarding the potential merger, and there were many discussions between William Blair Mezzanine Capital Fund III, L.P.’s counsel and ISI’s counsel regarding the merger after that date.

 

Messrs. Chaimovski, Marbut, Wachtel and Youngblood met in New York on October 24 and 25, 2006. Argyle’s director Gen. (ret.) Wesley K. Clark joined them for the October 24, 2006 meeting.

On October 25, 2006, another of Argyle’s consultants, Graham Wallis, joined the continuing discussions via telephone. They focused on the details of ISI’s businesses. These meetings were also attended by Robert “Butch” Roller and Walter Wallace, president and vice president, respectively, of MCS-Commercial, the subsidiary of ISI that deals with the commercial marketplace.

The Argyle Board of Directors met in New York on October 30, 2006, at which time Giuliani Capital Advisors gave a presentation on valuation, followed by Mr. Youngblood giving an independent presentation on ISI. Also in attendance for some of the meetings on October 30, 2006, including a portion of the Argyle Board meeting, was Mr. Jones. Mr. Jones expressed his firm’s support for the contemplated transaction.

In the executive session that followed the Argyle Board meeting on October 30, 2006, the Argyle Board of Directors unanimously agreed to pursue a possible transaction. A letter of intent was also approved. It was signed by the parties on the same day.

On the following day, the Argyle team again met with Messrs. Youngblood, Roller and Wallace to continue to increase their understanding of ISI’s businesses and growth opportunities, particularly in the commercial area. During these meetings Argyle and ISI developed a schedule for executing formal due diligence, the negotiation of a merger agreement and the creation of proxy/registration documents to file with the SEC.

Formal and intensive due diligence began on November 6, 2006 at the ISI corporate offices and continued until the definitive merger agreement was finalized. The Argyle due diligence team included Messrs. Marbut, Chaimovski, Mellin, Wachtel, and Wallis; representatives of Loeb & Loeb; representatives of Giuliani Capital Advisors; and representatives of Ernst & Young.

From November 6, 2006 through December 8, 2006, various representatives of Argyle and ISI were in constant communication in connection with due diligence and the negotiation of a definitive agreement. Mr. Jones, as the representative of William Blair Mezzanine Capital Fund III, L.P., participated in the negotiating and drafting of many of the provisions of the merger agreement. The specific subject matter the negotiations in which Mr. Jones was a participant included the terms pursuant to which $10 Million of William Blair Mezzanine Capital Fund III, L.P.’s $15.9 million debt would be converted to preferred stock in ISI, the terms of the remaining $6 million promissory note, and the fees to be paid and/or waived by William Blair Mezzanine Capital Fund III, L.P. Mr. Jones participated in the drafting of the merger agreement during numerous conference calls with varying representatives of ISI and Argyle and by reviewing various drafts of the documents, and providing comments and suggested or required changes.

Due diligence was physically conducted at ISI’s corporate office, MCS-Detention’s facility, and MCS-Commercial facilities in Dallas, Denver, and San Antonio. Customer contacts were made with both ISI-Detention/MCS-Detention and MCS-Commercial customers. The ISI Detention/MCS Detention customers contacted included: Hensel Phelps, Dinosaur Valley and White Construction Companies, and all gave opinions about ISI that ranged from very favorable to extraordinary. Those MCS-Commercial customers that were contacted included Travelport Data Center and Littleton (Colorado) Public Schools; their opinions were also very favorable. An interview questionnaire was used with each of the companies contacted to collect a consistent set of responses. Questions were asked relating to: longevity as a customer, view as to their relationship with ISI, pricing competitiveness, customer expectations achievement, misunderstandings/disputes experienced, on-time performance, professionalism of ISI personnel, system performance, post-installation service experience, improvements desired, willingness to be a reference, and repeat business potential. Customer responses were uniformly excellent, with one minor complaint about back-office billing mistakes in recent months after an ISI personnel change. On-site visits were conducted at current correctional projects in two widely separated parts of Texas to determine if Argyle concurred with ISI’s assessment of project completion percentages and to determine how well the projects were organized and managed. The results of those two site visits were very favorable.

 

Very soon after the letter of intent was signed by the parties on October 30, 2006, efforts were begun to create a definitive merger agreement, using the LOI content as a framework for discussion and negotiations. Messrs. Chaimovski and Mellin and Argyle’s outside counsel, Loeb & Loeb LLP represented Argyle in the negotiations. ISI was represented by Mr. Youngblood and ISI’s legal counsel, Hughes Luce, LLP. Representing William Blair Mezzanine Capital Fund III, L.P. was David Jones and counsel for William Blair Mezzanine Capital Fund III, L.P., Vedder, Price, Kaufman & Kammholz PC.

These parties, which did not directly include Giuliani Capital Advisors (which advised Argyle on the negotiations, but did not actually participate in such negotiations), negotiated the merger agreement throughout the month of November. In addition, during this period, Messrs. Youngblood and Marbut were in communication, both in person and electronically, to finalize certain open issues in the merger negotiation. Also throughout this period, when Argyle management and its consultants were involved in a formal due diligence process, the due diligence results were taken into account in finalizing the merger agreement.

The final open issues of the merger agreement were agreed to on December 8 just prior to the meeting of the Argyle Board of Directors in New York.

 

Beginning on October 7, 2006 and continuing on average on a weekly basis through December 7, 2006, Mr. Marbut communicated (primarily by email) with members of the Argyle Board on the progress of the due diligence effort, merger agreement negotiations, and the preparations of this proxy statement/prospectus.

The results of the due diligence process were reported at a meeting of the Argyle Board of Directors in New York on December 8, 2006. This was followed by Messrs. Chaimovski and Marbut making a presentation of the definitive merger agreement for the proposed ISI transaction. The Board then met with Walter Bailey and Anthony Sehnaoui of Giuliani Capital Advisors to receive an analysis of the proposed transaction and a presentation regarding the proposed transaction’s fairness from a financial point of view. The Argyle Board of Directors and the ISI Board of Directors then approved the merger agreement.

 

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The definitive merger agreement was signed on December 8, 2006 and publicly announced on December 14, 2006.

 

Board Consideration and Approval

 

While no one factor determined the final agreed upon consideration in the acquisition, Argyle’s Board of Directors reviewed various industry and financial data, including certain valuation analyses and metrics compiled by Argyle and Giuliani Capital Advisors in order to make its determination that the consideration to be paid to the ISI stockholders was reasonable and that the acquisition was in the best interests of Argyle’s stockholders. Argyle’s Board of Directors also reviewed and considered certain analyses provided by Giuliani Capital Advisors in order to determine that the merger consideration was fair from a financial point of view to Argyle.

 

Argyle’s officers and consultants conducted a due diligence review of ISI that included an industry analysis, a description of ISI’s existing business model, inspections of company premises, review of corporate records and files, on-site visits to selected jobs-in progress, in-depth meetings with three levels of ISI management, interviews with major ISI customers, a valuation analysis and financial projections in order to enable the Board of Directors to ascertain the reasonableness of the consideration. On December 8, 2006, Giuliani Capital Advisors and Argyle’s executive officers made a presentation to Argyle's Board of Directors relating to the acquisition.

 

Interest of Argyle’s Management in the Acquisition. When you consider the recommendation of Argyle’s Board of Directors that you vote in favor of the acquisition, you should keep in mind that Argyle’s officers and directors have interests in the acquisition that are different from, or in addition to, yours. These interests include the following:

 

·

If the acquisition is not approved and Argyle is therefore required to liquidate, the shares owned by Argyle’s officers and directors will be worthless because they will not be entitled to receive any of the assets held in the trust account. In addition, the possibility that the members of the Board of Directors will be required to perform their obligations under the indemnity agreements referred to above will be substantially increased.

·

In connection with the initial public offering, Argyle’s current officers and directors agreed to indemnify Argyle for debts and obligations to vendors that are owed money by Argyle for services rendered or products sold to Argyle, but only to the extent necessary to ensure that certain liabilities do not reduce funds in the trust account. If the offering is consummated, Argyle’s officers and directors will not have to perform such obligations.

 

·	Warrants to purchase Argyle common stock held by Argyle’s directors and officers are potentially exercisable upon consummation of the acquisition.

 

·

All rights specified in Argyle’s Second Amended and Restated Certificate of Incorporation relating to the right of directors and officers to be indemnified by Argyle, and of Argyle’s directors and officers to be exculpated from monetary liability with respect to prior acts or omissions, will continue after the acquisition. If the acquisition is not approved and Argyle liquidates, it will not be able to perform its obligations under those provisions. If the ISI acquisition is ultimately completed, the combined company’s ability to perform such obligations will probably be substantially enhanced.

 

·

Argyle’s financial, legal and other advisors have rendered services for which they may not be paid if the acquisition is not approved, and certain of them may have the opportunity to provide additional services to Argyle in the future. In connection with the ISI negotiations, the drafting of the merger agreement and this proxy statement/prospectus, Argyle’s counsel, Loeb & Loeb LLP, which is issuing an opinion as to the validity of the shares to be issued pursuant to this proxy statement/prospectus, has provided approximately $92,587 of services for which it has not been paid and is entitled to be reimbursed by Argyle for approximately $500 of out-of-pocket expenses as of November 30, 2006. In connection with due diligence and review of this proxy statement/prospectus, Argyle’s independent auditor, Ernst & Young LLP, has billed approximately $28,500 of services through November 30, 2006 for which it has not been paid. Giuliani Capital Advisors is owed a fee of $200,000 for its fairness opinion that has not been paid and, if a business combination is completed, will be entitled to receive from Argyle an advisory fee of approximately $.4 million. In addition, Rodman & Renshaw LLC, the representative of the underwriters in Argyle’s initial public offering will receive deferred underwriting fees of approximately $1.4 million from the trust account.

 

·

It is anticipated that Argyle’s current Co-Chief Executive Officers, Bob Marbut and Ron Chaimovski, will enter into employment agreements with Argyle post merger, though the terms of such agreements have not yet been determined and will be approved by the Compensation Committee of Argyle’s Board of Directors that will be formed after the closing of the merger.

·

Following the merger, Argyle has agreed that it will negotiate employment agreements with Sam Youngblood, Don Carr, Mark McDonald and Tim Moxon. Other than the agreement that the term of the employment agreements will be five years for Mark McDonald and two years for the others, and that Sam Youngblood and Don Carr must be directors of ISI post merger, the agreements have not yet been negotiated, meaning that the employment agreements currently in place with those parties will remain in full force and effect until the new agreements take effect. The employment agreements will be approved by the Compensation Committee of Argyle’s Board of Directors that will be formed after the closing of the merger.

·

The following table lists the securities owned by the members of Argyle’s current management team and Board of Directors and the amount of gain that each of them would realize if the merger is consummated, based on the market price of Argyle’s securities on January 31, 2007. If a merger is not consummated, the securities held by these individuals would be valueless since they would not be entitled to participate in distributions from the trust account.

		Securities in which named individual has a pecuniary interest						Value of such securities as of January 30, 2007 ($)						Aggregate Initial Purchase Price of Securities ($)						Gain on Securities as of January 30, 2007
Name		Shares			Units			Shares			Units			Shares			Units			($)
Bob Marbut			371,228			93,750			2,724,526			768,750			10,023			750,000			2,737,523
Ron Chaimovski			290,512			31,250			2,135,263			256,250			7,844			250,000			2,133,669
Wesley Clark			71,720			0			527,142			n/a			1,936			n/a			525,206
John J. Smith			47,813			0			351,426			n/a			1,291			n/a			305,135

 

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Argyle’s Reasons for the Acquisition and Its Recommendation. Argyle’s Board of Directors concluded that the acquisition is in the best interests of Argyle’s stockholders.

The Board considered a wide variety of factors in connection with its evaluation of the acquisition, including: 1) the conclusions of the analyses made by Messrs. Wachtel and Wallis of the market segments that ISI serves, its customers, its competitors and ISI’s relative competitive advantage; 2) the results of the due diligence evaluation that Messrs. Marbut, Chaimovski, Wachtel, Mellin and Wallis had made; 3) the qualitative evaluation of ISI’s management depth, its systems and processes, its pricing methods, its acquisition assimilation track record, its record of innovation, its growth strategy and its culture; 4) the quantitative analysis of ISI’s revenue and backlog growth, 5) a qualitative comparison of the proposed ISI transaction aspects to the acquisition criteria guidelines that had been established by Argyle management and the Board in March of 2006 and 6) various analyses provided by Giuliani Capital Advisors, including the fairness opinion.

In its evaluation of the proposed ISI transaction, the Argyle Board of Directors also considered what were felt to be the primary negative financial factors involved, including ISI’s relatively high debt, interest obligations, negative cash flow and accumulated deficit. The Board of Directors concluded that after the transaction with Argyle is completed, as shown in the pro forma analysis beginning on page 80 of the S-4 document, the consolidated balance sheet will be relatively strong. For example, the pro-forma long-term debt is significantly reduced and the pro-forma equity is significantly higher. Also, the interest payment obligation would be reduced. In addition, the Board took into account the increase in revenues and backlog from 2003 through the third quarter of 2006 and the likely impact that these trends would have on the income statement, the balance sheet and the statement of cash flows. The Board of Directors concluded that, after the transaction is complete, the consolidated financial strength of the merger of ISI and Argyle overcomes the negative financial factors that the Board had identified in its analysis.

 

In light of the complexity of those factors, the Board did not consider it practicable to, nor did it attempt to, quantify or otherwise assign relative weights to the specific factors it considered in reaching its decision.

 

In considering the acquisition, Argyle’s Board of Directors also gave considerable weight to the factors discussed below.

 

Satisfaction of 80% Test. It is a requirement that any business acquired by Argyle have a fair market value equal to at least 80% of Argyle’s net assets at the time of acquisition, which assets shall include the amount in the trust account. Based on the financial analysis of ISI generally used to approve the transaction, Argyle’s Board of Directors determined that this requirement was met and exceeded.

 

To determine the value of ISI, the Board of Directors first determined that as of September 30, 2006, Argyle had $28,402,813 in net assets (total assets minus total liabilities). The consideration being paid to ISI’s security holders, which Giuliani Capital Advisors determined was fair from a financial point of view to Argyle, is, at minimum, $16,300,000 and 1,180,000 shares of Argyle’s common stock based on the closing price of Argyle’s common stock on October 27, 2006, the trading day before the term sheet was signed. The fair market value of the common stock to be issued to ISI’s stockholders is $8,496,000 ($7.20 per share), for a total consideration of $24,796,000, which is over 87% of Argyle’s net assets at the time that the letter of intent was executed. Therefore, the 80% test was satisfied.

Engagement of Giuliani Capital Advisors

On June 29, 2006, Argyle engaged Giuliani Capital Advisors as its financial advisor. Argyle agreed to pay Giuliani Capital Advisors, upon the successful completion of a business combination, an advisory fee for acting in such capacity predicated on the final transaction value of the merger with ISI. The transaction value will be equal to the value of consideration delivered for the purchase of assets or stock plus net debt. Net debt, as defined, is total debt, including capital leases,  plus preferred stock less cash and cash equivalents. The estimated advisory fee is based upon the following assumptions: (1) the cash consideration paid is $16,300,000 or $18,200,000 (assuming ISI’s backlog meets or exceeds applicable metrics), (2) the value of the shares being issued is approximately $8,708,400 in the aggregate, based on Argyle’s closing stock price on December 6, 2006 of $7.38, and (3) the net debt assumed of $[12,177,927 as at September 30, 2006] as at ____{closing date], based on ISI’s September 30, 2006 balance sheet. Since such consideration includes a share component and a potential enhanced cash portion, the precise amount of the fee cannot be determined until immediately prior to the closing of the transaction, but is estimated to be approximately $.4 million. The scope of Giuliani Capital Advisors’ engagement as financial advisor to Argyle, included:

·	Gathering market intelligence on the security industry;

·	Analyzing relative valuations and appropriate bid amounts;

·	Assisting in structuring the offer and letter of intent;

·	Analyzing the terms of the agreement; and

·	Participating in drafting of the Company’s filings with the SEC relating to the merger.

In its capacity as financial advisor Giuliani Capital Advisors also sought to identify potential acquisition targets for Argyle’s consideration. Giuliani Capital Advisors identified and presented numerous potential acquisition targets to Argyle’s officers and directors for which no fees were paid as no agreement was reached with any such acquisition. Giuliani Capital Advisors did not identify or introduce ISI to Argyle.

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On __________, 2006, the Board of Directors orally advised Giuliani Capital Advisors that it was selected to provide to the Board an opinion with respect to the fairness, from a financial point of view, of the proposed Argyle merger. Argyle’s Board of Directors selected Giuliani Capital Advisors to provide the fairness opinion, after considering multiple potential advisors. The ultimate decision to select Giuliani Capital Advisors was based upon Giuliani Capital Advisors’ familiarity with the process that Argyle pursued in identifying ISI and negotiating the proposed merger with ISI, its knowledge of the security industry, its experience in preparing a fairness opinion and the Board’s familiarity with Giuliani Capital Advisors’ work, including from the assistance Giuliani Capital Advisors provided in connection with the merger. Giuliani Capital Advisors’ additional role as financial advisor to Argyle was independent from its role to provide a fairness opinion of the proposed merger. The Board of Directors of Argyle determined that Giuliani Capital Advisors’ role in connection with the merger with ISI would not compromise its ability to remain independent in rendering the fairness opinion.

Although the parties did not enter into a written engagement letter with respect to the preparation of the fairness opinion at such time, it was the arrangement between Argyle’s Board of Directors and Giuliani Capital Advisors that Giuliani Capital Advisors would immediately commence the necessary work to prepare the opinion and that the parties would continue to negotiate the detailed terms of the engagement letter prior to delivery of the fairness opinion. Giuliani Capital Advisors had been working on the opinion in anticipation of concluding the terms of the fairness opinion engagement letter prior to delivery of its fairness opinion. On December 8, 2006, the parties executed the fairness opinion engagement letter and, on the same day, Giuliani Capital Advisors delivered the fairness opinion. A fee of $200,000 for its services in connection with providing its fairness opinion is payable to Giuliani Capital Advisors. The fee for the fairness opinion was negotiated by Argyle and Giuliani Capital Advisors. The amount of this fee is consistent with industry custom and practice for the preparation of a fairness opinion, is not contingent upon consummation of the proposed merger and can not be credited against the success fee payable to Giuliani Capital Advisors upon consummation of the proposed merger. Argyle also agreed to reimburse Giuliani Capital Advisors for its reasonable out-of-pocket expenses in connection with its activities under the engagement letter, including reasonable fees and disbursements of its legal counsel. Argyle has also agreed to provide customary indemnification to Giuliani Capital Advisors against certain liabilities arising out of the engagement.

As of the date of the opinion, neither Giuliani Capital Advisors, nor its affiliates, held any securities of Argyle or ISI, nor did any members or officers of Giuliani Capital Advisors serve as a director of Argyle or ISI. Giuliani Capital Advisors may provide investment banking and related services to Argyle in the future.

 

Fairness Opinion

 

The Board of Directors has received a written fairness opinion, dated December 8, 2006, from Giuliani Capital Advisors LLC to the effect that, as of the close of the market on December 6, 2006, and consensus estimates from themarkets.com as of December 7, 2006 for projected year end 2006 and 2007 results, the merger consideration as stipulated in the merger agreement was fair from a financial point of view to Argyle.

 

THE FULL TEXT OF GIULIANI CAPITAL ADVISORS’ FAIRNESS OPINION, WHICH SETS FORTH THE ASSUMPTIONS MADE, GENERAL PROCEDURES FOLLOWED, MATTERS CONSIDERED AND METHODS EMPLOYED BY GIULIANI CAPITAL ADVISORS IN ARRIVING AT ITS OPINION, IS ATTACHED AS ANNEX A TO THIS PROXY STATEMENT/PROSPECTUS.

 

Giuliani Capital Advisors’ written opinion does not constitute a recommendation to the Board of Directors or to any holders of Argyle’s common stock as to how to vote or act on any of the proposals set forth in this proxy statement/prospectus. Holders of Argyle’s securities are urged to and should read the opinion in its entirety.

 

In arriving at its opinion, Giuliani Capital Advisors:

 

·	Reviewed a draft of the merger agreement which, for the purposes of the opinion, Giuliani Capital Advisors assumed, with Argyle’s permission, to be identical in all material respects to the executed agreement (which had been executed by the parties prior to the delivery of the written opinion);

 

·	Reviewed certain publicly available information about ISI;

 

·	Reviewed information furnished to Giuliani Capital Advisors by ISI’s management, including certain audited financial statements and unaudited financial analyses, projections, budgets, reports and other information;

 

·	Held discussions with various members of senior management of ISI concerning historical and current operations, financial condition and prospects, including recent financial performance;

 

·	Reviewed the valuation of ISI based on the terms of the merger agreement;

 

·	Reviewed the valuations of publicly traded companies that Giuliani Capital Advisors deemed comparable in certain respects to ISI;

 

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·	Reviewed the financial terms of selected acquisition transactions involving companies in lines of business that Giuliani Capital Advisors deemed comparable in certain material respects to the business of ISI;

 

·	Prepared a discounted cash flow analysis of ISI on a stand-alone basis;

 

·	Participated in discussions related to the proposed merger between ISI and Argyle; and

 

·	Conducted such other quantitative reviews, analyses and inquiries relating to ISI as considered appropriate in rendering the opinion.

 

These analyses were prepared primarily based on information that was obtained from publicly available sources, as well as information that was provided by, or on behalf of, ISI. Giuliani Capital Advisors’ opinion was necessarily based on market and economic conditions and other circumstances as they existed on, and could be evaluated as of the close of the market on December 6, 2006 and consensus estimates from themarkets.com as of December 7, 2006 for projected year end 2006 and 2007 results. Giuliani Capital Advisors’ opinion does not provide or imply any conclusion as to the likely trading range of any security issued by any party following the approval of the merger. This may vary depending upon, among other things, factors that generally influence the price of securities.

 

The following is a summary of the material analyses Giuliani Capital Advisors performed while preparing its fairness opinion.

 

Comparable Company Analysis

 

Comparable company analysis is a method of valuing an asset relative to publicly traded companies with similar products or services, similar operating or financial characteristics, or that serve similar markets displaying certain key similarities. Giuliani Capital Advisors analyzed enterprise values as multiples of Sales and adjusted EBITDA of fourteen publicly traded companies in the U.S. and the European markets. Enterprise value is market capitalization plus net debt, which includes total debt plus preferred stock, less cash and cash equivalents. In its analysis, Giuliani Capital Advisors segmented companies comparable to ISI into three populations. The first population consisted of access and video control solution providers. This group included companies which provide products, services, and/or solutions involved in monitoring, credentialing, authenticating, and identifying individuals with permission to access a particular area or areas of a facility. The second group included security integration companies which provide, among other things, products, design and engineering services, installation services, and/or solutions which allow multiple security-related components to communicate with each other in one common system. The third group consisted of non-security sector-specific integrators that were included due to similar characteristics of their businesses and ISI’s integration operations and the limited population size of security-specific companies.

 

Giuliani Capital Advisors’ review was limited to comparable companies for which information was publicly available. Sources of information used by Giuliani Capital Advisors’ included filings with the Securities and Exchange Commission to obtain historical operating data; equity market data which was extrapolated from Capital IQ as of the close of the market on December 6, 2006; and consensus estimates from themarkets.com as of December 7, 2006 for projected year end 2006 and 2007 results. The table below summarizes the results of this analysis:

 

Enterprise Value as a Multiple of

Sales

Adjusted EBITDA

Latest Twelve Months

Projected Calendar Year Ended 2006

Projected Calendar Year Ended 2007

Latest Twelve Months

Projected Calendar Year Ended 2006

Projected Calendar Year Ended 2007

Access and Video Control Solution Providers

NICE Systems Ltd.

3.9x

3.6x

3.0x

nm

19.8x

15.2x

Kaba Holding AG

1.6x

1.4x

1.2x

11.5x

9.1x

7.7x

Verint Systems Inc.

2.8x

2.2x

NA

18.7x

14.0x

NA

Gunnebo AB

0.9x

0.8x

0.8x

nm

17.8x

9.7x

NEDAP NV

1.8x

1.6x

1.4x

10.4x

9.2x

8.0x

March Networks Corporation

3.1x

2.7x

2.1x

12.3x

12.9x

9.8x

Quadnetics Group plc

1.0x

0.5x

NA

11.4x

6.1x

NA

Mace Security International Inc.

0.7x

NA

NA

nm

NA

NA

MDI Inc.

1.0x

NA

NA

nm

NA

NA

Mean

1.9x

1.8x

1.7x

12.9x

12.7x

10.1x

Median

1.6x

1.6x

1.4x

11.5x

12.9x

9.7x

Commercial Security Integrators

CompuDyne Corp.

0.5x

0.6x

0.5x

13.3x

12.8x

11.1x

Henry Bros Electronics, Inc.

0.6x

0.6x

0.5x

14.9x

NA

NA

Mean

0.6x

0.6x

0.5x

14.1x

12.8x

11.1x

Median

0.6x

0.6x

0.5x

14.1x

12.8x

11.1x

Non-Security Sector-Specific Integrators

Quanta Services, Inc.

1.2x

1.2x

1.0x

13.7x

13.5x

10.7x

MasTec, Inc.

0.9x

0.9x

0.8x

13.5x

13.3x

10.5x

Versar Inc.

0.4x

NA

NA

15.6x

NA

NA

Mean

0.8x

1.0x

0.9x

14.3x

13.4x

10.6x

Median

0.9x

1.0x

0.9x

13.7x

13.4x

10.6x

Aggregate Mean

1.5x

1.5x

1.3x

13.5x

12.9x

10.3x

Aggregate Median

1.0x

1.2x

1.0x

13.4x

13.1x

10.2x

 

The preceding comparable company analysis resulted in an implied enterprise valuation of ISI between approximately $50.3 million and $113.7 million.

 

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Comparable Transaction Analysis

 

Comparable transaction analysis is a method of valuing an asset relative to recent merger and acquisition transactions involving companies having similar products or services, similar operating or financial characteristics, similar security technology attributes, or servicing similar markets. In its comparable transaction analysis, Giuliani Capital Advisors identified transactions occurring within the preceding three years from October 2003 to September 2006 in which the company acquired had a business in one or more of the markets, or provided similar products/services or similar technology attributes, identified as, or related to, a security segment or business of the type being considered by Argyle. Giuliani Capital Advisors compared enterprise values implied by fourteen comparable merger transactions.

Sources used by Giuliani Capital Advisors included filings with the Securities and Exchange Commission relating to the transactions indicated, and data gleaned from information available to Giuliani Capital Advisors through FactSet Data Systems, Merger Stat, Merger Market and Lehman Brothers Inc. equity research. Giuliani Capital Advisors primarily focused on transactions in a valuation range of up to approximately $400 million. Transactions for which no public information was available or which involved conglomerates where security segment information could not be verified were not included in the group of comparable transactions.

 

			Enterprise Value as a Multiple of:
			Latest Twelve  Months Sales			Latest Twelve  Months  Adjusted EBITDA
United Technologies Corp. acquisition of Red Hawk Industries			1.0x			NA
NICE Systems Ltd. acquisition of FAST Video Security AG			2.1x			NA
Confidential Representative Private Company Acquisition			5.0x			28.5x
Axsys Technologies, Inc. acquisition of Diversified Optical Products, Inc.			2.5x			13.9x
United Technologies Corp. acquisition of Lenel Systems International Inc.			13.3x			20.0x
United Technologies Corp. acquisition of Kidde plc			2.0x			15.9x
Honeywell International, Inc. acquisition of Novar Plc			1.0x			8.7x
General Electric Co. acquisition of Edwards System Technology, Inc.			3.1x			14.7x
Siemens AG acquisition of Photo-Scan plc			1.7x			9.5x
Schneider Electric S.A. acquisition of Andover Controls Corp.			2.4x			14.4x
Securitas AB acquisition of Bell Group plc			1.5x			16.6x
The Stanley Works acquisition of Frisco Bay Industries, Ltd.			1.3x			11.3x
The Stanley Works acquisition of Blick Plc			1.6x			11.3x
Honeywell International, Inc. acquisition of Silent Witness Enterprises Ltd.			1.5x			11.2x
Mean			2.9x			14.7x
Median			1.9x			14.1x

The preceding comparable transaction analysis resulted in an implied valuation of ISI of between approximately $68.7 million and $76.2 million.

 

Based on this analysis, Giuliani Capital Advisors determined that the merger consideration was within or below the range of enterprise values implied by the multiples of the selected comparable transactions.

 

Discounted Cash Flow Analysis

 

Discounted cash flow analysis is a method of valuing an asset as the present value of the sum of (i) its unlevered free cash flows over a forecast period and (ii) its theoretical terminal value at the end of the forecast period. Giuliani Capital Advisors calculated the future cash flows of ISI according to the financial projections for the fiscal years 2007 through 2009 as provided by ISI or assumed in accordance with Argyle management’s views. The terminal values of ISI were calculated based on projected adjusted EBITDA for 2009, using exit multiples ranging from 7.5x to 11.5x. The range of EBITDA exit multiples Giuliani Capital Advisors applied to its discounted cash flow analysis of ISI was set at a minimum multiple of 7.5x to encompass the lowest comparable companies’ Enterprise Value/adjusted EBITDA multiple, as shown in the comparable company analysis table. The range was then increased by intervals of 1.0 in order to include the broader range of comparable companies’ Enterprise Value/adjusted EBITDA multiples. Giuliani Capital Advisors applied discount rates ranging from 12.5% to 22.5%. Giuliani Capital Advisors used such discount rates based on its judgment of the estimated weighted average cost of capital of comparable publicly traded companies, as well as adjustments relating to factors deemed specific to ISI, a privately held company. Based on this analysis, the implied enterprise value of ISI indicated a range of valuations for ISI between $66.2 million and $123.4 million. The implied results were trimmed to discard the highest and lowest ranges in order to avoid the potential anomalous effects of outliers and arrive at a more precise implied valuation range. The discounted cash flow analysis resulted in a minimum implied enterprise value of $75.4 million.

 

Based on this analysis, Giuliani Capital Advisors determined that the merger consideration was within or below the range of enterprise values implied by the multiples of the selected comparable companies, the multiples of the selected comparable transactions and the ISI discounted cash flow analysis. Giuliani Capital Advisors’ valuation was based upon the operating metrics of revenues and adjusted EBITDA. The recordation of $20.0 million of goodwill would affect the balance sheet, but not operating performance. Accordingly, the recordation of goodwill would be expected to have no effect on a valuation of ISI based upon comparable companies, comparable transactions or discounted cash flow analyses.

 

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Analysis of the Historical Trading Activity of Argyle’s Common Stock

 

Giuliani Capital Advisors analyzed the historical prices and trading activity of Argyle’s common stock on the OTC Bulletin Board. Since the date when Argyle’s common stock commenced trading on the OTC Bulletin Board, such date being March 2, 2006, until December 6, 2006, the price of Argyle’s common stock ranged from $7.15 to $7.55, with an average daily volume of approximately 12,159 shares. For the 90 trading days ended December 6, 2006, the price of Argyle’s common stock ranged from $7.15 to $7.39, with an average daily trading volume of approximately 9,173 shares. For the ten trading days ended December 6, 2006, the price of Argyle’s common stock ranged from $7.27 to $7.38, with an average daily trading volume of approximately 35,848 shares.

 

The closing price of $7.38 of Argyle’s common stock on December 6, 2006 was, in Giuliani Capital Advisors’ analysis, determined to be a representative price for Argyle’s common stock, as it relates to Argyle’s status as a special purpose acquisition company prior to the announcement of its merger with ISI. Giuliani Capital Advisors used this price for indicative purposes only, since share price may fluctuate, to calculate the value of the merger consideration, which will be partially paid in Argyle’s shares of common stock.

 

General Matters Regarding Fairness Opinion

 

The preparation of a fairness opinion involves various determinations as to the most appropriate and relevant methods of financial analysis and the application of those methods to particular circumstances and, therefore, such an opinion is not susceptible to summary description. Furthermore, Giuliani Capital Advisors did not attribute any particular weight to any analysis or factor considered by it, but rather made qualitative judgments as to the significance and relevance of each analysis and factor. Accordingly, Giuliani Capital Advisors’ analyses must be considered as a whole. Considering any portion of such analyses and of the factors considered without considering all analyses and factors, could create a misleading or incomplete view of the process underlying the conclusions expressed in the opinion.

 

In its analysis, Giuliani Capital Advisors made a number of assumptions with respect to industry performance, general business and economic conditions and other matters, many of which are beyond the control of ISI, Argyle and Giuliani Capital Advisors. Any estimates contained in these analyses are not necessarily indicative of actual values or predictive of future results or values, which may be significantly more or less favorable than those set forth in the analysis. In addition, analyses relating to the value of ISI do not purport to be appraisals or to reflect the prices at which securities of Argyle may be sold after the merger is approved.

 

Giuliani Capital Advisors’ opinion does not constitute a recommendation to the Board of Directors or to any holder of Argyle’s securities as to how such a person should vote or act with respect to any of the proposals set forth in this proxy statement/prospectus. The opinion does not address the merits of the decision of the Board of Directors to enter into the merger transaction as compared to any alternative business transactions that might be available to Argyle nor does it address the underlying business decision to engage in the merger transaction.

 

Giuliani Capital Advisors is a nationally recognized investment banking firm that is continually engaged in providing fairness opinions and advising in connection with mergers and acquisitions, leveraged buyouts, recapitalizations and private placement transactions. The Board of Directors retained Giuliani Capital Advisors based on such qualifications, as well as recommendations from other companies that had engaged members of Giuliani Capital Advisors’ engagement team for similar purposes and Giuliani Capital Advisors’ ability to perform research and render a fairness opinion within the required timeframe.

 

Conclusion of Argyle’s Board of Directors. After careful consideration of all relevant factors, Argyle’s Board of Directors determined that the acquisition is fair to and in the best interests of Argyle and its stockholders. The Board of Directors has approved and declared the proposal advisable and recommends that you vote or give instructions to vote “FOR” the approval of the acquisition.

 

The foregoing discussion of the information and factors considered by the Argyle Board is not meant to be exhaustive, but includes the material information and factors considered by it.

 

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Certain U.S. Federal Income Tax Consequences of the Merger

 

The following discussion is a general summary of the material U.S. federal income tax consequences of the merger to Argyle and to current holders of its common stock, as well as to the holders of the stock of ISI, who are “United States persons,” as defined in the Internal Revenue Code of 1986, as amended (referred to in this proxy statement/prospectus as the Code) and who hold such stock as a “capital asset,” as defined in the Code. The discussion does not purport to be a complete analysis of all of the potential tax effects of the merger. The discussion does not address the tax considerations applicable to particular stockholders based on their individual circumstances, or to particular categories of stockholders subject to special treatment under certain U.S. federal income tax laws (such as dealers in securities, banks, insurance companies, tax-exempt entities, mutual funds, and foreign persons). In addition, the discussion does not consider the tax treatment of partnerships or other pass-through entities or persons who hold stock through such entities. The discussion also does not describe tax consequences arising under the laws of any other federal tax or any state, local or foreign tax.

 

The discussion is based upon the Code, U.S. Treasury Department regulations, rulings of the Internal Revenue Service (“IRS”), and judicial decisions now in effect, all of which are subject to change or to varying interpretation at any time. Any such changes or varying interpretations may also be applied retroactively.

 

Argyle has not obtained a ruling from the IRS nor an opinion of counsel as to the U.S. federal income tax consequences of the merger. There can be no assurance that the IRS will not take a different position, or that position will not be sustained.

 

Because of the complexity of the tax laws and because the tax consequences to Argyle or any particular stockholder of Argyle or ISI may be affected by matters not discussed herein, stockholders are urged to consult their own tax advisors as to the specific tax consequences of the merger, including tax reporting requirements, the applicability and effect of federal, state, local, foreign and other applicable tax laws and the effect of any proposed changes in the tax laws.

 

Tax Consequences to Argyle and its Current Stockholders

 

Neither Argyle nor the current holders of its common stock will recognize gain or loss as a result of the merger for U.S. federal income tax purposes.

 

Tax Consequences to Stockholders of ISI

 

Gain or Loss on Merger. Amounts received by stockholders of ISI pursuant to the merger generally will be treated as full payment in exchange for their shares of stock in ISI. As a result, a stockholder of ISI generally will recognize gain or loss for U.S. federal income tax purposes equal to the difference between (1) the amount of cash and the fair market value of stock received by such stockholder pursuant to the merger and (2) such stockholder’s tax basis in its stock in ISI.

 

A stockholder’s gain or loss generally will be computed on a “per share” basis, so that gain or loss is calculated separately for blocks of stock acquired at different dates or for different prices. The amounts received by a stockholder of ISI pursuant to the merger will be allocated proportionately to each share of stock owned by such stockholder. The gain or loss recognized by such stockholder in connection with the merger generally will be a capital gain or loss, and will be a long-term capital gain or loss if the share has been held for more than one year, and a short-term capital gain or loss if the share has not been held for more than one year. Long-term capital gain of non-corporate taxpayers may be subject to more favorable tax rates than ordinary income or short-term capital gain. The deductibility of capital losses is subject to various limitations.

 

Back-Up Withholding. Unless a stockholder of ISI complies with certain reporting and/or Form W-9 certification procedures or is an exempt recipient under applicable provisions of the Code and Treasury Regulations, such stockholder may be subject to back-up withholding tax with respect to payments received pursuant to the merger. The back-up withholding tax is currently imposed at a rate of 28%. Back-up withholding generally will not apply to payments made to some exempt recipients (such as a corporation) or to a stockholder who furnishes a correct taxpayer identification number and certain other required information. If back-up withholding applies, the amount withheld is not an additional tax, but generally is allowed as a credit against the stockholder’s U.S. federal income tax liability provided the requisite procedures are followed.

 

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Anticipated Accounting Treatment

 

Argyle will account for the acquisition of ISI as a purchase. The purchase price will be allocated to the various tangible and intangible assets and assumed liabilities based upon an appraisal.

 

Regulatory Matters

 

The acquisition is not subject to the Hart-Scott-Rodino Act or any federal or state regulatory requirement or approval, except for filings necessary to effectuate related transactions with the state of Delaware.

 

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PROPOSAL TO APPROVE THE

2007 OMNIBUS SECURITIES AND INCENTIVE PLAN

Background

 

Argyle’s 2007 Omnibus Securities and Incentive Plan (referred to below as the 2007 Incentive Plan) has been approved by Argyle’s Board of Directors and will take effect upon consummation of the merger, provided that the merger and the 2007 Incentive Plan are approved by the stockholders at the special meeting.

 

Under the terms of the 2007 Incentive Plan, 1,000,000 shares of Argyle common stock are reserved for issuance in accordance with its terms. Argyle currently anticipates that, shortly after the merger, it will grant awards to acquire up to approximately ____________ shares pursuant to the 2007 Incentive Plan to members of the ISI management team, current officers, directors and consultants of Argyle and to new employees of Argyle to be hired after the merger. However, at this time, Argyle’s Board of Directors has not approved the issuance of any such awards and is not under any contractual obligation to do so - the merger agreement only requires the availability of a plan, not what awards will be made pursuant to the plan. Assuming that the anticipated grants are made, there would be at least approximately ___________ shares remaining for issuance in accordance with the 2007 Incentive Plan’s terms. The purpose of the 2007 Incentive Plan is to assist Argyle in attracting, retaining and providing incentives to its employees, officers, directors and consultants, or the employees, officers, directors and consultants of its affiliates, whose past, present and/or potential future contributions to Argyle have been, are or will be important to the success of Argyle and to align the interests of such persons with Argyle’s stockholders. It is also designed to motivate employees and to significantly contribute toward growth and profitability, to provide incentives to Argyle’s officers, directors, employees and consultants who, by their position, ability and diligence are able to make important contributions to Argyle’s growth and profitability. The various types of incentive awards that may be issued under the 2007 Incentive Plan will enable Argyle to respond to changes in compensation practices, tax laws, accounting regulations and the size and diversity of its business.

 

All officers, directors, employees and consultants of ISI and Argyle will be eligible to be granted awards under the 2007 Incentive Plan. All awards will be subject to the approval of Argyle’s Board of Directors or its Compensation Committee.

 

Description of the 2007 Incentive Plan

A summary of the principal features of the 2007 Incentive Plan is provided below, but is qualified in its entirety by reference to the full text of the 2007 Incentive Plan, a copy of which is attached to this proxy statement/prospectus as Annex B.

 

Awards

 

The 2007 Incentive Plan provides for the grant of distribution equivalent rights, incentive stock options, non-qualified stock options, performance share awards, performance unit awards, restricted stock awards, stock appreciation rights, tandem stock appreciation rights and unrestricted stock awards for an aggregate of not more than 1,000,000 shares of Argyle’s common stock, to directors, officers, employees and consultants of Argyle or its affiliates. If any award expires, is cancelled, or terminates unexercised or is forfeited, the number of shares subject thereto, if any, is again available for grant under the 2007 Incentive Plan. The number of shares of common stock, with respect to which stock options or stock appreciation rights may be granted to a participant under the 2007 Incentive Plan in any calendar year cannot exceed 150,000.

 

Assuming the merger is completed, there would be approximately ___ employees, directors and consultants who would be eligible to receive awards under the 2007 Incentive Plan. New officers, directors, employees and consultants would be eligible to participate in the 2007 Incentive Plan as well.

 

Argyle does not currently have any outstanding options or any intention, agreement or obligation to issue any options outside the 2007 Incentive Plan.

 

 

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Administration of the 2007 Incentive Plan

 

The 2007 Incentive Plan will be administered by either Argyle’s Board of Directors or its Compensation Committee (referred to as the committee), if the Board of Directors delegates the ability to administrate the plan. Among other things, the Board of Directors or, if the Board of Directors delegates its authority to the committee, the committee, has complete discretion, subject to the express limits of the 2007 Incentive Plan, to determine the employees, directors and consultants to be granted awards, the types of awards to be granted, the number of shares of Argyle common stock subject to each award, if any, the exercise price under each option, the base price of each stock appreciation right, the term of each award, the vesting schedule and/or performance goals for each award that utilizes such a schedule or provide for performance goals, whether to accelerate vesting, the value of the common stock, and any required withholdings. The Board of Directors or the Compensation Committee may amend, modify or terminate any outstanding award, provided that the participant’s consent to such action is required if the action would materially and adversely affect the participant. The Board of Directors or the committee is also authorized to construe the award agreements and may prescribe rules relating to the 2007 Incentive Plan.

 

Options

 

The 2007 Incentive Plan provides for the grant of stock options, which may be either “incentive stock options” (ISOs), which are intended to meet the requirements for special U.S. federal income tax treatment under the Code, or “nonqualified stock options” (NQSOs). Options may be granted on such terms and conditions as the Board of Directors or the committee may determine; provided, however, that the exercise price of an option may not be less than the fair market value of the underlying stock on the date of grant, and the term of an ISO may not exceed ten years (110% of such value and five years in the case of an ISO granted to an employee who owns (or is deemed to own) more than 10% of the total combined voting power of all classes of capital stock of Argyle or a parent or subsidiary of Argyle). ISOs may only be granted to employees. In addition, the aggregate fair market value of common stock underlying one or more ISOs (determined at the time of grant) which are exercisable for the first time by any one employee during any calendar year may not exceed $100,000.

 

Restricted Stock

 

A restricted stock award under the 2007 Incentive Plan is a grant or sale of Argyle common stock to the participant, subject to such transfer, forfeiture and/or other restrictions specified by the Board of Directors or the Compensation Committee in the award. Dividends, if any are declared by Argyle, will be paid on the shares, even during the period of restriction. The purchase price for each share of restricted stock may not be less than the par value of a share of Argyle’s common stock.

 

Unrestricted Stock Awards

 

An unrestricted stock award under the 2007 Incentive Plan is a grant or sale of Argyle common stock to the participant that is not subject to transfer, forfeiture or other restrictions, in consideration for past services rendered thereby to Argyle or an affiliate or for other valid consideration.

 

Performance Unit Awards

 

Performance unit awards under the 2007 Incentive Plan entitle the participant to receive a specified payment in cash and/or Argyle common stock upon the attainment of specified individual or company performance goals.

 

Performance Share Awards

 

Performance share awards under the 2007 Incentive Plan entitle the participant to receive a specified number of shares of Argyle’s common stock and/or cash upon the attainment of specified individual or company performance goals.

 

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Distribution Equivalent Right Awards

 

A distribution equivalent right award under the 2007 Incentive Plan entitles the participant to receive bookkeeping credits, cash payments and/or Argyle common stock distributions equal in amount to the distributions that would have been made to the participant had the participant held a specified number of shares of Argyle common stock during the period the participant held the distribution equivalent right. A distribution equivalent right may be awarded under the 2007 Incentive Plan as a component of another award, where, if so awarded, such distribution equivalent right will expire or be forfeited by the participant under the same conditions as under such other award.

 

Stock Appreciation Rights (SARs)

 

The award of an SAR under the 2007 Incentive Plan entitles the participant, upon exercise, to receive an amount in cash, Argyle common stock or a combination thereof, equal to the increase in the fair market value of the underlying Argyle common shares between the date of grant and the date of exercise. SARs may be granted in tandem with, or independently of, options granted under the 2007 Incentive Plan. An SAR granted in tandem with an option under the 2007 Incentive Plan is granted at the same time as the related option and is exercisable only at such times, and to the extent, that the related option is exercisable and expires upon termination or exercise of the related option. In addition, the related option may be exercised only when the value of the stock subject to the option exceeds the exercise price under the option. An SAR that is not granted in tandem with an option is exercisable at such times as the committee may specify.

 

Additional Terms

 

Except as provided in the 2007 Incentive Plan, awards granted under the 2007 Incentive Plan are not transferable and may be exercised only by the participant or by the participant’s guardian or legal representative. Each award agreement will specify, among other things, the effect on an award of the disability, death, retirement, authorized leave of absence or other termination of employment of the participant. Argyle may require a participant to pay Argyle the amount of any required withholding in connection with the grant, vesting, exercise or disposition of an award. A participant is not considered a stockholder with respect to the shares underlying an award until the shares are issued to the participant.

 

Amendments

 

Argyle’s Board of Directors may at any time amend, alter, suspend or terminate the 2007 Incentive Plan; provided, that no amendment requiring stockholder approval will be effective unless such approval has been obtained, and provided further that no amendment of the 2007 Incentive Plan or its termination may be effected if it would materially and adversely affect the rights of a participant without the participant’s consent.

 

Certain U.S. Federal Income Tax Consequences of the 2007 Incentive Plan

 

The following is a general summary of the U.S. federal income tax consequences under current tax law to Argyle and to individual participants in the 2007 Incentive Plan who are individual citizens or residents of the United States of ISOs, NQSOs, restricted stock awards, unrestricted stock awards, performance unit awards, performance share awards, distribution equivalent right awards and SARs granted pursuant to the 2007 Incentive Plan. It does not purport to cover all of the special rules that may apply, including special rules relating to limitations on the ability of Argyle to deduct certain compensation, special rules relating to deferred compensation, golden parachutes, participants subject to Section 16(b) of the Exchange Act and the exercise of an option with previously-acquired shares. In addition, this summary does not address the state or local income or other tax consequences inherent in the acquisition, ownership, vesting, exercise, termination or disposition of an award under the 2007 Incentive Plan or shares of Argyle common stock issued pursuant thereto.

 

A participant generally does not recognize taxable income upon the grant of an NQSO or an ISO. Upon the exercise of an NQSO, the participant generally recognizes ordinary income in an amount equal to the excess, if any, of the fair market value of the shares acquired on the date of exercise over the exercise price thereunder, and Argyle will generally be entitled to a deduction for such amount at that time. If the participant later sells shares acquired pursuant to the exercise of an NQSO, the participant generally recognizes a long-term or a short-term capital gain or loss, depending on the period for which the shares were held. A long-term capital gain is generally subject to more favorable tax treatment than ordinary income or a short-term capital gain. The deductibility of capital losses is subject to certain limitations.

 

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Upon the exercise of an ISO, the participant generally does not recognize taxable income. If the participant disposes of the shares acquired pursuant to the exercise of an ISO more than two years after the date of grant and more than one year after the transfer of the shares to the participant, the participant generally recognizes a long-term capital gain or loss, and Argyle is not entitled to a deduction. However, if the participant disposes of such shares prior to the end of the required holding period, all or a portion of the gain is treated as ordinary income, and Argyle is generally entitled to deduct such amount.

 

In addition to the tax consequences described above, a participant may be subject to the alternative minimum tax, which is payable to the extent it exceeds the participant’s regular tax. For this purpose, upon the exercise of an ISO, the excess of the fair market value of the shares over the exercise price thereunder is a preference item for purposes of the alternative minimum tax. In addition, the participant’s basis in such shares is increased by such excess for purposes of computing the gain or loss on the disposition of the shares for alternative minimum tax purposes. If a participant is required to pay an alternative minimum tax, the amount of such tax which  is attributable to deferral preferences (including any ISO adjustment) generally may be allowed as a credit against the participant’s regular tax liability (and, in certain cases, may be refunded to the participant) in subsequent years. To the extent the credit is not used, it is carried forward.

 

A participant who receives an unrestricted stock award recognizes ordinary compensation income upon receipt of the award equal to the excess, if any, of the fair market value of the shares over any amount paid by the participant for the shares, and Argyle is generally entitled to deduct such payment at such time.

 

A participant who receives a restricted stock award that is subject to a substantial risk of forfeiture and certain transfer restrictions generally recognizes ordinary compensation income at the time the restriction lapses in an amount equal to the excess, if any, of the fair market value of the stock at such time over any amount paid by the participant for the shares. Alternatively, the participant may elect to be taxed upon receipt of the restricted stock based on the value of the shares at the time of grant. Argyle is generally entitled to a deduction at the same time as ordinary compensation income is required to be included by the participant and in the same amount. Dividends received with respect to such restricted stock are generally treated as compensation, unless the participant elects to be taxed on the receipt (rather than the vestings) of the restricted stock. Other restricted stock awards are taxed in the same manner as an unrestricted stock award.

 

A participant generally does not recognize income upon the grant of an SAR. The participant has ordinary compensation income upon exercise of the SAR equal to the increase in the value of the underlying shares, and Argyle will generally be entitled to a deduction for such amount.

 

A participant generally does not recognize income for a performance unit award, a performance share award or a distribution equivalent right award until payments are received. At such time, the participant recognizes ordinary compensation income equal the amount of any cash payments and the fair market value of any Argyle common stock received, and Argyle is generally entitled to deduct such amount at such time.

Conclusion of Argyle’s Board of Directors. After careful consideration of all relevant factors, Argyle’s Board of Directors has determined that the proposal to adopt the 2007 Omnibus Securities and Incentive Plan is in the best interests of Argyle and its stockholders. Argyle’s Board of Directors has approved and declared advisable the proposal and recommends that you vote or give instructions to vote “FOR” the proposal.

 

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PROPOSAL TO CHANGE NAME TO ARGYLE SECURITY, INC.

 

Pursuant to the merger agreement, Argyle proposes to amend its Second Amended and Restated Certificate of Incorporation to change its corporate name from Argyle Security Acquisition Corporation to Argyle Security, Inc. upon consummation of the merger. If the merger proposal is not approved, the name change amendment will not be presented at the meeting. In addition, if the merger is not subsequently consummated, Argyle’s Board of Directors will not effect the name change.

 

In the judgment of Argyle’s Board of Directors, if the acquisition is consummated, the change of Argyle’s corporate name is desirable to reflect the fact that Argyle would then be an operating business. A copy of the amended and restated certificate of incorporation as it would be filed if the proposal to change Argyle’s name and to amend Argyle’s certificate of incorporation (pursuant to the immediately subsequent proposal) is attached to this proxy statement/prospectus as Annex C.

 

Stockholders will not be required to exchange outstanding stock certificates for new stock certificates if the amendment is adopted.

 

Conclusion of Argyle’s Board of Directors. After careful consideration of all relevant factors, Argyle’s Board of Directors determined that the proposal to amend Argyle’s Second Amended and Restated Certificate of Incorporation to change Argyle’s name to Argyle Security, Inc. is in the best interests of Argyle and its stockholders. The Board of Directors has approved and declared the proposal advisable and recommends that you vote or give instructions to vote “FOR” the approval of the name change.

PROPOSAL TO AMEND ARGYLE’S CERTIFICATE OF INCORPORATION TO REMOVE CERTAIN PROVISIONS THAT WOULD NO LONGER BE APPLICABLE TO ARGYLE

Argyle proposes to amend its Second Amended and Restated Certificate of Incorporation to remove those provisions of Argyle’s Second Amended and Restated Certificate of Incorporation that will no longer be operative upon consummation of the merger (which constitutes a business combination for purposes of Argyle’s Second Amended and Restated Certificate of Incorporation), but which were applicable at the time of Argyle’s formation as a blank-check company. In order to accomplish this, the text of Article Sixth except for the text of paragraph (E) will be deleted in its entirety. If the merger proposal is not approved, this proposal will not be presented at the meeting. In addition, if the merger is not subsequently consummated, Argyle’s Board of Directors will not effect this amendment to Argyle’s Second Amended and Restated Certificate of Incorporation.

Article Sixth of Argyle’s certificate of incorporation currently reads as follows:

“The following provisions (A) through (E) shall apply during the period commencing upon the filing of this Certificate of Incorporation and terminating upon the consummation of any “Business Combination,” and may not be amended during the “Target Business Acquisition Period.” A “Business Combination” shall mean the acquisition by the Corporation, whether by merger, capital stock exchange, asset or stock acquisition or other similar type of transaction, of an operating business (“Target Business”). The “Target Business Acquisition Period” shall mean the period from the effectiveness of the registration statement filed in connection with the Corporation’s initial public offering of securities (“IPO”) up to and including the first to occur of (a) a Business Combination or (b) the Termination Date (defined below).

(A)  Prior to the consummation of any Business Combination, the Corporation shall submit such Business Combination to its stockholders for approval regardless of whether the Business Combination is of a type which normally would require such stockholder approval under the GCL. In the event that a majority of the shares cast at the meeting to approve the Business Combination are voted for the approval of such Business Combination, the Corporation shall be authorized to consummate the Business Combination; provided that the Corporation shall not consummate any Business Combination if the holders of 20% or more of the Transaction Shares (as defined below) exercise their redemption rights described in paragraph B below.

 

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(B)  In the event that a Business Combination is approved in accordance with the above paragraph (A) and is consummated by the Corporation, any stockholder of the Corporation holding shares of Common Stock issued in the IPO (the “IPO Shares”) who voted against the Business Combination may, contemporaneous with such vote, demand that the Corporation redeem his IPO Shares into cash. If so demanded, the Corporation shall, promptly after consummation of the Business Combination, redeem such shares into cash at a per share redemption price equal to the quotient determined by dividing (i) the amount in the Trust Fund applicable to the net proceeds from the sale of the Transaction Shares (as defined below), inclusive of any interest thereon (exclusive of taxes payable and interest released to the Corporation used to fund the Corporation’s working capital), calculated as of two business days prior to the consummation of the Business Combination, by (ii) the total number of IPO Shares. “Transaction Shares” shall mean the IPO Shares, together with any shares of Common Stock issued by the Corporation in a private placement either concurrently with or within four business days prior to the IPO (the “Placement Shares”). “Trust Fund” shall mean the trust account established by the Corporation at the consummation of its IPO and into which, among other funds, a certain amount of the net proceeds of the IPO is deposited.

 

(C)  In the event that the Corporation does not consummate a Business Combination by the later of (i) 18 months after the consummation of the IPO or (ii) 24 months after the consummation of the IPO in the event that either a letter of intent, an agreement in principle or a definitive agreement to complete a Business Combination was executed but was not consummated within such 18 month period (such later date being referred to as the “Termination Date”), the officers of the Corporation shall take all such action necessary to dissolve and liquidate the Corporation as soon as reasonably practicable. In the event that the Corporation is so dissolved and liquidated, only the holders of IPO Shares shall be entitled to receive liquidating distributions and the Corporation shall pay no liquidating distributions with respect to any other shares of capital stock of the Corporation.

 

(D)  A holder of IPO Shares shall be entitled to receive distributions from the Trust Fund only in the event of a liquidation of the Corporation and/or the Trust Fund or in the event he demands redemption of his shares in accordance with paragraph (B), above. In no other circumstances shall a holder of IPO Shares have any right or interest of any kind in or to the Trust Fund. A holder of Placement Shares shall not have any right or interest of any kind in or to the Trust Fund.

(E)  The Board of Directors shall be divided into three classes: Class A, Class B and Class C. The number of directors in each class shall be as nearly equal as possible. At the first election of directors by the incorporator, the incorporator shall elect a Class C director for a term expiring at the Corporation’s third Annual Meeting of Stockholders. The Class C director shall then elect additional Class A, Class B and Class C directors. The directors in Class A shall be elected for a term expiring at the first Annual Meeting of Stockholders, the directors in Class B shall be elected for a term expiring at the second Annual Meeting of Stockholders and the directors in Class C shall be elected for a term expiring at the third Annual Meeting of Stockholders. Commencing at the first Annual Meeting of Stockholders, and at each annual meeting thereafter, directors elected to succeed those directors whose terms expire shall be elected for a term of office to expire at the third succeeding annual meeting of stockholders after their election. Except as the GCL may otherwise require, in the interim between annual meetings of stockholders or special meetings of stockholders called for the election of directors and/or the removal of one or more directors and the filling of any vacancy in that connection, newly created directorships and any vacancies in the Board of Directors, including unfilled vacancies resulting from the removal of directors for cause, may be filled by the vote of a majority of the remaining directors then in office, although less than a quorum (as defined in the Corporation’s Bylaws), or by the sole remaining director. All directors shall hold office until the expiration of their respective terms of office and until their successors shall have been elected and qualified. A director elected to fill a vacancy resulting from the death, resignation or removal of a director shall serve for the remainder of the full term of the director whose death, resignation or removal shall have created such vacancy and until his successor shall have been elected and qualified.”

 

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If this proposal is approved by stockholders, Article Sixth will read in its entirety as follows:

“The Board of Directors shall be divided into three classes: Class A, Class B and Class C. The number of directors in each class shall be as nearly equal as possible. At the first election of directors by the incorporator, the incorporator shall elect a Class C director for a term expiring at the Corporation’s third Annual Meeting of Stockholders. The Class C director shall then elect additional Class A, Class B and Class C directors. The directors in Class A shall be elected for a term expiring at the first Annual Meeting of Stockholders, the directors in Class B shall be elected for a term expiring at the second Annual Meeting of Stockholders and the directors in Class C shall be elected for a term expiring at the third Annual Meeting of Stockholders. Commencing at the first Annual Meeting of Stockholders, and at each annual meeting thereafter, directors elected to succeed those directors whose terms expire shall be elected for a term of office to expire at the third succeeding annual meeting of stockholders after their election. Except as the GCL may otherwise require, in the interim between annual meetings of stockholders or special meetings of stockholders called for the election of directors and/or the removal of one or more directors and the filling of any vacancy in that connection, newly created directorships and any vacancies in the Board of Directors, including unfilled vacancies resulting from the removal of directors for cause, may be filled by the vote of a majority of the remaining directors then in office, although less than a quorum (as defined in the Corporation’s Bylaws), or by the sole remaining director. All directors shall hold office until the expiration of their respective terms of office and until their successors shall have been elected and qualified. A director elected to fill a vacancy resulting from the death, resignation or removal of a director shall serve for the remainder of the full term of the director whose death, resignation or removal shall have created such vacancy and until his successor shall have been elected and qualified.”

 

In the judgment of Argyle’s Board of Directors, if the acquisition is consummated, the amendment to Argyle’s Second Amended and Restated Certificate of Incorporation to remove those provisions of Argyle’s Second Amended and Restated Certificate of Incorporation that will no longer be operative upon consummation of the merger is desirable to reflect the fact that Argyle would then be an operating business. A copy of the amended and restated certificate of incorporation as it would be filed if the proposal to amend Argyle’s certificate of incorporation and to change Argyle’s name (pursuant to the immediately preceding proposal) is attached to this proxy statement/prospectus  as Annex C.

 

Conclusion of Argyle’s Board of Directors. After careful consideration of all relevant factors, Argyle’s Board of Directors determined that the proposal to amend Argyle’s certificate of incorporation is in the best interests of Argyle and its stockholders. The Board of Directors has approved and declared the proposal advisable and recommends that you vote or give instructions to vote “FOR” the approval of the amendments to Article Sixth which remove certain paragraphs that were applicable to Argyle only until such time as Argyle consummated a business combination.

PROPOSAL TO ADJOURN OR POSTPONE THE SPECIAL MEETING FOR THE PURPOSE OF SOLICITING ADDITIONAL PROXIES 

 

This proposal allows Argyle’s Board of Directors to submit a proposal to adjourn the special meeting to a later date or dates, if necessary, to permit further solicitation of proxies in the event there are not sufficient votes at the time of the special meeting to approve the proposed merger.

 

If this proposal is not approved by Argyle’s stockholders, its Board of Directors may not be able to adjourn the special meeting to a later date in the event there are not sufficient votes at the time of the special meeting to approve the proposed merger.

 

Conclusion of Argyle’s Board of Directors. After careful consideration of all relevant factors, Argyle’s Board of Directors determined that the proposal to allow adjournment or postponement of the special meeting for the purpose of soliciting additional proxies is in the best interests of Argyle and its stockholders. The Board of Directors has approved and declared the proposal advisable and recommends that you vote or give instructions to vote “FOR” the proposal.

 

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INFORMATION ABOUT ISI

 

ISI’s History and Current Business

 

ISI is the parent company of several subsidiaries, including three solution providers in the physical security industry: ISI Detention Contracting (referred to as ISI-Detention), Metroplex Control Systems (referred to as MCS-Detention), and Metroplex Fire and Security Alarms (referred to as MCS-Commercial).

 

1.

ISI-Detention designs, engineers, supplies, installs, and maintains a full array of detention systems and equipment, targeting correctional facilities throughout the United States. The product line for ISI-Detention primarily includes detention hardware (prison bars, locks and locking systems), security glass, security furniture (metal furniture), detention grade hollow metal doors, frames and windows, and labor to install these items. All of these items are purchased from third party vendors and sold through ISI-Detention to its customer. ISI-Detention does not manufacture the hardware installed as part of its security solutions. All of these products are sold to contractors that are building, expanding or renovating a jail or prison, or they are sold to the owner (governmental or private entity) of a jail or prison that is being built, expanded or renovated. In either situation, these products are installed in city lockups, county jails, state prisons or federal prisons. At the beginning of a project (the design phase), ISI-Detention will help design the project by writing specifications, developing schedules (detailed lists) of doors, windows, door hardware and glazing for the customer. The design process provides all the vendors and contractors with a clear outline of what is needed for the project, without drawing every detailed plan that will be needed for construction. This provides the customer with a detailed list of the precise items that ISI-Detention will supply to the customer, and the cost for those items. To determine the pricing of a project, ISI-Detention will obtain the design drawings of the project in question and determine the precise quantity of each item needed for the project. (For example, a list will be prepared showing exactly how many left-swinging 3 ft x 7 ft doors and frames, as well as how many right-handed doors and frames of the same size, are required on a project. A similar list is prepared for each type of door, window, lock, hinge, light fixture, toilet and every other detention product that will be required in the project.) ISI-Detention provides these lists of required items to the appropriate vendors. Some vendors perform their own quantity determinations (“take-offs”) rather than relying upon the take-offs prepared by ISI-Detention. The vendor then provides ISI-Detention with the price for the items required. Once all the costs are received from vendors, and ISI-Detention determines the cost of the services that it will provide, ISI-Detention then adds profit and overhead, depending on many factors, including but not limited to what other competitors are known to be bidding on the project, local labor and other conditions, size of the project, complexity of the project, schedule for completion, etc. ISI-Detention then determines a sales price. This price is given to ISI-Detention’s customer. That customer may be a general contractor, a sub-contractor or the owner of the project – a city, county, state or federal agency.   In many cases, ISI is part of a team that prepares a bid. This team works together to create a total construction bid. The head of the team is usually a general contractor or private prison operator. Typically, ISI is invited to be part of this team because of a repeat customer relationship. This allows ISI the ability to negotiate this work with its repeat customers. The team then competes for the contract as a group. This type of repeat customer relationship allows ISI the ability to negotiate most of the work sold to repeat customers. Most governmental agencies require that their significant contracts be competitively bid. Typically they utilize the “Request for Proposal” (RFP) method where several competitors submit their sealed proposals for a particular project, or the “Request for Qualifications” (RFQ) process where competitors submit their qualifications for consideration by the customer. Some contracts are let upon the standard “Straight Bid” process where the detailed plans and specifications for a project are published and contractors submit a “Bid” or fixed price, for the contract to build the project. Other competitive bidding processes may also be utilized, such as the Construction Manager at Risk model, where a Construction Manager is hired for a fee to build the project for a fixed price, or “cost plus profit and overhead” basis. When ISI-Detention responds to an RFP, RFQ, Straight Bid, or other competitive bidding process, it typically provides the response to a general contractor (where ISI-Detention is one of several subcontractors in different disciplines providing prices) or directly to the owner (governmental agency or private entity) of a correctional project. The quality of ISI-Detention’s estimating process, knowledge of the industry, knowledge of its customers and other issues requiring significant judgment and expertise are key factors in determining whether ISI-Detention will ‘win’ the competitive bid process and be offered the contract for the project. When the customer sends ISI-Detention a contract, it contains typical construction contract terms and conditions, such as provision for retainage, certification of completion for progress payments, fixed markup on change orders, coordination responsibility, and similar provisions. Most contracts allow for progress payments on a monthly basis, and most contracts are fixed price. Progress payments and retainage provisions control the amount and timing of payments to ISI-Detention. For example, upon execution of a contract, an agreed upon mobilization payment may be paid to ISI-Detention. Thereafter, each month ISI-Detention certifies to the customer the percentage of the total work that has been completed through the preceding month. A third party (typically an architect) also provides the owner of the project with a certification of the percentage of completion. If the third party agrees with ISI-Detention’s certification of its percentage of completion, then ISI-Detention is entitled to receive that percentage of the entire contract amount, less the amount of retainage (typically 5% to 10%). (For example, if ISI-Detention claims that 60% of its work under its contract has been completed, then ISI-Detention is entitled to be paid 60% of the contract amount, less the retainage amount). At the conclusion of the project, assuming no other changes or charges, ISI-Detention should have been paid the full contract amount less the retainage. When the owner of the project, ISI-Detention’s customer and the third party have all certified that the project is complete and that all sub-contractors of ISI-Detention have been paid or other appropriate documentation provided, the retainage amount is paid to ISI-Detention. After a project is sold and ISI-Detention receives a contract, ISI prepares engineering drawings and schedules or lists creating more detail and information than in the design phase, which takes place early on in the development of a project. During the construction phase of the project, ISI orders materials from vendors and arranges for those materials to be shipped to the project site. Typically, ISI-Detention sends its employees to the job site to install this equipment. ISI-Detention’s projects usually take 9 to 14 months; some larger projects may run longer. From time to time, ISI-Detention’s customers require that ISI-Detention provide not only the detention equipment but the security electronics as well. When this occurs, ISI-Detention uses MCS-Detention (a wholly-owned subsidiary of ISI) to provide the security electronics as a subcontractor to ISI-Detention. The price for the detention equipment and the price for the security electronics (closed circuit television, infra-red alarms, access control systems, etc.) are combined together and submitted by ISI-Detention to its customer as a package price.

 

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2.

MCS-Detention’s expertise lies in designing, engineering, supplying, installing and maintaining complex, customized security, access control, video and electronic security control system solutions at correctional and governmental facilities. MCS-Detention provides electronic security systems for correctional facilities. MCS-Detention develops electronic security systems for its customers using door controls, intercoms, closed circuit television (CCTV) and other low voltage electronic security systems that can all be controlled from one location at one console. MCS-Detention does not manufacture the hardware installed as part of its security solutions. Many solutions are simultaneously provided for the customer because MCS-Detention determines the needs of its customer and puts systems together (from many different manufacturers) to fit those needs. More importantly, MCS-Detention can integrate the operation of those varied systems so that they work together without conflict. Because of the complexity of the systems involved, MCS-Detention regularly designs the security electronic systems and prepares the drawings for architects and engineers. This complex design work involves coordination of wiring and conduit on a project, developing the requirements for local control and satellite control stations. MCS-Detention maintains its sales force in San Antonio, Texas and in Indianapolis, Indiana. Sales are pursued nationwide from those locations. MCS-Detention estimates the cost and pricing of a project in a process that is similar to that of ISI-Detention. MCS-Detention will review the design drawings and written specifications, to create the same “take-offs,” or lists, of products and materials that are required on a project. MCS-Detention will then distribute the lists to vendors, receive the vendors’ bids on their respective portions of the project, and then MCS-Detention will calculate the costs to furnish and install the products required. MCS-Detention then adds profit and overhead to its calculations and determines the final price for the customer. In determining the final price, MCS-Detention uses the same subjective criteria that ISI-Detention uses. The contracts that MCS-Detention secures are subject to similar competitive bidding processes as are the contracts entered into by ISI-Detention. All products supplied by MCS-Detention are purchased from third party vendors, assembled and prepared by MCS-Detention, and then sold by MCS-Detention to its customer. Typically, all MCS-Detention systems are installed and tested by MCS personnel. The terms of the contracts MCS-Detention enters into with its customers, are similar to the types of contracts entered into by ISI-Detention. The types of customers that are served by MCS-Detention are the same types of customers that are served by ISI-Detention. The electronic security products of MCS-Detention are linked into an integrated system using applications software developed and provided by MCS-Detention.

 

3.

MCS-Commercial designs, engineers, supplies, installs, and maintains professional security, access control, video and fire alarm system solutions for large commercial customers. MCS-Commercial supplies security electronic products to end-users and contractors. These products include, access control systems, fire alarms, video, CCTV, sound paging systems and structured cabling. In contrast to ISI-Detention and MCS-Detention, which sell their products to the corrections industry for jails and prisons, MCS-Commercial typically sells its products to contractors that are building or renovating commercial projects, or owners of commercial properties. MCS-Commercial does not manufacture the hardware installed as part of its security solutions. Although the products of MCS-Commercial and MCS-Detention are similar in many respects (access control systems, CCTV, etc.), MCS-Commercial sells products only to commercial customers for commercial projects. MCS-Commercial maintains sales personnel in Dallas, San Antonio, Austin and Houston, Texas as well as in Denver, Colorado. Each sales person is responsible for selling MCS-Commercial products in his or her respective geographical area. The process of estimating and pricing projects for MCS-Commercial is substantially the same process used by ISI-Detention and MCS-Detention. Additionally, MCS-Commercial enters into contracts that are similar, if not identical, in terms and conditions to the contracts entered into by ISI-Detention and MCS-Detention. The contracts that MCS-Commercial secures are generally subject to the same competitive bidding processes as are the contracts entered into by ISI-Detention and MCS-Detention. MCS-Commercial buys and resells all its products to its customers. Installation is performed by MCS-Commercial employees and also by subcontractors.

 

The costs incurred by ISI for research and development are not material. The rights to the third party software utilized by ISI are also not material. ISI secured an indefinite license to utilize the third-party software. The purpose of the third-party software is to provide shortcuts in the ISI software, and eliminate the need for ISI to develop rudimentary programs (such as clocks, timers, counters, etc.). ISI’s proprietary software is configured around these third-party programs, and works with these programs. The third-party software used as a component of ISI software in creating solutions for the security needs of customers is not sold or licensed to customers.

When a computer is utilized in the solution of a client’s security needs, ISI will provide the computer to the customer with all required software pre-loaded. The license for the required software is purchased by ISI and conveyed to the customer with the computer.

 

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ISI has made a concerted effort to become the total solutions provider of security and detention for the corrections design/build market. In the security industry, a “total solutions provider” means that a vendor has the ability to design customized solutions for a wide range of security needs, and provide all of the hardware and software for those solutions, rather than designing a wide array of solutions, but only actually fulfilling the design in one or two areas. If a customer selects a series of security vendors, each providing a separate and independent system that addresses only a limited security need, then the numerous systems required to provide overall security can cause many unanticipated problems in operations, maintenance, and upgrades. ISI, as a “total solutions provider,” can provide its customers with one source for a wide range of security solutions that are tested and proven to work together.

 

ISI’s operating units provide a range of products as well as value-added services such as design assistance to architects, engineers and owners through writing specifications, providing CAD documents, equipment selection and vendor recommendation. The breadth of its offerings has enabled ISI to establish a leadership position in the design/build corrections market; in turn, this recognized expertise in providing customized, high-level solutions to the most demanding of customers has allowed ISI to acquire projects in other security-sensitive sectors, such as the healthcare industry, water treatment plants, federal courthouses and upscale private commercial buildings.

 

Through ISI’s design assistance and performance, ISI develops relationships that make repeat business with customers more likely. For example, more than 60% of the revenue for ISI-Detention and MCS-Detention during 2004, 2005, and 2006 has been the result of contracts with repeat customers. These repeat customers typically allow ISI to negotiate the work, especially on design-build projects. Design-build projects are contracts where ISI provides substantial design assistance to its customers.

Acquisitions

ISI has completed several acquisitions since 2000. Each of the businesses and the targeted personnel has been successfully assimilated into ISI’ operations. A summary of these transactions follows:

·

In 2000, ISI purchased the assets of Metroplex Control Systems, for a purchase price of $2.5 million. ISI assumed the obligation to perform an existing backlog of work for the pricing that had been estimated by others and convinced many of the key employees to move to San Antonio to integrate the corrections systems electronics business of the target with the corrections work of ISI already being done in San Antonio.

·

In 2002, ISI purchased certain service centers in Dallas, Texas and Denver, Colorado from Edwards System Technology for a purchase price of $564,764.88. The business acquired in Denver was integrated into the existing Denver operations, and the business acquired in Dallas was merged into the existing Dallas office.

·

In 2003, ISI purchased the assets of KMC/TL Services, LLC in Austin, Texas in consideration for the assumption of the obligation to complete the projects in the backlog of KMC. No additional cash consideration was paid to KMC. The business was converted into an office for MCS. The key risk in this transaction was the existing backlog of contracts, which was known to have difficulties and thin, if any, profit remaining in the completion of those contracts. ISI completed the troubled contracts, some at a loss, in order to acquire the repeat business from these customers, while establishing an office in Austin, Texas.

·	In November 2004, ISI purchased the assets of  Community Technical Solutions, Inc. for $350,000. The operations were successfully merged into the Denver office and the key employee of the business integrated into ISI’s operations.

·

In November 2005, ISI purchased the assets of Instant Photo, Inc. for $750,000. In this acquisition, ISI assumed certain troubled contracts held by unsatisfied, but potentially very good customers. ISI merged the acquired Dallas operations into its existing Dallas office, expanded its existing Austin operations with the acquired Austin business, and the acquired office in Houston, Texas gave ISI its first presence in that market. ISI focused its efforts on service to the disgruntled IPI customers and has completed this acquisition successfully.

 

Customers

ISI’s diverse customer base consists primarily of contractors, construction companies and architects catering to publicly and privately run detention facilities and commercial construction. For fiscal 2005, ISI generated 8% of its revenue from its top customer, 16% from the top two and 21% from the top three. For fiscal 2005, ISI’s largest client was Kelso/Gillbane, representing $3.3 million of revenues. Other large clients represented 8%, 5% and 4% of revenues in fiscal 2005, respectively.

 

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Competition

 

The security services industry is a large and competitive market. ISI competes for contracts based on its strong client relationships, successful past performance record, significant technical expertise and specialized knowledge. It often competes against defense contractors, as well as specialized information technology consulting and outsourcing firms. ISI-Detention’s competitors include Norment Security Group (part of Compudyne), Cornerstone Detention Products, Sierra Steel, CCC Group, G-S Company, and Pauly Jail Building Company.

 

There are also several smaller regional companies that compete with ISI-Detention. MCS-Detention’s competitors for its hardware/software solutions include: Norment Security Group, Stanley Integrator (part of Stanley Works), ESi Companies, Southwest Communications, and Accurate Controls. MCS-Commercial faces a much broader array of competitors such as: Koetter, Siemens, DSS, Fire Alarm Services, Fire Alarm Control Services, Tyco, Chubb and Lone Star. Management does not expect competition in any of the sectors to decline in the foreseeable future.

 

Employees

 

As of October 31, 2006, ISI had 249 full-time employees. Future success will depend significantly on ISI’s ability to attract, retain and motivate qualified personnel. ISI is not a party to any collective bargaining agreement, has not experienced any strikes or work stoppages and considers its relationship with its employees to be satisfactory.

Health and Dental Insurance

ISI has a self-insured Health and Dental Insurance Plan that allows ISI to insure for a maximum cost (generally not exceeding what can be paid to a third-party insurance company), but also get the financial benefit of the medical expenses incurred if such expenses do not reach this maximum. For example, in 2004 the maximum aggregate stop loss was $880,250; the company only incurred expenses of $566,704. Since the maximum stop loss amount is the amount that ISI would have had to pay to a third-party to provide identical coverages, the difference between the maximum stop loss and the actual costs incurred represented costs savings to ISI. This self-insurance plan, in general, allows the company to get the benefits of lower medical costs without being at risk for excessive medical costs.

In addition to the aggregate insurance, ISI also obtains individual stop loss insurance. This insurance pays if any individual exceeds spending of $65,000 per year. This additional insurance, when blended with the aggregate stop loss, allows ISI to provide good health care to its employees with a known medical expense, but leaves the potential for savings if expenses do not reach the maximum.

 

Self-insured health and dental insurance plan

		December 31,
		2004			2005
Insurance Coverage
Individual Stop Loss			65,000			65,000
Aggregate Stop Loss			880,250			857,359
Payments
Third Party Administrator (1)			184,594			199,762
Claims Paid			566,704			829,675
Accruals
Incurred But Not Reported			147,840			126,111

 

Note 1: The payments to Third Party Administrator covered the cost of both aggregate and individual stop loss coverage along with the cost of administering the plan.

 

Facilities

 

ISI’s corporate headquarters, where all corporate functions are housed, is located at 12903 Delivery Drive in San Antonio, Texas. These facilities of approximately 16,000 square feet also house the headquarters for ISI-Detention and MCS-Detention. The headquarters for MCS-Commercial and the San Antonio Regional Office of MCS-Commercial are located in a leased building of approximately 8,000 square feet at 12918 Delivery Drive in San Antonio, Texas, across the street from the ISI corporate headquarters. These two buildings, comprising approximately 24,000 square feet, are leased by ISI for approximately $16,667 per month. MCS-Detention occupies an additional building located at 12902 Flagship in San Antonio, Texas, of approximately 7,000 square feet, for approximately $7,000 per month. MCS-Commercial also conducts operations in Austin, Dallas and Houston, Texas, and Denver, Colorado. The Austin facilities are located at 8711 Burnett Road, Suite D-40, Austin, Texas, 78757 and are comprised of 400 square feet of warehouse space, 800 square feet of office space for combined square footage of 1200 square feet, at a current monthly cost to ISI of $960.00. MCS-Commercial conducts its operations in these offices. The Dallas facilities are located at 2472 Southwell Road, Dallas, Texas, 75229, and are comprised of 650 square feet of warehouse space, 14,350 square feet of office space, for a combined square footage of 15,000 square feet, at a current monthly cost to ISI of $5,000.00. The Denver facilities are located at 7388 South Revere Parkway, Unit 603, Centennial CO, 80112, Denver, Colorado, comprised of 1,100 square feet of warehouse space and 6,680 square feet of office space, for a combined square footage of 7,780 square feet, at a current monthly cost to ISI of $4,250.71. The Houston facilities, as of December 27, 2006, will be located at 10624 Rockley Road, Houston, Texas, 77009, and are comprised of 900 square feet of warehouse space, 4,328 square feet of office space for combined square footage of 5,228 square feet, at a monthly cost to ISI, commencing on April 1, 2007, of $3,398.20. No rental is due for the period of December 27, 2006 to March 31, 2007. The current lease for office space for the Houston facilities was acquired in a 2005 acquisition, and was scheduled to terminate by its own terms on December 31, 2006. The move to new facilities in Houston is not a material event for ISI.

The following facilities are leased from Green Wing Management, Ltd., an entity owned and controlled by Sam Youngblood and Don Carr:

·	12903 Delivery Dr., San Antonio, Texas

·	12918 Delivery Dr., San Antonio, Texas

·	12902 Flagship Dr., San Antonio, Texas

The Merger Agreement between ISI and Argyle requires that the leases on these properties be amended to reflect a term of 12 years from the closing of the merger, and also requires that an appraisal be completed by a qualified appraiser to determine the market rate of the leases on these three properties. The Merger Agreement requires that the rental rate to be paid on these properties be limited to no more than 90% of the market rate determined by the third-party appraiser. Additional appraisals by a third-party appraiser are to be conducted every three years during the 12 year terms, pursuant to the Merger Agreement, and the annual lease rate in the leases can increase at the time of these appraisals, but only to a level that does not to exceed 90% of the market rate determined by the third-party appraiser.

Pursuant to the Merger Agreement, Argyle has the right to purchase these three properties at any time, at the then current market value; however, the purchase price cannot be less than the value determined in the last appraisal preceding the effective date of the closing.

 

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Legal Proceedings

 

ISI and its subsidiaries are not presently subject to any material litigation, and management is not aware of any threatened material litigation. ISI is a party to routine litigation and administration proceedings that arise from time to time in the ordinary course of business, none of which, individually or in the aggregate, is expected to have a material effect on ISI’s financial situation or ability to operate.

 

ISI-Detention

 

ISI-Detention’s management has been involved in furnishing and installing detention equipment in more than 1,600 correctional facilities since the company’s inception in 1976. Its expertise and track record position ISI-Detention favorably among the nation’s leading providers of products and solutions for correctional facilities. Its custom-designed systems meet local standards and are in full compliance with the applicable standards of the American Correctional Association, a voluntary organization whose standards for correctional facility design, operation and construction are the recognized industry benchmark for quality and safety.

 

ISI-Detention offers a complete array of electronic security system solutions revolving around electronic locking systems and hardware, security doors and frames, jail furniture, security glazing and other security-based systems. Whether acting as prime contractor or as a subcontractor for projects spanning all levels of security. More than 60% of the revenue for ISI-Detention and MCS-Detention during 2004, 2005, and 2006 has been the result of contracts with repeat customers.

 

ISI-Detention’s product offerings include security locking systems, security hollow metal doors and wall panels, security windows, security glass and glazing, security furnishings and accessories, design support and full installation capabilities.

 

Beginning in the design phase, ISI-Detention works with architects, engineers and contractors to help design and develop plans and specifications for a given correctional facility. During this stage of development, ISI-Detention writes specifications for specific locking systems, analyzes particular conditions and requirements and recommends products that correspond to the needs of that correctional facility, depending on the type of security that is required and the underlying budget.

 

In many cases, ISI negotiates the contract with a repeat customer on a team approach (as described on page 54).

 

When competitive bids are solicited in connection with the construction of a correctional facility, ISI-Detention bids for the detention equipment portion of the overall project as a direct contractor or as one of the subcontractors for a general contractor. The furnished and installed package proposed by ISI-Detention typically includes security locking systems and hardware, security hollow metal (doors and frames), detention furniture (tables, bunks, benches, mirrors, etc.), security electronic controls (closed circuit television, intercom, etc.) and security glass and glazing. By providing this complete package furnished and installed, ISI-Detention is able to provide a warranty program and insure that all the pieces and components are fully integrated and inter-operate correctly.

ISI-Detention’s typical warranty is a limited warranty of one year and is provided in more than 95% of the contracts entered into. This warranty provides for repair or replacement of defective materials or workmanship, if a failure occurs within one year of installation of the product. In very limited circumstances, ISI-Detention will provide an extended warranty of two years (with the same repair and replacement obligations as the one year warranty) when it is demanded by a significant customer or is otherwise required to secure a contract. In even more limited circumstances, an extended warranty of three years (with the same repair and replacement obligations as the one year warranty) will be provided.

The aggregate cost of fulfilling ISI Detention’s warranty obligations on completed contracts in 2005 and 2006 has been less than $150,000 for those years combined, and there have been no claims asserted by customers or users of ISI’s products that are outside the normal scope of warranty work required. Additionally, since all of the products sold by ISI are manufactured by others, the ultimate burden for warranty of those items is passed on to the manufacturers by ISI.

MCS-Detention and MCS-Commercial

 

Metroplex Control Systems (or MCS) was formed in 1988 in Dallas and was subsequently acquired by ISI in 2000. After the acquisition, MCS was restructured into two separate subsidiary entities (each under its own management): MCS-Detention and MCS-Commercial. MCS-Detention shares its headquarters with ISI and also has a neighboring 7,000 square foot facility. MCS-Commercial currently operates out of its own San Antonio headquarters and five regional offices. The offices in Austin, Houston and Denver resulted from acquisitions made by ISI. The operations in Dallas and Denver were enhanced and complemented by the acquisition of several Edwards System Technology centers.

 

MCS-Detention specializes in turnkey installations for public and privately owned/operated detention facilities. MCS-Commercial has built a parallel business targeting commercial and industrial facilities.

 

MCS-Detention designs, manufactures, supplies, installs and maintains access control, video and integrated electronic control systems for correctional and government facilities throughout the United States. It also provides the above goods and services to detention market integrators, electrical contractors and competitors that lack their own in-house electronic solutions.

 

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MCS Products and Solutions

 

MCS-Detention and MCS-Commercial offer turnkey installations, using components which cover the full spectrum of electronic security and low voltage systems. Included in their offerings are access control, closed circuit television (including cameras, camera management and video image mass storage), detention control, fire alarm, intercom, perimeter protection, sound/paging, video visitation and other custom designed systems. Experience in planning, installation and service, combined with state-of-the-art equipment, provides MCS-Detention and MCS-Commercial with a distinct advantage in marketing and developing customized solutions for clients.

 

MCS-Detention and MCS-Commercial utilize programming and testing tools that are proprietary, which they believe provide faster and better solutions, installation, and updates than the competition.

The products and services of MCS-Detention and MCS-Commercial provide solutions for the combination and integration of disparate security systems, including a software suite called TotalWerks, user-friendly touch screens, PDA wireless control/displays, hardened (against physical abuse) control panels that use Internet protocol to communicate (rather than hard wire to each controlled device), computer-based door control systems, access control systems (Internet based and third party), guard watch tour devices, perimeter protection, panic and duress systems, nurse call systems, closed circuit television (including DVRs) and fire alarm and video visitation systems.

The TotalWerks suite of software tools is proprietary and is used to create and program security solutions for customers. The TotalWerks suite is not sold to customers; it is used by MCS-Commercial and MCS-Detention to efficiently solve security problems. One of the elements of TotalWerks is the OneFab development suite that contains three programs - the OneFab application, the OneMessage Client and the OneFab simulator. These proprietary development tools allow MCS-Detention and MCS-Commercial engineering and fabrication staffs to write software for, Input/Output (I/O) simulation, point confirmation and the ability to test each I/O point before the project leaves the factory. In short, these are software applications that assist MCS-Detention and MCS-Commercial in creating sophisticated security programs quickly and accurately.

The OneFab application’s “drag and drop” interface uses custom macros (software functional modules) for different security features. These macros can be reused on different projects, thereby cutting development time by as much as 75% versus competitors’ products. These macros are all stored in a digital library and classified, and can be retrieved and re-used at will.

Typical security programming is accomplished by the completion of a complex set of sophisticated spreadsheets that compile all of the security devices in a given project with all possible uses, applications and other requirements. The spreadsheet data is then converted to an equally complex and rough computer language (“ladder-logic”) that the specialized industrial computers utilize to harmonize, operate, control and monitor the many often disparate security systems from many different manufacturers. This conversion process to ladder-logic is typically a time consuming and error-prone process. By using the macros, and other features available in the OneFab application, the spreadsheet data can be quickly converted into ladder-logic that is fully useable by industrial grade computers required for complex and sophisticated security systems.

 

MCS Markets

 

MCS has developed a strong competence in both markets it serves, detention and commercial, in large part due to its team’s expertise in particular fields of the security industry. Supported by its sophisticated engineering and software design capabilities and solutions, MCS has developed a strong reputation for technical leadership. MCS-Detention’s first project was a renovation of the Lew Sterrett Tower (County Jail) in Dallas, Texas in August of 1988.

 

MCS has been selling products and providing the services necessary to support these products for over 18 years. MCS also uses a mobile OneLink satellite van that allows the firm to establish a live connection with the system programmers anywhere in the United States. This means quicker installations, modifications and additions to the systems as needed or required. With over 900 installations nationwide, management believes that MCS has established itself as a leader in the correctional security market.

 

MCS Employees

 

MCS management’s attention to recruiting, employee retention, training and support has enhanced the company’s ability to develop increasingly advanced proprietary technological solutions while demonstrating a service-oriented culture. In addition, MCS has evolved into a widespread organization with multiple offices, a structured sales organization and demonstrable service and maintenance abilities. MCS has 207 employees, multiple offices and multiple turnkey installation crews, 7,000 square feet of onsite fabrication area and a separate quality control room.

 

Market

 

Detention Market

 

At the end of 2005, there were 2,320,359 prisoners being held in federal or state prisons or in local jails or juvenile facilities. Statistically, 1 in every 136 U.S. residents was in prison or jail in 2005. The latter was an increase of 2.7% from year end 2004. The average growth in both the prison and jail populations during the previous ten years has been approximately 3% per year. At the end of 2005, state prisons were operating between 1% below and 14% above capacity, and federal prisons were operating at 34% above capacity. As a result of this situation, some states have had to ship their excess prisoners to other states where detention facilities have some excess capacity to absorb additional prisoners. Management believes that ISI is well positioned to take advantage of the continued growth in population in detention facilities. The statistics presented above were obtained from publicly available U.S. Department of Justice Bureau of Justice Statistics Bulletins.

 

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Commercial Security Market

 

The North American electronic security market reached $23.8 billion by the end of 2005, of which 70% was in the commercial/industrial sector - MCS-Commercial’s market. The fastest growing sectors within that market are video (10% per year) and access control (8-9% per year), both areas in which MCS-Commercial competes. MCS-Commercial also competes in the fire protection area. MCS-Commercial is also able to design and provide fire alarm products and services. The fire alarm market is a potential catalyst for garnering video and access control business because of the unique licensing requirements mandated by state and local authorities which oversee an industry that is focused more on life-safety than on property protection. Many of the organizations vying for commercial/industrial business lack the fire alarm certification licensing needed to provide a total system solution. 

 

Note: The statistics presented above were obtained from documents originally published by JP. Freeman & Co., IMS Research, and The Freedonia Group, market research organizations serving the physical security industry

 

Business Strategy

 

Solutions Focus

ISI plans to focus its growth efforts on the design-build/negotiated market sector. In order to accomplish that growth, management will need to hire additional personnel. ISI’s management has slated specific positions in sales and project development that must be filled with quality people to meet this growth goal. Although no firm targets have been set, benchmarks to determine the progress will be based on the increase of the backlog of work and in new customers from new territories and markets. How successfully the plan is being executed will be determined by whether ISI is able to stay within budget, maintain its planned growth in sales and earnings and by periodically checking on new projects. New projects will be monitored to determine increased sales activity and to determine probable sales closing success rates.

ISI anticipates that focusing on growth in the design build/negotiated sector will consume the majority of ISI’s available resources. ISI is attempting to expand in this sector, because the company can add value through its design expertise that allows the company to satisfy its customers and eliminate the “bid and chase,” or competitive bidding environment, where the company is not always able to provide its higher added value services to the customer.

 

In the detention sector, concentrating on the design-build/negotiated market offers the company the following advantages applicable to the detention market customer base:

 

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Develops a customer relationship at the initiation of projects, thereby maximizing the probability of success in the sales opportunity.

 

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Limits the exposure to competition, since the project requirements can be written around unique company product capabilities.

 

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Positions the company on the “customer’s side of the table” for a consolidated team sales effort relative to the facility operator/owner.

 

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Avoids the “low bidder take all” sector of the market in which reduced margins are typical in order to position the company for better margin returns.

The greatest risks associated with ISI’s growth strategy involve the hiring of employees. ISI must try to employ high-caliber sales and management personnel with professional expertise and past real-world practical experience. If these positions are filled with non-performing or under-performing people, the company will not be able to grow as it anticipates. In addition, ISI must hire an appropriate number of persons so that its customers can be appropriately serviced, but not so many persons such that its employees are working at substantially below capacity. ISI’s failure to appropriately hire personnel could result in slower growth than anticipated, or in less profit.

 

Key Alliances

 

In the detention sector, creating, maintaining and enhancing key alliances with prime contractors involved in the development and construction of detention facilities is critical for the development of a steady and recurring revenue stream in a market that is steadily growing.

 

In the commercial sector, the focus is to develop alliances with very large and multi-site regional or national organizations that will then utilize the company’s capabilities for their security needs in growth/expansion projects and/or in many locations, so as to provide a steady and profitable revenue stream for the company.

 

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Geographic Expansion and Strategic Acquisitions

 

In both sectors of the business, the acquisition of comprehensive video development/manufacturing capability that can be tightly integrated with the company’s other products will greatly enhance the competitive posture of the company in capturing business and will also result in more of the project revenue remaining in-house for enhanced margin.

 

In the commercial sector, either acquisition of existing solution providers in some of the larger metropolitan markets in the U.S., or internal expansion to address those markets, will greatly enlarge the company’s national footprint and better enable it to service the multi-site organizations that are being sought as customers. External acquisitions will give the company access to new customers in the regions that are of interest and would give the company a running start as opposed to the slower build-up that would ensue from internal expansion.

 

Marketing Initiatives

 

ISI intends to develop a market for its integrated detention electronic security solution that is developed utilizing ISI’s proprietary software system. ISI plans to focus on two markets not significantly penetrated at this time -- the Midwest and the Northeast -- by establishing a local sales presence in these markets to sell ISI’s detention solutions to contractors and integrators there. It has enlisted the support of a very strong sales professional with a background in the detention systems market to spearhead this effort. 

 

Sales and Marketing

The ISI Sales and Marketing organization and structure can be characterized as follows:

 

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Niche target market focused sales and marketing to maximize return.

 

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Dedicated national account selling team with impressive credentials to capture larger scale and multi-site commercial security opportunities.

 

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Dedicated selling team to sell the company’s hardware/software solutions to organizations that compete with the parent but that lack their own in-house capabilities and to organizations operating in portions of the national market not currently addressed by ISI.

 

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Highly motivated and organized sales organization that is keyed to profitability, rewards excellence, and that quickly weeds out non-performers.

 

Competitive Strengths

ISI management believes that it has a number of strengths versus the organizations with which it competes:

 

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Ability to react to changing technological needs.

 

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A software platform that lends itself to very rapid adaptation to the specific requirements of individual facilities and to the use of the two major operating systems in the market-Windows and Linux, with minimal effort.

 

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A broad array of software drivers that allow the company’s solutions to utilize a wide variety of security system peripherals from many different third-party suppliers.

 

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A solid reputation in both the detention and the commercial market sectors with its customers for on-time project execution, security solution performance and customer service that results in a significant amount of repeat business being garnered. For example, more than 60% of the revenue for ISI-Detention and MCS-Detention during 2004, 2005, and 2006 has been the result of contracts with repeat customers.

 

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A number of ISI’s competitors for entire detention facilities that do not have in-house electronic system solutions purchase their electronics systems from ISI based upon their knowledge that ISI has leading edge solutions, including touchscreen and PDA wireless control for the detention industry, plus a software development process that provides timely and efficient security solutions for customers.

 

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Research and Development

 

A software development team within MCS provides the operating arms of the company with new features and capabilities in developing  security solutions.

 

Government Regulations

 

Various states within the United States require companies performing the type of work performed by ISI in detention facilities to be licensed. ISI maintains active licenses in every state in which it does do business that requires licensing. Outside of detention facilities, many states and local municipalities require companies that provide turnkey electronic security systems for commercial facilities to obtain and maintain special security licenses.

The process of obtaining specialty security licenses is bureaucratic. ISI has designated personnel to oversee the process for maintaining all the licenses for the company. Obtaining new licenses typically requires that a test be taken in that state, if it requires a state license. If a state license expires or is revoked for any reason, it could prevent ISI from being authorized to enter into a contract in that state. If a local license expires or is revoked for any reason, ISI may be assessed a fine, depending on the delinquency in regard to that license. The following is a list of the specialty licenses that ISI has secured as of December 31, 2006:

·	Alabama - Detention & Security Equipment

·	Arkansas - Sound & Intercom Systems, Fire Detection Systems, Signal & Burglar Alarm Systems, Computer Cabling

·	Arizona - Low Voltage Communication Systems

·	California - Low Voltage Systems

·	Florida - Alarm System Contractor

·	Georgia - Unrestricted Low Voltage

·	Iowa - Subcontractor

·	Idaho - Electrical Limited Energy Specialty Contractor

·	Louisiana - Electrical Controls

·	Minnesota - Technology Systems Contractor

·	Mississippi - Security, Burglar & Fire Alarms

·	Montana - Subcontractor

·	North Carolina - Low Voltage Electrical and Alarm

·	North Dakota - Subcontractor

·	Nebraska - Subcontractor

·	New Mexico - Sound, Intercommunication, Alarm System

·	Nevada - Low Voltage Systems

·	Tennessee - Electrical Controls

·	Texas - Private Security Alarm License and Fire Alarm License

·	Virginia - Electronic Communications

·	City of Arvada - Building Subcontractor

·	City of Aurora - Fire Alarm Contractor and Fire Alarm Supervisor

·	City of Boulder - Fire Alarm Systems

·	City of Broomfield - Contractor

·	City of Centennial - Business license and Access Control and Security

·	City of Colorado Springs - Fire Alarm

·	City of Denver - Access Control System and Electrical Signal

·	City of Lakewood - Contractor

·	City of Littleton - Miscellaneous

·	City of Loveland - Fire Alarm

·	City of Thornton - Contractor - Fire Alarm

·	City of Westminster - General Building Contractor

·	City of Wheat Ridge - Electrical Signal

 

ISI has and maintains its security licensing in every locale where required and where business is being conducted by the company. ISI’s management believes that the acquisition will have no material adverse affect upon the licensing of ISI or its subsidiaries.

 

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ISI MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Business Overview

 

General

ISI is one of the nation’s largest providers of detention equipment products and service solutions for private and public-sector correctional and related facilities. ISI is the parent company of several subsidiaries; however, its primary business operates through three segments that are service and solution providers in the physical security industry: ISI-Detention Contracting, or ISI-Detention; Metroplex Control Systesm, or MCS-Detention; and MCFSA, Ltd., or MCS-Commercial.

Results of Operations

Management analyzes ISI’s results of operations , by identifying those critical items that impact each segment on a standalone basis, since such items are different for each sector.  More than 85% of ISI’s revenue is generated by fixed-price contracts. The success of a fixed-price contract is based in large part upon the quality of the process utilized when estimating the costs that will be incurred in performing the contract. The larger the project and the longer the term of completion of the contract, the greater the number of variable factors there are to be considered and evaluated in estimating costs. A successful estimating process requires substantial experience and judgment. Management is aware of the significant need for experience and qualified estimating personnel and regularly monitors the estimating process and its results.

The most obvious benchmark that management considers in evaluating the estimating process is whether the amount estimated, and submitted as a bid, was reasonably similar to the amount bid by ISI’s competitors on the same project. Other bidders may bid exceptionally low (even at a loss) in order to secure a contract that the competitor may desperately need in order to maintain at least a modest level of cash flow, or for other reasons. Management must evaluate the bids that were submitted in competition with ISI’s bid, based on their knowledge of each competitor’s history and character (for example, some typically bid high, some typically bid low), the condition of the market, the complexity of the project, the type of construction and other factors. This review, conducted regularly, provides management with an ongoing general basis for evaluating the estimating process that results in fixed price contracts. Evaluating the results of bidding competitions allows management to evaluate the company’s estimating capabilities at the beginning or “front-end” of a new contract or project. Other benchmarks are used to evaluate the estimating process while a project is ongoing.

One of the key indicators in evaluating the ISI’s performance is whether the budget for the individual projects is being met. These budgets are, in large part, based upon, the estimation of costs utilized in the preparing the bid. If the budget for a project is not met, then the budget may be faulty, which may indicate that the estimating process being used needs to be reviewed and adjusted. Management regularly monitors the status of budget compliance on every project. One of the many benefits provided to management from this exercise is that this provides management with an ongoing tool to evaluate the effectiveness of the ISI estimating process during the course of completing a contract and at the “back-end” of each contract, when the final budget analysis is completed on each project.

 

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Since ISI’s founding, the costs to complete a material fixed price contract, which is a contract that results in more than $50,000 in gross revenue, have never exceeded the amount of the contract price, which would result in a loss position. While this has occasionally occurred with regard to smaller contracts of $50,000.00 or less in gross revenue, those losses have not been deemed to be material. No loss position has ever been suffered by ISI with regard to any material contract. Management is not aware of any current contract of ISI that is in a loss position, or that with the passage of time is expected to result in a loss position.

 

Below is a table breaking down ISI's operations into three primary reportable segments.

 

Operating Segments		Revenue			Inter-segment Revenue			Operating Income (Loss)			Depreciation/ Amortization			Total Assets			Capital Expenditures
ISI
December 31, 2005		$	10,995,182		$	3,312,691		$	(562,750	)	$	561,992		$	17,627,240		$	130,620
December 31, 2004		$	14,756,861		$	7,046,554		$	(4,162,230	)	$	237,792		$	15,604,775		$	202,498
December 31, 2003		$	13,163,247		$	5,663,144		$	1,508,498		$	133,787		$	12,634,439		$	17,917
September 30, 2006*		$	14,714,767		$	6,571,221		$	480,406		$	76,994		$	25,273,735		$	93,159
September 30, 2005*		$	8,109,530		$	2,025,675		$	(89,800	)	$	104,757		$	15,376,843		$	142,195
MCS Detention
December 31, 2005		$	10,891,378		$	-		$	1,803,595		$	181,936		$	1,704,762		$	130,627
December 31, 2004		$	11,031,267		$	-		$	2,284,252		$	176,858		$	1,836,695		$	250,528
December 31, 2003		$	8,021,813		$	-		$	1,370,311		$	111,791		$	1,803,344		$	43,465
September 30, 2006*		$	9,919,561		$	-		$	1,294,702		$	152,585		$	2,614,884		$	295,932
September 30, 2005*		$	7,275,493		$	-		$	914,198		$	129,672		$	2,839,082		$	68,107
MCS Commercial
December 31, 2005		$	17,347,927		$	-		$	219,813		$	259,641		$	3,253,702		$	36,809
December 31, 2004		$	14,386,858		$	-		$	(164,544	)	$	255,688		$	2,895,194		$	167,045
December 31, 2003		$	13,540,535		$	-		$	423,126		$	245,999		$	1,435,514		$	390,658
September 30, 2006*		$	16,599,478		$	-		$	636,322		$	268,169		$	4,913,177		$	37,425
September 30, 2005*		$	13,045,057		$	-		$	41,564		$	231,605		$	2,756,029		$	20,826
Eliminations
December 31, 2005		$	-		$	(3,312,691	)	$	-		$	-		$	-		$	-
December 31, 2004		$	-		$	(7,046,554	)	$	-		$	-		$	-		$	-
December 31, 2003		$	-		$	(5,663,144	)	$	-		$	-		$	-		$	-
September 30, 2006*		$	-		$	(6,571,221	)	$	-		$	-		$	-		$	-
September 30, 2005*		$	-		$	(2,025,675	)	$	-		$	-		$	-		$	-
Total Company
December 31, 2005		$	39,234,487		$	-		$	1,460,658		$	1,003,569		$	22,585,704		$	298,056
December 31, 2004		$	40,174,986		$	-		$	(2,042,522	)	$	670,338		$	20,336,664		$	620,071
December 31, 2003		$	34,725,595		$	-		$	3,301,935		$	491,577		$	15,873,297		$	452,040
September 30, 2006*		$	41,233,806		$	-		$	2,411,430		$	497,748		$	32,801,796		$	426,516
September 30, 2005*		$	28,430,080		$	-		$	865,962		$	466,034		$	20,971,954		$	231,128

 

*Unaudited

 

ISI-DETENTION

The key element to monitor in analyzing how ISI-Detention’s business has performed or will perform during a period is market demand for the construction of correctional facilities. Management must engage in aggressive marketing to governmental entities and private prison operators that are at the earliest stages of considering the design or construction of a new correctional or related facility. Several factors are taken into consideration by management when determining which projects management is most likely to pursue, including location, how much work is available in the marketplace, the bidding process, the type of bidding (such as negotiated or competitive), the needs of the customer to use ISI-Detention’s design services, the complexity of the project and the clarity of the project.

Once a project is under contract, management uses several tools to evaluate pending projects to anticipate future sales revenue. Management uses backlog, which is the amount of revenue and gross margin left to earn on a contract, to determine (1) potential revenue and margin earned in the future from this work and (2) manpower requirements and also requirements of the company’s vendors to determine if more vendors are needed because of the workload. Using the amount of contracted backlog as a guide, management is able to monitor when the gross margins will be earned and the workload that will be required. In order to provide the best possible prediction of the earning of gross margin and incurrence of costs, all the costs and projected revenues for a project are calculated by “spreading” them over the estimated life of the project, on a monthly basis. This generates a prediction of profit margin and costs by month for each project.

By analyzing backlog, management can make a decision to execute new strategies, such as hiring new people, starting training programs or, if management determines that by spreading the backlog there is a dip in revenues or margins, they can go to the marketplace and acquire a contract, possibly with less margin, to fill a void that will cover some or all of the fixed costs at that time. This process may cause a fluctuation in revenues, gross margin and percentages, which can be seen in ISI’s results of operations. Further fluctuation is a result of the time frame over which contracts are sold and completed. Each project has its own schedule for completion, which could be anywhere from 90 days to two years or more. Revenue and gross margin for each project is earned over the course of such project’s schedule. Accordingly, if a significant number of projects have a short schedule, which come to a completion around the same time, the revenues for that period could be significantly higher than the next period where project schedules may not complete for several months.

The timing of the delivery of projects is based on customer needs. Since ISI does not manufacture the products, but relies on third parties to manufacture and then ship directly to customers, there may be significant fluctuations as to when revenue is earned, based on when these products are shipped and ultimately received by the customer. Management knows that this type of fluctuation exists, but proper scheduling and regular monitoring of these projects tends to manage the risks successfully.

Another key indicator for evaluating ISI-Detention’s performance is whether the budget for each individual project has been met. If a project meets, or is under budget, then gross margin percentages will be predictable. ISI carefully monitors the budget for each project to look for fluctuations and determine ways to protect from “overruns” that may result from mis-estimates in sales and construction risks, such as a defect at a project site that was not able to be determined during the estimating period, which causes excessive manhours on the project or possible mis-performance or financial instability of a subcontractor. These variables are managed carefully by a specific group of project managers with principal responsibility to oversee budgets and control costs, but can cause fluctuations in gross margins earned on projects by over running these projects.

 

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MCS-DETENTION

MCS-Detention is a subcontractor for ISI-Detention in many projects. Although a majority of MCS-Detention’s subscontracting business is sold to ISI-Detention, MCS-Detention also sells its services to ISI-Detention competitors, which provides additional revenue..

The key factors used to monitor the operation and financial condition of MCS-Detention are the same factors used to analyze ISI projects, such as monitoring sales, bidding and the pending work to determine what contracts MCS will obtain. Typically, this analysis has taken place at the ISI-Detention level, and since the majority of the ISI-Detention projects will be subcontracted to MCS-Detention. MCS-Detention also has a backlog similar to ISI-Detention, and the measurement and spreading of its backlog is similar to the processes used for ISI-Detention

MCS-Detention produces Head End Systems (the complex industrial grade computer brains behind a total security system), which have risks in regard to production scheduling, including assembly and software development that do not impact ISI-Detention. These Head End Systems are command and control stations, typically for correctional facilities that integrate a myriad of systems, door controls, intercom, CCTV, fire alarm, man down systems, access control systems, etc., all into one control station that is operated from a control room. The software to integrate this is developed by MCS and must be scheduled from the backlog of production scheduling to accomplish these tasks so that the Head End System is completed and tested and shipped on time in order to meet construction schedules.

As with ISI-Detention, meeting the delivery schedules is essential and is a key indicator for MCS-Detention management to use in determining if budgets are going to be met and when revenue will be earned. Determining how much manpower will be needed, and when it will be needed, is done through the scheduling of a project. Therefore, if the projects are on schedule, the manpower is usually also already built into the budget. Management is continually reviewing the demand for new employees based on the increasing backlog, and has developed a training program to insure that employee performance and customer satisfaction are maintained.

MCS-Commercial

MCS-Commercial is staffed with its own sales people. Its pending work is regularly reviewed by management to insure that the sales force is out quoting projects. The backlog for MCS-Commercial typically burns (turns over) at a faster rate than ISI-Detention and MCS-Detention. MCS-Commercial generates a higher percentage of its revenue from recurring revenue, sales from existing customers, rather than from one-time long term contracts. MCS-Commercial depends upon the information from its sales department as to manpower requirements for potential future sales. Management mitigates the risk of fluctuating revenues, by monitoring whether projects are meeting budget. This is similar to the process utilized to evaluate the performance by MCS-Detention and ISI-Detention.

Management believes that MCS-Commercial has the potential to acquire large long-term contracts, similar to the ISI-Detention and MCS-Detention contracts. Management’s strategy for growing this segment of the business would change if MCS-Commercial’s servicing contracts change from the current model. However, management believes that larger contracts will make it easier to monitor future sales, since the backlog will take longer to burn, providing management more time to react to growth and anticipate the future with a bit more clarity.

Critical Accounting Policies

ISI’s discussion and analysis of its financial condition and results of operations for the purposes of this proxy statement/prospectus are based upon historical combined financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America.

ISI’s significant accounting policies are summarized in Note 1 to its historical combined 2005 financial statements, and the following summaries should be read in conjunction with the historical combined financial statements and related notes contained elsewhere herein. While all accounting policies affect the financial statements, certain policies may be viewed as critical. Critical accounting policies are those that are most important to the presentation of the financial statements and results of operations and that required ISI’s management’s most subjective and complex judgments and estimates. ISI’s management believes the policies that fall within this category are percentage of completion estimates, allowance for doubtful accounts and IBNR estimates for health insurance.

Percentage of Completion Estimates. ISI uses percentage of completion accounting to determine revenue and gross margin earned on projects. Estimating the percentage completion on a project is a major critical estimate that ISI depends on. This estimate is determined as follows:

1.	The contract amount and all contract estimates are input into a job cost accounting system with detail of all significant estimates of purchases by vendor type, subcontractor, and labor.

2.	As the project is performed and purchases and costs are incurred, these are recorded in the same detail as the original estimate.

3.	The contract amount and estimated contract costs are updated monthly to record the effect of any contract change order received.

 

4.

On a monthly basis, management, along with its project managers, who are overseeing the contracts, review these estimated costs to complete the project and compare them to the original estimate and the estimate that was used in the prior month to determine the percentage of completion. If the cost to complete, determined by management and the project managers for the current month, confirms that the estimate used in the prior month is correct, then no action is taken to change the estimate and/or the percentage complete in that current month. However, if the current cost to complete estimate calculated by the management and the project managers, differs, then adjustments are made. If the costs are in excess of the estimate used in the prior month, then a decrease in the percentage complete on the project through the current month in the accounting period is made. If the costs are less than the estimate used in the prior accounting period, then the new estimate increases the percentage complete on the project.

5.	Revenue is recorded monthly based upon the contract amount, adjusted for change orders, if any, times the percentage of completion. This revises the revenue on a monthly basis for any changes in estimates.

 

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These estimates of percentage completion of a project determine how much revenue and gross margin is earned to date on a project. For example, if a contract is $100,000 with a 20% gross margin of $20,000, then a project that is estimated to be 50% complete accrues $50,000 in revenue and $10,000 in gross margin. If the percent complete is adjusted to 25%, then the revenue on the contact would be $25,000 and the earned gross margin would be $5,000. These estimates would be changed in the current month, and the actual accrual of the revenue and gross margin earned on this project would be reduced in the current month.

Another effect of the change in the estimated costs and percent complete, is that it changes the percentage of gross margin earned. For example, in the project mentioned above, if the estimated costs changed to 90% from 80% because of projected cost overruns, this would then reduce the gross margin percentage to 10% from 20%. Management attempts to recognize losses (over runs of cost estimates) as soon as they can be quantified. Management attempts to recognize gains (under runs of cost estimates) when they can be quantified and are certain.

Allowance for Doubtful Accounts. The allowance for doubtful accounts is accrued each month and is analyzed at the end of the year for adequacy. A careful analysis is made of each customer and each situation, along with the lien right and bond rights. Any adjustments are made at the end of the year.

IBNR Estimates for Health Insurance. Incurred but not reported (IBNR) is an estimate of claims to be processed and paid after year-end, even though the claims were actually incurred prior to year-end. The company has historically estimated the IBNR based on the first three months of the year in question.

 

Results of Operations for Nine Months Ended September 30, 2006 and 2005

 

Revenues 

 

ISI had revenues of $41.2 million and $28.4 million for the nine months ended September 30, 2006 and 2005, respectively, representing an increase of $12.8 million, or 45%. As discussed below, revenues have increased across ISI’s primary business segments.

 

ISI-Detention

 

Revenues were $14.7 million for the nine months ended September 30, 2006, or 81% higher than 2005. ISI-Detention is largely a construction driven-business. Much of its revenues are generated by working on new and retrofit construction projects in the corrections industry, as opposed to relying on repeat customers as a source of recurring revenue. The increase in revenue is largely attributable to ISI-Detention participating in a greater number of new long term projects in 2005 than it did in 2004. Better market conditions, increased marketing efforts and new products and services provided by ISI-Detention were all factors in ISI-Detention’s ability to compete and secure new projects in 2005. Fluctuation in revenues results from repeat customers that do not typically have the ability to increase spending on goods and services provided by ISI-Detention, and in certain instances have decreased spending. ISI-Detention must engage in aggressive marketing efforts to add new customers to increase revenues, while continuing to provide services to maintain its current customer base.

 

MCS-Detention

 

Revenues were $9.9 million for the nine months ended September 30, 2006 and $7.3 million for the nine months ended September 30, 2005. This represents an increase of 36% in revenue. MCS-Detention generates much of its revenue by working on new and retrofit construction projects in the corrections industry, as opposed to relying on repeat customers as a source of recurring revenue. The increase in revenue is largely attributable to MCS-Detention participating in a greater number of new projects due to better market conditions, increased marketing efforts, new products, and services. In addition, because MCS-Detention sells its products and services to certain of ISI-Detention’s competitors, it has a larger group of potential customers than other companies in its industry. The improved market conditions, marketing efforts, new products and services, in combination with increased sales to ISI-Detention and the sale of products and services to competitors, resulted in MCS-Detention’s increase in revenues for the period.

 

MCS-Commercial

 

Revenues from the MCS-Commercial segment were $16.6 million for the nine months ended September 30, 2006 and $13.0 million for the nine months ended September 30,2005. This represents a $3.6 million, or 28%, increase. A significant portion of the increase is due to the acquisition of Instant Photo, Inc. in November 2005. The Instant Photo revenues contributed approximately $1.5 million to revenue. The Instant Photo revenue was made up of approximately $1 million in additional service revenue primarily from photo ID equipment, and approximately $500,000 in access control related contract revenue.

 

Expenses

 

ISI had cost of goods sold of $32.6 million for the nine months ended September 30, 2006 and $22.7 million for the nine months ended September 30, 2005. This is an increase of $9.9 million or 44%. Gross margin percentage was 21% for the nine months ended September 30, 2006 and 20% for the nine months ended September 30, 2005.

 

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ISI-Detention

 

The cost of goods sold for the nine months ended September 30, 2006 was $11.8 million and $6.1 million for the nine months ended September 30, 2005, which is an increase of $5.7 million or 93%. This increase is due to increased sales of products resulting from a greater number of new construction projects during the period. The gross margin percentage decreased to 20% for the nine months ended September 30, 2006, which was down from 25% for the same period for 2005.

 

The reduction in gross margin percentage was the result of several factors. (1) ISI management determined that to reduce margins to be more competitive it would have to increase its sales at a lower margin. Since the corrections construction work was decreasing nationally, to remain competitive, ISI sold a larger percentage of work at a reduced margin. (2) ISI sold some projects with large turnkey vendors that allow for less risk. These projects earn lower margins than other projects. Some of the projects ISI completed during this period would be classified as such projects, which reduced gross margin. (3) From time to time, ISI completed work for less than the initial estimated cost. This occurred in September, 2005, to a greater degree than in September, 2006. Therefore, the margin in September, 2005 was higher because the cost of sales was less.

 

MCS-Detention

 

The cost of goods sold for the nine months ended September 30, 2006 was $7.4 million, an increase of $2.2 million from the $5.2 million reported in the same period for 2005. The gross profit percentage was 25% for the nine months ended September 30, 2006 as compared to 28% for the same period in 2005. The reduction in gross profit margin resulted from an increase in production costs on the backlog of work that was sold in prior years.

 

MCS-Commercial

 

The cost of goods sold for the nine months ended September 30, 2005 was $13.4 million, an increase of $2 million from the $11.4 million in the same period for 2005. The gross profit percentage was 19% for the nine months ended September 30, 2006, as compared to 13% for the same period in 2005. The increase in gross profit margin resulted from a change in estimating procedures that raised MCS -Commercial’s estimated cost of performance to more accurate levels and increased service revenues, which carry a higher gross profit margin. The change in estimating was accomplished through initiating an operations pre-bid review process, changing labor rates and standards and adding commissions to the cost of sales. MCS-Commerical continues to estimate using this enhanced procedure at this time.

 

Selling, General and Administrative Expenses.

 

Selling, general and administrative expenses for ISI were $6.2 million for the nine months ended September 30, 2006, an increase from $4.9 million for the same period of 2005. The increase is primarily due to additional administrative needs of ISI due to the overall increase in business.

 

ISI-Detention

 

Selling, general and administrative expenses were $2.5 million for the nine months ended September 30, 2006, an increase of $.4 million or 19% from $2.1 million for the same period of 2005. The increase is primarily due to additional administrative needs as a result of the growth in ISI-Detention business.

 

MCS-Detention

 

Selling, general and administrative expenses were $1.2 million for the nine months ended September 30, 2006 and $1.1 million for the same period of 2005. Significant additional expense was not required to support the 36% increase in revenue.

 

MCS-Commercial

 

Selling, general and administrative expenses for were $2.5 million for the nine months ended September 30, 2006 and $1.6 million for the same period of 2005. This is an increase of $.9 million or 56%. This increase resulted from higher levels of marketing, sales and training expenses.

 

Interest Expense

 

Interest expense for ISI was $2.8 million for the nine months ended September 30,2006, an increase of $.4 million or 17% from $2.4 million for the same period of 2005. 

 

Income Tax

 

As a result of the above, there was a small income tax provision of $10,000 for the nine months ended September 30, 2006, as compared to an income tax benefit of $.5 million for the nine months ended September 30, 2005.

 

Net Loss

 

ISI reported a net loss of $0.4 million for the nine months ended September 30, 2006 as compared to a net loss of $1.1 million for the same period of 2005. Weighted average number of shares outstanding, basic and diluted, for September 30, 2006 was 104.91, and for September 30, 2005 was 104.91. Income (Loss) per share, basic and diluted, for September 30, 2006 was $(3,606.03) and for September 30, 2005 was $(10,778.78).

 

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Results of Operations for Years Ended December 31, 2005 and 2004

 

Revenues

 

ISI had revenues of $39.2 million and $40.1 million for the years ended December 31, 2005 and December 31, 2004, respectively, representing a decrease of $.9 million or 2%. As discussed below, the decrease occurred primarily due to reduced revenues at ISI-Detention, which was partially offset by increased revenue from MCS-Commercial.

 

ISI-Detention

 

Revenues were $11.0 million for the year ended December 31, 2005, a decrease of $3.8 million from the $14.8 million recorded for the year ended December 31, 2004. ISI-Detention is largely a construction driven business. A significant portion of its revenues is obtained by working on new and retrofit construction projects in the corrections industry, relying on repeat customers as a source of recurring revenue. The decrease is the result of slow bidding periods for ISI-Detention for new projects. Although the gross amount of construction in the corrections area remained relatively flat between 2004 and 2005, the types of projects that ISI-Detention solicits, namely large-scale medium to maximum security installations, declined significantly in 2004 and 2005. This situation was further compounded by the general state and local governmental budget deficits which caused these governmental units to rethink and delay many of their pending corrections projects.

MCS-Detention

Revenues were $10.9 million for the year ended December 31, 2005 and $11.0 million for the year ended December 31, 2004. This represents a decrease of 1%. The factors that affected ISI-Detention’s revenues during 2004 and 2005, also had a negative impact on revenues for MCS-Detention. MCS-Detention has many repeat customers that stay in the correctional construction marketplace. As these customers develop and complete projects, they purchase goods from MCS-Detention. However, each project is under a separate contract. MCS-Detention does not have the benefit of recurring revenue, such as maintenance contracts that are renewable or several years long. Once a contract is complete, there is no additional revenue stream from that contract that could be regularly renewed over a significant time.

 

MCS-Commercial

 

Revenues from were $17.3 million for the year ended December 31, 2005 and $14.4 million for the year ended December 31, 2004. This $2.9 million dollar increase in revenues was primarily attributable to an increased sales staff, and the acquisition of CTS. Management’s decision to hire additional sales staff to increase marketing for sales at MCS-Commercial was in response to the slowdown in business at ISI-Detention. In analyzing the backlog spread management perceived a decline in revenues at ISI-Detention, To offset this decline in revenues for ISI, management increased sales efforts in the commercial security sector, which showed strong market potential.

 

Expenses

 

ISI’s cost of good sold of $30.9 million for the year ended December 31, 2005 increased $0.3 million or 1% from $30.6 million during the same period of 2004. Gross margin percentage was 21% for December 31, 2005 and 24% for December 31, 2004. The decrease in this percentage was caused primarily by the reallocation of sales commissions to cost of sales.

 

The reallocation of the sales commissions to cost of sales was the result of management’s decision to change the way the company estimates costs of a project when bidding. Prior to 2005, the commissions were deducted from estimated gross margin that was added onto a project once the costs were determined. Beginning in 2005, and forward, management changed the estimating procedures and included sales commissions in the estimated costs of sales. As a result this added additional costs to a project in the estimating phase, which has resulted in an increase in gross margin percentages, since the commissions are not expensed out of the gross margin, but are accounted for in the project before bidding. This reallocation has significantly helped the MCS-Commercial division to increase its earnings in gross dollars and in percentages.

 

ISI-Detention

 

The cost of goods sold was $8.7 million for the year ended December 31, 2005, compared to $11.6 million for the same period in 2004. This decrease was a result of the overall reduction in business and is consistent with the decrease in ISI-Detention revenues for the same period.

 

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MCS-Detention

 

The cost of goods sold for MCS-Detention was $7.3 million for the year ended December 31, 2005 and $7.5 million for the year ended December 31,2004, a decrease of $0.2 million or 3%. The gross margin percentage for MCS-Detention for the 12 months ended December 31,2005 of 32% was consistent with 2004 results.

 

The cost of goods for MCS-Detention was flat from 2004 to 2005, even though ISI-Detention revenues decreased. Typically in the past, MCS-Detention revenues have fluctuated in almost direct relationship to the fluctuation in revenues of ISI-Detention, since ISI-Detention is such a large customer of MCS-Detention. However, management’s implemented a strategy to increase MCS-Detention’s revenue by hiring additional sales staff to sell to third parties, including to competitors of ISI-Detention, resulted in stable revenue and cost of sales, rather than a dip, as occurred at ISI-Detention.

 

MCS-Commercial

 

The cost of goods sold was $14.9 million for the year ended December 31, 2005 and $11.6 for the year ended December 31, 2004, a difference of $3.3 million or a 28% increase. This increase was primarily due to increased sales. The gross margin percentage for the 12 months ended December 31, 2005 was 14% as compared to 20% for the 12 months ended December 31, 2004. This decrease was due primarily to the reallocation of sales commission cost to cost of sales from selling, general and administrative expenses. The reallocation of sales commissions was due to a change in the estimating procedure, which allowed MCS-Commercial to match costs to the way a project was estimated. Additionally, upon review of MCS-Commercial projects that were partially completed in 2004, management found that there were significant costs yet to be incurred that had not been estimated correctly in 2004.  Accordingly, management revised the percentage completions in the year 2005, which also reduced the gross margin percentage in 2005.

 

Selling, General and Administrative Expenses

 

Selling, general and administrative expenses for ISI were $6.9 million for the year ended December 31, 2005, an increase of $0.4 million, from $6.5 million for the same period of 2004. There was an additional special management bonus of $5.2 million in the year ended December 31, 2004. This special bonus was incurred during the recapitalization of ISI in October 2004.

 

ISI-Detention

 

Selling, general and administrative expenses were $2.9 million for the year ended December 31, 2005, an increase of $0.6 million from $2.3 million for the same period of 2004. This change was primarily the result of increased marketing and sales efforts which led to increased sales in 2006.

 

MCS-Detention

 

Selling, general and administrative expenses were $1.7 million for the year ended December 31, 2005, an increase of $0.4 million or 31 % from $1.3 million for the same period of 2004. This increase was the result of additional sales and marketing efforts which led to increased sales in 2006.

 

MCS-Commercial

 

Selling, general and administrative expenses were $2.2 million for the year ended December 31, 2005, a decrease of $0.7 million or 24% from $2.9 million for the same period of 2004. This decrease occurred because sales commissions were reallocated to cost of sales and significant cost cutting actions were taken to reduce overall selling, general and administrative costs.

 

MCS-Commercial had an operating loss of $164,000 for the year ended December 31, 2004. Management was not happy with the performance of this segment at the time, and used 2005 as a readjustment and reorganization year which included hiring a new direct manager for MCS-Commercial. Significant overhead was reduced, estimating procedures were changed, and several mid-level and lower-management were outplaced and assessed. These were all directives that management put in place to renew the profitability of this business segment. All of these actions produced the significant decrease in the SG&A expenses for MCS-Commercial.

 

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Interest Expense

 

Interest expense for ISI was $3.2 million for the year ended December 31. 2005, an increase of $2.4 million from $0.8 million for the same period of 2004. This increase was due to ISI entering into a subordinated mezzanine debt instrument and a warrant agreement in connection with the recapitalization of ISI in October 2004.

 

Income Tax

 

As a result of the above, the $0.5 million tax benefit for the year ended December 31, 2005 was approximately $0.4 million lower than the benefit in 2004. The tax benefit in 2005 was primarily attributable to the increased interest expense, and in 2004, primarily attributable to the special management bonus.

 

Net Loss

 

ISI reported a net loss of $1.2 million for the year ended December 31, 2005 and a net loss of $2.0 million for the year ended December 31, 2004. The weighted average number of shares outstanding, basic and diluted, for December 31, 2005 was 104.91, and for December 31, 2004 was 104.91. Income (Loss) per share, basic and diluted, for December 31, 2005 was $(11,281.12) and for December 31, 2004 was $(19,512.47).

 

Results of Operations for Years Ended December 31, 2004 and 2003

 

Revenues

 

ISI had revenues of $40.1 million and $34.7 million for the years ended December 31, 2004 and December 31, 2003, respectively, representing an increase of $5.4 million or 16%.

 

ISI-Detention

 

Revenues were $14.8 million for the year ended December 31, 2004, an increase of $1.6 million or 12% from the $13.2 million earned in 2003. ISI-Detention is largely a construction driven business. Much of its revenues are obtained by working on new and retrofit construction projects in the corrections industry, as opposed to relying on repeat customers as a source of recurring revenue. The increase in revenues experienced by this segment is largely attributable to its greater participation in such projects. Revenue from backlog at the beginning of January 2003, was approximately $18 million. In January 2004, the backlog was approximately $23 million. This increase in backlog directly affected the increase in the revenue from 2003 to 2004.

 

MCS-Detention

 

Revenues were $11.0 million for the year ended December 31, 2004 and $8.0 million for the year ended December 31, 2003. This represents an increase of 3 8% in revenues. MCS-Detention generates much of its revenue by working on new and retrofit construction projects in the corrections industry, as opposed to relying on repeat customers as a source of recurring revenue. The increase in revenues experienced by this segment is largely attributable to greater participation in projects than in the previous year. Revenue from backlog at January 2003, was approximately $8.4 million, as compared to approximately $12.1 million at January 2004. This increase in backlog from 2003 to 2004, corresponds to the increase in revenues between these two years.

 

MCS-Commercial

 

Revenues for MCS-Commercial were $14.4 million for the year ended December 31, 2004 and $13.5 for the year ended December 31, 2003. This represents a $0.9 million increase in revenues, or an increase of 7%.

 

Expenses

 

ISI’s cost of goods sold of $30.5 million for the year ended December 31, 2004 increased by $5.4 million or 22% from $25.1 million during the same period of 2003. Gross margin percentage was 24% for the year ended December 31, 2004 and 28% for the year ended December 31, 2003.

 

ISI-Detention

 

The cost of goods sold of $11.6 million for the year ended December 31, 2004 increased $2.1 million or 22% from $9.5 million during the same period of 2003. The gross margin decreased to 22% for the 12 months ended December 31, 2004 as compared to 28% for the 12 months ended December 31, 2003, primarily as a result of pricing pressure within the industry. Gross margin declined from 28% in 2003, to 22% in 2004 as a result of ISI completing some projects under budget. In addition, the average gross margin in the backlog at the beginning of 2003, was higher than the average gross margin of the backlog at the beginning of 2004.

 

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MCS-Detention

 

The cost of goods sold was $7.5 million for the year ended December 31, 2004 and $5.4 million for the year ended December 31, 2003, an increase of $2.1 million or 39%. The gross margin percentage reduction from 39% in 2003, to 32% in 2004, was primarily due to MCS-Detention reducing the gross margin in its project pricing. Management determined that it was necessary to reduce the price of projects being bid, in order to generate revenues from additional work that was needed to cover fixed costs.

 

MCS-Commercial

 

The cost of goods sold was $11.6 million for the year ended December 31, 2004 and $10.1 million for the year ended December 31, 2003, a difference of $1.5 million or a 15% increase. The gross margin for the year ended December 31, 2004 was 20% as compared to 25% for the year ended December 31, 2003. The decrease in the gross margins was primarily due to estimated cost overruns from significant work that had been sold in 2003 and was completed in 2004.

 

Selling, General and Administrative Expenses

 

Selling, general and administrative expenses for ISI were $6.5 million for the year ended December 31, 2004, an increase of $0.2 million or 3% from $6.3 million for the same period of 2003. There was an additional special management bonus of $5.2 million in the year ended December 31, 2004. This special bonus was incurred during the recapitalization of the company in October 2004.

 

ISI-Detention

 

Selling, general and administrative expenses were $2.3 million for the year ended December 31, 2004, as compared to $2.2 million for the same period of 2003. During the period ended December 2004, management decided not to add any significant costs to overhead, especially in the area of sales expense, since they saw that there were fewer new correctional projects to be sold in the corrections market at that time. Therefore, the general administrative expenses did not go up.

 

MCS-Detention

 

Selling, general and administrative expenses were $1.3 million for the year ended December 31, 2004, as compared to $1.2 million for the same period of 2003. During the period ended December2004, management decided not to add any significant costs to overhead, especially in the area of sales expense, since they saw that there fewer new correctional projects to be sold in the corrections market at that time. Therefore, the general administrative expenses did not go up.

 

MCS-Commercial

 

Selling, general and administrative expenses were $2.9 million for the years ended December 31, 2004 and 2003.

 

Interest Expense

 

Interest expense for ISI was $0.8 million for the year ended December 31, 2004. There was no significant interest expense in 2003. The 2004 interest expense is the result of the debt incurred in 2004 associated with the recapitalization of ISI.

 

Income Tax

 

As a result of the above, a tax benefit of $0.9 million was recorded in 2004 as compared to an expense of $1.2 million in 2003. The tax benefit in 2004 was primarily due to the interest expense on debt and the special management bonus described above.

 

Net Loss

 

ISI reported a net loss of $2.0 million for the year ended December 31, 2004 and a net income of $2.1 million for the year ended December 31,2003. The weighted average number of shares outstanding, basic and diluted, for December 31, 2004 was 104.91, and for December 31, 2003 was 100.00. Income (Loss) per share, basic and diluted, for December 31, 2004 was $(19,512.47), and for December 31, 2003 was $20,817.48.

 

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Liquidity and Capital Resources

ISI’s primary liquidity needs are for financing working capital and purchase of computers and related equipment. The nature of its business and operations as a detention contractor causes cash flow from operations to be highly volatile. Its large construction contracts can produce or consume cash. The production or consumption of cash is dependent on factors inherent to the construction industry including billing and payment terms of the contracts. ISI has in place a credit facility to allow it to manage it cash flows. ISI expects it will generate sufficient cash flow from operations, supplemented from borrowings on its credit facility, as needed to meet its normal working capital and capital expenditure requirements for at least the next 12 months.

The major liquidity components of ISI’s cash flow relate to several of the sources and uses of cash and material changes.

As would be expected, net income after interest payments and tax payments is the first source of liquidity for the company. However, this income is reduced by interest accretion on the warrants. This interest accretion is a non-cash item which has reduced net income and must be added back as a source of funding.

Since the company has a continued pattern of increased growth, receivables have increased in the past years. These receivables are determined to be a use of working capital as they increase; however, as the volume of the business increases, accounts payable also increase on contract terms which allows the receivables increase to be offset and the increase in payables to increase working capital.

Cost and estimated earnings in excess of billings on incomplete contracts and billings in excess of cost and estimated earnings on incomplete contracts are items of ISI’s sources and uses of cash that relate to billing practices and cost incurred on contracts. For example, if a project has costs incurred that are required to complete an MCS-Detention head-end system and these costs cannot be billed until the system is complete, this necessitates a use of cash to fund this cost until the equipment is completed so that billing can be made to the customer. Conversely, if a project has a schedule of values which allows billing for a line item where the cost incurred is much less than the comparative revenue, this excess billing over the revenue is a source of cash which can be used in financing operations.

 

Supplemental disclosures of cash flow, including cash paid for interest is a use of cash, the majority of which is primarily related to the long term borrowings.

Cash and working capital. The following table sets forth ISI’s cash and working capital, defined as current assets less current liabilities, as of December 31, 2004 and 2005 and September 30, 2006, respectively:

		December 31, 2004			December 31, 2005			September 30, 2006
		(in thousands)
Cash and cash equivalent		$	1,308		$	416		$	254
Working capital			5,230			5,523			6,395

ISI considers cash and liquid investments with maturities of three months or less to be cash equivalents. ISI maintains minimal cash balances and has substantially all available cash credited against its borrowings under its line of credit.

Credit facility. As of September 30, 2006, ISI had a line of credit with LaSalle Bank, N.A. In December 2006, ISI amended its credit facility to increase its line of credit to $9 million and extend the maturity date of the line of credit to October 21, 2008. The line of credit is secured by all tangible and intangible assets of ISI, excluding vehicles. The line of credit requires all accounts receivable collections to be deposited directly into a lockbox. Interest is payable quarterly and is calculated at the lender’s base rate (greater of prime or federal funds rate) plus 0.5%, or 350 basis points in excess of LIBOR for the applicable period. The outstanding balance of the line of credit, which is recorded as a long-term liability, as of December 31, 2004 and 2005 and September 30, 2006, was $4,429,335, $4,450,850 and $4,662,850, respectively. The agreement contains restrictive and affirmative covenants as well as the following financial covenants:

·

ISI shall have a fixed charge ratio of not less than 1.10:1.00 based on the trailing 12 months.

 

·

ISI shall have a senior cash flow leverage ratio of more than 1.75:1.00 based on the trailing 12 months.

 

·

ISI shall not make capital expenditures during any fiscal year in excess of $500,000.

 

·

ISI shall not incur purchase money indebtedness during any fiscal year in excess of $200,000.

In January 2006, ISI was not in compliance with the fixed charge ratio. However, under the terms of the line of credit agreement, ISI had a period of 30 days to cure such non-compliance. Since ISI regained compliance with the covenant with respect to its February 2006 financial statements, no violation occurred.

 

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Subordinated debt. Gross proceeds of $15,300,000 were received from a subordinated lender in 2004. Of such gross proceeds, $11,335,104 was allocated to debt and $3,964,896 was allocated to a common stock warrant, which granted the subordinated lender the right to acquire 30% of ISI stock for approximately $310,000 based on an assessment of fair values. Additional funds totaling $651,609 were advanced in 2005. The gross proceeds of $15,951,609 is due and payable in one payment in October 2011. The debt discount of $3,964,896 is being accreted as interest expense over the life of the debt. Interest is payable quarterly and is computed on the gross proceeds, non-discounted, at a rate of 11.58%. The financial statement balance of the subordinated debt as of December 31, 2004 and 2005 and September 30, 2006 was $11,445,240, $12,757,665 and $13,275,777, respectively. The subordinated notes are unsecured, contain restrictive and affirmative covenants as well as the following financial covenants:

·

ISI shall not make capital expenditures during any fiscal year in excess of $600,000.

·

ISI shall have a fixed charge coverage ratio of not less than 1.00 to 1.00.

·

ISI shall have a leverage ratio of not more than 2.00 to 1.00.

 

Operating cash flows. Net cash used in operations was $0.7 million and $0.1 million for the year ended December 31, 2005 and nine months ended September 30, 2006, respectively. Net cash used in operations is attributable to a net loss of $1.2 million and $0.4 million for the year ended December 31, 2005 and nine months ended September 30, 2006, respectively, adjusted by the following non-cash items included in net income and the following working capital changes:

		Year Ended December 31, 2005			Nine Months Ended September 30, 2006
		(in thousands)
Non-cash items:
Interest accretion and fair value adjustment of stock warrants		$	920		$	902
Depreciation and amortization of property and equipment			1,004			498
Deferred income taxes			(78	)		—
Working capital charges which contributed to cash used in operations:
(Increase) Decrease in assets:
Contracts and other receivables		$	(2,677	)	$	(8,330	)
Inventory			(454	)		31
Refundable income taxes			531			(169	)
Costs and estimated earnings in excess of billings on incomplete contracts			(681	)		(1,386	)
Deposits and other assets			(9	)		—
Increase (Decrease) in liabilities:
Accounts payable and accrued liabilities			2,241			5,387
Billings in excess of costs and estimated earnings on incomplete contracts			(298	)		3,378

 

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Accounts Receivable. ISI’s accounts receivable has historically varied greatly between accounting periods due to various factors. The fluctuation in accounts receivable is the result of billings that are “lumpy”, collection periods that vary greatly between contracts, and the fact that ISI’s revenues are not based on billing, but rather based on the percent complete of each project. The accounts receivable balance is based on billing to the customers and cash collected. These amounts can vary greatly with the difference showing up on the balance sheet as Cost and estimated earnings in excess of billings on incomplete contracts or billings in excess of cost and estimated earnings on incomplete contracts.

Allowance for doubtful accounts. The allowance for doubtful accounts is accrued each month and is analyzed at the end of the year for adequacy. A careful analysis is made of each customer and each situation along with the lien right and bond rights. Any adjustments are made at the end of the year. At December 31, 2005, an adjustment was made to increase the allowance for doubtful accounts due to the uncertainty of three customers. In June of 2006, the three customers were deemed uncollectible and charged off against the reserve. The decrease in allowance for doubtful accounts as of September 2006 was due to the chargeoff of accounts receivable totaling $228,107 deemed uncollectible in June 2006. The chargeoff was concentrated among three customers, which accounted for $179,163 of the total amount written off. In prior years, the amount of the chargeoff was $42,900 and $38,221 for 2004 and 2005, respectively.

Backlog. Based on the percentage of completion method of accounting utilized by ISI, each project has an amount referred to as “earned gross margin” and “earned revenue” for the total contract. The earned revenue and the amount of earned gross margin are subtracted from the total contract amount and the total estimated gross margin. The net difference is the backlog available for each project. The total of these sums for all projects makes up the amount of total backlog. Each business segment is totaled together to calculate the total backlog for the company. The company is unaware of any projects in the backlog that are not funded. Historically, the company has not removed any projects due to the lack of funding. Approximately 84% of the backlog at the end of December 31, 2004 was turned into revenues in 2005. Due to the make up of the backlog, the percentage of turnover each year can vary, due to such factors as contracts that are fast tracked as opposed to contracts that are phased in over time. Also, the product mix of contracts can vary over the time required to complete them.

 

Investing activities. Cash flow from investing activities relate to leasehold improvements and other expenses on property, plant and equipment. Net cash used in investing activities was $766,867 and $345,613 for the year ended December 31, 2005 and nine months ended September 30, 2006, respectively. Net cash used in investing activities is primarily related to purchases of property and equipment.

Financing activities. Cash flows from financing activities relate to the net change in terms of banking arrangements, both short term and long term. As described, the line of credit and long term borrowings increased to fund primarily a stockholder distribution in the year 2004. The stockholder distribution consisted of proceeds taken by the shareholders of the company at that time. Net cash provided by financing activities was $558,515 and $250,513 for the year ended December 31, 2005 and the nine months ended September 30, 2006, respectively. Cash provided by financing activities primarily related to additional long-term borrowings in 2005 and additional line of credit borrowings in 2006. In the fourth quarter of 2005, ISI entered into a long term debt instrument in the aggregate principal amount of $15,300,000 and increased its line of credit facility to $6,000,000. The proceeds of this new debt were used to distribute dividends of approximately $16.9 million to its existing shareholders.

Non-cash Investing and Financing Activities. The consolidated statements of cash flows do not reflect the following non-cash investing and financing activities:

·

Direct financing of $118,551 was used for the purchase of equipment and vehicles during the year ended December 31, 2005 ($136,099 in 2004).

·

Debt totaling $1,544,095 was assumed by a partnership owned by the Company’s stockholders during the year ended December 31, 2004.

·

Goodwill of $15,913 was funded by the issuance of 2.2 shares of common stock during the year ended December 31, 2004.

·

Direct financing of $220,335 was used for the purchase of vehicles during the year ended December 31, 2003.

·

Direct financing of $624,950 was used for the addition of the new facilities during the year ended December 31, 2003.

 

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Acquisition by Argyle. ISI’s acquisition by Argyle is expected to be consummated in the first half of 2007, assuming that Argyle’s stockholders approve the acquisition. If the acquisition is consummated, and ISI can provide no assurance that the acquisition will be consummated, the ISI line of credit will remain in place, and the debt to the subordinated lender will be reduced to $5,951,609, with an anticipated due date of 18 months after the closing of the transaction.

 

Although projects vary in size and duration, ISI’s management believes that its backlog of orders is a key indicator of how future revenues will trend. Historically, over 90% of ISI’s revenues have been generated from the backlog. The following table shows ISI’s backlog of orders at the end of the periods shown:

 

ISI Backlog
Date		ISI Detention			MCS Detention			MCS Commercial			Consolidated(1)			Intercompany Elimination			Backlog
12/31/2003		$	15,026,143		$	10,085,849		$	6,646,742		$	31,758,733		$	(5,042,596	)	$	26,716,137
12/31/2004			14,308,348			6,829,299			8,870,082			30,007,729			(4,166,421	)		25,841,308
9/30/2005			37,011,837			16,870,344			7,667,101			61,549,283			(9,305,791	)		52,243,492
12/31/2005			33,522,159			14,697,586			9,410,114			57,629,859			(12,190,414	)		45,439,445
9/30/2006			47,402,373			18,984,696			9,429,238			75,816,308			(10,769,159	)		65,047,149

 

(1)	The February 28, 2006 Backlog as defined in the merger agreement will be calculated on this column before intercompany eliminations. This is consistent with past practices.

 

Based on ISI's percentage of completion method of accounting, each project has an amount that is earned in gross margin and revenue with regard to the total contract. This amount of revenue earned to date and the amount of gross margin earned to date are subtracted from the total contract amount and the total estimated gross margin. The net difference is the backlog available for each project. The total for all projects makes up the total backlog. Each business segment is totaled together to calculate the total backlog for the company.

The company is unaware of any projects in the backlog that are not funded or incrementally funded. ISI does not record in its backlog any ID/IQ or Option year contracts. Historically, ISI has not removed any projects due to the lack of funding.

 

Contractual Obligations and Commercial Commitments. ISI has various contractual obligations that will affect its liquidity. The following table sets forth the contractual obligations of ISI as of September 30, 2006:

 

		Payments due by period
Contractual Obligations		Total			Less than 1 year			1-3 years			3-5 years			More than 5 years
Long-Term Debt Obligations		$	18,254		$	80.8		$	288.3			N/A		$	17,884.9
Capital Lease Obligations		$	271.1		$	33.6		$	237.5			N/A			N/A
Operating Lease Obligations		$	154.1		$	10.3		$	113.9		$	21.1		$	8.8
Purchase Obligations			N/A - none
Other Long-Term Liabilities Reflected on the Registrant’s Balance Sheet under GAAP		$	4,820			-			-			-		$	4,820
Total			23,499.2			124.7			639.7			21.1			22,713.7

 

Off-Balance Sheet Arrangements

 

ISI does not have any off-balance sheet arrangements.

 

Quantitative and Qualitative Disclosures about Market Risk

 

ISI’s exposure to market risk primarily relates to changes in interest rates for borrowings under its line of credit. Borrowing under this line of credit accrue interest at a variable rate. Based upon ISI’s borrowings under the facility in 2005, a hypothetical 10% increase in interest rates would have increased interest expense by approximately $34,000 and would have decreased annual cash flow by a comparable amount.

 

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INFORMATION ABOUT ARGYLE

 

Argyle’s History and Business Plans

 

Argyle Security Acquisition Corporation is a Delaware corporation that was incorporated on June 22, 2005 in order to serve as a vehicle for the acquisition of an operating business through a merger, capital stock exchange, asset acquisition or other similar business combination. To date, Argyle’s efforts have been limited to organizational activities, completion of its initial public offering and the evaluation of possible business combinations. Argyle does not currently have any operations.

On January 24, 2006, Argyle completed a private placement of 125,000 units to Ron Chaimovski, one of its Co-Chief Executive Officers, and Argyle New Ventures, LP, an entity controlled by Bob Marbut, Argyle’s other Co-Chief Executive Officer, and received net proceeds of $892,500. On January 30, 2006, Argyle consummated its initial public offering of 3,700,046 units (which includes 75,046 units sold as part of the underwriter’s over-allotment option). Each unit in both the private placement and the public offering consisted of one share of common stock and one redeemable common stock purchase warrant. Each warrant entitles the holder to purchase from Argyle one share of Argyle’s common stock at an exercise price of $5.50. Argyle’s common stock and warrants started trading separately as of March 2, 2006.

 

The net proceeds from the sale of Argyle’s units, after deducting certain offering expenses of approximately $2,387,706, including underwriting discounts of approximately $1,836,022, were approximately $28,212,662. Approximately $27,344,346 of the proceeds from the initial public offering and the private placement was placed in a trust account for Argyle’s benefit. Except for $600,000 in interest that was earned on the funds contained in the trust account and that was released to Argyle to be used as working capital, and the amounts that may be released to Argyle for the payment of taxes, Argyle is not be able to access the amounts held in the trust until it consummates a business combination. The trust account also contains $1,377,016 of the compensation of Argyle’s underwriters in its initial public offering which will be paid to them only in the event of a business combination. The amounts held outside of the trust account are being used by Argyle to provide for business, legal and accounting due diligence on prospective acquisitions and continuing general and administrative expenses. The net proceeds deposited into the trust fund remain on deposit in the trust account earning interest. In connection with the initial public offering and the private placement, Argyle’s officers and directors placed all the shares owned by them before the private placement and the initial public offering into an escrow account. Except in certain circumstances, the shares held in escrow may not be released prior to January 24, 2009.

 

The segments of the security industry on which Argyle indicated it would focus in its prospectus relating to its initial public offering included perimeter security (to detect unauthorized entrance or exit to/from the grounds or campus), video surveillance (to monitor all areas of interest with video cameras and to capture images of activity in these areas) and access control (to control physical access to/from facilities or areas within facilities using electronically operated locks controlled by the use of PIN codes, proximity cards, or biometric identification). The security industry was further described as encompassing the development, sale, or distribution of software solutions and equipment components, as well as consulting in the design of said security systems. ISI participates in the perimeter security, access control and video and design consultation segments in the correctional sector through its ISI-Detention and MCS-Detention subsidiaries and in the commercial/industrial/educational sectors through its MCS-Commercial subsidiary. In addition, the MCS-Commercial operation is also engaged in providing its sectors with fire detection security system solutions.

 

The Initial Public Offering and Trust Account. The funds held in the trust account are not to be released until the earlier of the consummation of a business combination or liquidation of Argyle, although, as noted elsewhere in this proxy statement/prospectus, claims might be made against Argyle as a result of extending the period in which it may complete a business combination in order to avoid liquidation (or in other circumstances not now anticipated by Argyle). The trust account contained approximately $29,073,971 as of September 30, 2006. If the acquisition is consummated, the trust account, reduced by amounts paid to stockholders of Argyle who do not approve the acquisition and elect to redeem their shares of common stock into their pro rata shares of net funds in it, will be released to Argyle.

 

Fair Market Value of Target Business. Pursuant to Argyle’s Second Amended and Restated Certificate of Incorporation, the initial target business that Argyle acquires must have a fair market value equal to at least 80% of Argyle’s net assets at the time of such acquisition, determined by Argyle’s Board of Directors based on standards generally accepted by the financial community, such as actual and potential sales, earnings, cash flow and book value. Argyle is not required to obtain an opinion from an investment banking firm as to fair market value if its Board independently determines that the target business has sufficient fair market value.

 

Limited Ability to Evaluate The Target Business’ Management. Although Argyle closely examined the management of ISI, Argyle cannot assure you that its assessment of ISI’s management will prove to be correct, or that future management will have the necessary skills, qualifications or abilities to manage its business successfully. Essentially, all of ISI’s current management will remain with the combined company, and will for the most part run its day-to-day operations. Argyle’s current Board of Directors will remain directors of Argyle subsequent to the acquisition.

 

Stockholder Approval of Business Combination. Provided that a quorum exists, Argyle will proceed with the acquisition only if a majority of the shares of common stock voted at the special meeting are voted in favor of the acquisition and holders of shares sold in Argyle’s initial public offering, representing no more than 20% of the shares sold in the initial public offering and the private placement, exercise their redemption rights, and if the 2007 Incentive Plan is approved or the Board of Directors of ISI chooses to waive the condition to the merger that the 2007 Incentive Plan be adopted. The holders of Argyle common stock issued prior to its initial public offering have agreed to vote 956,261 of their shares in accordance with the holders of a majority of the public shares voting in person or by proxy at the meeting and have agreed to vote the 125,000 of their shares purchased in the private placement that took place immediately prior to Argyle’s initial public offering and all shares acquired after such initial public offering in favor of all of the acquisition. The 125,000 shares that Argyle’s initial stockholders will vote in favor of the proposals presented in this prospectus represent 2.6% of Argyle’s outstanding shares of common stock. By voting these shares for the merger, Argyle’s initial stockholders increase the number of shares held by Argyle’s public stockholders that must be voted against the merger proposal to reject the proposal. If holders of 765,009 shares of Argyle’s common stock purchased in Argyle’s initial public offering (which number represents 20% or more of the shares of Argyle common stock issued in Argyle’s initial public offering and private placement) vote against the acquisition and exercise their right to redeem their shares for cash, the acquisition will not be consummated.

 

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If the Acquisition is Not Consummated. If Argyle does not consummate the business combination with ISI, it will continue to seek another target business until it is required to liquidate and dissolve pursuant to its certificate of incorporation. As provided in its Second Amended and Restated Certificate of Incorporation, Argyle is required, by July 30, 2007, to consummate a business combination or enter a letter of intent, agreement in principle or definitive agreement relating to a business combination, in which case Argyle would be allowed an additional six months to complete the transactions contemplated by such agreement. Under its Second Amended and Restated Certificate of Incorporation as currently in effect, if Argyle does not acquire at least majority control of a target business by January 30, 2008, Argyle will dissolve and distribute to its public stockholders the amount in the trust account plus any remaining net assets.

 

Redemption rights. Each holder of public shares who votes against the acquisition has the right to have his or her public shares redeemed for cash, if the acquisition is approved and completed.

 

The actual per share redemption price will be equal to the amount in the trust account, inclusive of any interest, as of two business days prior to the consummation of the acquisition, less taxes payable, $600,000 of interest released to us from the trust account to fund our working capital and the payment of the deferred underwriting fees, divided by the number of shares issued in Argyle’s initial public offering and the private placement, which, as of September 30, 2006 would be $7.20 per share. The redemption amount (approximately $7.20) is less than the liquidation amount (approximately $7.84) you would receive if we fail to timely consummate a business combination, since the liquidation amount will include certain amounts held in trust that will not be paid to stockholders upon a redemption, such as the deferred portion of the underwriters’ discount from Argyle’s initial public offering and the deferred private placement fee proceeds attributable to the units sold in Argyle’s private placement that took place immediately prior to its initial public offering. An eligible stockholder may request redemption at the time the vote is taken with respect to the acquisition, but the request will not be granted unless the stockholder votes against the acquisition and the acquisition is approved and completed. Any request for redemption, if made by proxy prior to the date of the special meeting, may be withdrawn at any time up to the date of the meeting. Funds to be distributed to stockholders who elect redemption will be distributed promptly after consummation of the acquisition. Any stockholder who redeems stock into a portion of the trust account still has the right to exercise any warrants to purchase Argyle common stock that he or she owns. Argyle will not complete the acquisition if holders 765,009 or more of shares of Argyle’s common stock purchased in Argyle’s initial public offering (which number represents 20% or more of the shares of Argyle common stock issued in Argyle’s initial public offering and private placement) vote against the acquisition and exercise their redemption rights.

 

Competition.  If the acquisition is completed, Argyle will become subject to competition from competitors of ISI. For more information of the competition ISI faces, please see the section entitled, “Information About ISI—Competition” elsewhere in this document.

 

Facilities. Argyle maintains executive offices at Concord Plaza, Suite 700, San Antonio, TX 78216. The base rental cost for this space is approximately $5,500 per month. Argyle considers its current office space adequate for current operations.

 

Employees

 

Argyle has two officers. They are not obligated to contribute any specific number of hours per week on Argyle’s affairs, and they devote only as much time as they deem necessary to Argyle’s affairs. Argyle has no other employees.

 

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Periodic Reporting and Audited Financial Statements

 

Argyle has registered its securities under the Securities Exchange Act of 1934 and has reporting obligations, including the requirement to file annual and quarterly reports with the SEC. In accordance with the requirements of the Securities Exchange Act of 1934, Argyle’s annual report contains financial statements audited and reported on by Argyle’s independent accountants.

 

Legal Proceedings

 

Argyle is not currently a party to any pending material legal proceedings.

 

ARGYLE MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

The following discussion should be read in conjunction with Argyle’s financial statements and related notes thereto included elsewhere in this proxy statement/prospectus.

Forward Looking Statements

 

The statements discussed in this proxy statement/prospectus include forward looking statements that involve risks and uncertainties, including the risks detailed from time to time in Argyle’s reports filed with the Securities and Exchange Commission.

Critical Accounting Policies

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of income and expenses during the reporting period. Actual results could differ from those estimates.

 

Management does not believe that any recently issued, but not yet effective, accounting standards if currently adopted would have a material effect on the accompanying financial statements.

Results of Operations for the Nine-Month Period Ended September 30, 2006

Argyle reported net income of $71,066 for the nine-month period ended September 30, 2006, before the deduction of $152,941 of interest income, net of taxes, attributable to common stock subject to possible redemption. Argyle incurred a net loss of $4,538 for the period from inception (June 22, 2005) through September 30, 2005. Argyle’s net income consists of interest earned on the trust account.

Argyle’s trust account earned interest of $952,609 for the nine months ended September 30, 2006 and its funds outside the trust account earned interest of $11,409. Until Argyle enters into a business combination, it will not generate operating revenues. Argyle had no funds in trust as of September 30, 2005.

For the nine months ended September 30, 2006, Argyle incurred expenses of $372,008 for consulting and professional fees, $130,632 for stock compensation, $108,991 for franchise taxes, $60,411 for insurance expense, $44,363 for rental expense pursuant to Argyle’s lease of office space and other operating costs of $92,873.

 

The consulting and professional fees of $372,008 for the nine months ended September 30, 2006 relate primarily to monthly consulting fees that, cumulatively, totaled approximately $216,000, legal fees of approximately $46,000, auditing, tax and accounting fees of approximately $83,000 and bankers’ fees and expenses of approximately $22,000.

On February 1, 2006, Argyle’s officers and directors exercised options and purchased 18,761 shares of common stock for an aggregate cost of $507. The compensation cost associated with these options of $130,632 was recorded in the first quarter of 2006 and was computed utilizing the Black-Scholes pricing model.

The franchise tax expense of $108,991 for the first nine months of 2006 is due to the state of Delaware, and the entire amount due for 2006 will be paid in the first quarter of 2007.

The insurance expense of $60,411 for the first nine months of 2006 relates to the amortization of the pre-paid directors and officers insurance policy which was acquired in January 2006.

The other operating costs of $92,873 for the first nine months of 2006 relate primarily to travel expenses of approximately $32,000, computer server hosting expense of approximately $15,000, communications expenses of approximately $9,000, stock transfer fees of $9,000, office supplies and expenses of approximately $5,000 and other miscellaneous costs of approximately $23,000.

 

Results of Operations for the Period from June 22, 2005 (inception) to December 31, 2005

Argyle had a net loss of $7,743 for the period ended December 31, 2005 as a result of formation and operating costs. Additionally, deferred offering costs of approximately $295,000 were incurred in 2005. These costs consisted of professional fees of approximately $203,000, road show and travel expenses of approximately $25,000, and regulatory and filing fees of approximately $67,000. Argyle had no income in 2005. Until Argyle enters into a business combination, it will not have revenues and will continue to incur losses due to management’s expenses relating to locating a target business to acquire.

 

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Liquidity and Capital Resources

On January 24, 2006, Argyle completed a private placement of 125,000 units to its executive officers and their affiliates and received net proceeds of approximately $900,000. On January 30, 2006, Argyle consummated its initial public offering of 3,700,046 units (which includes 75,046 units sold as part of the underwriter’s over-allotment option). Each unit in both the private placement and the public offering consisted of one share of common stock and one redeemable common stock purchase warrant. Each warrant entitles the holder to purchase from Argyle one share of Argyle’s common stock at an exercise price of $5.50 per share commencing on the later of the completion of a business combination or January 24, 2007 and expiring January 24, 2011. Argyle’s common stock and warrants started trading separately as of March 2, 2006.

The net proceeds from the sale of Argyle’s units, after deducting certain offering expenses of approximately $2.4 million, including underwriting discounts of approximately $1.8 million, were approximately $28.2 million. Approximately $27.3 million of the proceeds from the initial public offering and the private placement was placed in a trust account for Argyle’s benefit. Except for reimbursement of taxes payable and $600,000 in interest from the trust account that was released to Argyle in September 2006 for working capital, Argyle will not be able to access the amounts held in the trust until it consummates a business combination. The $29.1 million held in trust as of September 30, 2006 includes approximately $1.4 million of underwriter’s and placement agent’s compensation from Argyle’s private placement and initial public offering that will be paid to the underwriters and placement agent only in the event of a business combination. The trust account earned interest income of $952,609 during the nine months ended September 30, 2006. The amounts held outside of the trust account are available to be used by Argyle to provide for business, legal and accounting due diligence on prospective acquisitions and continuing general and administrative expenses. As of December 31, 2006, Argyle had approximately $.7 million outside the trust account to fund its working capital requirements.

 

Argyle expects to use up to approximately $20.5 million (including Argyle and ISI transaction costs) of the net proceeds of the initial public offering to acquire ISI. After paying off any expenses relating to the identification and evaluation of prospective acquisition candidates, the structuring, negotiation and consummation of the business combination and paying for the redemption of the stock of any of Argyle’s stockholders who choose to exercise their redemption rights, any residual proceeds from Argyle’s initial public offering will be used by the company as working capital.

Argyle anticipates that it will incur total transaction costs of approximately $1.3 million. Such costs do not include those transaction costs of approximately $1.0 million to be incurred by ISI (related primarily to anticipated attorney, brokerage and accounting fees). Of the $1.3 million of Argyle anticipated transaction costs, approximately $.4 million relate to certain Giuliani Capital Advisors’ advisory fees which are contingent upon the closing of the transaction. Approximately $.5 million of the $.9 million in non-contingent anticipated costs had been incurred and recorded as of December 31, 2006. The $.9 million primarily relates to Loeb and Loeb legal expenses, fees for Giuliani Capital Advisors’ fairness opinion, accountants and valuation consultants’ fees, road show expenses, printer fees and other miscellaneous expenses. Argyle’s cash outside the trust and accrued expenses as of December 31, 2006 was approximately $.7 million and $.6 million, respectively. Argyle expects to incur the remaining anticipated non-contingent transaction costs of $.4 million over the first two quarters of 2007. Additionally, recurring monthly operating expenses of approximately $75,000 per month will continue to accrue after December 31, 2006, and in January 2007, Argyle renewed its directors and officers insurance policy, incurring a premium of $88,000.

As a result of the foregoing, Argyle anticipates that the costs to consummate the acquisition will greatly exceed its available cash outside of the trust, and that Argyle will not be able to consummate the merger without receiving additional funds and/or reaching agreements with Argyle’s service providers to defer their fees and expenses. Argyle expects these expenses would ultimately be borne by the combined company from the funds held in trust if the proposed ISI acquisition is completed. If it is not, they would be subject to the potential indemnification obligations of Argyle’s officers and directors to the trust account related to expenses incurred for vendors or service providers. If these obligations are not performed or are inadequate, it is possible that vendors or service providers could seek to recover these expenses from the trust account, which could ultimately deplete the trust account and reduce a stockholder’s current pro rata portion of the trust account upon liquidation. As of January 31, 2007, Argyle has not entered into any formal arrangements with its professional service providers to defer their fees; however, they anticipate that certain providers may be agreeable to such deferral. Additionally, the officers of Argyle are considering various potential funding mechanisms; however, as of January 31, 2007, no additional financing has been provided or agreements reached.

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Upon going public in late January 2006, Argyle has focused its attention on the search for a target business in the security industry. The expense related to this effort is primarily comprised of certain monthly consulting fees paid to parties identified below for the research and investigation of potential target companies, and professional fees and travel expenses associated with targets which are no longer being pursued. Argyle has recorded these expenses as either part of the disclosed consulting and professional fees, or as travel expenses which are classified as other operating costs. The costs directly associated with the ISI acquisition, excluding the recurring monthly consulting fees which are expensed, have been capitalized as transaction costs. Two of Argyle’s consultants work exclusively on the research, investigation and targeting of security companies while one of the other consultants spends approximately one-half of his time on acquisitions. Argyle believes that the amounts recorded as expenses associated with its search during 2006 were approximately $.2 million. Additionally, transaction costs associated with the ISI acquisition of approximately $.5 million were capitalized during 2006 and approximately $.4 million of additional non-contingent transaction costs associated with the ISI acquisition are anticipated. In the prospectus related to Argyle’s initial public offering, Argyle estimated legal, accounting and other expenses attendant to the structuring and negotiation of a business combination, and the preparation and filing of the related proxy statement of $.15 million and due diligence of prospective target businesses of $.225 million. The majority of the difference is related primarily to the cost of a fairness opinion from Giuliani Capital Advisors and legal fees which are accumulating at a higher rate than those estimated in the Form S-1.

Argyle’s accrued expenses, as of September 30, 2006, totaled $166,141. The majority of this total is represented by an accrual to the state of Delaware for franchise taxes in the amount of approximately $106,000 and accruals for professional fees, associated with attorneys, accountants and bankers and related expenses of approximately $48,000. The franchise tax and banker fees are not specifically disclosed in the use of proceeds section of Argyle’s prospectus related to its initial public offering, but expenses for legal and accounting are disclosed.

Assuming the completion of the ISI acquisition, Argyle will assume approximately $6.0 million in long term debt, in addition to the $9.0 million ISI line of credit which had an outstanding balance of approximately $5.0 million as of December 31, 2006. Additionally, Argyle will assume the capital lease obligation related to ISI’s offices in San Antonio, Texas which had a balance of approximately $2.1 million as of December 31, 2006. At closing, Argyle will pay certain ISI obligations totaling approximately $1.9 million as of December 31, 2006, relating to ISI*MCS and notes payable to ISI shareholders. Argyle will also assume the current liabilities relating to accounts payable, accrued liabilities and billings in excess of costs and estimated earnings on incomplete contracts.

 

As of February 1, 2006 Argyle entered into a lease for Argyle’s office space in San Antonio, Texas and began to pay a base rental of approximately $5,500 per month. The lease was originally scheduled to terminate on January 31, 2007; however, it was amended to extend the termination date by six months. In connection with its operations, in March 2006, Argyle paid an outstanding obligation to a consultant for approximately $53,000 and is currently paying approximately $24,000 per month in consulting fees for services assisting Argyle in the identification of a target business and with securities compliance. The consulting agreements entered into thus far may be terminated by either party for any reason upon 15 days notice.

Presently, Argyle is utilizing four consultants on a monthly basis. Alan Wachtel and Graham Wallis perform research and investigation of target companies in the security industry and assist in the performance of due diligence on potential acquisition candidates. Cindy Kittrell is the office manager and performs associated administrative functions. Mark Mellin is a financial consultant who assists Argyle in its SEC reporting responsibilities, accounting matters and also assists in the investigation and due diligence of potential acquisition candidates.

 

Off Balance Sheet Arrangements

Argyle does not have any off-balance sheet arrangements.

 

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UNAUDITED PRO FORMA

 

CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

The following unaudited pro forma condensed consolidated balance sheet combines Argyle’s historical balance sheets and those of ISI as of September 30, 2006, giving effect to the transactions described in the purchase agreement as if they had occurred on September 30, 2006. The following unaudited pro forma condensed consolidated statements of operations combine (i) Argyle’s historical statement of operations for the nine months ended September 30, 2006 with those of ISI and (ii) Argyle’s historical statement of operations from inception (June 22, 2005) to December 31, 2005 with those of ISI for the year ended December 31, 2005, in each case giving effect to the acquisition as if it had occurred on January 1, 2005.

 

The unaudited pro forma condensed consolidated financial statements have been prepared using two different levels of approval of the transaction by the Argyle stockholders, as follows:

 

·

Assuming Maximum Approval: This presentation assumes that no stockholder exercised their redemption rights

 

·

Assuming Minimum Approval: This presentation assumes that holders of 19.99% of Argyle’s common stock exercised redemption rights

 

Under the purchase method of accounting, the preliminary purchase price has been allocated to the net tangible and intangible assets acquired and liabilities assumed, based upon preliminary estimates. Management estimates that a substantial portion of the excess purchase price will be allocated to non-amortizable intangible assets. These estimates are subject to change upon the finalization of the valuation of certain assets and liabilities.

 

Argyle is providing this information to aid you in your analysis of the financial aspects of the acquisition. The unaudited pro forma condensed consolidated financial statements described above should be read in conjunction with the historical financial statements of Argyle and ISI and the related notes thereto. The pro forma adjustments are preliminary and the unaudited pro forma information is not necessarily indicative of the financial position or results of operations that may have actually occurred had the acquisition taken place on the dates noted, or Argyle’s future financial position or operating results.

 

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Argyle Security Acquisition Corporation

Unaudited Pro Forma Condensed Consolidated Balance Sheet

September 30, 2006

Assuming Maximum Approval

								Pro Forma			Pro Forma
		Argyle			ISI			Adjustments			Combined
Assets
Cash		$	920,429		$	254,483		$	$29,073,971	a	$
			-			-			(20,500,000	) c
			-			-			(1,422,740	) e
			-			-			(2,084,447	) g		6,241,696
Cash and cash equivalents, held in trust			29,073,971			-			(29,073,971	) a		-
Contract receivables (net of reserve for doubtful accounts of $264,488)			-			16,694,584			-			16,694,584
Contract receivables - related party			-			4,160,046			-			4,160,046
Other receivables			-			377,098			-			377,098
Prepaid expenses			29,333			-			-			29,333
Inventory			-			324,464			-			324,464
Refundable federal income taxes			-			655,843			-			655,843
Costs and estimated earnings in excess of billings on incomplete contracts			-			4,178,225			-			4,178,225
Total current assets		$	30,023,733		$	26,644,743		$	(24,007,187	)	$	32,661,289
Deferred income taxes			34,442			-			-			34,442
Property and equipment:
Land and buildings			-			2,645,438			-			2,645,438
Furniture, fixtures and equipment			6,520			2,506,579			-			2,513,099
Vehicles			-			1,767,351			-			1,767,351
		$	6,520		$	6,919,368		$	-		$	6,925,888
Accumulated depreciation and amortization			(1,075	)		(3,195,984	)		-			(3,197,059	)
Net property and equipment		$	5,445		$	3,723,384		$	-		$	3,728,829
Other assets:
Tradename			-			-			4,912,000	c		4,912,000
Customer relationships			-			-			6,905,000	c		6,905,000
Backlog			-			-			2,232,000	c		2,232,000
Software			-			-			300,000	c		300,000
Goodwill			-			1,254,306			(1,254,306	) c
			-			-			23,280,917	c		23,280,917
Loan origination fees, net of accumulated amortization of $649,815			-			1,008,008			(1,008,008	) c		-
Deposits and other assets			-			171,355			-			171,355
Total other assets		$	-		$	2,433,669		$	35,367,603		$	37,801,272
Total assets		$	30,063,620		$	32,801,796		$	11,360,416		$	74,225,832

See notes to unaudited pro forma condensed consolidated financial statements.

 

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Argyle Security Acquisition Corporation

Unaudited Pro Forma Condensed Consolidated Balance Sheet

September 30, 2006

Assuming Maximum Approval

								Pro Forma			Pro Forma
		Argyle			ISI			Adjustments			Combined
Liabilities and stockholders’ equity
Accounts payable and accrued liabilities		$	166,141		$	11,175,091		$	166,000	o	$	11,507,232
Accounts payable - related party			-			1,986,056			(1,986,056	) g		-
Accrued income taxes			71,926			-			(64,000	) o		7,926
Current maturities of long-term debt			-			80,814			-			80,814
Current portion of capital lease obligations			-			95,580			-			95,580
Deferred underwriting costs			1,422,740			-			(1,422,740	) e		-
Billings in excess of costs and estimated earnings on incomplete contracts			-			6,912,067			-			6,912,067
Total current liabilities		$	1,660,807		$	20,249,608		$	(3,306,796	)	$	18,603,619
Long-term liabilities
Line of credit			-		$	4,662,850		$	-		$	4,662,850
Long-term debt less current maturities			-			13,510,651			(10,000,000	) b
			-			-			2,675,832	c
			-			-			(98,391	) g		6,088,092
Long-term portion of capital lease obligations			-			2,011,705			-			2,011,705
Deferred income taxes			-			255,188			5,524,365	c		5,779,553
Warrants subject to redemption			-			4,819,615			(4,819,615	) c		-
Total long-term liabilities		$	-		$	25,260,009		$	(6,717,809	)	$	18,542,200
Total liabilities		$	1,660,807		$	45,509,617		$	(10,024,605	)	$	37,145,819
Common stock subject to possible conversion -764,627 shares  at $7.14 per share		$	5,459,435		$	-		$	(5,459,435	) d1	$	-
Deferred interest attributable to common stock subject to possible redemption (net of taxes of $37,484)			152,941			-			(152,941	) d1		-
Stockholders’ equity:
ISI preferred stock			-			-			10,000,000	b
			-			-			(10,000,000	) c		-
Preferred stock - $.0001 par value; 1,000,000 shares authorized; 0 shares issued and outstanding			-			-			-			-
Common stock - $.0001 par value; 89,000,000 shares authorized; issued and outstanding 4,781,307 (including 764,627 shares of common stock subject to possible redemption)			478			-			118	c		596
Common Stock - $1 par value; 3,000 shares authorized; 105 shares issued and outstanding			-			105			(105	) c		-
Additional paid in capital			22,726,636			16,808			(16,808	) c
			-			-			8,779,082	c
			-			-			5,459,435	d1		36,965,153
Retained earnings during the development stage			63,323			-			(63,323	) f		-
Accumulated deficit			-			(12,724,734	)		12,724,734	c		-
Retained earnings			-			-			152,941	d1
			-			-			63,323	f
			-			-			(102,000	) o		114,264
Total stockholders’ equity		$	22,790,437		$	(12,707,821	)	$	26,997,397		$	37,080,013
Total liabilities and stockholders’ equity		$	30,063,620		$	32,801,796		$	11,360,416		$	74,225,832

See notes to unaudited pro forma condensed consolidated financial statements.

 

83

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Argyle Security Acquisition Corporation

Unaudited Pro Forma Condensed Consolidated Balance Sheet

September 30, 2006

Assuming Minimum Approval

								Pro Forma			Pro Forma
		Argyle			ISI			Adjustments			Combined
Assets
Cash		$	920,429		$	254,483		$	29,073,971	a	$	-
			-			-			(20,500,000	) c
			-			-			(5,612,376	) d2
			-			-			(1,422,740	) e
			-			-			(2,084,447	) g		629,320
Cash and cash equivalents, held in trust			29,073,971			-			(29,073,971	) a		-
Contract receivables (net of reserve for doubtful accounts of $264,488)			-			16,694,584			-			16,694,584
Contract receivables - related party			-			4,160,046			-			4,160,046
Other receivables			-			377,098			-			377,098
Prepaid expenses			29,333			-			-			29,333
Inventory			-			324,464			-			324,464
Refundable federal income taxes			-			655,843			-			655,843
Costs and estimated earnings in excess of billings on incomplete contracts			-			4,178,225			-			4,178,225
Total current assets		$	30,023,733		$	26,644,743		$	(29,619,563	)	$	27,048,913
Deferred income taxes		$	34,442		$	-		$	-		$	34,442
Property and equipment:
Land and buildings			-			2,645,438			-			2,645,438
Furniture, fixtures and equipment			6,520			2,506,579			-			2,513,099
Vehicles			-			1,767,351			-			1,767,351
		$	6,520		$	6,919,368		$	-		$	6,925,888
Accumulated depreciation and amortization			(1,075	)		(3,195,984	)		-			(3,197,059	)
Net property and equipment		$	5,445		$	3,723,384		$	-		$	3,728,829
Other assets:
Tradename			-			-			4,912,000	c		4,912,000
Customer relationships			-			-			6,905,000	c		6,905,000
Backlog			-			-			2,232,000	c		2,232,000
Software			-			-			300,000	c		300,000
Goodwill			-			1,254,306			(1,254,306	) c
			-			-			23,280,917	c		23,280,917
Loan origination fees, net of accumulated amortization of $649,815			-			1,008,008			(1,008,008	) c		-
Deposits and other assets			-			171,355			-			171,355
Total other assets			-		$	2,433,669		$	35,367,603		$	37,801,272
Total assets		$	30,063,620		$	32,801,796		$	5,748,040		$	68,613,456

See notes to unaudited pro forma condensed consolidated financial statements.

84

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Argyle Security Acquisition Corporation

Unaudited Pro Forma Condensed Consolidated Balance Sheet

September 30, 2006

Assuming Minimum Approval

								Pro Forma						Pro Forma
		Argyle			ISI			Adjustments						Combined
Liabilities and stockholders’ equity
Accounts payable and accrued liabilities		$	166,141		$	11,175,091		$	166,000			o		$	11,507,232
Accounts payable - related party			-			1,986,056			(1,986,056	)		g			-
Accrued income taxes			71,926			-			(64,000	)		o			7,926
Current maturities of long-term debt			-			80,814			-						80,814
Current portion of capital lease obligations			-			95,580			-						95,580
Deferred underwriting costs			1,422,740			-			(1,422,740	)		e			-
Billings in excess of costs and estimated earnings on incomplete contracts			-			6,912,067			-						6,912,067
Total current liabilities		$	1,660,807		$	20,249,608		$	(3,306,796	)				$	18,603,619
Long-term liabilities
Line of credit		$	-		$	4,662,850		$	-					$	4,662,850
Long-term debt less current maturities			-			13,510,651			(10,000,000	)		b
			-			-			2,675,832			c
			-			-			(98,391	)		g			6,088,092
Long-term portion of capital lease obligations			-			2,011,705			-						2,011,705
Deferred income taxes			-			255,188			5,524,365			c			5,779,553
Warrants subject to redemption			-			4,819,615			(4,819,615	)		c			-
Total long-term liabilities			-			25,260,009			(6,717,809	)					18,542,200
Total liabilities		$	1,660,807		$	45,509,617		$	(10,024,605	)				$	37,145,819
Common stock subject to possible conversion -764,627 shares at $7.14 per share		$	5,459,435		$	-		$	(5,459,435	)		d2		$	-
Deferred interest attributable to common stock subject to possible redemption (net of taxes of $37,484)			152,941			-			(152,941	)		d2			-
Stockholders’ equity:
ISI preferred stock			-			-			10,000,000			b
			-			-			(10,000,000	)		c			-
Preferred stock - $.0001 par value; 1,000,000 shares authorized; 0 shares issued and outstanding			-			-			-						-
Common stock - $.0001 par value; 89,000,000 shares authorized; issued and outstanding 4,781,307 (including 764,627 shares of common stock subject to possible redemption)			478			-			118			c
									(76	)		d2			520
Common Stock - $1 par value; 3,000 shares authorized; 105 shares issued and outstanding			-			105			(105	)		c			-
Additional paid in capital			22,726,636			16,808			(16,808	)		c
			-			-			8,779,082			c
			-			-			76			d2			31,505,794
Retained earnings during the development stage			63,323			-			(63,323	)		f			-
Accumulated deficit			-			(12,724,734	)		12,724,734			c			-
Retained earnings			-			-			63,323			f
			-			-			(102,000	)		o			(38,677	)
Total stockholders’ equity		$	22,790,437		$	(12,707,821	)	$	21,385,021					$	31,467,637
Total liabilities and stockholders’ equity		$	30,063,620		$	32,801,796		$	5,748,040					$	68,613,456

 

See notes to unaudited pro forma condensed consolidated financial statements.

 

85

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Argyle Security Acquisition Corporation

 

Unaudited Pro Forma Condensed Consolidated Statement of Operations

Nine Months Ended September 30, 2006

Assuming Maximum Approval

 

								Pro Forma						Pro Forma
		Argyle			ISI			Adjustments						Combined
Revenues:
Contract revenues		$	-		$	22,729,085		$	-					$	22,729,085
Contract revenues - related party			-			13,586,044			-						13,586,044
Service revenues			-			4,881,879			-						4,881,879
Other revenues			-			36,798			-						36,798
			-		$	41,233,806			-					$	41,233,806
Cost of revenues:
Contract costs		$	-		$	29,018,321		$	-					$	29,018,321
Other costs			-			3,554,670			-						3,554,670
		$	-		$	32,572,991		$	-					$	32,572,991
Gross profit		$	-		$	8,660,815		$	-					$	8,660,815
General and administrative expenses		$	809,278		$	6,249,385		$	-					$	7,058,663
Amortization of intangibles			-			-			1,148,000			j			1,148,000
Operating income / (loss)		$	(809,278	)	$	2,411,430		$	(1,148,000	)				$	454,152
Other income and expense:
Interest income		$	11,409		$	-		$	(680,000	)		k		$
			-			-			952,609			n			284,018
Interest on cash and cash equivalents held in trust			952,609			-			(952,609	)		n			-
Interest expense			(46,190	)		(2,779,773	)		8,855			l
			-			-			1,815,887			m			(1,001,221	)
Investment and other income (loss) - net			-			346			-						346
Total other income and expense		$	917,828		$	(2,779,427	)	$	1,144,742					$	(716,857	)
Income / (loss) before provision for income taxes		$	108,550		$	(367,997	)	$	(3,258	)				$	(262,705	)
Income tax expense (benefit)
Current		$	71,926		$	10,312		$	(157,821	)		p			(75,583	)
Deferred			(34,442	)		-			-						(34,442	)
		$	37,484		$	10,312		$	(157,821	)				$	(110,025	)
Net income / (loss)		$	71,066		$	(378,309	)	$	154,563					$	(152,680	)
Deferred interest (net of taxes), attributable to common subject to possible redemption		$	152,941		$	-		$	(152,941	)		h		$	-
Net income / (loss) allocable to holders of non-redeemable common stock		$	(81,875	)	$	(378,309	)	$	307,504					$	(152,680	)

 

See notes to unaudited pro forma condensed consolidated financial statements.

 

86

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Argyle Security Acquisition Corporation

 

Unaudited Pro Forma Condensed Consolidated Statement of Operations

Nine Months Ended September 30, 2006

Assuming Maximum Approval

								Pro Forma						Pro Forma
		Argyle			ISI			Adjustments						Combined
Earnings / (loss) per share:
Basic		$	0.02		$	(3,606.03	)							$	(0.03	)
Diluted		$	0.02		$	(3,606.03	)							$	(0.03	)
Weighted-average number of shares outstanding:
Basic			4,375,600			104.91						q			5,961,307
Diluted			4,375,600			104.91									6,916,620
Earnings per share exclusive of interest and shares
subject to redemption:
Basic		$	(0.02	)
Diluted		$	(0.02	)
Weighted-average number of shares outstanding
exclusive of shares subject to possible redemption:
Basic			3,692,197
Diluted			3,692,197

See notes to unaudited pro forma condensed consolidated financial statements.

 

87

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Argyle Security Acquisition Corporation

Unaudited Pro Forma Condensed Consolidated Statement of Operations

Nine Months Ended September 30, 2006

Assuming Minimum Approval

 

								Pro Forma						Pro Forma
		Argyle			ISI			Adjustments						Combined
Revenues:
Contract revenues		$	-		$	22,729,085			-					$	22,729,085
Contract revenues - related party			-			13,586,044			-						13,586,044
Service revenues			-			4,881,879			-						4,881,879
Other revenues			-			36,798			-						36,798
		$	-		$	41,233,806			-					$	41,233,806
Cost of revenues:
Contract costs			-			29,018,321			-						29,018,321
Other costs			-			3,554,670			-						3,554,670
		$	-		$	32,572,991			-					$	32,572,991
Gross profit		$	-		$	8,660,815		$	-					$	8,660,815
General and administrative expenses			809,278			6,249,385			-						7,058,663
Amortization of intangibles			-			-			1,148,000			j			1,148,000
Operating income / (loss)		$	(809,278	)	$	2,411,430		$	(1,148,000	)				$	454,152
Other income and expense:
Interest income		$	11,409		$	-		$	(186,000	)		i		$
			-			-			(680,000	)		k
			-			-			952,609			n			98,018
Interest on cash and cash equivalents held in trust			952,609			-			(952,609	)		n			-
Interest expense			(46,190	)		(2,779,773	)		8,855			l
			-			-			1,815,887			m			(1,001,221	)
Investment and other income (loss) - net			-			346			-						346
Total other income and expense		$	917,828		$	(2,779,427	)	$	958,742					$	(902,857	)
Income / (loss) before provision for income taxes		$	108,550		$	(367,997	)	$	(189,258	)				$	(448,705	)
Income tax expense (benefit)
Current			71,926			10,312			(229,431	)		p			(147,193	)
Deferred			(34,442	)		-			-						(34,442	)
		$	37,484		$	10,312		$	(229,431	)				$	(181,635	)
Net income / (loss)		$	71,066		$	(378,309	)	$	40,173					$	(267,070	)
Deferred interest (net of taxes), attributable to common subject to possible redemption		$	152,941		$	-		$	(152,941	)		h		$	-
Net income / (loss) allocable to holders of non-redeemable common stock		$	(81,875	)	$	(378,309	)	$	193,114					$	(267,070	)

 

See notes to unaudited pro forma condensed consolidated financial statements.

 

88

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Argyle Security Acquisition Corporation

Unaudited Pro Forma Condensed Consolidated Statement of Operations

Nine Months Ended September 30, 2006

Assuming Minimum Approval

								Pro Forma						Pro Forma
		Argyle			ISI			Adjustments						Combined
Earnings / (loss) per share:
Basic		$	0.02		$	(3,606.03	)							$	(0.05	)
Diluted		$	0.02		$	(3,606.03	)							$	(0.05	)
Weighted-average number of shares outstanding:
Basic			4,375,600			105						q			5,196,680
Diluted			4,375,600			105									6,151,993
Earnings per share exclusive of interest and shares
subject to redemption:
Basic		$	(0.02	)
Diluted		$	(0.02	)
Weighted-average number of shares outstanding
exclusive of shares subject to possible redemption:
Basic			3,692,197
Diluted			3,692,197

See notes to unaudited pro forma condensed consolidated financial statements.

 

89

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Argyle Security Acquisition Corporation

 

Unaudited Pro Forma Condensed Consolidated Statement of Operations

Twelve Months Ended December 31, 2005

Assuming Maximum Approval

								Pro Forma						Pro Forma
		Argyle			ISI			Adjustments						Combined
Revenues:
Contract revenues		$	-		$	20,905,409		$	-					$	20,905,409
Contract revenues - related party			-			14,475,895			-						14,475,895
Service revenues			-			3,771,050			-						3,771,050
Other revenues			-			82,133			-						82,133
		$	-		$	39,234,487		$	-					$	39,234,487
Cost of revenues:
Contract costs		$	-		$	28,213,117		$	-					$	28,213,117
Other costs			-			2,652,272			-						2,652,272
		$	-		$	30,865,389		$	-					$	30,865,389
Gross profit		$	-		$	8,369,098		$	-					$	8,369,098
General and administrative expenses		$	7,743		$	6,908,440		$	-					$	6,916,183
Amortization of intangibles			-			-			2,516,000			j			2,516,000
Operating income / (loss)		$	(7,743	)	$	1,460,658		$	(2,516,000	)				$	(1,063,085	)
Other income and expense:
Interest expense		$	-		$	(3,177,891	)	$	1,968			l		$
			-			-			2,022,215			m			(1,153,708	)
Investment and other income (loss) - net			-			7,915			-						7,915
Loss before income taxes		$	(7,743	)	$	(1,709,318	)	$	(491,817	)				$	(2,208,878	)
Income tax expense (benefit)
Current		$	-		$	(448,249	)	$	(289,085	)		p		$	(737,334	)
Deferred			-			(77,567	)		-						(77,567	)
		$	-		$	(525,816	)	$	(289,085	)				$	(814,901	)
Net loss		$	(7,743	)	$	(1,183,502	)	$	(202,732	)				$	(1,393,977	)
Loss per share:
Basic and diluted		$	(0.01	)	$	(11,281.12	)	$						$	(0.23	)
Weighted-average number of shares outstanding:
Basic and diluted			937,500			104.91						q			5,961,307

See notes to unaudited pro forma condensed consolidated financial statements.

 

90

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Argyle Security Acquisition Corporation

 

Unaudited Pro Forma Condensed Consolidated Statement of Operations

Twelve Months Ended December 31, 2005

Assuming Minimum Approval

								Pro Forma						Pro Forma
		Argyle			ISI			Adjustments						Combined
Revenues:
Contract revenues		$	-		$	20,905,409			-					$	20,905,409
Contract revenues - related party			-			14,475,895			-						14,475,895
Service revenues			-			3,771,050			-						3,771,050
Other revenues			-			82,133			-						82,133
		$	-		$	39,234,487			-					$	39,234,487
Cost of revenues:
Contract costs		$	-		$	28,213,117			-					$	28,213,117
Other costs			-			2,652,272			-						2,652,272
		$	-		$	30,865,389			-					$	30,865,389
Gross profit		$	-		$	8,369,098			-					$	8,369,098
General and administrative expenses		$	7,743		$	6,908,440		$	-					$	6,916,183
Amortization of intangibles			-			-			2,516,000			j			2,516,000
Operating income / (loss)		$	(7,743	)	$	1,460,658		$	(2,516,000	)				$	(1,063,085	)
Other income and expense:
Interest expense		$	-		$	(3,177,891	)	$	1,968			l		$
			-			-			2,022,215			m			(1,153,708	)
Investment and other income (loss) - net			-			7,915			-						7,915
Loss before income taxes		$	(7,743	)	$	(1,709,318	)	$	(491,817	)				$	(2,208,878	)
Income tax expense (benefit)
Current		$	-		$	(448,249	)	$	(289,085	)		p		$	(737,334	)
Deferred			-			(77,567	)		-						(77,567	)
		$	-		$	(525,816	)	$	(289,085	)				$	(814,901	)
Net loss		$	(7,743	)	$	(1,183,502	)	$	(202,732	)				$	(1,393,977	)
Loss per share:
Basic and diluted		$	(0.01	)	$	(11,281.12	)	$						$	(0.27	)
Weighted-average number of shares outstanding:
Basic and diluted			937,500			105						q			5,196,680

 

See notes to unaudited pro forma condensed consolidated financial statements.

 

91

---

 

NOTES TO UNAUDITED PRO FORMA CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

a.	To record the reclassification of funds held in trust by Argyle.

 

b.	To record the conversion of $10 million of ISI long-term debt to preferred stock.

 

c.	To record the purchase of the outstanding common stock and preferred stock of ISI and the allocation of the purchase price to the assets acquired and liabilities assumed as follows:

Calculation of allocable purchase price(i):
Cash		$	18,200,000
Stock			8,779,200	(ii)
Transaction costs			2,300,000
Total allocable purchase price		$	29,279,200
Estimated allocation of purchase price(iii):
ISI net assets acquired (book value after conversion of $10 million ISI debt to ISI preferred stock)		$	(2,707,821	)
Fair value adjustments to assets acquired / liabilities assumed:
ISI goodwill			(1,254,306	)
ISI loan origination fees			(1,008,008	)
Warrants subject to redemption (iv)			4,819,615
Adjustments to long-term debt to reflect transaction (v)			(2,675,832	)
Fair value of tangible assets acquired		$	(2,826,352	)
Fair value of intangible assets acquired
Intangible assets:
Trade name (vi)		$	4,912,000
Customer relationships (vi)			6,905,000
Backlog (vi)			2,232,000
Software (vi)			300,000
Deferred taxes on intangible assets (vii)			(5,524,365	)
Goodwill			23,280,917
Total allocable purchase price		$	29,279,200

(i)

Assumes that the adjusted EBITDA of ISI for the year ending December 31, 2006 is $4,500,000 or greater and the amount of the February 28, 2007 backlog is $80 million or greater.

(ii)

1,180,000 shares of Argyle common stock at a price per share of $7.44, which was the closing price of a share of Argyle common stock on the OTC market on December 14, the date the transaction was announced.

 

(iii)

The purchase price allocation has not been finalized and is subject to change upon recording of actual transaction costs and completion of appraisals of tangible and intangible assets. The purchase price allocation will be finalized when all necessary information is obtained which is expected to occur within one year of the consummation of the transaction.

 

(iv)

Upon completion of the ISI acquisition and in accordance with the merger agreement, the ISI warrant holder will receive its share of the total consideration paid by Argyle. As a result, the warrant will no longer be outstanding after the completion of the acquisition.

(v)

This pro forma adjustment to long term debt is necessary to reflect the amount which will be due the lender, in accordance with the merger agreement, upon completion of the acquisition transaction. As there will be no warrants associated with this remaining debt, there will be no debt discount as there was in the historical financial statements of ISI.

 

(vi)

For financial reporting purposes, it is required that purchasers allocate the total consideration paid in a business combination under purchase accounting to the fair value of the acquired company’s assets and liabilities. The purchase price should first be allocated to the current assets, but not in excess of their fair values and then to non-current assets, again not in excess of their fair values. If after allocation to non-current assets a portion of the purchase price remains unallocated, it is assigned to identifiable intangible assets and goodwill. Trade name, customer relationships, backlog and software were identified as intangible assets. Argyle engaged a valuation consultant to assist them in this purchase price allocation.

A trade name valuation was performed for each of the ISI entities including ISI Detention, MCS Detention and MCS Commercial. The relief from royalty method was used to value the trade name. This methodology utilizes market royalty rates and trade name terminal values.

Customer relationships valuations were performed for each of the ISI entities. The excess earnings method is typically used to value customer relationships. Similar to the discounted cash flow method, the excess earnings method estimates the fair value of an intangible asset by discounting its future cash flows and applying charges related to the company’s other contributory assets.

Backlog valuations were performed for each of the ISI entities. Based on an excess earnings analysis, the present values of the cash flows were calculated.

The valuation of the MCS Detention software, which is utilized within detention facilities, was estimated based upon the costs to create the software.

(vii)

FASB 109, “Accounting for Income Taxes” requires the recognition of deferred tax assets and liabilities for the tax effects of differences between the assigned values in the purchase price allocation and the tax basis of assets acquired and liabilities assumed in a purchase business combination (except for the goodwill which is not deductible for tax purposes). As a result, Argyle has reflected a $5,524,365 deferred tax pro forma adjustment which represents the total value assigned to the intangible assets tax effected at 38.5%

 

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d1.

Assuming maximum approval to reclassify common stock subject to possible conversion as permanent equity $(5,459,435) and to record related deferred interest as income $(152,941) for the nine months ended September 30, 2006).

d2.

Assuming minimum approval, to record refund to dissenting shareholders $(5,612,376) and to reclassify common stock $(76) as additional paid-in-capital.

e.	To reflect the payment of the deferred underwriting fees associated with Argyle’s initial public offering.

f.	To reclassify retained earnings during the development stage to retained earnings.

 

g.	To reflect the repayment of amounts due to ISI* MCS and to shareholders.

h.	To eliminate the deferred interest income recorded on the income statements.

i.	To reduce interest income on the minimum approval income statement for the nine months ended September 30, 2006 to reflect the cash paid to the dissenting shareholders.

j.

To record amortization of intangible assets recorded in the purchase price allocation. Customer relationships for ISI-Detention and MCS-Detention are being amortized over a 12-year period. Customer relationships for MCS-Commercial are being amortized over a 5-year period. Backlog is being amortized over a 16-month period for ISI-Detention and MCS-Detention and over a 12-month period for MCS-Commercial. Software is being amortized over a 5-year period and the trade names have an indefinite life.

k.	To reduce interest income to reflect the payment of $20.5 million as the cash portion of the acquisition including transaction costs.

l.	To reduce interest expense on the long-term shareholder debt.

m.	To reduce interest expense to reflect the reduction of long-term debt and the elimination of the warrant.

n.	To reclassify interest on cash and cash equivalents held in trust to interest income.

o.	To record additional Argyle consulting fees which become due upon completion of the transaction.

p.	To adjust income taxes due to pro forma income adjustments.

 

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q.	Pro forma net income per share was calculated by dividing pro forma net income by the weighted average number of shares outstanding as follows:

 

		Maximum Approval			Minimum Approval
Nine months ended September 30, 2006:
Basic - Assuming initial public offering as of January 1, 2005			4,781,307			4,016,680
Shares issued in connection with the transaction			1,180,000			1,180,000
Basic - Total			5,961,307			5,196,680
Incremental shares on exercise of warrants*			955,313			955,313
Diluted			6,916,620			6,151,993

* Assuming stock price of $ 7.31 per share based on the average share price from January 1, 2006 to September 30, 2006.

		Maximum Approval			Minimum Approval
Twelve months ended December 31, 2005:
Basic - Assuming initial public offering as of January 1, 2005			4,781,307			4,016,680
Shares issued in connection with the transaction			1,180,000			1,180,000
Basic - Total **			5,961,307			5,196,680

** No diluted shares could be calculated for 2005 as Argyle’s stock did not trade publicly until 2006.

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DIRECTORS AND MANAGEMENT

 

Directors, Management and Key Employees Following the Acquisition

 

Upon consummation of the acquisition, Argyle and ISI intend the Board of Directors, executive officers and key employees of Argyle to be as follows:

 

Name		Age		Position
Bob Marbut		71		Chairman of the Board and Co-Chief Executive Officer
Ron Chaimovski		47		Vice Chairman of the Board and Co-Chief Executive Officer
Wesley Clark		61		Director
John J. Smith		58		Director
Sam Youngblood		51		Chief Executive Officer of ISI
Donald Carr		55		President of ISI
Mark McDonald		51		President of MCS-Detention
Robert Roller		54		President of MCS-Commercial
Tim Moxon		46		Chief Financial Officer of ISI
Neal Harmon		41		Senior Software Developer of ISI

Bob Marbut has been Argyle’s Chairman of the Board and Co-Chief Executive Officer since Argyle’s inception. From November 2004 to the present, Mr. Marbut has been the Executive Chairman of Electronics Line 3000 Ltd., an intrusion protection security company, and from July 2002 to the present he has been the Executive Chairman of SecTecGLOBAL, Inc., a sales and marketing subsidiary of Electronics Line 3000 Ltd., and was the Chief Executive Officer of SecTecGLOBAL from July 2002 to February 2006. From October 2001 to the present, Mr. Marbut has served as the Managing Director of Argyle Global Opportunities, LP, an investment partnership which owns a 41% interest in Electronics Line 3000 Ltd. From January 2001 to January 2003, Mr. Marbut served as the Chairman of Hearst-Argyle Television, Inc., a non-network owned television group and, from August 1997 to January 2001, served as its Chairman and Co-Chief Executive Officer. From January 1995 to August 1997, Mr. Marbut was the co-founder, Chairman and controlling partner of Argyle Television, Inc., which became a Nasdaq traded company and was merged with Hearst Broadcasting in August 1997 to form Hearst-Argyle Television, Inc. From 1993 to 1995, Mr. Marbut founded and was the Chief Executive Officer of Argyle Television Holding, Inc., a private television group that was sold in 1995. From August 1970 through 1990, Mr. Marbut served as the President and Chief Executive Officer of Harte-Hanks Communications, Inc., and concurrently as its Chief Operating Officer from April 1973 to September 1984, and as Vice-Chairman in 1991. During the period that Mr. Marbut was CEO, Harte-Hanks developed from a family-owned newspaper company into a Fortune 500 company listed on the New York Stock Exchange that Mr. Marbut took private in 1984 in a management buyout that he led. In addition to the Board of Directors of Electronics Line 3000 Ltd., Mr. Marbut currently serves on the boards of directors of Hearst-Argyle Television, Tupperware Corporation and Valero Energy Corporation. Mr. Marbut, through control of the general partner of Argyle Joint Venture, manages Argyle Joint Venture, one of Argyle’s stockholders which was formed to make equity investments in companies. Mr. Marbut is the sole investor and manager of Argyle New Ventures, which manages Mr. Marbut’s personal family investments. He has a Masters of Business Administration degree with Distinction from Harvard University and was a registered engineer in the State of California and holds a Bachelors of Industrial Engineering from Georgia Tech.

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Ron Chaimovski has been Argyle’s Vice Chairman of the Board and Co-Chief Executive Officer since Argyle’s inception. Mr. Chaimovski has served as the Vice Chairman of Electronics Line 3000 Ltd. since May 2005 and as a partner in Argyle Global Opportunities, LP since January 2001. From October 1998 to August 2001 Mr. Chaimovski served as the Israeli Economic Minister to North America. From 1991 to 1998, Mr. Chaimovski was a partner in an Israeli law firm. Mr. Chaimovski was the co-founder of Transplan Enterprises Group, an investment group, and served as its Co-Chairman from 1993 to 1998. Mr. Chaimovski served in the Israeli Navy from 1977 to 1983 in various command roles, including those of combat officer and flotilla commander. Mr. Chaimovski, through entities controlled by him or his spouse, owns limited partnership interests in Argyle Joint Venture. Mr. Chaimovski is a member of the Israeli Bar. Mr. Chaimovski received an LLB from Tel Aviv University and an LLM from the University of London.

 

Gen. (Ret.) Wesley K. Clark joined Argyle’s Board of Directors in September 2005. Since March 2003, he has been the Chairman and Chief Executive Officer of Wesley K. Clark & Associates, a business services and development firm based in Little Rock, Arkansas. In February 2006, Gen. Clark joined Rodman & Renshaw Holdings, LLC, which controls Rodman & Renshaw, LLC, one of the co-managing underwriters in the initial public offering, as Chairman of the Board and as a member of their Advisory Board. From March 2001 to February 2003 he was the Managing Director of the Stephens Group Inc., an emerging company development firm. From July 2000 to March 2001 he was a consultant for Stephens Group Inc. Prior to that time, Gen. Clark served as the Supreme Allied Commander of NATO and Commander-in-Chief for the United States European Command and as the Director of the Pentagon’s Strategic Plans and Policy operation. Gen. Clark retired from the United States Army as a four-star general in July 2000 after 38 years in the military and received many decorations and honors during his military career. Gen. Clark is a graduate of the United States Military Academy and studied as a Rhodes Scholar at the Magdalen College at the University of Oxford.

John J. “Chip” Smith has been one of Argyle’s directors since Argyle’s inception. He has been the Director of Security for the Bank of New York since February 2000. At the Bank of New York, Mr. Smith directs and supervises a worldwide security program that encompasses the investigation and prevention of fraud-related activities, as well as the physical protection of corporate assets, employees, customers and executives. Mr. Smith retired from the United States Secret Service in January 2000 after 24 years of service. He held a variety of positions in field offices and headquarters, culminating with his appointment as the Special Agent in Charge of the New York Field Office, the Service’s largest and busiest office. During his career, Mr. Smith was assigned to the Vice Presidential Protective Division, the Presidential Protective Division and as the Special Assistant to the Treasury Secretary. He served as the security coordinator for several high profile protective venues, including: the U.S. delegation attending the Olympic Games in Barcelona, Spain, 1992; the Presidential Inaugural activities of 1993; the dedication of the Holocaust Museum, Washington, DC, 1994; and the visit of Pope John Paul II to New York, 1995. In 1996, he supervised the protective detail assigned to Presidential Candidate Robert Dole. Mr. Smith holds bachelors and masters degrees in Criminal Justice from West Chester University in West Chester, Pennsylvania.

Sam Youngblood has been the chief Executive Officer of ISI since 1991. During that 15 year span Mr. Youngblood acted as the Project Manager on many projects. As the company grew, he became responsible for all acquisitions. From 1984 to 1991, he founded and was the Chief Executive Officer of ADTEC, Inc. From 1974 to 1984, he served in several managerial positions with Southern Steel Company, lastly as its President. Mr. Youngblood graduated from Baylor University in 1978 with a BBA in Accounting and a minor in Finance. Mr. Youngblood has served on the Board of the Baptist Center for Ethics (BCE) from 2001 to 2005.

Donald Carr has been the President of ISI since 1991. During this time, Mr. Carr has been responsible for project management, sales and estimating. Over time, Mr. Carr built a sales team and relinquished his project management responsibilities to focus on the sales growth of the business. From 1987 to 1991, Mr. Carr served as the Project Manager of American Detention Services, Inc. a subsidiary or ADTEC, Inc. Prior to that time, from 1985 to 1987, Mr. Carr served as the Director of Contract Administration of Southern Steel Company. Mr. Carr attended St. Edwards University.

Mark McDonald has been the President of MCS-Detention since 2000. MCS-Detention was acquired by ISI in 2000 and it is currently one of ISI’s subsidiaries. During this period Mr. McDonald was responsible for Sales, Marketing and Product Development. Mr. McDonald oversaw development of the OneFab product line which opened MCS to a much larger market. Prior to 2000, Mr. McDonald was Vice President of Sales of Metroplex-Control Systems operating in Dallas Texas. He served in this capacity from 1990 to 2000. Prior to that time, from 1983 to 1990, he was the General Manager of Dilok, Inc. From 1980 to 1983 he was the Service Manager of Edwards Company. Mr. McDonald received an Associated Arts Degree in Electronics from Chabot College in 1979.

 

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Robert Roller has been the President of MCS-Commercial since January 2006. During this period Mr. Roller has focused his time on developing the Sales and Operations for that subsidiary necessary to build the revenues relating to access control and video. Prior to that, from November 2004 to December 2005, Mr. Roller was Vice President of Operations for MCS-Commercial. Mr. Roller peformed the duties of Operational Vice President and produced significant changes to make this company more profitable. After the execution of these initiatives by Mr. Roller, MCS-Commercial began to increase its profits. Prior to that time, from February 2002 to October 2004, Mr. Roller was the District Operations Manager Pacific Northwest of Siemens Building Technologies, having more than 40 direct employees and managers reporting to him. From 1999 to January 2002 he was the Vice President Western Region of Pinkerton Systems Integration, and from 1992 to 1999 he was the Operations Manager/Project Manager of ASSI Security. Mr. Roller received a Bachelor of Aeronautics from Embry Riddle Aeronautical University.

Tim Moxon has been the Chief Financial Officer of ISI since November 2004. During this period, Mr. Moxon has been responsible for all banking and other financial requirements of the company. Prior to that time from 2000 to October 2004 Mr. Moxon served as Comptroller of ISI Security. From 1993 to 2000, Mr. Moxon was Comptroller of Metroplex-Control Systems operating in Dallas, Texas. From 1989 to 1993, Mr. Moxon was the Controller for Texas Lime Company and, from 1988 to 1989, he was the Assistant Controller for Food City, Inc. Mr. Moxon has a BBA in accounting from Baylor University.

Neal Horman has been the Head Programmer of MCS-Detention since June 2001. During this period Mr. Horman developed the software for the OneFab product line. Prior to that time, from 1999 to 2000, Mr. Horman was a Programmer for Intelli-Site. From 1997 to 1999, he was a Software/Computer Programmer for American Express. From 1996 to 1997, he was a Programmer for Internet Now. From 1993 to 1996, he was a Programmer and Systems Engineer for MCS. From 1989 to 1992, he was a Programmer for Dilok, and from 1985 to 1988, he was a Programmer for Spectrum West.

 

None of the persons named above is or was affiliated with another blank check company similar to Argyle.

 

Argyle’s Board of Directors is divided into three classes, with only one class of directors being elected in each year and each class serving a three-year term. The term of office of the first class of directors, consisting of John J. Smith, will expire at Argyle’s first annual meeting of stockholders. The term of office of the second class of directors, consisting of Wesley Clark, will expire at the second annual meeting. The term of office of the third class of directors, consisting of Bob Marbut and Ron Chaimovski, will expire at the third annual meeting.

The Board of Directors has not determined whether anyone on the Board is an “audit committee financial expert,” as such term is defined by SEC rules. Since the Board does not have a separately designated Audit Committee and Argyle will not have any operating activities until such time as Argyle enters into a business combination (meaning that its financial statements are relatively simple), Argyle’s Board of Directors did not feel it was necessary to determine if anyone on Argyle’s Board of Directors was an audit committee financial expert. Argyle’s Board of Directors will make a determination if there is an audit committee financial expert on its Board of Directors after a business combination with a target business is consummated.

 

Director Independence

 

Argyle’s Board of Directors has not determined if any of its directors qualifies as independent, although Argyle’s management believes that Gen. Clark and Mr. Smith would qualify as independent directors under the rules of the American Stock Exchange because they do not currently own a large percentage of Argyle’s stock, are not currently employed by Argyle, have not been actively involved in the management of Argyle and do not fall into any of the enumerated categories of people who cannot be considered independent in the American Stock Exchange Rules. Argyle’s Board of Directors will make a determination about independence after the business combination is consummated. Argyle does not have an audit committee, nominating committee or compensation committee and therefore the entire Board of Directors performs those functions for Argyle.

 

Compensation Committee Interlocks and Insider Participation

During the last fiscal year, no officer and employee of Argyle, and no former officer of Argyle, during the last completed fiscal year, participated in deliberations of Argyle’s Board of Directors concerning executive officer compensation. Bob Marbut and Ron Chaimovski are each officers and directors of SecTecGlobal and Electronics Line 3000 Ltd.

ISI’s management team will remain substantially the same, and Sam Youngblood, its current Chief Executive Officer, will remain the Chief Executive Officer of ISI.

 

Argyle’s Principal Accountant

During the fiscal year ended December 31, 2005, Argyle’s principal independent auditor was Goldstein Golub Kessler LLP, the services of which were provided in the following categories and amount:

Audit Fees

The aggregate fees billed by Goldstein Golub Kessler LLP for professional services rendered for the audit of Argyle’s balance sheet at January 30, 2006 included in Argyle’s Current Report on Form 8-K, for the audit of Argyle’s annual financial statements for the fiscal year ended December 31, 2005 and for services performed in connection with Argyle’s registration statement on Form S-1 initially filed in 2005, were $47,460.

 

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Audit -Related Fees

Other than the fees described under the caption “Audit Fees” above, Goldstein Golub Kessler LLP did not bill any fees for services rendered to Argyle during fiscal year 2005 for assurance and related services in connection with the audit or review of Argyle’s financial statements.

Tax Fees

There were no fees billed by Goldstein Golub Kessler LLP for professional services rendered during the fiscal year ended December 31, 2005 for tax compliance, tax advice, and tax planning.

All Other Fees

There were no fees billed by Goldstein Golub Kessler LLP for other professional services rendered during the fiscal year ended December 31, 2005.

Pre-Approval Of Services

Argyle does not have an Audit Committee. The Board of Directors does not have any pre-approval policies and procedures described in Rule 2-01(c)(7)(i)(C) in place.

Change in Auditors

On April 18, 2006, Argyle’s Board of Directors terminated Goldstein Golub Kessler LLP as Argyle’s principal accountants.

 

During Argyle’s fiscal year ended December 31, 2005 and the subsequent interim period ended April 18, 2006, there were no disagreements with Goldstein Golub Kessler LLP on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedures, which disagreements, if not resolved to their satisfaction, would have caused them to make reference in connection with their opinion to the subject matter of the disagreement.

 

The audit reports of Goldstein Golub Kessler LLP on the financial statements of Argyle as of and for the year ended December 31, 2005 and as of and for the interim period ended January 30, 2006 did not contain any adverse opinion or disclaimer of opinion, nor were they qualified or modified as to uncertainty, audit scope, or accounting principles.

 

There were no “reportable events”, as that term is described in Item 304(a)(1)(v) of Regulation S-K, for the year ended December 31, 2005 and the subsequent interim period ended April 18, 2006.

On May 1, 2006, Argyle engaged Ernst & Young LLP as its independent registered public accounting firm for the fiscal year ending December 31, 2006, and such engagement was approved by Argyle’s Board of Directors.

 

During the fiscal year ended December 31, 2005, and in the subsequent interim period, Argyle did not consult with Ernst & Young LLP regarding (i) the application of accounting principles to a specific completed or contemplated transaction, or the type of audit opinion that might be rendered on Argyle’s consolidated financial statements and no written or oral advice was provided by Ernst & Young LLP that was an important factor considered by Argyle in reaching a decision as to any accounting, auditing or financial reporting issue or (ii) any matter that was either the subject of a disagreement or event, as set forth in Item 304(a)(1)(iv) or Item 304(a)(1)(v) of Regulation S-K.

 

Code of Ethics

Argyle does not have a formal code of ethics. Upon consummation of a business combination, Argyle intends to adopt a code of ethics that applies to Argyle’s principal executive officers, principal financial officer, principal accounting officer or controller or persons performing similar functions.

 

Director Compensation

 

Argyle will compensate its Board of Directors based on policies put into place after the acquisition, but which are expected to include a per diem for each Board meeting attended, an annual fee, reimbursement of expenses incurred in attending meetings and equity awards pursuant to the 2007 Incentive Plan, if the 2007 Incentive Plan is approved by Argyle’s stockholders. The amounts of compensation, numbers of shares subject to awards and other terms of director compensation have not been finally determined.

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Argyle’s current directors do not currently receive any compensation for their services.

 

Executive Compensation

 

ISI Compensation Discussion and Analysis. ISI’s Board of Directors bases the salaries it pays its executive officers on the amounts other companies pay their executive officers for similar performance. In, general, if an executive performs exceptionally well, the performance and, if applicable, the increase in responsibilities would also merit a salary increase.

ISI’s Board of Directors conducts reviews informally, and compensation is not typically changed on a regimented time-frame.

The Board of Directors has granted certain rights to Mark McDonald, Robert Roller, and Tim Moxon to acquire shares of ISI’s common stock (valued at $________ if ISI is acquired by Argyle) immediately prior to an acquisition of ISI of greater than $6,000,000. The Board of Directors believes that these rights have given these executive officers an incentive for the executives to help make the company prosper so that they can obtain the equity. The amount of the equity incentive was determined by ISI in consultation with William Blair Mezzanine Capital Fund III, L.P., who would not agree to be diluted above a certain amount. The persons who received the right were selected based on their relative importance to ISI, and the total rights were distributed relatively equally among such persons. These rights terminate if the executive is no longer employed by ISI at the time of an acquisition.

Tim Moxon receives his bonus as a part of a cash bonus pool which is based on ISI’s profits. Mr. Moxon would receive a smaller percentage of the bonus pool as additional people become eligible for that bonus. In theory, as more people become eligible for the option pool, ISI’s profits should increase.

Robert Roller receives a bonus equal to 2% of EBITDA for MCS-Commercial. This gives Mr. Roller an incentive to increase MCS-Commercial’s EBITDA. Since Mr. Roller is directly responsible for the overall operations of the commercial business, but not responsible for ISI or MCS-Detention, segmenting his bonus directly to what he affects pinpoints his performance.

Mark McDonald receives a bonus equal to 5% of earned gross margin greater than a base amount equal to $1.5 million plus $.4 million for every sales person under his control for more than 12 months for MCS-Detention. Since Mr. McDonald is directly responsible for the sales of MCS-Detention, basing his bonus on gross margin removes selling, general and administrative decisions from the calculation. MCS-Detention is dependent on proper estimating of costs on a project to make a profit. Mr. McDonald acquired equity when ISI purchased MCS, so Mark has a vested interest in ISI increasing profits.

Sam Youngblood and Don Carr do not currently receive any bonus. However, both Mr. Youngblood and Mr. Carr have a large equity stake in ISI and therefore have sufficient incentives to have ISI be successful.

All executives are involved in decisions relating to their compensation. ISI believes that, for the most part, its executives believe they are fairly compensated.

 

ISI’s Executive Officers. The following sets forth summary information concerning the compensation paid by ISI to its chief executive officer and its other four most highly compensated officers during the last three fiscal years.

 

Summary Compensation Table

 

Name and Principal Position   (a)		(b)			Salary ($)   (c)			Bonus ($)   (d)			Option Awards ($)   (f)			All other Compen- sation ($)   (i)			Total ($)   (j)
Sam Youngblood			2006			368,225												368,225
Chief Executive Officer			2005			357,500									3,891,793.37	(1)		4,249,293.37
			2004			350,000									60,292.94	(1)		410,292.94
Don Carr			2006			242,050												242,050
President			2005			235,000									1,258,746.20	(1)		1,493,746.2
			2004			220,385									84,512.33	(1)		304,897.33
Mark McDonald			2006			144,008			45,835			217,335						407,178
President			2005			144,008			79,850			217,335			79,850			521,043
			2004			144,008						169,949						313,957
Tim Moxon			2006			125,000			24,038			61,065						210,103
Chief Financial Officer			2005			105,000			13,721			61,065			13,720.94			193,506.94
			2004			90,000			30,648			65,258			30,648.31			216,554.31
Butch Roller			2006			135,000			9,330			94,431						238,761
			2005			115,000						94,431						209,431

 

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(1) This consideration was paid in connection with the recapitalization of ISI.

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The following table shows the outstanding option awards for our named executive officers as of December 31, 2006.

 

Outstanding Option Awards at Fiscal Year-End Table

 

		Option Awards
Name   (a)		Number of Securities Underlying Unexercised Options (#) Exercisable   (b)			Number of Securities Underlying Unexercised Options (#) Unexercisable   (c)			Option Exercise Price ($)   (e)			Option Expiration date   (f)
Sam Youngblood		0			0			0			0
Don Carr		0			0			0			0
Mark McDonald		0			7.4673			29,104.9162			None*
Tim Moxon		0			2.0981			29,104.9162			None*
Butch Roller		0			3.2445			29,104.9162			None*

 

* These options do not expire until ISI is acquired by a third party.

 

The following table sets forth aggregate information regarding ISI’s equity compensation plans in effect as of December 31, 2006:

 

ISI Equity Compensation Plan Information

 

Plan category	Number of securities to be issued upon exercise of outstanding options, warrants and rights   (a)	Weighted-average exercise price of outstanding options, warrants and rights   (b)	Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a))   (c)
Equity compensation plans approved by security holders	0.00	$0.00	0.00
Equity compensation plans not approved by security holders	14.9729(1)	$36,302.34	0.00
Total	14.9729	$36,302.34	0.00

 

(1)

ISI made verbal agreements with certain key employees to provide stock incentive compensation for enhancement of company and stockholder value and to share in the future economic success of the Company. Under these agreements, ISI committed to issue common stock shares to the key employees if ISI is sold, the employees are employed by the Company at time of the sale, and the sale price of the Company exceeds $6,000.000.

Director  Compensation

 

ISI does not have any independent directors and does not pay its directors any amounts in excess of the amounts it pays them for services as officers of ISI.

 

Employment Agreements

The following discussion summarizes the material terms of current employment agreements between ISI and its executive officers:

Sam Youngblood

Mr. Youngblood’s employment agreement, effective as of October 19, 2004, with Detention Contracting Group, Ltd., a wholly owned limited partnership subsidiary of ISI (referred to below as Detention Contracting), provides that Mr. Youngblood will be employed as the Company’s Chief Executive Officer, Vice President, and the Secretary of Detention Contracting’s general partner for a period of five years with an automatic renewal of one year unless either party gives notice to the contrary to the other party. During the employment period, Mr. Youngblood is prohibited from serving as a consultant, employee, officer, manager, agent, or director of any other entity and from owning more than 5% of any other entity if Detention Contracting’s Board of Directors determines that such service or ownership would have a material adverse effect on Mr. Youngblood’s ability to perform his duties under the employment agreement. This restriction does not, however, apply to Mr. Youngblood’s service to and ownership of ISI*MCS, Ltd.

Mr. Youngblood receives an annual salary of not less than $350,000.00, to be increased by Detention Contracting’s Board of Directors annually by an amount of at least the amount of change in the Consumer Price Index. Mr. Youngblood is also eligible for benefits and bonuses in accordance with Detention Contracting’s executive benefits and bonus plans and those of its parent company. Other benefits include membership dues for the Plaza Club of San Antonio; tickets to the San Antonio Stock Show and Rodeo, San Antonio Spurs, and Majestic Theatre; and an automobile allowance of $900.00 per month.

Mr. Youngblood agrees to a perpetual confidentiality provision and a non-competition and non-solicitation provision that lasts for two years from the date Mr. Youngblood’s employment is terminated for any reason. If Mr. Youngblood breaches these restrictive covenants, then the agreement requires disgorgement of benefits derived from such breach and injunctive relief, as well as other rights and remedies available to ISI.

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If Mr. Youngblood’s employment is terminated without cause, then Mr. Youngblood is entitled to receive payment of his annual salary for one year following the date of termination. Immediately following the final payment of the one-year post-termination salary, Mr. Youngblood is released from the non-solicitation and non-competition covenants contained in the agreement, unless the Company elects to continue severance payments, including salary prorated over the extension period.

If Mr. Youngblood voluntarily resigns or is terminated for cause during the period of employment, then he is not entitled to receive any benefit or compensation following the date of termination.

 

Don Carr

Mr. Carr’s employment agreement with Detention Contracting, effective as of October 19, 2004, provides that Mr. Carr will be employed as President of Detention Contracting and the Treasurer of its general partner for a period five years with an automatic renewal of one year unless either party gives notice to the contrary. During the employment period, Mr. Carr is prohibited from serving as a consultant, employee, officer, manager, agent, or director of any other entity and from owning more than 5% of any other entity if Detention Contracting’s Board of Directors determines that such service or ownership would have a material adverse effect on Mr. Carr’s ability to perform his duties under the employment agreement. This restriction does not, however, apply to Mr. Carr’s service to and ownership of ISI*MCS, Ltd.

Mr. Carr receives an annual salary of not less than $235,000.00, to be increased by Detention Contracting’s Board of Directors annually by an amount of at least the amount of change in the Consumer Price Index. Mr. Carr is also eligible for benefits and bonuses in accordance with Detention Contracting’s executive benefits and bonus plans and those of its parent company.

Mr. Carr agrees to a perpetual confidentiality provision and a non-competition and non-solicitation provision that lasts for two years from the date Mr. Carr’s employment is terminated for any reason. If Mr. Carr breaches these restrictive covenants, then the agreement requires disgorgement of benefits derived from such breach and injunctive relief, as well as other rights and remedies available to the Company.

If Mr. Carr’s employment is terminated without cause, then Mr. Carr is entitled to receive payment of his annual salary for one year following the date of termination. Immediately following the final payment of the one-year post-termination salary, Mr. Carr is released from the non-solicitation and non-competition covenants contained in the agreement, unless Detention Contracting elects to continue severance payments, including salary prorated over the extension period.

If Mr. Carr voluntarily resigns or is terminated for cause during the period of employment, then he is not entitled to receive any benefit or compensation following the date of termination.

 

Mark McDonald

Mr. McDonald’s employment agreement with MCS-Detention, effective as of October 19, 2004, provides that Mr. McDonald will be employed as President of MCS-Detention for a period five years with an automatic renewal of one year unless either party gives notice to the contrary. During the employment period, Mr. McDonald is prohibited from serving as a consultant, employee, officer, manager, agent, or director of any other entity and from owning more than a 5% stake in any other entity if MCS-Detention’s Board of Directors determines that such service or ownership would have a material adverse effect on Mr. McDonald’s ability to perform his duties under the employment agreement.

Mr. McDonald receives an annual salary of not less than $125,000.00, to be reviewed annually by MCS-Detention’s Board of Directors. Mr. McDonald is also entitled to receive an annual bonus equal to 5% of the total gross margin of MCS-Detention that exceeds a specified amount during the year prior. Mr. McDonald is also eligible for benefits in accordance with MCS-Detention’s executive benefits plan, including full payment of all health/medical insurance coverage for Mr. McDonald and his dependents.

Mr. McDonald agrees to a perpetual confidentiality provision and a non-competition and non-solicitation provision that lasts for two years from the date Mr. McDonald’s employment is terminated for any reason. If Mr. McDonald breaches these restrictive covenants, then the agreement requires disgorgement of benefits derived from such breach and injunctive relief, as well as other rights and remedies available to the Company.

If Mr. McDonald’s employment is terminated without cause, then Mr. McDonald is entitled to receive payment of his annual salary for one year following the date of termination. Immediately following the final payment of the one-year post-termination salary, Mr. McDonald is released from the non-solicitation and non-competition covenants contained in the agreement, unless MCS-Detention elects to continue severance payments, including salary prorated over the extension period.

If Mr. McDonald voluntarily resigns or is terminated for cause during the period of employment, then he is not entitled to receive any benefit or compensation following the date of termination.

 

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Tim Moxon

Mr. Moxon’s employment agreement with MCS-Detention effective as of October 19, 2004, provides that Mr. Moxon will be employed as the Chief Financial Officer of MCS-Detention for a period five years with an automatic renewal of one year unless either party gives notice to the contrary. During the employment period, Mr. Moxon is prohibited from serving as a consultant, employee, officer, manager, agent, or director of any other entity and from owning more than a 5% stake in any other entity if MCS-Detention’s Board of Directors determines that such service or ownership would have a material adverse effect on Mr. Moxon’s ability to perform his duties under the employment agreement.

Mr. Moxon receives an annual salary of not less than $105,000.00, to be reviewed annually by MCS-Detention’s Board of Directors. Mr. Moxon is also entitled to receive an annual bonus equal to 15% of the 9% bonus pool derived from all entities of ISI. Mr. Moxon is also eligible for benefits in accordance with MCS-Detention’s executive benefits plan including full payment of all health/medical insurance coverage for Mr. Moxon and his dependents. Mr. Moxon is also granted an option to purchase common stock in the parent company, such that upon full dilution, and the exercise of all options, Mr. Moxon may own 1.9% of the ownership interest in the parent company.

Mr. Moxon agrees to a perpetual confidentiality provision and a non-competition and non-solicitation provision that lasts for two years from the date Mr. Moxon’s employment is terminated for any reason. If Mr. Moxon breaches these restrictive covenants, then the agreement requires disgorgement of benefits derived from such breach and injunctive relief, as well as other rights and remedies available to the Company.

If Mr. Moxon’s employment is terminated without cause, then Mr. Moxon is entitled to receive payment of his annual salary for one year following the date of termination. Immediately following the final payment of the one-year post-termination salary, Mr. Moxon is released from the non-solicitation and non-competition covenants contained in the agreement, unless MCS-Detention elects to continue severance payments, including salary prorated over the extension period.

If Mr. Moxon voluntarily resigns or is terminated for cause during the period of employment, then he is not entitled to receive any benefit or compensation following the date of termination.

 

Post Merger Employment Agreements

There have been no employment agreements negotiated or drafted between Argyle and the executive officers of ISI, although it is anticipated that such agreements will be put in place after the closing of the ISI transaction.

It is anticipated that the Argyle Board of Directors will form a compensation committee promptly after the ISI transaction is closed. It is currently contemplated that at least a majority of the members of the Compensation Committee will be comprised of independent directors. Employment agreements for the executive officers of ISI will be negotiated with the independent members of this committee.

 

Argyle Executive Officers and Stockholders. No compensation of any kind, including finders and consulting fees, has been or will be paid to any Argyle stockholder who acquired common stock prior to its initial public offering, or any of their respective affiliates, for services rendered prior to or in connection with a business combination. However, those Argyle stockholders have been and will continue to be reimbursed for any out-of-pocket expenses incurred in connection with activities on Argyle’s behalf, such as identifying potential target businesses and performing due diligence on suitable business combinations. There is no limit on the amount of these out-of-pocket expenses, and there will be no review of the reasonableness of the expenses by anyone other than Argyle’s directors, or a court of competent jurisdiction if such reimbursement is challenged.

Since Argyle does not currently have an operating business, its officers do not receive any compensation for their service to Argyle; and, since it has no other employees, Argyle does not have any compensation policies, procedures, objectives or programs in place. Argyle will adopt appropriate compensation policies, procedures, objectives or programs after a merger with a target business is consummated and Argyle’s management team has had the opportunity to fully understand the operations of the business. However, it is anticipated that, after closing, the compensation for senior executives of Argyle will be comprised of four elements: a base salary, an annual performance bonus, equity and benefits.

In developing salary ranges, potential bonus payouts, equity awards and benefit plans, it is anticipated that the Compensation Committee will take into account: 1) competitive compensation among comparable companies and for similar positions in the market, 2) relevant ways to incentivize and reward senior management for improving shareholder value while building Argyle into a successful company, 3) individual performance, 4) how best to retain key executives, 5) the overall performance of the Company and its various key component entities, 6) the Company’s ability to pay and 7) other factors deemed to be relevant at the time.

Argyle and ISI senior management have discussed Argyle’s above mentioned planned process for executive compensation after the merger is complete and the four compensation components. Specific compensation plans for ISI’s key executives will be negotiated and established by the Compensation Committee after closing. This will include, but may not be limited to, the four ISI executives who currently have employment contracts (which will be modified, if necessary, to reflect any additions to or changes in compensation).

 

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CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

 

Argyle

 

On June 23, 2005, Argyle issued an aggregate of 937,500 shares of Argyle’s common stock to the individuals and entities set forth below for $25,000 in cash, at a purchase price of $0.027 per share, as follows:

 

Name		Number of Shares		Relationship to Argyle
Argyle Joint Venture		296,875		The general partner is an entity controlled by Bob Marbut, Argyle’s Co-Chief Executive Officer, and Mr. Chaimovski, Argyle’s other Co-Chief Executive Officer, owns interests in certain of its limited partners
Bob Marbut		296,875		These shares are owned by Argyle New Ventures, L.P., whose general partner is owned by Mr. Marbut, Argyle’s Chairman and Co-Chief Executive Officer
Ron Chaimovski		296,875		Vice Chairman and Co-Chief Executive Officer
John J. Smith		46,875		Director

 

On July 13, 2005, Argyle issued the aforementioned stockholders options to purchase such additional number of shares as would be necessary to maintain their percentage ownership in Argyle after the offering in the event the underwriters exercise the over-allotment option. Such options were exercisable at $0.027 per share only if and only to the extent that the over-allotment option was exercised. On September 23, 2005, Messrs. Marbut and Chaimovski, along with their affiliated entities, transferred an aggregate of 70,313 of their shares and a pro rata portion of their over-allotment options to Wesley Clark in connection with his appointment to Argyle’s Board of Directors. On January 30, 2006, the underwriters exercised a portion of their over-allotment option and on February 1, 2006, the stockholders exercised their option for an aggregate of 18,761 shares of Argyle’s common stock and Argyle received $506.55 in connection with such exercise.

 

The holders of the majority of these shares will be entitled to make up to two demands that Argyle register these shares pursuant to an agreement January 24, 2006. The holders of the majority of these shares may elect to exercise these registration rights at any time after the date on which these shares of common stock are released from escrow, which, except in limited circumstances, is not before three years from the date of this prospectus. In addition, these stockholders have certain “piggy-back” registration rights on registration statements filed subsequent to the date on which these shares of common stock are released from escrow. Argyle will bear the expenses incurred in connection with the filing of any such registration statements.

 

On June 23 and July 6, 2005, Mr. Chaimovski and Argyle New Ventures, L.P., an entity controlled by Mr. Marbut, advanced a total of $125,000 to Argyle to cover expenses related to Argyle’s initial public offering. Such were payable with 4% annual interest on the earlier of June 30, 2006 or the consummation of Argyle’s initial public offering. In November 2005, these stockholders loaned Argyle an additional $30,000 pursuant to 4% promissory notes due the earlier of November 15, 2006 or the consummation of Argyle’s initial public offering. These loans were repaid on January 30, 2006 with the proceeds of Argyle’s initial public offering.

 

Bob Marbut, Ron Chaimovski, Argyle New Ventures L.P. and Argyle Joint Venture purchased an aggregate of 125,000 units from Argyle at a purchase price of $8.00 per unit in a private placement that occurred immediately prior to the effectiveness of Argyle’s registration statement relating to its initial public offering on January 24, 2006. Argyle has granted the holders of such units demand and “piggy-back” registration rights with respect to the 125,000 shares, the 125,000 warrants and the 125,000 shares underlying the warrants at any time commencing on the date argyle announces that it has entered into a letter of intent with respect to a proposed business combination. The demand registration may be exercised by the holders of a majority of such units. Argyle will bear the expenses incurred in connection with the filing of any such registration statements.

 

Argyle reimburses its officers and directors for any reasonable out-of-pocket business expenses incurred by them in connection with certain activities on Argyle’s behalf such as identifying and investigating possible target businesses and business combinations. There is no limit on the amount of accountable out-of-pocket expenses reimbursable by Argyle, which will be reviewed only by Argyle’s Board of Directors or a court of competent jurisdiction if such reimbursement is challenged.

 

Argyle’s Board of Directors does not have any policies or procedures that it follows in connection to transactions it undertakes with related parties. The determination of any policies or procedures will be made after Argyle consummates a business combination. Other than the repayment of expenses, Argyle has had no transactions with related parties since its initial public offering.

 

ISI

MCS has entered into a global permanent exclusive license agreement for certain software with Mark McDonald, currently ISI’s President of MCS-Detention. There are no ongoing payment obligations under this agreement.

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In September 2004, Sam Youngblood and Don Carr created ISI*MCS, Ltd., a Texas limited partnership, for ISI*MCS to facilitate ISI’s ability to perform contracts that require performance and payment bonds after ISI’s bonding company indicated that it would not provide bonding to ISI after the William Blair Mezzanine Capital Fund III, L.P. refinancing and distributions to the ISI stockholders in connection with the Blair transaction, due to the deficit in equity at ISI after those transactions. ISI*MCS was formed to function as the contracting entity for all of ISI’s bonded projects. In October 2004, all existing ISI bonded projects were transferred to ISI*MCS, and all future bonded projects were bid and contracted by ISI*MCS with the owner or general contractor. After the closing of the merger between ISI and Argyle, ISI*MCS will have no further arrangement, contract or agreement with ISI or Argyle.

Currently, ISI*MCS enters into contracts and provides the performance and payment bonds. ISI*MCS then subcontracts the work required by the bonded contracts to ISI-Detention, MCS-Detention or MCS-Commercial. ISI*MCS retains 2% of the amount of the contract for providing the bonds and assuming all risk under the bonds. ISI, through its three divisions, performs the work required by the bonded contracts in consideration for 98% of the original contract amount.

ISI*MCS does not compete with ISI. ISI*MCS only enters into contracts that require bonds, which ISI could not enter into, since ISI had no bonding capacity. After the merger, ISI and Argyle will provide ISI with any required bonding capacity, and ISI*MCS will no longer enter into contracts and subcontract them to ISI. After the completion of the ISI/Argyle merger, ISI*MCS will terminate all relationships with ISI. It is not anticipated that there will be an entity similar to ISI*MCS, after the merger is closed. ISI*MCS will not be dissolved after the merger because ISI*MCS will remain liable on the contracts entered into prior to the merger, and will remain in existence until all such liability has ended.

ISI-Detention, MCS-Detention and MCS-Commercial each entered into a master subcontract with ISI*MCS, whereby each of the entities agreed to fully and completely perform the work required by the bonded contracts that ISI*MCS subcontracted to such entities. There have been no defaults in performance of the work required by these contracts, or in payments between ISI*MCS and ISI.

As of September 30, 2006, ISI was obligated to pay ISI*MCS $1,497,766.25 pursuant to its funding agreements and fees of $488,289.89. Pursuant to the merger agreement, ISI*MCS is to be paid up to $2,000,000 in full payment of all obligations of ISI.

On October 20, 2004, ISI*MCS and all of its limited partners granted to ISI the option to acquire 200 Units of Class A Limited Units in ISI*MCS (33% of the limited partnership interest) in ISI*MCS . The only limited partners in ISI*MCS at the time were Sam Youngblood and Don Carr (Chief Executive Officer and President of ISI, respectively). The General Partner of ISI*MCS was, and remains, ISI*MCS GP, Inc. a Texas corporation, of which Sam Youngblood and Don Carr are the only shareholders, officers and directors. ISI paid $300,000 to ISI*MCS for this option. The exercise price per unit is $1.00, and the option becomes exercisable upon (i) termination of the ISI*MCS partnership agreement or (ii) dissolution of ISI*MCS, and cannot be exercised after distribution of all or substantially all of the assets of ISI*MCS. ISI retains a put right to require the limited partners to purchase the option from ISI, which can be exercised upon (i) the seventh anniversary of the grant of the option or (ii) the dissolution of ISI*MCS. The put price is 33% of the Class A Preference Return to be paid to the partners of ISI*MCS upon dissolution of ISI*MCS . Payment of the put price is non-recourse to the partners, other than the funds made available to the Partners upon dissolution of ISI*MCS .

 

D. Hull Youngblood, Jr., brother to Sam Youngblood, the Chief Executive Officer of ISI, and the law firm of Hughes Luce, LLP, in which Mr. D. Hull Youngblood is a partner, provide legal services to ISI and its subsidiaries.

 

As of September 30, 2006 ISI held accounts receivable from Sam Youngblood and Don Carr in the amounts of $174,617.89 and $18,502.45, respectively. Effective November 30, 2006, Sam Youngblood and Don Carr had repaid these amounts in full.

 

Sam Youngblood and Don Carr are the principals in Green Wing Management, LP, the owner and lessor of the San Antonio office and warehouse facilities utilized by ISI and its subsidiaries. ISI currently pays Green Wing Management, LP $23,667 per month in connection with such leases.

 

On November 1, 2005, Sam Youngblood, ISI’s Chief Executive Officer loaned ISI $65,922.00 and received a promissory note in that principal amount in exchange. The note matures on October 22, 2011 and until maturity interest at the rate of 12.00% per annum is payable quarterly. ISI is current in its obligations under this promissory note. Pursuant to the merger agreement, this promissory note will be paid off prior to or at the closing of the acquisition of ISI by Argyle.

 

On November 1, 2005, Don Carr, ISI’s President loaned ISI $32,469.00 and received a promissory note in that principal amount in exchange. The note matures on October 22, 2011 and until maturity interest at the rate of 12.00% per annum is payable quarterly. ISI is current in its obligations under this promissory note. Pursuant to the merger agreement, this promissory note will be paid off prior to or at the closing of the acquisition of ISI by Argyle.

Interests of Named Experts and Counsel

Loeb & Loeb LLP, Argyle’s counsel, is issuing an opinion as to the validity of the shares of Argyle’s common stock that will be issued pursuant to this prospectus/proxy statement. Loeb & Loeb LLP has waived its ability to sue the trust account in the event that the merger is not consummated, and, therefore, will not be paid for its services rendered in connection with the merger and this proxy statement/prospectus to the extent that the costs for such services (and those of all of our other vendors) exceed the amounts held outside of our trust account.

 

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BENEFICIAL OWNERSHIP OF SECURITIES

The following table sets forth, as of ______________, 2007, certain information regarding beneficial ownership of Argyle’s common stock by each person who is known by Argyle to beneficially own more than 5% of Argyle’s common stock. The table also identifies the stock ownership of each of Argyle’s directors, each of Argyle’s officers, and all directors and officers as a group. Except as otherwise indicated, the stockholders listed in the table have sole voting and investment powers with respect to the shares indicated.

Shares of common stock which an individual or group has a right to acquire within 60 days pursuant to the exercise or conversion of options, warrants or other similar convertible or derivative securities are deemed to be outstanding for the purpose of computing the percentage ownership of such individual or group, but are not deemed to be outstanding for the purpose of computing the percentage ownership of any other person shown in the table.

 

Name and Address of Beneficial Owner(1)		Amount and Nature of Beneficial Ownership			Approximate Percentage of Outstanding Common Stock
Bob Marbut			651,569	(2)		13.6	%
Argyle Joint Venture(3) 200 Concord Plaza, Suite 700 San Antonio, Texas 78216			278,910			5.8	%
Ron Chaimovski			310,159			6.5	%
Wesley Clark			71,720			1.50	%
John J. Smith			47,813			1.00	%
Sapling, LLC (4) Fir Tree Recovery Master Fund, L.P. 535 Fifth Avenue 31st Floor New York, New York 10017			273,476			5.72	%
Jack Silver (5) STAR Capital LLC 660 Madison Avenue New York, New York 10021			250,000			5.23	%
Jonathan M. Glaser Daniel Albert David Roger Richter Pacific Assets Management, LLC Pacific Capital Management, Inc. JMG Triton Offshore Fund, Ltd.			247,751			5.2	%
All directors and executive officers as a group (4 individuals)			1,081,261			22.61	%

 

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 (1) The business address of each of officers and directors of Argyle is 200 Concord Plaza, Suite 700, San Antonio, Texas 78216.

 

(2) Consists of 372,659 shares of Argyle common stock held by Argyle New Ventures, LP, which is controlled by Mr. Marbut, and 278,910 shares by Argyle Joint Venture, over which Mr. Marbut has voting and dispositive power.

 

(3) Mr. Marbut has voting and dispositive power over the shares held by Argyle Joint Venture.

 

(4) The information relating to Sapling and Fir Tree Master Recovery Fund is derived from a Schedule 13G dated January 30, 2006 filed by such entities with the Securities and Exchange Commission. Each person has shared voting and dispositive power with respect to each share of Argyle’s common stock owned. Sapling may direct the voting and disposition of 186,610 shares of Argyle’s common stock and Fir Tree Master Recovery Fund may direct the voting and disposition of 86,866 shares of Argyle’s common stock. The sole member of both Sapling and Fir Tree Master Recovery Fund is Fir Tree Value Master Fund, LP and their investment manager is Fir Tree, Inc. Jeffrey Tannenbaum is the President of Sapling, LLC and Fir Tree Recovery Master Fund, L.P.

 

(5) The information relating to Jack Silver is derived from a Schedule 13G dated January 25, 2006 filed by Mr. Silver with the Securities and Exchange Commission.

(6) The information relating to the indicated stockholders is derived from a Schedule 13G, dated December 8, 2006, filed by such persons with the Securities and Exchange Commission. The principal business address of Jonathan M. Glaser is 11601 Wilshire Boulevard, Suite 2180, Los Angeles, CA 90025. The principal business address of Daniel Albert David, Pacific Assets Management, LLC and Pacific Capital Management, Inc. is 100 Drakes Landing, Suite 207, Greenbrae, CA 94904. The principal business address of Roger Richter is One Sansome Street, 39th Floor, San Francisco, CA 94104. The principal business address of JMG Triton Offshore Fund, Ltd. is Citco Building, Wickhams Cay, P.O. Box 662, Road Town, Tortola, BVI. Each person has shared voting and dispositive power with respect to each share of Argyle’s common stock owned. Pacific Assets Management, LLC is the investment adviser to JMG Triton Offshore Fund, Ltd. and Pacific Capital Management, Inc. is a member of Pacific Assets Management, LLC. Mr. Glaser, Mr. David and Mr. Richter are control persons of Pacific Capital Management, Inc. and Pacific Assets Management, LLC.

 

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Security Ownership of Officers and Directors of the Combined Company after the Acquisition

 

The following table sets forth information with respect to the beneficial ownership of the combined company’s common stock immediately after the consummation of the acquisition by each person who is known by Argyle to beneficially own more than 5% of Argyle’s common stock of Argyle’s common stock, each officer, each director and all officers and directors as a group.

Shares of common stock which an individual or group has a right to acquire within 60 days pursuant to the exercise or conversion of options, warrants or other similar convertible or derivative securities are deemed to be outstanding for the purpose of computing the percentage ownership of such individual or group, but are not deemed to be outstanding for the purpose of computing the percentage ownership of any other person shown in the table.

Name and Address of Beneficial Owner(1)		Amount and Nature of Beneficial Ownership			Approximate Percentage of Outstanding Common Stock
Bob Marbut			651,569	(2)		10.9	%
Ron Chaimovski			310,159			5.2	%
Wesley Clark			71,720			1.2	%
John J. Smith			47,813			0.8	%
Sam Youngblood			395,048			6.6	%
Don Carr			194,576			3.3	%
Mark McDonald			106,644			1.8	%
William Blair Mezzanine Capital Fund III, L.P. (3)			440,288			7.4	%
All directors and executive officers as a group (7 individuals)			1,777,529			29.8	%

 

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(1) The business address of each of officers and directors of Argyle is 200 Concord Plaza, Suite 700, San Antonio, Texas 78216.

 

(2) Consists of 372,659 shares of Argyle common stock held by Argyle New Ventures, LP, which is controlled by Mr. Marbut, and 278,910 shares by Argyle Joint Venture, over which Mr. Marbut has voting and dispositive power.

 

(3) David Jones has voting and dispositive power over the shares held by William Blair Mezzanine Capital Fund III, L.P.

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SHARES ELIGIBLE FOR FUTURE SALE

 

After the acquisition of ISI, there will be 5,961,307 shares of Argyle common stock outstanding, of which all but 2,261,261(1,081,261 shares owned by our current officers and directors and their respective offiliates and 1,180,000 shares to be issued to the current security holders of ISI.) shares will be registered and freely tradable without securities law restriction. The shares of common stock being issued in connection with the acquisition of ISI, by virtue of registration hereunder, will be freely tradable. In addition, there are outstanding warrants to purchase 3,825,046 shares of Argyle’s common stock, each to purchase one share of common stock, 3,700,046 of which are freely tradable. The common stock issuable upon exercise of the warrants will also be freely tradable, provided that there is a registration statement in effect at the time of their exercise. Argyle intends to use its best efforts to cause such a registration statement to be in effect at such time as the warrants become exercisable. In addition, in connection with Argyle’s initial public offering, Argyle issued a unit purchase option to the representative of the underwriters which is exercisable for 187,500 units, consisting of one share of common stock and one warrant to purchase one share of common stock at $5.50 per share, at an exercise price of $8.80 per unit. The securities underlying the representative’s unit purchase option and underlying securities have registration rights and may be sold pursuant to Rule 144. Therefore, there are an aggregate of 4,200,046 shares of common stock that may be issued in the future upon exercise of outstanding warrants and options.

The 1,081,261 shares of Argyle’s common stock owned by its officers and directors and their respective affiliates are being held in escrow, and, subject to certain limited exceptions, such as transfers to family members and trusts for estate planning purposes and upon death, these shares will not be transferable during the escrow period and will not be released from escrow until January 24, 2009, unless we were to consummate a transaction after the consummation of the initial business combination which results in all of the stockholders of the combined entity having the right to exchange their shares of common stock for cash, securities or other property.

At the closing of the merger, each of the security holders of ISI will enter into a lock-up agreement with Argyle with respect to the shares that they acquire pursuant to the merger so that they will not be able to sell the shares (except to family members or affiliates) until the specified times expire. William Blair Mezzanine Capital Fund III, L.P. will acquire 440,288 shares in connection with the merger and will not be able to sell such shares until the earlier of six months after the closing of the acquisition or November 1, 2007, whichever is earlier. The remaining 739,712 shares issued to Sam Youngblood, Don Carr, Mark McDonald and The Youngblood Trust will not be able to sell their shares until January 24, 2009.

 

In general, under Rule 144, a person who has owned restricted shares beneficially for at least one year is entitled to sell, within any three-month period, a number of shares that does not exceed the greater of the then-average preceding four weeks’ average weekly trading volume or one percent of the total number of shares outstanding. Sales under Rule 144 are also subject to manner of sale provisions, notice requirements and the availability of current public information about the company. A person who has not been an affiliate of the company for at least the three months immediately preceding the sale and who has beneficially owned shares for at least two years is entitled to sell the shares under Rule 144 without regard to the limitations described above.

 

No prediction can be made about the effect that market sales of Argyle common stock or the availability for sale of Argyle common stock will have on its market price. Sales of substantial amounts of common stock in the public market could adversely affect the market price for Argyle’s securities and could impair Argyle’s future ability to raise capital through the sale of common stock or securities linked to it.

 

ARGYLE’S SECURITIES

 

General

 

Argyle is authorized to issue 89,000,000 shares of common stock, par value $.0001, and 1,000,000 shares of preferred stock, par value $.0001. As of the date of this proxy statement/prospectus, 4,781,307 shares of common stock are outstanding, held by six holders of record. No shares of preferred stock are currently outstanding.

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Common Stock

 

Holders of the combined company’s common stock will be to one vote for each share on all matters submitted to a vote of stockholders and do not have cumulative voting rights. Subject to the preferences and rights, if any, applicable to preferred stock, holders of common stock of the combined company are entitled to receive dividends if and when declared by the Board of Directors. Subject to the prior rights of the holders, if any, of preferred shares, holders of common stock are entitled to share ratably in any distribution of the assets of the combined company upon liquidation, dissolution or winding-up, after satisfaction of all debts and other liabilities.

 

Preferred Stock

 

Shares of preferred stock may be issued from time to time in one or more series. The Board of Directors of the combined company, without approval of the stockholders, will be authorized to designate series of preferred stock and to fix the rights, privileges, restrictions and conditions to be attached to each such series. The issuance of preferred stock, while providing flexibility in connection with possible acquisitions and other corporate purposes, could, among other things, adversely affect the voting power of the common stock.

 

As of the date of this document, there are no outstanding shares of preferred stock of any series.

 

Warrants

 

Argyle has 3,825,046 warrants currently outstanding, entitling the registered holder to purchase one share of common stock at $5.50 per share. Argyle also has one unit purchase option outstanding, entitling the holder to purchase 187,500 units, consisting of one share of common stock and one warrant to purchase one share of common stock at $5.50 per share, at an exercise price of $8.80 per unit. The warrants are each subject to adjustment as discussed below, and are exercisable at any time commencing on the completion of the acquisition. The warrants will expire at 5:00 p.m., New York City time on January 24, 2011.

 

Argyle may call the warrants for redemption in whole and not in part, at a price of $.01 per warrant, at any time after they become exercisable, upon not less than 30 days’ prior written notice of redemption to each warrant holder; and if, and only if, the reported last sale price of the common stock equals or exceeds $11.50 per share for any 20 trading days within a 30 trading day period ending on the third business day prior to the notice of redemption to warrant holders.

 

The warrants have been issued in registered form under a warrant agreement between American Stock Transfer & Trust Company, as warrant agent, and Argyle.

 

The exercise price and number of shares of common stock issuable on exercise of the warrants may be adjusted in certain circumstances including in the event of a stock dividend, or recapitalization, reorganization, merger or consolidation. However, the warrants will not be adjusted for issuances of common stock at a price below their respective exercise prices.

 

The warrants may be exercised upon surrender of the warrant certificate on or prior to the expiration date at the offices of the warrant agent, with the exercise form on the reverse side of the warrant certificate completed and executed as indicated, accompanied by full payment of the exercise price, by certified check payable to Argyle, for the number of warrants being exercised. Warrant holders do not have the rights or privileges of holders of common stock, or any voting rights, until they exercise their warrants and receive common stock. After the issuance of common stock upon exercise of the warrants, each holder will be entitled to one vote for each common share held of record on all matters to be voted on by stockholders.

 

The warrants may be deprived of any value and the market for the warrants may be limited if the prospectus relating to the common stock issuable upon their exercise of the warrants is not current or if the common stock is not qualified or exempt from qualification in the jurisdictions in which the holders of the warrants reside. No fractional shares will be issued upon exercise of the warrants. However, if a warrant holder exercises all warrants then owned of record by him, Argyle will pay to the warrant holder, in lieu of the issuance of any fractional share which is otherwise issuable, an amount for such fractional share in cash based on the market value of the common stock on the last trading day prior to the exercise date.

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Change of Control Provisions

 

A number of provisions in Argyle’s charter and bylaws and under Delaware law may make it more difficult to acquire control of Argyle. These provisions may have the effect of delaying, deferring, discouraging, preventing or rendering more difficult a future takeover attempt which is not approved by Argyle’s Board, but which individual stockholders may deem to be in their best interests or in which they may receive a substantial premium over then-current market prices. As a result, stockholders who might desire to participate in such a transaction may not have an opportunity to do so. These provisions may also adversely affect the prevailing market price of the common stock. These provisions, which are described below, are intended to:

 

·	Enhance the likelihood of continuity and stability in the Board of Directors;

 

·	Discourage some types of transactions that may involve an actual or threatened change in control;

 

·	Discourage certain tactics that may be used in proxy fights;

 

·	Ensure that the Board of Directors will have sufficient time to act in what it believes to be in the best interests of the company and its stockholders; and

 

·	Encourage persons seeking to acquire control to consult first with the Board to negotiate the terms of any proposed business combination or offer.

 

Unissued Shares of Capital Stock

 

Common Stock. After the acquisition, Argyle will have approximately 5,961,307 shares of common stock outstanding, assuming that no stockholders elect to exercise their redemption rights. The remaining authorized and unissued common stock will be available for future issuance without additional stockholder approval. While the additional shares are not designed to deter or prevent a change of control, under some circumstances Argyle could use them to create voting impediments or to frustrate persons seeking to effect a takeover or otherwise gain control, by, for example, issuing shares in private placements to purchasers who might side with the Board of Directors in opposing a hostile takeover bid.

 

Preferred Stock. Argyle’s Second Amended and Restated Certificate of Incorporation grants the Board of Directors the authority, without any further vote or action by stockholders, to issue preferred stock in one or more series, fix the number of shares constituting the series and establish the preferences, limitations and relative rights, including dividend rights, dividend rate, voting rights, terms of redemption, redemption price or prices, redemption rights and liquidation preferences of the shares of the series. The existence of authorized but unissued preferred stock could reduce the company’s attractiveness as a target for an unsolicited takeover bid, since the company could, for example, issue preferred stock to parties who might oppose such a takeover bid, or issue shares with terms the potential acquirer may find unattractive. This may have the effect of delaying or preventing a change in control, discourage bids for the common stock at a premium over the market price, and adversely affect the market price, and voting and other rights of holders of common stock.

 

Comparison of Certain Charter and Bylaw Provisions of Argyle and ISI.

 

This section describes material differences between the rights of holders of Argyle common stock and the rights of holders of ISI capital stock. This summary is not intended to be a complete discussion of Argyle’s Second Amended and Restated Certificate of Incorporation and bylaws and the certificate of incorporation and bylaws of ISI and is qualified in its entirety by reference to the applicable document and applicable Delaware law.

 

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Argyle and ISI are both organized under the laws of the State of Delaware. Therefore, any differences in the rights of holders of Argyle’s capital stock and ISI capital stock arise primarily from differences in their respective certificates of incorporation and bylaws. Upon completion of the merger, holders of ISI capital stock will become holders of Argyle’s capital stock, and their rights will be governed by Delaware law and Argyle’s Second Amended and Restated Certificate of Incorporation and the bylaws of Argyle. The following discussion summarizes material differences between the rights of Argyle stockholders and ISI stockholders under the respective certificates of incorporation and bylaws of Argyle and of ISI. Copies of the governing corporate instruments are available without charge, to any person, including any beneficial owner to whom this document is delivered, by following the instructions listed under “Where You Can Find More Information.” 

 

		Argyle		ISI
GENERAL MATTERS
Registered office		615 South DuPont Highway, Dover, Delaware		1209 Orange Street Wilmington, Delaware
Transfer agent		American Stock Transfer and Trust Company		None
CAPITAL STRUCTURE
Authorized capital stock		89,000,000 shares Common Stock, par value of $.0001 per share 1,000,000 shares Preferred Stock, par value of $.0001 per share		3,000 shares common stock, $1.00 par value per share (ISI’s certificate of incorporation will be amended immediately prior to the consummation of the acquisition to create a class of preferred stock that will be issued to William Blair Mezzanine Capital Fund III, L.P. in payment for a portion of outstanding debt).
Preferred (Preference) Shares		The Board of Directors is expressly granted authority to issue shares of the preferred stock, in one or more series, and to fix for each such series such voting powers, full or limited, and such designations, preferences and relative, participating, optional or other special rights and such qualifications, limitations or restrictions as shall be stated and expressed in the resolution or resolutions adopted by the Board of Directors providing for the issue of such series.		No class of preferred stock is currently authorized in ISI’s certificate of incorporation. (ISI’s certificate of incorporation will be amended immediately prior to the consummation of the acquisition to create a class of preferred stock that will be issued to William Blair Mezzanine Capital Fund III, L.P. in payment for a portion of outstanding debt).
STOCKHOLDERS
Annual meetings		The Board of Directors sets the date and time for the annual meeting. To be properly brought before the annual meeting, business must be either (i) specified in the notice of annual meeting (or any supplement or amendment thereto) given by or at the direction of the Board of Directors, (ii) otherwise brought before the annual meeting by or at the direction of the Board of Directors, or (iii) otherwise properly brought before the annual meeting by a stockholder. In addition to any other applicable requirements for business to be properly brought before an annual meeting by a stockholder, the stockholder must have given timely notice thereof in writing to the Secretary of Argyle. To be timely, a stockholder’s notice must be delivered to or mailed and received at the principal executive offices of Argyle not less than sixty days nor more than ninety days prior to the meeting; provided, however, that in the event that less than seventy days notice or prior public disclosure of the date of the annual meeting is given or made to stockholders, notice by a stockholder, to be timely, must be received no later than the close of business on the tenth day following the day on which such notice of the date of the annual meeting was mailed or such public disclosure was made, whichever first occurs.		The annual meeting is held at 11:00 a.m. on the last Tuesday of March in each year, unless that date is a legal holiday, in which case the meeting will be held on the next full business day.

 

 

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		Argyle		ISI
Special meetings		Special meetings are not permitted to be called by Argyle’s stockholders.		Special meetings could be called by the Chairman of the Board, the President, the Board of Directors or by the holders of not less than one-tenth of all shares entitled to vote at the special meeting.
BOARD OF DIRECTORS
Nominations		Nominations of persons for election to the Board of Directors at a meeting of stockholders may be made at such meeting by or at the direction of the Board of Directors, by any committee or persons appointed by the Board of Directors or by any stockholder entitled to vote for the election of directors. Such nominations by any stockholder are to be made pursuant to timely notice (as specified in the bylaws) in writing to the Secretary of Argyle.		Nominations may only be made by the Board of Directors or a committee of the Board of Directors.
Classes of directors; term		The Argyle Board of Directors is divided into three classes, with each class serving a staggered three-year term. Currently, Argyle’s currently authorized number of directors is four, including one Class I director, one Class II director, and two Class III directors. The Argyle bylaws provide that its Board of Directors will consist of a number of directors to be fixed from time to time by a resolution duly adopted by the Argyle Board of Directors.		ISI’s certificate of incorporation does not provide for classes of directors.

 

 

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		Argyle		ISI
Vacancies		Newly created directorships and vacancies on the Board of Directors of Argyle resulting from death, resignation, disqualification, removal or other causes may be filled by a majority of the directors then in office, although less than a quorum, or by a sole remaining director.		Vacancies on the Board of Directors may be filled by a majority of the directors then in office, although less than a quorum. Newly created directorships must be filled at an annual or special meeting of stockholders.
Removal		Argyle’s bylaws provide that the entire Board of Directors or any individual director may be removed from office with or without cause by a majority vote of the holders of the outstanding shares then entitled to vote at an election of directors.		A director may only be removed at a special meeting of stockholders called for that purpose, with or without cause, by a vote of the holders of a majority of shares then entitled to vote at an election of directors.
ORGANIC CHANGES
Amendment of charter and bylaws		Argyle’s certificate of incorporation may be amended in accordance with the general provisions of Delaware law; provided, however, that Article Sixth of Argyle’s certificate of incorporation may not be amended prior to the consummation of a business combination (such as the one described in this proxy statement/prospectus).		ISI’s certificate of incorporation may be amended in accordance with the general provisions of Delaware law.

 

Classified Board of Directors, Vacancies and Removal of Directors

 

Argyle’s Second Amended and Restated Certificate of Incorporation and bylaws provide that the Board of Directors will be divided into three classes of even number or nearly even number, with each class elected for staggered three-year terms expiring in successive years. Any effort to obtain control of the Board of Directors by causing the election of a majority of the Board of Directors may require more time than would be required without a staggered election structure. Under normal circumstances, stockholders may remove directors with or without cause. Vacancies in Argyle’s Board of Directors, including a vacancy created by increasing the size of the Board of Directors, may only be filled by a majority of the directors. Any director elected to fill a vacancy, including a vacancy created by increasing the size of the Board of Directors, will hold office for the remainder of the full term of the class of directors in which the vacancy occurred and until such director’s successor shall have been duly elected and qualified. No decrease in the number of directors will shorten the term of any incumbent director. The certificate of incorporation and bylaws also provide that the number of directors will be fixed and increased or decreased from time to time by resolution of the Board of Directors. These provisions may have the effect of slowing or impeding a third-party from initiating a proxy contest, making a tender offer or otherwise attempting a change in the membership of Argyle’s Board of Directors that would effect a change of control.

 

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Business Combinations Under Delaware Law

 

As a Delaware corporation, Argyle is subject to Section 203 of the Delaware General Corporation Law, unless it elects in its charter not to be governed by that Section, which it has not done. Subject to specified exceptions, Section 203 prohibits a publicly held Delaware corporation from engaging in a “business combination” with an “interested stockholder” for a period of three years following the date the person became an interested stockholder, unless:

 

·	Before that date, the Board of Directors approved either the business combination or the transaction in which the stockholder became an interested stockholder;

 

·	Upon consummation of the transaction that resulted in the stockholder’s becoming an interested stockholder, the interested stockholder owned at least 85% of the voting stock outstanding at the time the transaction commenced, other than statutorily excluded shares; or

 

·	On or after that date, the business combination is approved by the Board of Directors and authorized at an annual or special meeting of stockholders, and not by written consent, by the holders of at least two-thirds of the outstanding voting stock not owned by the interested stockholder.

 

A “business combination” includes a merger, asset or stock sale, or other transaction resulting in a financial benefit to the interested stockholder. Please note this is entirely different from the “business combination” provisions of Argyle’s certificate of incorporation that exist because Argyle is a “blank check” company. Except as otherwise described in the Delaware General Corporation Law, an “interested stockholder” is any person owning 15% or more of the outstanding voting stock of the corporation, or who is an affiliate or associate of the corporation and was the owner of 15% or more of the outstanding voting stock at any time within three years immediately before the date of determination, and the affiliates and associates of that person.

 

Limitation of Liability of Directors and Officers

 

Argyle’s Second Amended and Restated Certificate of Incorporation provides that no director will be personally liable to Argyle or its stockholders for monetary damages for breach of fiduciary duty as a director, except to the extent this limitation or exemption is not permitted by the Delaware General Corporation Law. As currently enacted, the Delaware General Corporation Law permits a corporation to provide in its certificate of incorporation that a director will not be personally liable to the corporation or its stockholders for monetary damages for breach of fiduciary duty as a director, except for liability for: (i) any breach of the director’s duty of loyalty; (ii) acts or omissions not in good faith or which involve intentional misconduct or a knowing violation of law, (iii) payments of unlawful dividends or unlawful stock repurchases or redemptions or (iv) any transaction from which the director derived an improper personal benefit.

 

The principal effect of this provision is that a stockholder will be unable to recover monetary damages against a director for breach of fiduciary duty unless the stockholder can demonstrate that one of the exceptions listed above applies. This provision, however, will not eliminate or limit liability arising under federal securities laws. The combined company’s charter will not eliminate its directors’ fiduciary duties. The inclusion of this provision in the charter may, however, discourage or deter stockholders or management from bringing a lawsuit against directors for a breach of their fiduciary duties, even though such an action, if successful, might otherwise have benefited the combined company and its stockholders. This provision should not affect the availability of equitable remedies such as injunction or rescission based upon a director’s breach of his or her fiduciary duties.

 

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The Delaware General Corporation Law provides that a corporation may indemnify its directors and officers as well as its other employees and agents against judgments, fines, amounts paid in settlement and expenses, including attorneys’ fees, in connection with various proceedings, other than an action brought by or in the right of the corporation, if such person acted in good faith and in a manner he or she reasonably believed to be in or not opposed to the best interests of the corporation, and, with respect to any criminal action or proceeding, if he or she had no reasonable cause to believe his or her conduct was unlawful. A similar standard is applicable in the case of an action brought by or in the right of the corporation (commonly known as “derivative suits”), except that indemnification in such a case may only extend to expenses, including attorneys’ fees, incurred in connection with the defense or settlement of such actions, and the statute requires court approval before there can be any indemnification where the person seeking indemnification has been found liable to the corporation. The combined company’s charter and, with regard to its officers, its bylaws provide that the combined company will indemnify its directors and officers to the fullest extent permitted by Delaware law. Under these provisions and subject to the Delaware General Corporation Law, the combined company will be required to indemnify its directors and officers for all judgments, fines, settlements, legal fees and other expenses incurred in connection with pending or threatened legal proceedings because of the director’s or officer’s position with the combined company or another entity that the director or officer serves as a director, officer, employee or agent at the combined company’s request, subject to various conditions, and to advance funds to the combined company’s directors and officers before final disposition of such proceedings to enable them to defend against such proceedings. To receive indemnification, the director or officer must have been successful in the legal proceeding or have acted in good faith and in what was reasonably believed to be a lawful manner in the best interest of the combined company. The bylaws also specifically authorize the combined company to maintain insurance on behalf of any person who is or was or has agreed to become a director, officer, employee or agent of the combined company, or is or was serving at the combined company’s request as a director, officer, employee or agent of another entity, against certain liabilities.

 

Transfer Agent and Registrar

 

The Transfer Agent and Registrar for the shares of Argyle common stock, warrants and units is American Stock Transfer & Trust Company, 59 Maiden Lane, Plaza Level, New York, NY 10038, (212) 936-5100.

 

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STOCKHOLDER PROPOSALS

 

If the acquisition is consummated, the Argyle 2007 annual meeting of stockholders will be held on or about ________________, 2007 unless the date is changed by the Board of Directors. If you are a stockholder and you want to include a proposal in the proxy statement for that annual meeting, you need to provide it to Argyle by no later than ______________, 2007. You should direct any proposals to Argyle’s secretary at Argyle’s principal office.

 

LEGAL MATTERS

 

Loeb & Loeb LLP, New York, New York, will pass upon the validity of the Argyle common stock to be issued in the acquisition as set forth in this proxy statement/prospectus. A copy of their opinion is filed as an annex to the Registration Statement of which this proxy statement/prospectus forms a part.

 

EXPERTS

 

The financial statements of ISI included in this proxy statement/prospectus, have been audited by Padgett, Stratemann & Co., L.L.P., an independent registered public accounting firm, as stated in their report appearing herein, and have been so included in reliance upon the report of such firm, given upon their authority as experts in accounting and auditing.

 

The financial statements for the year ended December 31, 2005 for Argyle included in this document have been audited by Goldstein Golub Kessler LLP, independent registered public accounting firm, as stated in their report appearing herein, and have been so included in reliance upon their report, given upon their authority as experts in accounting and auditing.

 

DELIVERY OF DOCUMENTS TO STOCKHOLDERS

 

Pursuant to the rules of the Securities and Exchange Commission, Argyle and services that it employs to deliver communications to its stockholders are permitted to deliver to two or more stockholders sharing the same address a single copy of each of Argyle’s annual report to stockholders and proxy statement. Upon written or oral request, Argyle will deliver a separate copy of the annual report to stockholders and/or proxy statement to any stockholder at a shared address who wishes to receive separate copies of such documents in the future. Stockholders receiving multiple copies of such documents may likewise request that Argyle deliver single copies of such documents in the future. Stockholders may notify Argyle of their requests by calling or writing Argyle at Argyle’s principal executive offices at 200 Concord Plaza, Suite 700, San Antonio, TX 78216.

 

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WHERE YOU CAN FIND MORE INFORMATION

 

Argyle files reports, proxy statements and other information with the Securities and Exchange Commission as required by the Securities Exchange Act of 1934, as amended.

 

You may read and copy reports, proxy statements and other information filed by Argyle with the SEC at its public reference room located at 100 F Street, N.E., Washington, D.C. 20549-1004.

 

You may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. You may also obtain copies of the materials described above at prescribed rates by writing to the SEC, Public Reference Section, 100 F Street, N.E., Washington, D.C. 20549-1004.

 

Argyle files its reports, proxy statements and other information electronically with the SEC. You may access information on Argyle at the SEC web site containing reports, proxy statements and other information at http://www.sec.gov.

 

This proxy statement/prospectus describes the material elements of relevant contracts, exhibits and other information described in this proxy statement/prospectus. Information and statements contained in this proxy statement/prospectus are qualified in all respects by reference to the copy of the relevant contract or other document included as an annex to this document.

 

All information contained or incorporated by reference in this proxy statement/prospectus relating to Argyle has been supplied by Argyle, and all such information relating to ISI has been supplied by ISI. Information provided by either of us does not constitute any representation, estimate or projection of the other.

 

If you would like additional copies of this proxy statement/prospectus, or if you have questions about the acquisition, you should contact:

Bob Marbut

Chairman and Co-Chief Executive Officer

Argyle Security Acquisition Corporation

200 Concord Plaza, Suite 700

San Antonio, TX 78216

(210) 828-1700

 

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INDEX TO FINANCIAL STATEMENTS

 

ISI Financial Statements		F-2
Argyle Financial Statements		F-30

 

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ISI DETENTION CONTRACTING GROUP, INC.

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

	PAGE
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM	F-3
CONSOLIDATED BALANCE SHEETS	F-4
CONSOLIDATED STATEMENTS OF OPERATIONS	F-6
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ DEFICIT	F-7
CONSOLIDATED STATEMENTS OF CASH FLOWS	F-8 - F-9
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS	F-10 - F-29

 

 

F-2

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Independent Auditors’ Report

To the Board of Directors and Stockholders

ISI Detention Contracting Group, Inc.

and Subsidiaries

San Antonio, Texas

We have audited the accompanying consolidated balance sheets of ISI Detention Contracting Group, Inc. and Subsidiaries as of December 31, 2005 and 2004, and the related consolidated statements of operations, stockholders’ deficit, and cash flows for the years ended December 31, 2005, 2004, and 2003. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

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

As described in note 2, the consolidated financial statements as of December 31, 2005 and 2004 and for the years then ended have been restated to reflect additional interest expense.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of ISI Detention Contracting Group, Inc. and Subsidiaries as of December 31, 2005 and 2004, and the results of their operations and their cash flows for the years ended December 31, 2005, 2004, and 2003, in conformity with accounting principles generally accepted in the United States of America.

/s/ Padgett, Stratemann & Co., L.L.P.

San Antonio, Texas

March 17, 2006, except for notes 2, 7, 9,

10, 14, 15, and 16, as to which the

date is December 1, 2006

F-3

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ISI Detention Contracting Group, Inc. and Subsidiaries

Consolidated Balance Sheets

Assets

		December 31,			December 31,			September 30,			September 30,
		2005			2004			2006			2005
								(Unaudited)			(Unaudited)
Current Assets
Cash and cash equivalents		$	415,764		$	1,308,344		$	254,483		$	149,707
Receivables:
Contract - net of allowance for doubtful accounts of $450,099 and $113,328 at December 31, 2005 and 2004, respectively, and $264,488 and $284,220 at September 30, 2006 and 2005, respectively			10,229,418			6,678,633			16,694,584			11,150,997
Receivable - related party			2,327,846			3,493,640			4,160,046			1,416,142
Other			344,142			152,145			377,098			282,276
Inventory			355,493			1,726			324,464			1,725
Refundable income taxes			487,335			1,018,645			655,843			162,556
Deferred income taxes			-			17,736			-			17,736
Costs and estimated earnings in excess of billings on incomplete contracts			2,792,706			2,111,726			4,178,225			2,387,494
Total current assets			16,952,704			14,782,595			26,644,743			15,568,633
Property and Equipment
Land and buildings			1,774,265			1,774,265			2,645,438			1,774,265
Furniture, fixtures, and equipment			2,368,561			2,060,771			2,506,579			2,157,966
Vehicles			1,670,024			1,561,207			1,767,351			1,611,417
			5,812,850			5,396,243			6,919,368			5,543,648
Less accumulated depreciation and amortization			2,694,422			2,063,407			3,195,984			2,510,109
Net property and equipment			3,118,428			3,332,836			3,723,384			3,033,539
Other Assets
Goodwill			1,255,252			1,059,822			1,254,306			1,101,762
Loan origination fees - less accumulated amortization of $387,731 and $38,285 at December 31, 2005 and 2004, respectively, and $649,815 and $268,516 at September 30, 2006 and 2005, respectively			1,223,862			1,135,340			1,008,008			1,233,751
Deposits and other assets			35,458			26,071			171,355			34,269
Total other assets			2,514,572			2,221,233			2,433,669			2,369,782
		$	22,585,704		$	20,336,664		$	32,801,796		$	20,971,954

 

Notes to consolidated financial statements form an integral part of these statements.

 

F-4

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Liabilities and Stockholders’ Deficit

		December 31,			December 31,			September 30,			September 30,
		2005			2004			2006			2005
								(Unaudited)			(Unaudited)
Current Liabilities
Current maturities of long-term debt		$	60,788		$	131,836		$	80,814		$	61,444
Current portion of capitalized lease obligations			61,369			55,815			95,580			59,931
Accounts payable and accrued liabilities			5,973,993			4,034,804			11,175,091			5,256,680
Accounts Payable - related party			1,799,710			1,497,766			1,986,056			1,886,155
Billings in excess of costs and estimated earnings on incomplete contracts			3,533,968			3,831,885			6,912,067			3,487,879
Total current liabilities			11,429,828			9,552,106			20,249,608			10,752,089

 

Long-Term Liabilities
Line of credit			4,450,850			4,429,335			4,662,850			4,281,850
Long-term debt - less current maturities			12,944,401			11,513,476			13,510,651			12,050,559
Long-term portion of capitalized lease obligations			1,422,001			1,483,370			2,011,705			1,433,519
Deferred income taxes			255,188			350,491			255,188			350,491
Warrants subject to redemption			4,412,948			4,153,896			4,819,615			4,380,258
Total long-term liabilities			23,485,388			21,930,568			25,260,009			22,496,677
Total liabilities			34,915,216			31,482,674			45,509,617			32,248,766

Stockholders’ Deficit
Common stock - $1 par value; 3,000 shares authorized; 105 shares issued and outstanding			105			105			105			105
Additional paid-in capital			16,808			16,808			16,808			16,808
Accumulated deficit			(12,346,425	)		(11,162,923	)		(12,724,734	)		(12,293,725	)
Total stockholders’ deficit			(12,329,512	)		(11,146,010	)		(12,707,821	)		(12,276,812	)
		$	22,585,704		$	20,336,664		$	32,801,796		$	20,971,954

 

F-5

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ISI Detention Contracting Group, Inc. and Subsidiaries

 

Consolidated Statements of Operations

		Years Ended December 31,									Nine Months Ended September 30,
		2005			2004			2003			2006			2005
											(Unaudited)			(Unaudited)
Revenues:
Contract revenues		$	20,905,409		$	34,871,115		$	31,823,804		$	22,729,085		$	16,021,017
Contract revenues - related party			14,475,895			2,872,324			-			13,586,044			9,970,445
Service revenues			3,771,050			2,420,096			2,522,983			4,881,879			2,409,492
Other revenues			82,133			11,451			378,808			36,798			29,126
			39,234,487			40,174,986			34,725,595			41,233,806			28,430,080
Cost of revenues:
Contract costs			28,213,117			28,299,615			22,916,750			29,018,321			20,944,829
Other costs			2,652,272			2,271,716			2,165,342			3,554,670			1,772,683
			30,865,389			30,571,331			25,082,092			32,572,991			22,717,512
Gross profit			8,369,098			9,603,655			9,643,503			8,660,815			5,712,568
Management special bonuses			-			5,150,539			-			-			-
General and administrative expenses			6,908,440			6,495,638			6,341,568			6,249,385			4,846,606
			1,460,658			(2,042,522	)		3,301,935			2,411,430			865,962
Interest expense			(3,177,891	)		(812,777	)		-			(2,779,773	)		(2,459,407	)
Investment and other income (loss) - net			7,915			(85,343	)		(55,418	)		346			(573	)
Income (loss) before income taxes			(1,709,318	)		(2,940,642	)		3,246,517			(367,997	)		(1,594,018	)
Income tax expense (benefit):
Current			(448,249	)		(969,232	)		1,745,613			10,312			(463,216	)
Deferred			(77,567	)		75,643			(580,844	)		-			-
			(525,816	)		(893,589	)		1,164,769			10,312			(463,216	)
Net income (loss)		$	(1,183,502	)	$	(2,047,053	)	$	2,081,748		$	(378,309	)	$	(1,130,802	)
Weighted-average number of shares
outstanding:
Basic and diluted			104.91			104.91			100.00			104.91			104.91
Income (loss) per share:
Basic and diluted		$	(11,281.12	)	$	(19,512.47	)	$	20,817.48		$	(3,606.03	)	$	(10,778.78	)

 

Notes to consolidated financial statements form an integral part of these statements.

 

F-6

---

 

ISI Detention Contracting Group, Inc. and Subsidiaries

 

Consolidated Statements of Stockholders’ Deficit

 

Years Ended December 31, 2005, 2004, and 2003

					Additional			Retained
		Common			Paid-In			Earnings
		Stock			Capital			(Deficit)			Total
Balance at December 31, 2002		$	100		$	900		$	5,737,722		$	5,738,722
Net income - year ended December 31, 2003			-			-			2,081,748			2,081,748
Balance at December 31, 2003			100			900			7,819,470			7,820,470
Stockholder distributions			-			-			(16,935,340	)		(16,935,340	)
Common stock issued			5			15,908			-			15,913
Net loss - year ended December 31, 2004 - as restated			-			-			(2,047,053	)		(2,047,053	)
Balance at December 31, 2004 - as restated			105			16,808			(11,162,923	)		(11,146,010	)
Net loss - year ended December 31, 2005 - as restated			-			-			(1,183,502	)		(1,183,502	)
Balance at December 31, 2005 - as restated			105			16,808			(12,346,425	)		(12,329,512	)
Net loss - nine months ended September 30, 2006 -
unaudited			-			-			(378,309	)		(378,309	)
Balance at September 30, 2006 - unaudited		$	105		$	16,808		$	(12,724,734	)	$	(12,707,821	)

 

Notes to consolidated financial statements form an integral part of these statements.

F-7

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ISI Detention Contracting Group, Inc. and Subsidiaries

 

Consolidated Statements of Cash Flows

Increase (Decrease) in Cash and Cash Equivalents
 

											Nine Months Ended
		Years Ended December 31,									September 30,
											2006			2005
		2005			2004			2003			(Unaudited)			(Unaudited)
Cash Flows From Operating Activities
Net income (loss)		$	(1,183,502	)	$	(2,047,053	)	$	2,081,748		$	(378,309	)	$	(1,130,802	)
Adjustments to reconcile net income (loss) to net
cash provided by (used in) operating activities:
Interest accretion and fair value adjustment
of stock warrants			919,868			299,136			-			902,279			721,974
Depreciation and amortization of
property and equipment			1,003,569			670,338			491,577			497,748			466,034
Loss on disposal of assets			-			37,129			20,827			-			-
Deferred income taxes			(77,567	)		75,643			(585,351	)		-			(17,735	)
Changes in:
Net decrease in marketable securities			-			-			784,231			-			-
Receivables:
Contract			(3,650,791	)		1,744,604			(43,613	)		(6,498,122	)		(4,602,495	)
Contract - related party			1,165,794			(3,493,640	)		-			(1,832,200	)		2,077,498
Note receivable			-			177,386			-			-			-
Other			(191,997	)		606,591			(446,194	)		-			-
Prepared income taxes			-			-			189,667			-			-
Inventory			(453,767	)		-			-			31,029			-
Refundable income taxes			531,310			(1,017,172	)		-			(168,508	)		873,825
Costs and estimated earnings in excess of
billings on incomplete contracts			(680,980	)		456,219			(1,705,399	)		(1,385,519	)		(275,768	)
Prepaid expenses and other assets			-			900			32,647			-			-
Deposits and other assets			(9,387	)		(3,712	)		-			-			-
Accounts payable and accrued liabilities			1,939,195			718,875			(306,984	)		5,201,098			1,221,876
Accounts payable - related party			301,944			1,497,766			-			186,346			388,389
Billings in excess of costs and estimated
earnings on incomplete contracts			(297,917	)		1,576,040			(319,942	)		3,378,099			(344,006	)
Income taxes payable			-			(1,071,291	)		1,071,291			-			-
Net cash provided by (used in)
operating activities			(684,228	)		257,759			1,264,505			(66,059	)		(621,210	)

 

 

Notes to consolidated financial statements form an integral part of these statements.

 

F-8

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ISI Detention Contracting Group, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(Continued)

 

Increase (Decrease) in Cash and Cash Equivalents

		Years Ended December 31,									Nine Months Ended September 30,
											2006			2005
		2005			2004			2003			(Unaudited)			(Unaudited)
Cash Flows From Investing Activities
Purchases of property and equipment		$	(298,056	)	$	(620,071	)	$	(452,040	)	$	(426,516	)	$	(231,128	)
Proceeds from sale of property and equipment			-			4,000			-			-			-
Loan origination fees and other assets			(468,811	)		(1,676,131	)		49,858			80,903			(148,549	)
Net cash used in investing activities			(766,867	)		(2,292,202	)		(402,182	)		(345,613	)		(379,677	)
Cash Flows From Financing Activities
Line of credit borrowings - net			21,515			4,429,335			-			212,000			(147,485	)
Short-term borrowings - net			-			-			(565,000	)		-			-
Long-term borrowings			715,000			15,300,000			714,465			-			-
Payments on long-term borrowings and capitalized
lease obligations			(178,000	)		(318,985	)		(861,799	)		38,513			-
Stockholder distributions			-			(16,935,340	)		-			-			-
Net cash provided by (used in)
financing activities			558,515			2,475,010			(712,334	)		250,513			(147,485	)
Net increase (decrease) in cash
and cash equivalents			(892,580	)		440,567			149,989			(161,159	)		(1,148,372	)
Cash and cash equivalents at beginning of period			1,308,344			867,777			717,788			415,642			1,298,079
Cash and cash equivalents at end of period		$	415,764		$	1,308,344		$	867,777		$	254,483		$	149,707
Supplemental Disclosures of Cash Flow
Information
Cash paid for interest		$	2,258,023		$	513,641		$	72,565		$	1,877,494		$	1,737,733
Cash paid for income taxes - net of refunds		$	-		$	-		$	450,000		$	-		$	-

 

Notes to consolidated financial statements form an integral part of these statements.

 

F-9

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1. Nature of Business and Significant Accounting Policies

ISI Detention Contracting Group, Inc. and Subsidiaries (the “Company”) are detention equipment contractors that specialize in turnkey installations, including design, engineering, supply, and installation of various detention equipment for correctional facilities and institutions. The work is performed under fixed-price contracts. The projects are located in various cities in the United States. The length of the contracts varies but is typically less than two years.

Metroplex Control Systems (“MCS”), a subsidiary of the Company, is a multi-faceted company responsible for turnkey installations covering the full spectrum of electronic security and low voltage systems, including fire alarm, access control, closed circuit television, intercom, sound/paging, and other custom designed systems.

Cash balances are maintained by the Company at several banks. Accounts at each institution are insured by the Federal Deposit Insurance Corporation up to $100,000.

The accounting and reporting policies of the Company conform to accounting principles generally accepted in the United States of America. The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

A summary of the significant accounting policies followed by the Company in preparation of the accompanying consolidated financial statements is set forth below:

Basis of Consolidation

The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries and partnerships. Intercompany transactions and balances have been eliminated in consolidation.

 

Consolidated subsidiaries include ISI Detention Contracting Group, Inc.; ISI Detention Systems, Inc.; ISI Systems, Ltd.; Detention Contracting Group, Ltd.; ISI Controls, Ltd.; Metroplex Commercial Fire and Security Alarms, Inc.; MCFSA, Ltd.; and Metroplex Control Systems, Inc.

F-10

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 1. Nature of Business and Significant Accounting Policies (continued)

Recently Issued Accounting Pronouncements

In November 2005, the Financial Accounting Standards Board (“FASB”) issued Staff Position No. FAS 115-1, The Meaning of Other-Than-Temporary Impairment and its Application to Certain Investments (“FSP 115-1”). FSP 115-1 provides accounting guidance for determining and measuring other-than-temporary impairments of debt and equity securities, and confirms the disclosure requirements for investments in unrealized loss positions as outlined in EITF issue 03-01, The Meaning of Other-Than-Temporary Impairments and its Application to Certain Investments. The accounting requirements of FSP 115-1 are not expected to have a material impact on the Company’s consolidated financial position, results of operations, or cash flows.

In June 2005, FASB issued Statement on Financial Accounting Standards (“SFAS”) No. 154, Accounting Changes and Error Corrections (“SFAS No. 154”) - a replacement of APB No. 20 and FAS No. 3. SFAS No. 154 provides guidance on the accounting for and reporting of accounting changes and error corrections. It establishes, unless impracticable, retrospective application as the required method for reporting a change in accounting principle in the absence of explicit transition requirements specific to the newly adopted accounting principle. SFAS No. 154 also provides guidance for determining whether retrospective application of a change in accounting principle is impracticable and for reporting a change when retrospective application is impracticable. The correction of an error in previously issued financial statements is not an accounting change. However, the reporting of an error correction involves adjustments to previously issued financial statements similar to those generally applicable to reporting an accounting change retrospectively. Therefore, the reporting of a correction of an error by restating previously issued financial statements is also addressed by SFAS No. 154. SFAS No. 154 is required to be adopted in fiscal years beginning after December 15, 2005. The Company does not believe its adoption will have a material impact on its financial position, results of operations, or cash flows.

F-11

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 1. Nature of Business and Significant Accounting Policies (continued)

Recently Issued Accounting Pronouncements (continued)

In December 2004, FASB revised and reissued SFAS No. 123-R, Share-Based Payment (“SFAS No. 123-R”), which supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees. The revised statement addresses the accounting for share-based payment transactions with employees and other third parties, eliminates the ability to account for share-based payment transactions using APB No. 25, and requires that the compensation costs relating to such transactions be recognized in the consolidated statement of operations. In March 2005, the Securities and Exchange Commission (“SEC”) released Staff Accounting Bulletin (“SAB”) No. 107, Share-Based Payment (“SAB No. 107”), to provide public companies additional guidance in applying the provisions of SFAS No. 123-R. Among other things, the SAB describes the staff’s expectations in determining the assumptions that underlie the fair value estimates and discusses the interaction of SFAS No. 123-R with certain existing staff guidance. SAB No. 107 should be applied upon the adoption of SFAS No. 123-R. In April 2005, the SEC amended Regulation S-X to provide a six-month adoption deferral period for public companies. The Company does not believe its adoption will have a material impact on its financial position, results of operations, or cash flows.

On December 16, 2004, FASB issued SFAS No. 153, Exchanges of Nonmonetary Assets(an amendment of APB Opinion No. 129) (“SFAS No. 153”). SFAS No. 153 addresses the measurement of exchanges of nonmonetary assets and redefines the scope of transactions that should be measured based on the fair value of the assets exchanged. SFAS No. 153 is effective for nonmonetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. The Company does not believe the adoption of SFAS No. 153 will have a material effect on its results of operations, financial position, or cash flows.

In November 2004, FASB issued SFAS No. 151, Inventory Costs (“SFAS No. 151”),which amends part of Accounting Research Bulletin (“ARB”) No. 43, Inventory Pricing (“ARB No. 43”), concerning the treatment of certain types of inventory costs. The provisions of ARB No. 43 provided that certain inventory-related costs, such as double freight and re-handling might be “so abnormal” that they should be charged against current earnings rather than be included in the cost of inventory. As amended by SFAS No. 151, the “so-abnormal” criterion has been eliminated. Thus, all such (abnormal) costs are required to be treated as current period charges under all circumstances. In addition, fixed production overhead should be allocated based on the normal capacity of the production facilities, with unallocated overhead charged to expense when incurred. SFAS No. 151 is required to be adopted for fiscal years beginning after June 15, 2005. The Company does not believe the adoption of SFAS No. 153 will have a material effect on its results of operations, financial position, or cash flows.

F-12

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 1. Nature of Business and Significant Accounting Policies (continued)

Recently Issued Accounting Pronouncements (continued)

In June 2006, FASB issued Interpretation Number FIN 48, Accounting for Uncertainty in Income Taxes, an Interpretation of FASB Statement No. 109 (“FIN 48”). FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return, and provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. The Company is evaluating the impact of the interpretation on its consolidated financial statements and will adopt the provisions of this interpretation in fiscal year 2007.

In September 2006, the SEC issued SAB 108. SAB 108 addresses the process and diversity in practice of quantifying financial statement misstatements resulting in the potential build up of improper amounts on the balance sheet. The Company will be required to adopt the provisions of SAB 108 effective during the fourth quarter of 2006. The Company does not believe the adoption of SAB 108 will have a material impact on its consolidated financial statements.

In September 2006, FASB issued FAS 157, Fair Value Measurements (“FAS 157”). FAS 157 establishes a framework for measuring fair value and expands disclosures about fair value measurements. The changes to current practice resulting from the application of this standard relate to the definition of fair value, the methods used to measure fair value, and the expanded disclosures about fair value measurements. FAS 157 is effective for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. The Company does not believe the adoption of the provisions of FAS 157 will materially impact its financial position and consolidated results of operations.

Cash and Cash Equivalents

Cash equivalents for purposes of the consolidated statements of cash flows are all highly liquid debt instruments with original maturities of three months or less.

 

Accounts Receivable

Accounts receivable are recorded at the invoiced amount and do not bear interest. The allowance for doubtful accounts is established as losses are estimated to have occurred through a provision for bad debts charged to earnings. Losses are charged against the allowance when management believes the uncollectibility of a receivable is confirmed. Subsequent recoveries, if any, are credited to the allowance. The allowance for doubtful accounts is evaluated on a regular basis by management and is based on historical experience and specifically identified questionable receivables. The evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

F-13

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 1. Nature of Business and Significant Accounting Policies (continued)

Accounts Receivable

Accounts receivable are recorded at the invoiced amount and do not bear interest. The allowance for doubtful accounts is established as losses are estimated to have occurred through a provision for bad debts charged to earnings. Losses are charged against the allowance when management believes the uncollectibility of a receivable is confirmed. Subsequent recoveries, if any, are credited to the allowance. The allowance for doubtful accounts is evaluated on a regular basis by management and is based on historical experience and specifically identified questionable receivables. The evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

Fair Value of Financial Instruments

The recorded values of financial instruments, including accounts receivable, other assets, and accounts payable, approximate fair value due to their short maturity. The carrying value of the revolving line of credit approximates fair value due to its variable interest rate. The recorded value of the long-term debt approximates fair value based on borrowing rates currently available to the Company for financing arrangements with similar terms and average maturities. The warrants are recorded at fair value based on independent appraisals obtained by the Company.

Revenue Recognition 

The Company recognizes revenue when services are performed except when work is being performed under a construction contract. Such contracts generally provide that the customers accept completion of progress to date and compensate the Company for services rendered measured in terms of units installed, hours expended, or some other measure of progress. Revenues from construction contracts are recognized on the percentage-of-completion method in accordance with the American Institute of Certified Public Accountants’ Statement of Position 81-1, “Accounting for Performance of Construction-Type and Certain Production-Type Contracts.” The Company recognizes revenue on signed contracts and change orders. The Company generally recognizes revenue on unsigned change orders where it has written notices to proceed from the customer and where collection is deemed probable. Percentage-of-completion for construction contracts is measured principally by the percentage of costs incurred and accrued to date for each contract to the estimated total costs for each contract at completion. The Company generally considers contracts to be substantially complete upon departure from the work site and acceptance by the customer. Contract costs include all direct material, labor, subcontract, equipment costs, related payroll taxes and insurance costs, and any other indirect costs related to contract performance. Changes in job performance, job conditions, estimated contract costs, and profitability, and final contract settlements may result in revisions to costs and income and the effects of these revisions are recognized in the period in which the revisions are determined. Provisions for total estimated losses on incomplete contracts are made in the period in which such losses are determined.

Costs incurred prior to award of contracts are expensed as incurred.

The balances billed but not paid by customers pursuant to retainage provisions in construction contracts will be due upon completion of the contracts and acceptance by the customer. Based on the Company’s experience with similar contracts in recent years, the retention balance at each balance sheet date will be collected within the subsequent fiscal year.

 

The current asset “Costs and estimated earnings in excess of billings on incomplete contracts” represents revenues recognized in excess of amounts billed which management believes will be billed and collected within the subsequent year. The current liability “Billings in excess of costs and estimated earnings on incomplete contracts” represents billings in excess of revenues recognized.

 

Property and Equipment

Property and equipment are stated at cost. Depreciation and amortization are calculated on the straight-line method based on the following estimated useful lives: buildings - 10 to 40 years; furniture, fixtures, and equipment - 3 to 10 years; and vehicles - 3 to 7 years.

F-14

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1. Nature of Business and Significant Accounting Policies (continued)

 

Property and Equipment (continued)

The Company reviews the carrying value of property and equipment for impairment whenever events and circumstances indicate the carrying value of the asset may not be recoverable from the estimated future cash flows expected to result from its use and eventual disposition. In cases where undiscounted expected future cash flows are less than the carrying value, an impairment loss is recognized equal to an amount by which the carrying value exceeds the fair value of assets. The factors considered by management in performing this assessment include current operating results, trends and prospects, and the effects of obsolescence, demand, competition, and other economic factors. Based on this assessment, there was no impairment at December 31, 2005 and 2004.

Assets Held Under Capital Leases

Assets held under capital leases are recorded at the lower of the net present value of the minimum lease payments or the fair value of the asset at the inception of the lease. Amortization expense is computed using the straight-line method over the shorter of the estimated useful life of the asset or the lease term.

Income Taxes

Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets, including tax loss and credit carryforwards, and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Deferred income tax expense represents the change during the period in the deferred tax assets and deferred tax liabilities. The components of the deferred tax assets and liabilities are individually classified as current and noncurrent based on their characteristics. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized.

F-15

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 1. Nature of Business and Significant Accounting Policies (continued)

Goodwill

As required by SFAS No. 142, Goodwill and Other Intangible Assets, the Company reviews goodwill annually for impairment at the end of each fiscal year, or if events or circumstances indicate potential impairment. The Company must recognize an impairment loss if, and to the extent that, goodwill exceeds fair value. Based on the reviews, the Company has determined that no goodwill impairment exists at December 31, 2005, 2004, and 2003.

Loan Origination Fees

Loan origination fees and costs related to the line of credit and the long-term note agreement (notes 7 and 8) are being amortized over the term of each respective note (three years for the line of credit and seven years for the long-term note agreement). Additional loan fees totaling approximately $438,000 were added during 2005 relating to transactions occurring during 2005 and 2004. These amounts are being amortized over the original terms.

Contingencies

Certain conditions may exist as of the date the consolidated financial statements are issued, which may result in a loss to the Company but which will only be resolved when one or more future events occur or fail to occur. The Company’s management and its legal counsel assess such contingent liabilities, and such assessment inherently involves an exercise of judgment. In assessing loss contingencies related to legal proceedings that are pending against the Company or unasserted claims that may result in such proceedings, the Company’s legal counsel evaluates the perceived merits of any legal proceedings or unasserted claims, as well as the perceived merits of the amount of relief sought or expected to be sought therein.

If the assessment of a contingency indicates that it is probable that a material loss has been incurred and the amount of the liability can be estimated, then the estimated liability would be accrued in the Company’s consolidated financial statements. If the assessment indicates that a potentially material loss contingency is not probable but is reasonably possible, or is probable but cannot be estimated, then the nature of the contingent liability, together with an estimate of the range of possible loss if determinable and material, would be disclosed.

Loss contingencies considered remote are generally not disclosed unless they involve guarantees, in which case the guarantees would be disclosed.

F-16

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 1. Nature of Business and Significant Accounting Policies (continued)

Basic and Diluted Net Income (Loss) Per Share

Basic net income (loss) per common share is computed by dividing net income (loss) applicable to common stockholders by the weighted-average number of common shares outstanding during the period. Diluted net income (loss) per common share is determined using the weighted-average number of common shares outstanding during the period, adjusted for the dilutive effect of common stock equivalents, consisting of shares that might be issued upon exercise of common stock warrants and stock appreciation rights. In periods where losses are reported, the weighted-average number of common shares outstanding excludes common stock equivalents, because their inclusion would be anti-dilutive.

A reconciliation of basic and dilutive common stock shares is as follows:

 

											Nine Months Ended
		Years Ended December 31,									September 30,
											2006			2005
		2005			2004			2003			(Unaudited)			(Unaudited)
Weighted-average number of shares:
Basic shares outstanding			104.91			104.91			100.00			104.91			104.91
Potential dilutive shares outstanding:
Employee stock appreciation rights			19.65			17.48			-			22.89			19.65
Common stock warrants			52.45			52.45			-			52.46			52.45
Total potential dilutive common shares			72.10			69.93			-			75.35			72.10
Total basic and potential dilutive shares			177.01			174.84			100.00			180.26			177.01

 

Reclassification

Certain amounts have been reclassified from prior presentations to conform to current classifications. There is no effect on previously reported net income (loss) or accumulated deficit.

 

2. Restatements

Subsequent to the issuance of the consolidated financial statements of the Company as of December 31, 2005 and 2004, and for the years then ended, interest expense was adjusted to reflect an adjustment to the fair value of the warrants issued in connection with long-term debt issued in 2004. Accordingly, the consolidated financial statements as of December 31, 2005 and 2004, and for the years then ended, have been restated to reflect additional interest expense of $884,868 and $299,136, respectively, related to the stock warrants described in note 7. The warrants have been reclassified from stockholders’ equity to long-term liabilities.

F-17

---

 

2. Restatements (continued)

The cumulative effect of the matters described above on the accompanying consolidated financial statements as of December 31, 2005 and 2004, and for the years then ended, was as follows:

		2005						2004
		As Previously Reported			As Restated			As Previously Reported			As Restated
Interest expense		$	2,293,023		$	3,177,891		$	513,641		$	812,777
Loss before income taxes			(824,450	)		(1,709,318	)		(2,641,506	)		(2,940,642	)
Income tax benefit			313,039			525,816			856,143			893,589
Net loss			(511,411	)		(1,183,502	)		(1,785,363	)		(2,047,053	)
Basic and diluted
earnings per share			(4,874.76	)		(11,281.12	)		(17,018.04	)		(19,512.47	)

 

Selected balance sheet accounts as of December 31, 2005 and 2004 are as follows:

		2005						2004
		As Previously Reported			As Restated			As Previously Reported			As Restated
Long-term debt - less
current maturities		$	16,163,345		$	12,944,401		$	15,158,236		$	11,513,476
Warrants subject to
redemption			-			4,412,948			-			4,153,896
Stockholders’ deficit			(11,185,731	)		(12,329,512	)		(10,674,320	)		(11,146,010	)

F-18

---

 

 

3. Contract Receivables

Contract receivables consist of the following:

		December 31,
		2005			2004
Completed contracts and
and contracts in progress		$	10,140,046		$	8,070,923
Retainage			2,417,218			2,101,350
		$	12,557,264		$	10,172,273

4. Related Party Transactions

Other receivables included $164,266 and $57,194 at December 31, 2005 and 2004, respectively, due from stockholders of the Company. The remainder of the other receivables include amounts due from employees and miscellaneous sales.

The Company had notes payable to the stockholders at December 31, 2005. The terms are included in note 7.

In conjunction with the major refinancing of the Company in 2004, the majority stockholders formed a new company in 2004 which is used as the contracting entity on all future bonded contracts. The Company transferred certain existing bonded contracts at their remaining contract values, and no gain or loss was recognized on the transfers to the new company (ISI*MCS, Ltd.) at the time of its formation. All contracts of ISI*MCS, Ltd. will be subcontracted to ISI Detention Contracting Group, Inc. for the full contract amount, less a 2% fee. The Company records contract revenue based on the ISI*MCS, Ltd.’s contract amount, net of the 2% fee. Contract revenue from ISI*MCS, Ltd. totaled $14,475,895 for the year ended December 31, 2005 ($2,872,324 in 2004). Contract receivables from ISI*MCS, Ltd. at December 31, 2005 totaled $2,327,846 ($3,493,640 in 2004).

Amounts payable to ISI*MCS, Ltd. at December 31, 2005 totaled $1,799,710 ($1,497,766 in 2004).

F-19

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5. Costs and Estimated Earnings on Incomplete Contracts and Backlog

Costs and estimated earnings on incomplete contracts and backlog information are as follows:

		December 31,
		2005			2004
Amended contract amount		$	86,733,666		$	66,911,055
Revenue recognized to date			41,294,221			41,069,747
Unearned contract amount - backlog		$	45,439,445		$	25,841,308
Cost to date		$	33,140,765		$	34,559,481
Estimated cost to complete			40,488,728			19,999,573
Estimated total cost		$	73,629,493		$	54,559,054
Billings to date		$	42,035,483		$	42,789,906
Costs and estimated earnings in excess of
billings on incomplete contracts		$	2,792,706		$	2,111,726
Billings in excess of costs and estimated
earnings on incomplete contracts		$	3,533,968		$	3,831,885

The Company recognizes as backlog only those contracts on which it has received signed contracts or executed letters of intent to award a contract from its customers. The Company also verifies funding is in place on the contracts prior to inclusion in backlog. Backlog is the contract amount less revenue recognized using percentage-of-completion accounting as described in note 1 of these consolidated financial statements.

 

The various subsidiary companies often function as subcontractors to other subsidiary companies. The above schedule is computed on a consolidated basis. Intercompany contract amounts and billings have been eliminated, and costs and estimated earnings in excess of billings and billings in excess of costs and estimated earnings have been recomputed based on actual combined costs of the companies.

F-20

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6. Goodwill

The following analysis details the changes in goodwill for each reportable segment during the years ended December 31, 2005 and 2004:

		MCS Detention			MCS Commercial			Total
Balance at December 31, 2003		$	496,233		$	45,170		$	541,403
Acquisitions			-			138,744			138,744
Purchase accounting adjustments			379,675			-			379,675
Balance at December 31, 2004			875,908			183,914			1,059,822
Acquisitions			-			195,430			195,430
Balance at December 31, 2005		$	875,908		$	379,344		$	1,255,252

The acquisition of goodwill in 2005 resulted from the acquisition of the net assets of a company in a related line of business for approximately $550,000. The allocation of the purchase price included approximately $150,000 of goodwill acquired.

The acquisition of goodwill in 2004 resulted from the acquisition of the net assets of a company in a related line of business for approximately $250,000. The allocation of the purchase price included approximately $125,000 of goodwill acquired.

Purchase accounting adjustments in 2004 relate to a contingent payment of approximately $380,000 related to the purchase of MCS Detention in 2001. The purchase agreement provided for a contingent payment in the event of a sale of MCS Detention. The Company and the seller agreed to the refinancing which occurred in 2004 as an event that triggered the payment of the contingent amount.

 

F-21

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7. Long-Term Debt

Long-term debt consists of the following:

		Monthly		Interest		Payable		December 31,
Collateral		Installment		Rate		Through		2005			2004
Vehicles		$473 to $1,008		0.00% to 1.90%		2006		$	21,605		$	130,284
Vehicles		$430 to $579		Prime plus 0.50% to 1.00%		2009			38,112			-
Equipment		$1,277		Prime plus 0.50%		2008			38,992			-
Unsecured (A)		(B)		11.58%		2011			12,757,665			11,445,240
Phone system		$2,220		9.00%		2006			50,424			69,788
Stockholders -
unsecured (A)		(B)		12.00%		2011			98,391			-
									13,005,189			11,645,312
Less current maturities									60,788			131,836
Long-term debt - less current maturities								$	12,944,401		$	11,513,476

(A)	The notes are unsecured and subordinated to the line of credit (note 8). The note agreements contain prepayment options with prepayment penalties. There are both financial and restrictive covenants associated with the note agreements.

Proceeds received from the lender during 2004 totaled $15,300,000 and were allocated $11,335,104 to debt and $3,964,896 to a common stock warrant based on an assessment of fair values. Total debt of $15,300,000 is due and payable in one single payment in October 2011. The note payable discount of $3,964,896 will be accreted as interest expense on the effective interest rate method through that date. Total accretion for 2005 was $660,816 ($110,136 in 2004).

F-22

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 7. Long-Term Debt (continued)

The lender warrant was for 52.4532 shares of common stock, which equated to giving the warrant holder 30% of the Company’s shares after exercise of the warrant. Subsequent issuances of stockholder appreciation rights to key employees have caused the percentage to be diluted to 29.1%. The warrant has an exercise price of $1.00 per share and is exercisable in whole or in part at any time through October 2014. The warrant contains put privileges, effective October 2011 or prior to that date upon the occurrence of certain events, which could cause settlement in cash versus Company shares; therefore, the warrants have been recorded as a liability. The put price is determined as the greater of five times earnings before income tax, depreciation, and amortization plus cash positions of the Company or market value of the Company.

Additional funds totaling $651,609 were advanced from the lender during 2005 for the purchase of a company in a similar line of business. In connection with the acquisition, the stockholders loaned the Company funds in the amount of $98,391. The 2005 advances have terms similar to the original terms and are unsecured and subordinated to the line of credit.

(B)	Interest only through October 22, 2011, payable quarterly.

Aggregate maturities required on long-term debt at December 31, 2005 are as follows:

Year ending December 31,
2006		$	60,788
2007			54,661
2008			122,452
2009			111,232
2010			-
Later years			12,656,056
		$	13,005,189

 

Interest expense includes the accretion of interest on the common stock warrant and mark-to-market adjustments for the fair value of the warrants. Increase in fair value of the warrants was estimated at $259,052 and $189,000 for the years ended December 31, 2005 and 2004, respectively.

F-23

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8. Line of Credit

During 2004, the Company secured a new three-year line of credit agreement for $6,000,000. The line of credit is secured by all tangible and intangible assets of the Company excluding vehicles. The line calls for all accounts receivable collections to be deposited directly to a lockbox. The note matures and is payable October 21, 2007. Interest is payable quarterly and is calculated at the lender’s base rate (greater of prime or federal funds rate) plus 0.5% or 350 basis points in excess of LIBOR for the applicable period. The outstanding balance on the line at December 31, 2005 and 2004 was $4,450,850 and $4,429,335, respectively. The agreement contains both financial and restrictive covenants.

9. Capitalization of Leases

The Company sold its owner-occupied real estate to a partnership owned by the Company’s stockholders during 2004 and entered into a lease back of the properties with the partnership. The lease is a triple net lease, expiring in 2018, at a monthly rental of $16,667. The lease is required to be classified as a capital lease under accounting principles generally accepted in the United States or America. The Company had previously recorded and reported the asset and liability based on estimated incremental borrowing rates of the Company. The asset and liability have been adjusted and reported in these consolidated financial statements at their historical net carrying value at the date of sale, due to the related party nature of the sale. The effect of the changes in these carrying values did not result in any change in previously reported net income or stockholders’ deficit.

The following is a summary of the leased property, included in property and equipment in the accompanying consolidated financial statements:

		December 31,
		2005			2004
Land, buildings, and improvements		$	1,598,487		$	1,598,487
Less accumulated amortization			206,546			98,783
		$	1,391,941		$	1,499,704

Amortization of assets held under capital leases is included with depreciation expense.

F-24

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 9. Capitalization of Leases (continued)

The following is a schedule by years of future minimum lease payments under capital leases together with the present value of net minimum lease payments at December 31, 2005:

Year ending December 31,
2006		$	200,000
2007			200,000
2008			200,000
2009			200,000
2010			200,000
Later years			1,583,334
Future minimum lease payments			2,583,334
Less amount of net minimum lease payments
attributable to interest			1,099,964
Present value of net minimum lease payments		$	1,483,370
Current portion of capitalized lease obligations		$	61,369
Long-term portion of capitalized lease obligations			1,422,001
		$	1,483,370

September 30, 2006 (Unaudited)

The Company entered into a new lease in 2006. The lease expires in 2018 and has a monthly rental payment of $7,000. The lease is required to be classified as a capital lease under accounting principles generally accepted in the United States of America.

The following is a summary of the additional property leased in 2006, which is included in property and equipment in the accompanying consolidated financial statements as of September 30, 2006:

Land and buildings		$	680,000
Less accumulated amortization			27,200
		$	652,800

 

F-25

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10. Income Taxes

Income tax expense (benefit) differs from the amount which would be provided by applying the statutory federal income tax rates as follows:

		Years Ended December 31,
		2005			2004			2003
Computed at the expected statutory rate		$	(581,168	)	$	(999,818	)	$	1,104,253
Permanent differences			100,535			96,120			4,757
State income tax - net of federal tax benefit			-			3,307			2,315
Change in beginning temporary differences			30,933			-			3,914
Change in valuation allowance			(21,855	)		-			18,704
Long-term contract adjustments			(25,390	)		-			-
Other			(28,871	)		6,802			30,826
Tax expense (benefit)		$	(525,816	)	$	(893,589	)	$	1,164,769

 

The following temporary differences gave rise to the deferred tax liability at December 31:

		December 31,
		2005			2004
Excess of tax over financial accounting depreciation		$	(1,006,801	)	$	(921,204	)
Capital lease			82,292			-
Reserve for bad debts			350,099			113,327
Section 267 disallowed loss			64,279			-
Long-term contracts less than 10% complete			(200,970	)		(69,408	)
Charitable contribution carryover			24,827			8,246
Realized capital losses			260,247			260,247
			(426,027	)		(608,792	)
Tax rate			34	%		34	%
Net deferred tax liability			(144,849	)		(206,989	)
Valuation allowance			(110,339	)		(125,766	)
		$	(255,188	)	$	(332,755	)
Deferred tax assets		$	265,793		$	106,220
Less valuation allowance			110,339			88,484
			155,454			17,736
Total deferred tax liability			410,642			350,491
Net deferred tax liability		$	(255,188	)	$	(332,755	)

 

F-26

---

 

10. Income Taxes (continued)

Change in the valuation allowance for the year ended December 31, 2005 was $21,855 ($32,865 for the year ended December 31, 2004). The allowance is related to capital losses incurred by the Company which can only be used to offset future capital gains.

11. Commitments

The Company leases office equipment under operating leases expiring through 2009. Rental expense was $154,996, $170,108, and $160,650 for the years ended December 31, 2005, 2004, and 2003, respectively.

Minimum rental commitments as of December 31, 2005 are as follows:

Year ending December 31,
2006		$	150,018
2007			151,518
2008			121,692
2009			30,000
		$	453,228

12. Noncash Investing and Financing Activities

The consolidated statements of cash flows do not reflect the following noncash investing and financing activities:

-	Direct financing of $118,551 was used for the purchase of equipment and vehicles during the year ended December 31, 2005 ($136,099 in 2004).

-	Debt totaling $1,544,095 was assumed by a partnership owned by the Company’s stockholders during the year ended December 31, 2004.

-	Goodwill of $15,913 was funded by the issuance of 2.2 shares of common stock during the year ended December 31, 2004.

F-27

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12. Noncash Investing and Financing Activities (continued)

-	Direct financing of $220,335 was used for the purchase of vehicles during the year ended December 31, 2003.

-	Direct financing of $624,950 was used for the addition of the new facilities during the year ended December 31, 2003.

 

13. Self Insurance

The Company is self-insured to certain limits under its group health and dental plans. Stop-loss coverage is provided for claims above $65,000 per employee. Operations are charged with the cost of claims reported and an estimate of claims incurred but not reported based on prior experience. The determination of such claims and expenses and the appropriateness of the related liability are continually reviewed and updated. Total claims payable and claims incurred but not reported were $126,111 and $147,840 at December 31, 2005 and 2004, respectively. These amounts are included in accrued liabilities.

14. Stock Appreciation Rights

The Company made verbal agreements with certain key employees to provide incentive compensation for enhancement of Company and stockholder value and to share in the future economic success of the Company. Under these agreements, the Company has committed to issue common stock shares to the key employees if the Company is sold, the employees are employed by the Company at time of sale, and sale price of the Company exceeds $6,000,000.

In accordance with EITF No. 96-5, Recognition of Liabilities for Contractual Termination Benefits or Changing Benefit Plan Assumptions in Anticipation of a Business Combination, compensation cost will be recognized when a business combination has not been consummated.

Common shares committed to the employees are as follows:

		December 31,
		2005			2004
Number of common stock shares			19.65			17.48
Estimated fair value		$	435,785		$	415,295

F-28

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15. Segment Reporting

The Company’s operations are classified into three principal reportable segments that provide different products and services. Separate management of each segment is required because each business unit is subject to different marketing, production, and technology strategies.

Operating Segments		Revenue			Inter-segment Revenue			Operating Income (Loss)			Depreciation/ Amortization			Total Assets			Capital Expenditures
ISI
December 31, 2005		$	10,995,182		$	3,312,691		$	(562,750	)	$	561,992		$	17,627,240		$	130,620
December 31, 2004		$	14,756,861		$	7,046,554		$	(4,162,230	)	$	237,792		$	15,604,775		$	202,498
December 31, 2003		$	13,163,247		$	5,663,144		$	1,508,498		$	133,787		$	12,634,439		$	17,917
September 30, 2006*		$	14,714,767		$	6,571,221		$	480,406		$	76,994		$	25,273,735		$	93,159
September 30, 2005*		$	8,109,530		$	2,025,675		$	(89,800	)	$	104,757		$	15,376,843		$	142,195
MCS Detention
December 31, 2005		$	10,891,378		$	-		$	1,803,595		$	181,936		$	1,704,762		$	130,627
December 31, 2004		$	11,031,267		$	-		$	2,284,252		$	176,858		$	1,836,695		$	250,528
December 31, 2003		$	8,021,813		$	-		$	1,370,311		$	111,791		$	1,803,344		$	43,465
September 30, 2006*		$	9,919,561		$	-		$	1,294,702		$	152,585		$	2,614,884		$	295,932
September 30, 2005*		$	7,275,493		$	-		$	914,198		$	129,672		$	2,839,082		$	68,107
MCS Commercial
December 31, 2005		$	17,347,927		$	-		$	219,813		$	259,641		$	3,253,702		$	36,809
December 31, 2004		$	14,386,858		$	-		$	(164,544	)	$	255,688		$	2,895,194		$	167,045
December 31, 2003		$	13,540,535		$	-		$	423,126		$	245,999		$	1,435,514		$	390,658
September 30, 2006*		$	16,599,478		$	-		$	636,322		$	268,169		$	4,913,177		$	37,425
September 30, 2005*		$	13,045,057		$	-		$	41,564		$	231,605		$	2,756,029		$	20,826
Eliminations
December 31, 2005		$	-		$	(3,312,691	)	$	-		$	-		$	-		$	-
December 31, 2004		$	-		$	(7,046,554	)	$	-		$	-		$	-		$	-
December 31, 2003		$	-		$	(5,663,144	)	$	-		$	-		$	-		$	-
September 30, 2006*		$	-		$	(6,571,221	)	$	-		$	-		$	-		$	-
September 30, 2005*		$	-		$	(2,025,675	)	$	-		$	-		$	-		$	-
Total Company
December 31, 2005		$	39,234,487		$	-		$	1,460,658		$	1,003,569		$	22,585,704		$	298,056
December 31, 2004		$	40,174,986		$	-		$	(2,042,522	)	$	670,338		$	20,336,664		$	620,071
December 31, 2003		$	34,725,595		$	-		$	3,301,935		$	491,577		$	15,873,297		$	452,040
September 30, 2006*		$	41,233,806		$	-		$	2,411,430		$	497,748		$	32,801,796		$	426,516
September 30, 2005*		$	28,430,080		$	-		$	865,962		$	466,034		$	20,971,954		$	231,128

 

*Unaudited

16. Subsequent Event

Subsequent to September 30, 2006, the Company entered into a stock purchase agreement with Argyle Security Acquisition Corporation to sell all of its outstanding stock.

 

F-29

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ARGYLE SECURITY ACQUISITION CORPORATION

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 

			PAGE
SEPTEMBER 30, 2006 FINANCIAL STATEMENTS:
BALANCE SHEETS			F-31
STATEMENTS OF OPERATIONS			F-32
STATEMENTS OF STOCKHOLDERS’ EQUITY			F-33
STATEMENTS OF CASH FLOWS			F-34
NOTES TO THE FINANCIAL STATEMENTS			F-35 - F-39
DECEMBER 31, 2005 FINANCIAL STATEMENTS:
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM			F-40
BALANCE SHEET			F-41
STATEMENT OF OPERATIONS			F-42
STATEMENT OF STOCKHOLDERS’ EQUITY			F-43
STATEMENT OF CASH FLOWS			F-44
NOTES TO THE FINANCIAL STATEMENTS			F-44 - F-50

 

F-30

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Argyle Security Acquisition Corporation

(a development stage company)

 

Balance Sheet 

		September 30, 2006			December 31, 2005
		(unaudited)
ASSETS
Current assets:
Cash		$	920,429		$	9,608
Cash and cash equivalents, held in trust			29,073,971			-
Prepaid expenses			29,333			-
Other assets, deferred offering costs			-			294,745
Total current assets			30,023,733			304,353
Deferred income taxes			34,442			-
Property and equipment, net of accumulated depreciation of $1,075			5,445			-
Total assets		$	30,063,620		$	304,353
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accrued expenses		$	166,141		$	132,096
Notes payable - stockholders			-			155,000
Deferred underwriting costs			1,422,740			-
Accrued income taxes			71,926			-
Total liabilities			1,660,807			287,096
Common stock, subject to possible redemption - 764,627 shares at $7.14 per share			5,459,435			-
Deferred interest attributable to common stock subject to possible redemption (net of taxes of $37,484)			152,941			-
Stockholders’ Equity:
Preferred stock — $.0001 par value; 1,000,000 shares authorized; 0 shares issued and outstanding			-			-
Common stock—$.0001 par value; 89,000,000 shares authorized; issued and outstanding: 4,781,307 at September 30, 2006 (including 764,627 shares of common stock subject to possible redemption) and 937,500 at December 31, 2005			478			94
Additional paid-in capital			22,726,636			24,906
Retained earnings/(deficit accumulated) during the development stage			63,323			(7,743	)
Total stockholders’ equity			22,790,437			17,257
Total liabilities and stockholders’ equity		$	30,063,620		$	304,353

See notes to unaudited financial statements

F-31

---

Argyle Security Acquisition Corporation

(a development stage company)

 

Unaudited Statements of Operations 

		Three months ended September 30, 2006			Three months  ended September 30, 2005			Nine months ended September 30, 2006			Inception through September 30, 2005			Inception through September 30, 2006
Operating expenses		$	229,829		$	3,157		$	809,278		$	3,246			814,310
Other income and expense
Bank interest income			5,173			-			11,409			-			11,409
Interest on cash and cash equivalents held in trust			382,549			-			952,609			-			952,609
Interest expense			(18,362	)		(1,292	)		(46,190	)		(1,292	)		(48,901	)
Total other income and expense			369,360			(1,292	)		917,828			(1,292	)		915,117
Income/(Loss) before provision for income taxes			139,531			(4,449	)		108,550			(4,538	)		100,807
Provision for income taxes			37,484			-			37,484			-			37,484
Net income/(loss)			102,047			(4,449	)		71,066			(4,538	)		63,323
Deferred interest (net of taxes), attributable to common stock subject to possible redemption			38,987			-			152,941			-			152,941
Net income/(loss) allocable to holders of non-redeemable common stock		$	63,060		$	(4,449	)	$	(81,875	)	$	(4,538	)	$	(89,618	)
Net income/(loss) per share — basic and diluted		$	0.02		$	(0.00	)	$	0.02		$	(0.00	)	$	0.02
Weighted average number of shares outstanding — basic and diluted			4,781,307			937,500			4,375,600			937,500			2,951,666
Net income/(loss) per share exclusive of shares and related interest subject to possible redemption - - basic and diluted		$	0.02		$	(0.00	)	$	(0.02	)	$	(0.00	)	$	(0.04	)
Weighted average number of shares outstanding exclusive of shares subject to possible redemption — basic and diluted			4,016,680			937,500			3,692,197			937,500			2,551,303