**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**WASHINGTON,
      D.C. 20549**




**FORM
      10-Q/A** **(Amendment
      No. 1)**




x
            **Quarterly
                Report Pursuant to Section 13 or 15(d) of the Securities Exchange
                Act of
                1934**





**For
                the quarterly period ended September 30,
                2007.**




or




o
            **Transition
                Report Pursuant to Section 13 or 15(d) of the Securities Exchange
                Act of
                1934**





**For
                the transition period from
                to.**




**Commission
      File Number: 000-51639**




**Argyle
      Security, Inc.**


(Exact
      name of registrant as specified in its charter)




**Delaware**
            
            **20-3101079**(State
                or Other Jurisdiction of
              Incorporation
                or Organization)
            
            (I.R.S.
                Employer
              Identification
                No.)




**200
      Concord Plaza Suite 700 San Antonio, TX 78216**


(Address
      of Principal Executive Offices including Zip Code)





**(210)
      828-1700**


(Registrant’s
      Telephone Number, Including Area Code)




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




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




Large
                Accelerated Filero
            Accelerated
                Filero
            Non-Accelerated
                Filerx




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




There
      were 5,879,342 shares of the Registrant’s common stock issued and outstanding as
      of January 21, 2008.











**Argyle
      Security, Inc. Index to Form 10-Q/A**




**Part
                I.**
            **Financial
                Information**
            1Item
                1. Consolidated Financial Statements (unaudited)
            1Consolidated
                Balance Sheets
            1Consolidated
                Statements of Operations
            3Consolidated
                Statement of Stockholders’ Equity
            5Consolidated
                Statement of Cash Flows
            6Notes
                to Consolidated Financial Statements
            8Item
                2. Management’s Discussion and Analysis of Financial Condition and Results
                of Operations
            28Item
                3. Quantitative and Qualitative Disclosures About Market Risk
            48Item
                4. Controls and Procedures
            48Item
                4T. Controls and Procedures
            48**Part
                II.**
            **Other
                Information**
            49Item
                1. Legal Proceedings
            49Item
                1A. Risk Factors
            49Item
                2. Unregistered Sales of Equity Securities and Use of
                Proceeds
            49Item
                3. Defaults Upon Senior Securities
            49Item
                4. Submission of Matters to a Vote of Security Holders
            50Item
                5. Other Information
            50Item
                6. Exhibits
            51SIGNATURES
            52









**EXPLANATORY
      NOTE**


Argyle
        Security, Inc. is filing this Amendment Number 1 to its Quarterly Report
        on Form
        10-Q for the period ended September 30, 2007, which was originally filed
        with
        the SEC on November 19, 2007, to remove certain disclosure that was
        inadvertently not removed prior to filing with the SEC and to correct certain
        typographical errors. These changes include:
 1.
                Note
                    18 to the financial statements has been revised to remove paragraphs
                    referencing pro-forma data that were intended to be deleted from
                    the
                    quarterly report prior to filing and to count the amount of total
                    operating income for the three months ended September 30,
                    2007.
 
 2.
                Note
                    19 to the financial statements has been
                    revised.
 
 3.
                On
                    the consolidated statements of cash flows, under cash flows from
                    financing
                    activities, a line has been added entitled “cash flows from sale of
                    stock”. The amounts in this line-item (which totaled $118 in 2007)
                    was
                    accounted for in the financial results but inadvertently omitted
                    from the
                    filing. Other than the addition of this line-item, no other numbers
                    in our
                    financial statements have been
                    changed.
 
 4.
                In
                    Item 2, under “pro-forma financial information”, in the second to last
                    sentence of the first paragraph, the phrase “to exclude the amortization
                    of intangible assets and goodwill” has been revised to read “to exclude
                    the amortization of intangible
                    assets.”
 
 5.
                The
                    section entitled "Pro Forma Financial Information" on page 31
                    has been
                    changed to "Pro Forma and Adjusted Pro Forma Financial Information".
                    In
                    addition, management has included a discussion regarding the
                    use of these
                    adjusted measurements and why they are relevant to our
                    stockholders.
 
 6.
                The
                    Sections entitled “Results of operations for the nine-month periods ended
                    September 30, 2007 and 2006” and “Results of operations for the three
                    month periods ended September 30, 2007 and 2006 beginning on
                    pages 34 and
                    38, respectively, have been modified in the following
                    manner:
 
 a.
                the
                    use of the term “adjusted “ was eliminated from the sections entitled
                    “Revenues”, “Other Income/Expense” and “Earnings before Interest, Taxes,
                    Depreciation and Amortization.”
 
 b.
                the
                    Sections previously entitled “Interest, net and Other Income” and
                    “Adjusted Pro-Forma Interest and Other Income” were consolidated into a
                    new section entitled “Other
                    Income/Expense.”
 
 c.
                the
                    explanation of the increase in adjusted gross margin was
                    revised.
 
 d.
                the
                    table entitled “Adjusted Pro-Forma Operating Expenses was revised to
                    eliminate the first two rows.
 
 7.
                The
                    table entitled “Contractual Obligations as of September 30, 2007” was
                    revised by increasing the amount of operating lease obligations
                    for the
                    last year, the total amount of operating lease obligations and
                    the total
                    of the total column.
  Except
        for the foregoing and some minor typographical errors (including the addition
        of
        punctuation and the correction of page numbering), the document has not been
        revised and is being re-filed in its entirety for the purposes of
        clarity.
  
  **PART
        I - FINANCIAL INFORMATION**





**ITEM
      1 - CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)**




**Argyle
      Security, Inc.**


**Consolidated
      Balance Sheet** s




Predecessor
                (ISI)September
                30,
            
            December
                31,
            
            December
                31,2007
            
            2006
            
            2006(unaudited)**Assets**Cash
                and cash equivalents
            
            $
            4,281,925
            
            $
            694,115
            
            $
            359,042Cash
                and cash equivalents, held in trust
            
            
            —
            
            
            29,453,449
            
            
            —Receivables:Contract
                receivables - net of allowance for doubtful accounts of $1,109,701
                atSeptember
                30, 2007 and $411,988 at December 31, 2006.
            
            
            13,185,067
            
            
            —
            
            
            13,430,624Contract
                receivables - related party
            
            
            11,469,117
            
            
            —
            
            
            6,262,411Other
                receivables - related party
            
            
            81,577
            
            
            —
            
            
            —Costs
                and estimated earnings in excess of billings on incomplete
                contracts
            
            
            6,771,703
            
            
            —
            
            
            3,870,959Customer
                backlog
            
            
            3,798,874
            
            
            —
            
            
            —Refundable
                income taxes
            
            
            464,568
            
            
            —
            
            
            517,335Other
                current assets
            
            
            169,974
            
            
            —
            
            
            128,870Inventory
            
            
            182,054
            
            
            —
            
            
            229,040Prepaids
            
            
            311,536
            
            
            7,333
            
            
            315,012Deferred
                income taxes
            
            
            254,803
            
            
            27,932
            
            
            —Total
                current assets
            
            
            40,971,198
            
            
            30,182,829
            
            
            25,113,293Property
                and equipment, net
            
            
            4,848,099
            
            
            4,901
            
            
            3,969,648Other
                assets:Goodwill
            
            
            19,762,685
            
            
            —
            
            
            1,365,038Customer
                relationships
            
            
            11,419,628
            
            
            —
            
            
            —Trade
                name
            
            
            3,776,000
            
            
            —
            
            
            —Software
            
            
            283,334
            
            
            —
            
            
            —Loan
                origination fees - less accumulated amortization
            
            
            —
            
            
            —
            
            
            971,898Deferred
                transaction costs
            
            
            —
            
            
            493,583
            
            
            —Deposits
                and other assets
            
            
            355,600
            
            
            —
            
            
            197,088Total
                other assets
            
            
            35,597,247
            
            
            493,583
            
            
            2,534,024Total
                assets
            
            $
            81,416,544
            
            $
            30,681,313
            
            $
            31,616,965




1




**Liabilities
                and Stockholders' Equity**Current
                liabilities:Accounts
                payable and accrued liabilities
            
            $
            11,981,353
            
            $
            624,129
            
            $
            10,736,153Billings
                in excess of costs and estimatedearnings
                on incomplete contracts
            
            
            8,501,456
            
            
            —
            
            
            6,004,689Deferred
                underwriting costs
            
            
            —
            
            
            1,162,183
            
            
            —Current
                portion of capitalized lease obligations
            
            
            96,960
            
            
            —
            
            
            103,134Current
                portion of long-term debt
            
            
            79,497
            
            
            —
            
            
            405,908Deferred
                federal income taxes
            
            
            804,232
            
            
            —
            
            
            —Accrued
                income taxes payable
            
            
            —
            
            
            118,855
            
            
            —Accounts
                payable - related party
            
            
            39,346
            
            
            —
            
            
            1,806,187Total
                current liabilities
            
            
            21,502,844
            
            
            1,905,167
            
            
            19,056,071


Long-Term
                Liabilities:Line
                of credit
            
            
            7,538,850
            
            
            —
            
            
            4,957,850Deferred
                federal income taxes
            
            
            6,158,608
            
            
            —
            
            
            247,617Long-term
                debt - less current portion
            
            
            6,105,981
            
            
            —
            
            
            13,611,168Long-term
                debt - related party
            
            
            1,925,001
            
            
            —
            
            
            —Long-term
                capitalized lease obligations - less current portion
            
            
            1,940,788
            
            
            —
            
            
            1,972,352Total
                long-term liabilities
            
            
            23,669,228
            
            
            —
            
            
            20,788,987Total
                liabilities
            
            
            45,172,072
            
            
            1,905,167
            
            
            39,845,058Common
                stock, subject to possible redemption - 764,627 shares at $7.50 per
                share
            
            
            —
            
            
            5,738,206
            
            
            —Warrants,
                subject to redemption shares
            
            
            —
            
            
            —
            
            
            5,018,777Deferred
                interest attributable to redemptive shares (net of taxes)
            
            
            —
            
            
            175,747
            
            
            —Stockholders’
                EquityPreferred
                stock of Argyle Security, Inc. - $.0001 par value;1,000,000
                shares authorized; 0 shares issued and outstanding
            
            
            —
            
            
            —
            
            
            —Common
                stock of Argyle Security, Inc. - $.0001 par value; 89,000,000 shares
                authorized; 5,749,342 shares issued and outstanding at September
                30, 2007
                and 4,781,307 at December 31, 2006
            
            
            575
            
            
            478Additional
                paid in capital
            
            
            35,891,774
            
            
            22,696,946
            
            
            —Stockholders'
                deficit
            
            
            —
            
            
            —
            
            
            (13,246,870
            )Accumulated
                earnings
            
            
            352,123
            
            
            164,769
            
            
            —Total
                stockholders’ equity
            
            
            36,244,472
            
            
            22,862,193
            
            
            (13,246,870
            )Total
                liabilities and stockholders' equity
            
            $
            81,416,544
            
            $
            30,681,313
            
            $
            31,616,965




See
      notes
      to unaudited financial statements


2




**Argyle
      Security, Inc.**


**Consolidated
      Statements of Operations**


**(unaudited)**




Three
                Months Ended September 30,
            
            Predecessor
                (ISI)
              Three
                Months Ended
              September
                30,2007
            
            2006
            
            2006Net
                revenues:Contract
                revenues
            
            $
            10,669,686
            
            $
            —
            
            $
            5,874,343Contract
                revenues - related party
            
            
            4,558,533
            
            
            —
            
            
            7,689,881Service
                and other revenues
            
            
            1,864,254
            
            
            —
            
            
            1,890,08117,092,473
            
            
            —
            
            
            15,454,305Cost
                of revenues:Contract
                costs
            
            
            11,585,962
            
            
            —
            
            
            10,807,659Service
                and other costs, including amortization of intangibles
            
            
            1,839,911
            
            
            —
            
            
            1,341,558Cost
                of revenues
            
            
            13,425,873
            
            
            —
            
            
            12,149,217Gross
                profit
            
            
            3,666,600
            
            
            —
            
            
            3,305,088Operating
                expenses:Selling,
                general and administrative expenses
            
            
            3,399,015
            
            
            229,829
            
            
            2,277,275Amortization
                of intangible assets
            
            
            222,038
            
            
            —
            
            
            —Total
                operating expenses
            
            
            3,621,053
            
            
            229,829
            
            
            2,277,275Operating
                income / (loss)
            
            
            45,547
            
            
            (229,829
            )
            
            1,027,813Other
                income / (expense):Bank
                interest income
            
            
            46,703
            
            
            5,173
            
            
            124Interest
                on cash and cash equivalents
            
            
            127,882
            
            
            382,549
            
            
            —Interest
                expense
            
            
            (327,021
            )
            
            (18,362
            )
            
            (956,860
            )Total
                other income / (expense)
            
            
            (152,436
            )
            
            369,360
            
            
            (956,736
            )Income
                / (loss) before provision for income taxes
            
            
            (106,889
            )
            
            139,531
            
            
            71,077Provision
                for income taxes
            
            
            9,230
            
            
            37,484
            
            
            767Net
                income / (loss)
            
            
            (116,119
            )
            
            102,047
            
            
            70,310Deferred
                interest, net of taxes, attributable to common stock subject to possible
                redemption
            
            
            —
            
            
            (38,987
            )
            
            —Net
                income / (loss) allocable to holders of non-redeemable common
                stock
            
            $
            (116,119
            )
            $
            63,060
            
            $
            70,310Weighted-average
                number of shares outstanding:Basic
            
            
            5,423,156
            
            
            4,781,307
            
            
            —Diluted
            
            
            5,423,156
            
            
            4,781,307
            
            
            —Net
                income / (loss) per share:
            
            
            
            
            
            
            
            
            —Basic
            
            $
            (0.02
            )
            $
            0.02
            
            $
            —Diluted
            
            $
            (0.02
            )
            $
            0.02
            
            $
            —Weighted-average
                number of shares outstanding exclusiveof
                shares subject to possible redemption:Basic
            
            
            5,165,510
            
            
            4,016,680
            
            
            —Diluted
            
            
            5,165,510
            
            
            4,016,680
            
            
            —Net
                income / (loss) per share exclusive of shares and relateddeferred
                interest subject to possible redemption:Basic
            
            $
            (0.02
            )
            $
            0.02
            
            $
            —Diluted
            
            $
            (0.02
            )
            $
            0.02
            
            $
            —




See
      notes
      to unaudited financial statements




3




**Argyle
      Security, Inc.**


**Consolidated
      Statements of Operations**


**(unaudited)**




Nine
                Months Ended September 30,
            
            Predecessor
                (ISI)
              Nine
                Months Ended
              September
                30,2007
            
            2006
            
            2006Net
                revenues:Contract
                revenues
            
            $
            10,669,686
            
            $
            —
            
            $
            18,867,183Contract
                revenues - related party
            
            
            4,558,533
            
            
            —
            
            
            17,447,945Service
                and other revenues
            
            
            1,864,254
            
            
            —
            
            
            4,918,67717,092,473
            
            
            —
            
            
            41,233,805Cost
                of revenues:Contract
                costs
            
            
            11,585,962
            
            
            —
            
            
            29,018,321Service
                and other costs, including amortization of intangibles
            
            
            1,839,911
            
            
            —
            
            
            3,554,670Cost
                of revenues
            
            
            13,425,873
            
            
            —
            
            
            32,572,991Gross
                profit
            
            
            3,666,600
            
            
            —
            
            
            8,660,814Operating
                expenses:Selling,
                general and administrative expenses
            
            
            3,919,335
            
            
            809,278
            
            
            6,249,385Amortization
                of intangible assets
            
            
            222,038
            
            
            —
            
            
            —Total
                operating expenses
            
            
            4,141,373
            
            
            809,278
            
            
            6,249,385Operating
                income / (loss)
            
            
            (474,773
            )
            
            (809,278
            )
            
            2,411,429Other
                income / (expense):Bank
                interest income
            
            
            50,541
            
            
            11,409
            
            
            346Interest
                on cash and cash equivalents
            
            
            895,820
            
            
            952,609
            
            
            —Interest
                expense
            
            
            (424,129
            )
            
            (46,190
            )
            
            (2,779,773
            )Total
                other income / (expense)
            
            
            522,232
            
            
            917,828
            
            
            (2,779,427
            )Income
                / (loss) before provision for income taxes
            
            
            47,459
            
            
            108,550
            
            
            (367,998
            )Provision
                for income taxes
            
            
            62,184
            
            
            37,484
            
            
            10,312Net
                income / (loss)
            
            
            (14,725
            )
            
            71,066
            
            
            (378,310
            )Deferred
                interest, net of taxes, attributable to common stock subject to possible
                redemption
            
            
            —
            
            
            (152,941
            )
            
            —Net
                income / (loss) allocable to holders of non-redeemable common
                stock
            
            $
            (14,725
            )
            $
            (81,875
            )
            $
            (378,310
            )Weighted-average
                number of shares outstanding:Basic
            
            
            4,997,607
            
            
            4,375,600
            
            
            —Diluted
            
            
            4,997,607
            
            
            4,375,600
            
            
            —Net
                income / (loss) per share:
            
            
            
            
            
            
            
            
            —Basic
            
            $
            (0.00
            )
            $
            0.02
            
            $
            —Diluted
            
            $
            (0.00
            )
            $
            0.02
            
            $
            —Weighted-average
                number of shares outstanding exclusiveof
                shares subject to possible redemption:Basic
            
            
            4,403,832
            
            
            3,692,197
            
            
            —Diluted
            
            
            4,403,832
            
            
            3,692,197
            
            
            —Net
                income / (loss) per share exclusive of shares and relateddeferred
                interest subject to possible redemption:Basic
            
            $
            (0.00
            )
            $
            (0.02
            )
            $
            —Diluted
            
            $
            (0.00
            )
            $
            (0.02
            )
            $
            —




See
      notes
      to unaudited financial statements




4




**Argyle
      Security, Inc.**


**Statement
      of Changes in Stockholders’ Equity**


**December
      31, 2006 through September 30, 2007**


**(unaudited)**


TotalAccumulated
              
              Shareholders'Shares
              
              Amount
              
              APIC
              
              Earnings
              
              EquityBalances,
                  at December 31, 2006
              
              
              4,781,307
              
              $
              478
              
              $
              22,696,946
              
              $
              164,769
              
              $
              22,862,193Repayment
                  to redeeming stockholders
              
              
              (211,965
              )
              
              (21
              )
              
              (1,661,097
              )
              
              —
              
              
              (1,661,118
              )Issuance
                  of additional common stock at $7.78 / share
              
              
              1,180,000
              
              
              118
              
              
              9,180,282
              
              
              —
              
              
              9,180,400Deferred
                  financing costs - warrants
              
              
              —
              
              
              —
              
              
              93,000
              
              
              —
              
              
              93,000Payment
                  of underwriter fees
              
              
              —
              
              
              —
              
              
              (102,924
              )
              
              —
              
              
              (102,924
              )Release
                  of redemptive reserves
              
              
              —
              
              
              —
              
              
              5,736,341
              
              
              —
              
              
              5,736,341Recognize
                  current period deferred interest
              
              
              —
              
              
              —
              
              
              (101,159
              )
              
              101,159
              
              
              —Recognize
                  deferred interest
              
              
              —
              
              
              —
              
              
              —
              
              
              100,920
              
              
              100,920Stock-based
                  Compensation
              
              
              —
              
              
              —
              
              
              50,385
              
              
              —
              
              
              50,385Net
                  income (Loss)
              
              
              —
              
              
              —
              
              
              —
              
              
              (14,725
              )
              
              (14,725
              )Balance
                  at September 30, 2007
              
              
              5,749,342
              
              $
              575
              
              $
              35,891,774
              
              $
              352,123
              
              $
              36,244,472


5




**Argyle
      Security, Inc.**


**Consolidated
      Statement of Cash Flows**


**(Unaudited)**




Nine
                Months Ended September 30,
            
            Predecessor
                (ISI)
              Nine
                Months Ended
              September
                30,2007
            
            2006
            
            2006**Cash
                flows from operating activities**Net
                Income (Loss)
            
            $
            (14,725
            )
            $
            71,066
            
            $
            (378,402
            )Adjustments
                to reconcile net income (loss) to net cash provided by operating
                activities:Stock
                based compensation
            
            
            50,384
            
            
            130,632
            
            
            —Amortization
            
            
            875,165
            
            
            —
            
            
            262,080Depreciation
            
            
            286,269
            
            
            1,075
            
            
            239,482Payment
                to ISI*MCS Ltd on Behalf of ISI
            
            
            (1,918,960
            )
            
            —
            
            
            —Accrued
                interest on deferred underwriting costs
            
            
            29,718
            
            
            45,725
            
            
            —Interest
                accretion and fair market adjustments of warrants
            
            
            —
            
            
            —
            
            
            924,779Interest
                earned on assets held in trust
            
            
            (895,820
            )
            
            (952,609
            )
            
            —Interest
                income released from the trust
            
            
            —
            
            
            600,000
            
            
            —Tax
                payments released from the trust
            
            
            148,854
            
            
            —
            
            
            —*Net
                Decrease (Increase) in Operating Assets:*Prepaid
                & other current assets
            
            
            (14,484
            )
            
            (29,333
            )
            
            —Contract
                receivables
            
            
            (2,386,738
            )
            
            —
            
            
            (766,241
            )Related
                party contract receivables
            
            
            (2,033,052
            )
            
            —
            
            
            (4,160,046
            )Related
                party receivables
            
            
            (42,383
            )
            
            —
            
            
            (901
            )Other
                receivables
            
            
            32,776
            
            
            —
            
            
            (16,988
            )Inventory
            
            
            665
            
            
            —
            
            
            31,030Costs
                and estimated earnings in excess of billings
            
            
            (1,845,819
            )
            
            —
            
            
            (1,385,959
            )Prepaids
            
            
            
            
            
            
            
            
            (21,757
            )Deferred
                income taxes
            
            
            (226,871
            )
            
            (34,442
            )
            
            (655,843
            )Deposits
                and other assets
            
            
            
            
            
            
            
            
            (150,578
            )*Net
                Increase (Decrease) in Operating Liabilities:*Accounts
                payable and accrued expenses
            
            
            2,462,042
            
            
            162,045
            
            
            2,615,298Accrued
                deferred income taxes
            
            
            122,084
            
            
            71,926
            
            
            —Deferred
                interest liability
            
            
            —
            
            
            —
            
            
            —Billings
                in excess of cost and estimated earnings
            
            
            86,713
            
            
            —
            
            
            3,378,100Net
                cash provided / (used) by operating activities
            
            
            (5,284,182
            )
            
            66,085
            
            
            (85,946
            )**Cash
                flow from investing activities:**Purchase
                of investments held in trust
            
            
            (171,372,405
            )
            
            (249,269,030
            )
            
            —Maturity
                of investments held in trust
            
            
            171,372,405
            
            
            220,547,667
            
            
            —Acquisition
                of ISI (net of cash assumed)
            
            
            (17,157,364
            )
            
            —
            
            
            —Purchase
                of property and equipment
            
            
            (53,617
            )
            
            (6,520
            )
            
            (376,570
            )Transaction
                costs
            
            
            (928,576
            )
            
            —
            
            
            —Increase
                in other assets
            
            
            (15,970
            )
            
            —
            
            
            215,854Net
                cash used in investing activities
            
            
            (18,155,527
            )
            
            (28,727,883
            )
            
            (160,716
            )


6




**Cash
                flows from financing activities:**Gross
                proceeds from public offering and private placement
            
            
            —
            
            
            30,600,368
            
            
            —Offering
                costs
            
            
            (6,885
            )
            
            (873,356
            )
            
            —Proceeds
                from issuance and exercise of options
            
            
            —
            
            
            607
            
            
            —Receipt
                of funds held in trust
            
            
            30,200,415
            
            
            —
            
            
            —Investment
                banker fees paid
            
            
            (1,369,652
            )
            
            —
            
            
            —Repayment
                on borrowings
            
            
            (5,137,989
            )
            
            —
            
            
            (15,286,909
            )Proceeds
                from borrowings
            
            
            5,020,000
            
            
            —
            
            
            15,428,376Proceeds
                from notes payable & warrants stockholders
            
            
            300,000
            
            
            —
            
            
            —Repayment
                of notes payable & warrants stockholders
            
            
            (300,000
            )
            
            (155,000
            )
            
            —Redemption
                of common stock
            
            
            (1,661,118
            )
            
            —
            
            
            —Issuance
              of common stock
            
            
            118
            
            
            —
            
            
            —Payments
                on capital lease obligations
            
            
            (17,370
            )
            
            —
            
            
            (56,086
            )Net
                cash provided by investing activities
            
            
            27,027,519
            
            
            29,572,619
            
            
            85,381


**Net
                increase (decrease) in cash**
            
            $
            3,587,810
            
            $
            910,821
            
            $
            (161,281
            )Cash
                & cash equivalents, beginning of period
            
            
            694,115
            
            
            9,608
            
            
            415,764**Cash
                and cash equivalents, end of period**
            
            $
            4,281,925
            
            $
            920,429
            
            $
            254,483**Supplemental
                disclosures of cash flow information:**Cash
                paid for interest
            
            
            3,485
            
            
            3,177
            
            
            1,877,494**Supplemental
                schedule of non-cash investing activities:**Financed
                purchases property and equipment
            
            
            160,932
            
            
            —
            
            
            —**Supplemental
                schedule of non-cash financing activities:**Reduction
                in deferred interest liability
            
            
            100,920
            
            
            —
            
            
            —Reduction
                in deferred underwriter liability
            
            
            185,115
            
            
            —
            
            
            —Reduction
                in common stock subject to redemption
            
            
            5,736,341
            
            
            —
            
            
            —Issuance
                of warrants associated with notes to related parties
            
            
            93,000
            
            
            —
            
            
            —Accrual
                of deferred underwriting costs
            
            
            —
            
            
            1,377,017
            
            
            —


7




**Argyle
      Security, Inc.**




**Notes
      to Unaudited Consolidated Financial Statements**


**September
      30, 2007**




**Note
      1 - Basis of Presentation**




The
      unaudited consolidated financial statements of Argyle Security, Inc. (the
“Company” or “Argyle”) as of September 30, 2007, and for the three and nine
      months ended September 30, 2007 and 2006, respectively, include the accounts
      of
      the Company and all wholly owned subsidiaries. All significant inter company
      transactions and balances have been eliminated in consolidation. In the opinion
      of management, all normal recurring adjustments considered necessary for a
      fair
      presentation have been included. Operating results for the interim periods
      presented are not necessarily indicative of the results to be expected for
      a
      full fiscal year.




The
      statements and related notes have been prepared in accordance with U.S.
      generally accepted accounting principles (U.S. GAAP) for interim financial
      information and pursuant to the rules and regulations of the U.S. Securities
      and
      Exchange Commission. Accordingly, certain information and footnote disclosures
      normally included in financial statements prepared in accordance with generally
      accepted accounting principles have been omitted pursuant to such rules and
      regulations. These financial statements should be read in conjunction with
      the
      financial statements that were included in the Company’s Annual Report on Form
      10-K for the year ended December 31, 2006, as filed with the U.S. Securities
      and
      Exchange Commission.


Argyle
          Security, Inc. (formerly Argyle Security Acquisition Corporation) was
          incorporated in Delaware in June 2005 as a blank check company formed to
          acquire, through merger, capital stock exchange, asset acquisition, or
          other
          similar business combination, a business in the security industry. On July
          31,
          2007, Argyle consummated its initial acquisition through the acquisition
          of 100%
          of the outstanding capital stock of ISI Detention Contracting Group, Inc.
          and
          its subsidiaries (ISI). Prior to the acquisition of ISI, Argyle had no
          operations and was considered a developmental stage enterprise. ISI is
          deemed to
          be a “predecessor” to the Company. As a result, the statement of operations and
          statement of cash flows of ISI for the period ended September 30, 2006
          are
          presented for comparative purposes. The accompanying unaudited consolidated
          statements of operations and cash flows present the results of operations
          and
          cash flows for i) the three months and nine months ended September 30,
          2007
          period preceding the acquisition of ISI, exclusive of ISI results of operations
          and cash flows and ii) for the periods succeeding the acquisition, the
          consolidated results of operations including ISI. The results of operations
          and
          cash flows on a consolidated basis subsequent to the acquisition of ISI
          are not
          comparative to the predecessor ISI results of operations and cash flows
          because
          the basis for the acquired assets and liabilities of ISI have been adjusted
          to
          fair value pursuant to Statement of Financial Accounting Standards (SFAS)
          No.
          141, *Business
          Combinations* .


ISI
      is a
      detention equipment contractor that specializes 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. ISI also provides 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.





The
      Company’s operations are classified into three reportable segments, described in
      further detail in Note 18.




8


***Pro
      Forma Results of Operations***


The
          accompanying unaudited consolidated statements of operations only reflect
          the
          operating results of ISI following the date of acquistion and do not reflect
          the
          operating results of ISI prior to the acquisition. Following are pro forma
          unaudited results of operations for the Company for the three months and
          nine
          months ended September 30, 2007 and September 30, 2006 assuming the acquisition
          of ISI occurred on January 1, 2007 and 2006,
          respectively:




**Argyle
      Security, Inc**


**Pro
      Forma Consolidated Statements of Operations**


**(unaudited)**




Three
                Months Ended September 30,
            
            Nine
                Months Ended September 30,2007
            
            2006
            
            2007
            
            2006Net
                revenues:Contract
                revenues
            
            $
            12,836,317
            
            $
            5,874,343
            
            $
            30,617,766
            
            $
            18,867,183Contract
                revenues - related party
            
            
            8,132,200
            
            
            7,689,881
            
            
            21,298,650
            
            
            17,447,945Service
                and other revenues
            
            
            2,618,961
            
            
            1,890,081
            
            
            8,309,825
            
            
            4,918,677$
            23,587,478
            
            $
            15,454,305
            
            $
            60,226,241
            
            $
            41,233,805Cost
                of revenues:Contract
                costs
            
            
            16,117,788
            
            
            10,807,659
            
            
            40,212,278
            
            
            29,018,321Service
                and other costs, including amortization of intangibles
            
            
            2,650,341
            
            
            2,181,746
            
            
            8,690,218
            
            
            6,075,23718,768,129
            
            
            12,989,405
            
            
            48,902,496
            
            
            35,093,558Gross
                profit
            
            
            4,819,349
            
            
            2,464,900
            
            
            11,323,745
            
            
            6,140,247Selling,
                general and administrative expenses
            
            
            4,226,857
            
            
            2,841,152
            
            
            10,958,813
            
            
            8,069,396Amortization
                of intangible assets
            
            
            333,057
            
            
            333,057
            
            
            999,171
            
            
            999,171Total
                operating expenses
            
            
            4,559,914
            
            
            3,174,209
            
            
            11,957,984
            
            
            9,068,567Operating
                income / (loss)
            
            
            259,435
            
            
            (709,309
            )
            
            (634,239
            )
            
            (2,928,320
            )Other
                income / (expense):Bank
                interest income
            
            
            65,706
            
            
            62,297
            
            
            187,339
            
            
            182,755Interest
                expense
            
            
            (479,379
            )
            
            (390,811
            )
            
            (1,305,854
            )
            
            (1,062,968
            )(413,673
            )
            
            (328,514
            )
            
            (1,118,514
            )
            
            (880,213
            )Income
                / (loss) before provision for income taxes
            
            
            (154,238
            )
            
            (1,037,822
            )
            
            (1,752,753
            )
            
            (3,808,532
            )Provision
                for income taxes
            
            
            (58,610
            )
            
            (394,372
            )
            
            (666,046
            )
            
            (1,447,242
            )Net
                income / (loss)
            
            $
            (95,627
            )
            $
            (643,450
            )
            $
            (1,086,707
            )
            $
            (2,361,290
            )Weighted-average
                number of shares outstanding:Basic
            
            
            5,749,342
            
            
            5,749,342
            
            
            5,749,342
            
            
            5,310,111Diluted
            
            
            5,749,342
            
            
            5,749,342
            
            
            5,749,342
            
            
            5,310,111Net
                income / (loss) per share:Basic
            
            $
            (0.02
            )
            $
            (0.11
            )
            $
            (0.19
            )
            $
            (0.44
            )Diluted
            
            $
            (0.02
            )
            $
            (0.11
            )
            $
            (0.19
            )
            $
            (0.44
            )Weighted-average
                number of shares outstanding exclusiveof
                shares subject to possible redemption:Basic
            
            
            5,749,342
            
            
            5,749,342
            
            
            5,749,342
            
            
            5,310,111Diluted
            
            
            5,749,342
            
            
            5,749,342
            
            
            5,749,342
            
            
            5,310,111Net
                income / (loss) per share exclusive of shares and relateddeferred
                interest subject to possible redemption:Basic
            
            $
            (0.02
            )
            $
            (0.11
            )
            $
            (0.19
            )
            $
            (0.44
            )Diluted
            
            $
            (0.02
            )
            $
            (0.11
            )
            $
            (0.19
            )
            $
            (0.44
            )




See
      notes
      to unaudited financial statements




9


The
              Company derived the pro forma results of operations from (i) the unaudited
              consolidated financial statements of ISI from January 1, 2007 to July
              31, 2007
              (the date of the ISI acquisition) and the three months and nine months
              ended
              September 30, 2006, and (ii) the unaudited consolidated financial statements
              of
              the Company for the three months and nine months ended September 30,
              2007 and
              September 30, 2006. The pro forma results of operations are not necessarily
              indicative of results of operations that may have actually occurred
              had the
              merger taken place on the dates noted, or the future financial position
              or
              operating results of the Company or ISI. The pro forma adjustments
              are based
              upon available information and assumptions that the Company believes
              are
              reasonable. The pro forma adjustments include adjustments for interest
              expense
              (relating primarily to interest on the $10.0 million of principal of
              the
              unsecured debt of a related party) and increased depreciation and amortization
              expense as a result of the application of the purchase method of accounting
              based on the fair values of the tangible and intangible assets of ISI.
              Additionally, the pro forma results of operations do not include approximately
              $1.4 million in non-recurring charges relating to the stock appreciation
              rights
              incurred in connection with the acquisition.


**Note
      2 - Background, Formation, and Summary of Significant Accounting
      Policies**




Argyle
      completed a private placement (the Private Placement) in January 2006 and
      received net proceeds of approximately $0.9 million. Also in January 2006,
      the
      registration statement for Argyle’s initial public offering (Public Offering)
      was declared effective, and 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 Public Offering and the Private Placement were placed in a trust account
      for
      Argyle’s benefit. Except for $0.6 million 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 released to Argyle for the payment of taxes,
      Argyle was not able to access the amounts held in the trust until it consummated
      a business combination. The amounts held outside of the trust account were
      used
      by Argyle to provide for business, legal, and accounting due diligence on
      prospective acquisitions and continuing general and administrative expenses.
      Prior to releasing the funds held in trust, the trust account contained $1.4
      million reserved for the compensation of Argyle’s underwriters in its Public
      Offering which was paid to them upon completion of the business combination.
      All
      amounts held in trust were released at July 31, 2007 to fund the ISI
      acquisition.





On
      March
      14, 2007, the underwriters from Argyle’s Public Offering agreed to forfeit any
      and all rights or claims to a pro-rata portion of the deferred underwriting
      costs and associated interest with respect to any shares of common stock
      redeemed in connection with any acquisition (see Note 14). In connection with
      the Public Offering and the Private Placement, Argyle’s officers and directors
      placed all the shares owned by them before the Private Placement and the Public
      Offering into an escrow account. Except in certain circumstances, the shares
      held in escrow may not be released prior to January 24, 2009.





As
      part
      of the ISI merger, public stockholders holding 211,965 of the aggregate number
      of shares sold in the Public Offering elected to redeem such shares (see Note
      12). The per share redemption price was equal to $7.80 per share including
      interest earned thereon in the trust account, net of taxes payable, $0.6 million
      of interest income which was released from the trust account in September 2006
      to fund our working capital, and amounts owed to the underwriter for the Private
      Placement (approximately $0.5 million plus interest). Approximately $1.6 million
      was paid to redemptive shareholders in August of 2007.





In
      the
      2006 annual report on Form 10-K, Argyle disclosed that declining cash available
      outside the trust account and the lack of assurance that the Company would
      be
      able to successfully complete a business combination within the required time
      frame raised substantial doubt about Argyle’s ability to continue as a going
      concern. With the completion of the ISI acquisition and release of the funds
      held in trust, there is no longer substantial doubt about Argyle’s ability to
      continue as a going concern.





***Cash
      and Cash Equivalents***





The
      Company considers all highly liquid investments with original maturities of
      three months or less to be cash equivalents, and the carrying amounts
      approximate fair value.





***Contracts
      Receivable***





Contracts
      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.





***Revenue
      Recognition***




The
      Company receives its revenues primarily from performance of fixed-price
      construction contracts and from service sales.




10




***Construction
      Contracts***





Construction
      contracts are those as defined in the American Institute of Certified Public
      Accountants’ Statement of Position 81-1 (SOP 81-1), *Accounting
      for Performance of Construction-Type and Certain Production-Type
      Contracts* .





Most
      of
      the Company’s contracts extend over a period of 12 to 16 months, which is the
      period the Company considers to be its operating cycle. 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 SOP 81-1. 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.





Precontract
      costs are costs that are incurred for a specific anticipated contract and that
      will result in no future benefits unless the contract is obtained. Such costs
      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.





***Inventory***





Inventory
      is valued at the lower of cost or market and consists primarily of finished
      goods. Costs of finished goods are determined using the average cost method.
      Inventory that was acquired from ISI has been stated at fair value at July
      31,
      2007; all subsequent purchases are recorded based on cost.





***Property
      and Equipment***





Property
      and equipment is stated at cost less accumulated depreciation, except for the
      plant and equipment acquired in the ISI acquisition which has been recorded
      at
      fair value at July 31, 2007 (see Note 4); all subsequent purchases are recorded
      based on cost. **** Depreciation
      is calculated on the straight-line method based on the following estimated
      useful lives: leasehold improvements - 12 to 15 years, furniture, fixtures,
      and
      equipment - 3 to 10 years, and vehicles - 3 to 7 years.





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.


11




***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. Assets
      held under capital leases that were acquired from ISI have been stated at fair
      value as of July 31, 2007.





***Goodwill
      and Other Intangible Assets***





Goodwill
      represents the excess of consideration paid over the fair value of net assets
      acquired in the business combination in accordance with SFAS No. 142, *Goodwill
      and Other Intangible Assets* .
      Goodwill and other indefinite-lived intangibles (trade name) are not amortized
      but are tested at least annually for impairment. The Company must recognize
      an
      impairment loss if, and to the extent that, goodwill exceeds fair value. The
      Company has determined that no impairment exists at September 30,
      2007.





The
      Company has three primary reporting units that provide different services and
      products. Accordingly, goodwill was allocated to each. Management believes
      that
      the relationship between allocation of identified tangible and intangible assets
      to be in similar proportion to how goodwill is to be allocated among its
      reporting units. Accordingly, each reporting division was allocated its share
      of
      goodwill based upon its percentage of purchase price allocation related to
      identified tangible and intangible assets. As a result, goodwill was allocated
      in the approximate percentages as follows: ISI Detention 18%; MCS Detention
      48%;
      and MCS Commercial 34%. Additionally, unidentified intangible assets were
      allocated in the approximate percentages as follows: ISI Detention 10%; MCS
      Detention 48%; and MCS Commercial 42%. These amounts are included in each
      reporting division’s segment reporting.





Intangible
      assets that have finite useful lives are amortized over their useful lives,
      which range from 96 to 120 months for customer relationships and 12 to 16 months
      for customer backlog.





***Software
      Costs***





Software
      costs represent internally-developed software that is proprietary to the Company
      and assists in its operations. According to Statement of Position 98-1, *Accounting
      for the Costs of Computer Software Developed or Obtained for Internal
      Use* ,
      the
      costs of computer software developed or obtained for internal use are to be
      amortized on a straight-line basis unless another systematic and rational basis
      is more representative of the software’s use. Management does not believe there
      is another more rational basis and therefore the assets are amortized on the
      straight-line basis over a 36-month period.





***Fair
      Value of Financial Instruments***





The
      recorded values of financial instruments, including contracts 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.





***Income
      Taxes***





The
      Company accounts for income taxes under the liability method in accordance
      with
      SFAS No. 109, *Accounting
      for Income Taxes* .
      Deferred income taxes are recorded based on enacted statutory rates to reflect
      the tax consequences in future years of the differences between the tax bases
      of
      assets and liabilities and their financial reporting amounts. Deferred tax
      assets which will generate future tax benefits are recognized to the extent
      that
      realization of such benefits through future taxable earnings or alternative
      tax
      strategies in the foreseeable short-term future is more likely than not. A
      valuation allowance is established when necessary to reduce deferred tax assets
      to the amount expected to be realized.




12




The
      Company adopted FASB Interpretation No. 48, *Accounting
      for Uncertainty in Income Taxes* , *an
      interpretation of FASB Statement No. 109* (FIN 48)
      on January 1, 2007. FIN 48 clarifies the accounting for uncertainty in income
      taxes recognized in financial statements and requires the impact of a tax
      position to be recognized in the financial statements if that position is more
      likely than not of being sustained by the taxing authority. The adoption of
      FIN
      48 did not have an effect on our consolidated financial position or results
      of
      operations.





***Reclassifications***




Certain
      prior period predecessor balances have been reclassified to conform to the
      current period presentation.




***Recently
      Issued Accounting Pronouncements***





In
      September 2006, the FASB issued SFAS No. 157, *Fair
      Value Measurements* .
      SFAS
      No. 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. SFAS No. 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 SFAS No. 157 will materially
      impact its consolidated financial position or results of
      operations.





In
      February 2007, the FASB issued SFAS No. 159, T *he
      Fair Value Option for Financial Assets and Liabilities* .
      SFAS
      No. 159 permits all entities to choose to elect to measure eligible financial
      instruments at fair value. SFAS No. 159 applies to fiscal years beginning after
      November 15, 2007, with early adoption permitted for an entity that has also
      elected to apply the provisions of SFAS No. 157. The Company does not believe
      the adoption of SFAS No. 159 will have a material impact on its consolidated
      financial position or results of operations.





***Use
      of Estimates***





The
      preparation of financial statements in conformity with U.S. GAAP requires
      management to make estimates and assumptions that affect the reported amounts
      of
      assets and liabilities at the date of the financial statements. Actual results
      could differ from those estimates.





***Contingencies***





Certain
      conditions may exist as of the date of the consolidated balance sheet, 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 its subsidiaries
      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 in the notes to the consolidated financial
      statements.


13




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





***Concentrations
      of Credit Risk***





Financial
      instruments that potentially expose the Company to concentrations of credit
      risk, as defined by SFAS No. 105, *Disclosure
      of Information about Financial Instruments with Off-Balance Sheet Risk and
      Financial Instruments with Concentrations of Credit Risk* ,
      consist
      primarily of contract receivables. No unaffiliated customer accounts for more
      than 10% of revenues. See Related-Party Transactions footnote (see Note 17)
      for
      discussion of transactions with ISI*MCS, Ltd.




***Net
      Income (Loss) Per Share***




Net
      income (loss) per share (basic) is calculated by dividing net income (loss)
      by
      the weighted average number of common shares outstanding during the period.
      Net
      income (loss) per share (diluted) is calculated by adjusting the number of
      shares of common stock outstanding using the treasury stock method. Under the
      treasury stock method, an increase in the fair market value of the Company's
      common stock results in a greater dilutive effect from outstanding warrants,
      options, restricted stock awards and convertible securities (common stock
      equivalents.)





Since
      the Company reported a net loss for the three months ended and nine months
      ended
      September 30, 2007, all common stock equivalents would be anti-dilutive and
      the
      basic and diluted weighted average shares outstanding are the same.








**Note
      3 - Contract Receivables**





Contract
      receivables consist of the following as of September 30, 2007:




Completed
                contracts and contracts in progress
            
            $
            20,523,289Retainage
            
            
            4,130,895$
            24,654,184




14




**Note
      4 - ISI Acquisition**




On
      July
      31, 2007, following the stockholder approval and pursuant to the terms of the
      merger agreement, Argyle acquired all of the assets and liabilities of ISI.
      The
      acquisition was accounted for in accordance with the provisions of SFAS No.
      141
      and 142. As a result of the merger, ISI became a wholly owned subsidiary of
      Argyle. See Note 1 and 18 for a description of ISI operations.




At
      the
      closing of the merger, the following consideration was paid by the Company
      to
      the stockholders and debt holders of ISI:




Ÿ
            $18.6
                million in cash




Ÿ
            1,180,000
                shares of common stock of Argyle (valued at approximately $9.2
                million)




Ÿ
            $1.9
                million of unsecured promissory notes convertible into shares of
                common
                stock of the Company at a conversion price of $10 per
                share




The
      value
      of Argyle common stock issued as merger consideration is based on the average
      closing price of Argyle’s common stock for the two days prior to, including the
      day of, and two days subsequent to the second amendment to the merger agreement
      resulting in the final negotiated purchase price (June 29, 2007) of $7.78.
      Based
      on the cash paid, common stock and convertible promissory note issued, and
      capitalized merger transaction costs of $2.7 million, the transaction was valued
      for accounting purposes at $32.4 million.




The
      acquisition of ISI is accounted for as a business combination in accordance
      with
      SFAS No. 141 with Argyle as the acquirer. Under the purchase method of
      accounting, the assets and liabilities of ISI acquired are recorded as of the
      acquisition date at their respective fair values, and added to those of Argyle.
      The following table summarizes the estimated fair value of assets acquired
      and
      the liabilities assumed and related deferred income taxes at the date of the
      acquisition.




All
      amounts below are depicted in thousands (000’s):




Current
                assets
            
            $
            27,892Property
                and equipment
            
            
            4,915Goodwill
            
            
            19,763Customer
                relationships
            
            
            11,625Customer
                backlog
            
            
            4,359Trade
                name
            
            
            3,776Software
            
            
            300Deposits
                and other assets
            
            
            229Total
                assets acquired
            
            
            72,859Current
                liabilities
            
            
            (17,052
            )Deferred
                income taxes
            
            
            (6,722
            )Debt
            
            
            (13,681
            )Obligations
                under capital leases
            
            
            (2,055
            )Other
                liabilities
            
            
            (991
            )Total
                liabilities assumed
            
            
            (40,500
            )Allocated
                purchase price
            
            $
            32,359




The
      primary reasons for the acquisition were the physical security solutions to
      commercial, governmental, and correctional customers provided by ISI. As a
      security solutions provider, ISI has the ability to interview a customer, assess
      needs, and determine solutions within the customer’s budget. The security
      systems provided to customers are fully integrated security systems. Using
      its
      expertise, ISI develops security systems specific to each customer’s needs. Most
      hardware and software is purchased from third parties or involves ISI’s own
      proprietary software. ISI does not manufacture any products. ISI makes these
      disparate systems effectively communicate, react, and work together. This
      communication is made possible because of the proprietary development software
      that ISI has created. ISI does not sell or license this software. ISI customers
      get “one-stop” shopping for customized solutions to their physical security
      needs. The customer can look to ISI as the sole source for the solution to all
      of its physical security needs, even if those needs require hardware and
      software from many different manufacturers.


15




The
      purchased intangibles and goodwill are not deductible for tax purposes. However,
      purchase accounting allows for the establishment of deferred tax liabilities
      on
      purchased intangibles (other than goodwill), which will be reflected as a tax
      benefit on our future consolidated statements of income in proportion to and
      over the amortization period of related intangible assets.





We
      have
      not identified any material unrecorded preacquisition contingencies where the
      related asset, liability, or impairment is probable and the amount can be
      reasonably estimated. Prior to the end of the one-year purchase price allocation
      period, if information becomes available that would indicate it is probable
      that
      such events had occurred and the amounts can be reasonably estimated, such
      items
      will be included in the final purchase price allocation and may adjust
      goodwill.








**Note
      5 - Costs and Estimated Earnings on Incomplete Contracts and Backlog
      Information**




Costs
      and
      estimated earnings on incomplete contracts and backlog information are as
      follows as of September 30, 2007:




Amended
                contract amount
            
            $
            212,876,483Revenue
                recognized to date
            
            
            112,325,095Unearned
                contract amount - backlog
            
            $
            100,551,388Costs
                incurred to date
            
            $
            93,278,854Estimated
                cost to complete
            
            
            81,754,514Estimated
                total cost
            
            $
            175,033,368Billings
                to date
            
            $
            114,045,805Costs
                and estimated earnings in excess of billings on incomplete
                contracts
            
            $
            6,771,703Billing
                in excess of costs and estimated earnings on incomplete
                contracts
            
            $
            8,501,456





Backlog
      is the aggregate contract amount less revenue recognized using
      percentage-of-completion accounting as described in Note 1 of these consolidated
      financial statements. 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.




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.




16




**Note
      6 -Long-Term Debt**





Notes
      payable and long-term debt consists of the following:




Collateral
            
            Monthly
                Installments
            
            Interest
                Rate
            
            Payable
                Through
            
            September
                30, 2007Notes
                payable:Vehicles
                and equipment
            
            
            $430
                to $3,861
            
            
            (A)
            
            
            2008-2011
            
            $
            233,869Unsecured
                debt - related party
            
            
            
            
            
            11.58%
            
            
            2010
            
            
            5,951,609Unsecured
                convertible debt - stockholders
            
            
            
            
            
            5.00%
            
            
            2012
            
            
            1,925,0018,110,479Less
                current maturities
            
            
            
            
            
            
            
            
            
            
            
            79,497Long-term
                debt for notes - less current maturities
            
            
            
            
            
            
            
            
            
            
            $
            8,030,982Line
                of credit
            
            
            
            
            
            Prime
                + 0.50% or LIBOR + 350 bps
            
            
            2009
            
            $
            7,538,850




(A)  Amounts
      include notes related to Company vehicles and various equipment. Vehicle and
      equipment notes are staggered in regards to their maturity, each amortizing
      over
      36 - 48 month periods.




Interest
      rates on the individual notes range from fixed rate of 7% up to Prime plus
      1.0%.
      Included with the equipment is a note related to the phone system with a fixed
      rate of interest at 9.0% which matures
      in 2008.




***Unsecured
      Debt - Related Party***




All
      notes
      are unsecured and subordinated to the line of credit facility. The unsecured
      note agreement contains prepayment options without prepayment penalties.
      Interest accrues at 11.58% per annum and is payable quarterly. The total debt
      of
      $6.0 million is due and payable in one single payment on January 31, 2010.
      There
      are both financial and restrictive covenants associated with the note agreement.
      As of September 30, 2007. The Company was in compliance with all covenants
      except the covenants related to capital expenditures and vehicle purchases.
      The
      covenant limits capital expenditures to $0.6 million annually, and the Company
      has spent approximately $1.4 million as of September 30, 2007. The Company
      obtained a waiver from the lender curing the default through December 31, 2007,
      provided that capital expenditures do not exceed $1.8 million for fiscal year
      2007. The Company obtained a waiver from the lender curing the vehicle purchase
      default through October 31, 2007. The Company has cured the default as of
      November 14, 2007 by prepaying a portion of the vehicle loan
      indebtedness.




***Unsecured
      Convertible Debt - Stockholders***




As
      part
      of the merger consideration, the Company issued unsecured convertible debt
      to
      the stockholders in the amount of $1.9 million which bears interest at 5% per
      annum, paid semiannually. The notes mature five years from the date of issuance
      on July 31, 2012. The notes may be converted in whole or in part into shares
      of
      the Company’s common stock at the election of the note holder at a share price
      of $10 any time after January 1, 2008. The debt may be redeemed by the Company
      at $10 per share any time after January 1, 2009.




***Unsecured
      Debt - Stockholders***




In
      April
      2007, Argyle’s officers and directors, an affiliate of Argyle’s Chairman and
      Co-Chief Executive Officer, and certain of Argyle’s consultants, pursuant to a
      note and warrant acquisition agreement, loaned Argyle an aggregate of $0.3
      million and in exchange received promissory notes in the aggregate principal
      amount of $0.3 million and warrants to purchase an aggregate of 37,500 shares
      of
      Argyle’s common stock. The warrants are exercisable at $5.50 per share of common
      stock and expire on January 24, 2011. The warrants also may be exercised on
      a
      net-share basis by the holders of the warrants. The Company has estimated,
      based
      upon a Black-Scholes model, that the fair value of the warrants on the date
      of
      issue was approximately $2.48 per warrant (a total value of approximately $.09
      million) using an expected life of 2 years, volatility of 2.39%, and a risk-free
      rate of 5%. However, because the Company’s warrants have a limited trading
      history, the volatility assumption was based on information currently available
      to management. The promissory notes had an interest at a rate of 4% per year
      and
      were repayable 30 days after the consummation of a business combination. The
      notes and the associated accrued interest were paid in full In August
      2007.


17




***Line
      of Credit Facility***




The
      Company has a line of credit facility totaling $9.0 million. 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. 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 September 30, 2007 was $7.5 million **** due
      December 31, 2009 with an interest rate of prime plus 0.5%. The agreement
      contains both financial and restrictive covenants, including a restriction
      on
      the payment of dividends. At September 30, 2007, the Company was in compliance
      with such covenants. The Company has agreed to pay an annual commitment fee
      of
      0.5% per year on the unused borrowing capacity, which was $1.5 million at
      September 30, 2007.




Aggregate
      maturities required on all debt at September 30, 2007 are as
      follows:




Year
                Ending December 312007
                (remaining 3 months)
            
            $
            24,4382008
            
            
            79,4972009
            
            
            7,595,5792010
            
            
            5,995,1432011
            
            
            29,671Thereafter
            
            
            1,925,001Total
                commitment outstanding
            
            $
            15,649,329




**Note
      7 - Capitalization of Leases**




ISI
      sold
      its owner-occupied real estate to a partnership owned by ISI’s stockholders
      during 2004 and entered into a leaseback of the properties with the partnership.
      ISI entered into a second lease on another property owned by the same
      partnership in 2006. Both leases were triple net leases. A triple net lease
      is a
      lease agreement on a property where the tenant or lessee agrees to pay all
      real
      estate taxes, building insurance, and maintenance (the three 'Nets') on the
      property in addition to any normal fees that are expected under the agreement
      (rent, etc.). In such a lease, the tenant or lessee is responsible for all
      costs
      associated with repairs or replacement of the structural building elements
      of
      the property.




The
      leased property, included in property and equipment in the accompanying
      consolidated balance sheet, amounted to $1.8 million **** at
      September 30, 2007. As of September 30, 2007 depreciation of these assets
      amounted to $27,907.




The
      terms
      of the aforementioned leases were modified on July 31, 2007 to extend the
      expiration date from 2018 to 2019 and increase the monthly rental from $23,667
      to $24,000. The modification did not materially affect the carrying value of
      the
      assets or related liabilities recorded in the accompanying consolidated balance
      sheet. The Company reassessed these leases for proper classification under
      SFAS
      No. 13, *Accounting
      for Leases* ,
      and
      determined they remain properly classified as capital leases.




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
      September 30, 2007:


18




Year
                Ending December 312007
                (remaining 3 months)
            
            $
            72,0002008
            
            
            288,0002009
            
            
            288,0002010
            
            
            288,0002011
            
            
            288,000Thereafter
            
            
            2,208,000Future
                minimum lease payments
            
            
            3,432,000Less
                amount of net minimum lease payments attributable to
                interest
            
            
            (1,394,252
            )Present
                value of net minimum lease payments
            
            $
            2,037,748Current
                portion of capitalized lease obligations
            
            $
            96,960Long-term
                portion of capitalized lease obligations
            
            
            1,940,788$
            2,037,748




**Note 8
      - Commitments**





The
      Company leases office space and equipment under operating leases expiring
      through 2011.




Minimum
      rental commitments at September 30, 2007 are as follows:




Year
                Ending December 312007
                (remaining 3 months)
            
            $
            67,4502008
            
            
            224,1042009
            
            
            104,1882010
            
            
            60,3522011
            
            
            17,272Thereafter
            
            
            —Total
                commitment outstanding
            
            $
            473,366





The
      corporate office lease space of Argyle expired as of July 31, 2007 and Argyle
      currently operates under a month-to-month lease arrangement. No lease agreements
      contain bargain purchase options or similar clauses in which management intends
      to execute or that are considered material requiring disclosure.




In
      August
      2007 the Company entered into a letter of credit facility with a financial
      institution. The letter of credit may not exceed $500,000. The facility requires
      a 1% annual commitment fee on the unused portion of the letter of credit
      facility. The commitment fee is to be paid quarterly.




**Note 9
      - Self Insurance**





ISI
      is
      self-insured to certain limits under its group health and dental plans.
      Stop-loss coverage is provided for claims above $75,000 per employee up to
      a
      maximum $925,000. 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 $544,323 at September 30, 2007. ISI has not
      yet
      met its stop-loss limit for 2007.


19




**Note
      10 - Offerings**




***Public
      Offering***




In
      January 2006, Argyle sold 3,700,046 units (which included 75,046 units sold
      by
      the underwriters pursuant to a partial exercise of their over-allotment option)
      to the public at a price of $8.00 per unit. Each unit consists of one share
      of
      the Company’s common stock, $0.0001 par value, and one redeemable common stock
      purchase warrant (warrant). Each warrant entitles the holder to purchase from
      the Company one share of common stock at an exercise price of $5.50 commencing
      the later of the completion of a business combination with a target business
      or
      January 24, 2007, and expiring January 24, 2011. The warrants are redeemable
      by
      the Company at a price of $.01 per warrant upon 30 days’ notice after the
      warrants become exercisable, only in the event that the last sale price of
      the
      common stock is at least $11.50 per share for any 20 trading days within a
      30-trading-day period ending three business days before a notice of redemption
      is delivered.




***Private
      Placement***




In
      January 2006, Argyle sold to its officers an aggregate of 125,000 units
      identical to the units sold in the Public Offering at a price of $8.00 per
      unit.




**Note
      11 - Common Stock Reserved for Issuance**




As
      of
      September 30, 2007, 5,839,342 shares of common stock were reserved for issuance
      upon exercise of redeemable warrants and 375,000 shares of common stock were
      reserved for issuance pursuant to the underwriters’ unit purchase option
      described above. In addition, warrants were issued in connection with the notes
      to stockholders entitling the holder to exercise the warrants for a total of
      37,500 shares of stock. In August 2007, the company granted certain employees
      incentive stock options (ISOs) and non-qualified stock options entitling the
      holder to exercise options for a total of 125,000 shares of stock and 90,000
      shares of restricted stock.




**Note
      12 - Redemptive Status of Common Stock**




The
      registration statement for Argyle’s initial public offering indicated that,
      after signing a definitive agreement for the acquisition of a target business,
      Argyle would submit such transaction for stockholder approval. Based on the
      votes submitted, 211,965 shares voted against the proposed ISI business
      combination and sought to be redeemed for cash. As a result, $1.7 million of
      net
      proceeds from the initial public offering which included interest was redeemed
      to stockholders in August 2007. The 211,965 shares of common stock were
      cancelled as of August 2007.




**Note
      13 - Preferred Stock**




The
      Company is authorized to issue 1,000,000 shares of preferred stock with such
      designations, voting, and other rights and preferences, as may be determined
      from time to time by the Board of Directors. No shares of preferred stock are
      currently issued or outstanding.




In
      connection with the merger, and immediately prior to the merger, one of ISI’s
      unsecured debt holders converted $10.0 million of long-term debt with ISI into
      shares of ISI preferred stock. Upon closing of the purchase of ISI, the same
      debt holder received $10.0 million for the preferred stock of ISI.


20




**Note
      14 - Agreement With Underwriters**




In
      March
      2007, the underwriters from Argyle’s Public Offering agreed to forfeit any
      and all rights or claims to a pro-rata portion of the deferred underwriting
      costs and associated accrued interest with respect to any shares of common
      stock
      that are redeemed in connection with the proposed acquisition. This fee was
      charged against additional paid-in capital and was payable upon a successful
      business combination. Based on the redemption of 211,965 shares, $0.08 million
      related to these waived underwriter fees had been included in payable to
      redemptive stockholders. Upon closing of the purchase of ISI, Argyle paid
      approximately $1.4 million for services performed related to Argyle’s Public
      Offering.




**Note
      15 - Stockholders’ Equity and Stock-Based Compensation**




On
      January 1, 2006, the Company adopted SFAS No. 123 (revised 2004), *Share
      Based Payment* .
      SFAS
      No. 123(R) requires all share-based payments to employees, including grants
      of
      employee stock options, to be recognized in the financial statements based
      on
      their fair values. Following is a description of the various grants made and
      the
      impact to the financial statements.




***2005
      - 2006 Options***




In
      July
      2005, Argyle granted to its officers, directors, and their respective affiliates
      certain options, which were exercisable only in the event the underwriters
      exercised the over-allotment option, to purchase that number of shares enabling
      them to maintain their 20% ownership interest in the Company (without taking
      into account the units they purchased in the private placement). The measurement
      date was deemed to be January 30, 2006, the date the over-allotment was
      exercised because the number of options to be issued was not known until that
      date.




In
      January 2006, the underwriters exercised a portion of the over-allotment option
      in the amount of 75,046 units. In February 2006, the officers and directors
      exercised their options and purchased 18,761 units for an aggregate cost of
      $507
      (or $0.027 per share). The compensation cost, recorded in operating
      expenses, resulting from these share-based payments was $130,632 at January
      30, 2006, using the Black-Scholes pricing model. This model was developed for
      use in estimating the fair value of traded options that have no vesting
      restrictions and are fully transferable. The fair value of the options was
      estimated at the measurement date using the assumptions of weighted-average
      volatility factor of 0.10; no expected dividend payments; weighted-average
      risk-free interest rate of 5%; and a weighted-average expected life of 0.13
      years.




The
      fair
      value of each option was $6.99 per share. All options vested immediately at
      the
      measurement date and no further options may be exercised. Compensation expense
      was recognized immediately and recorded as an operating expense.




***Underwriter
      Options***




Argyle
      sold to its underwriters options to purchase up to an aggregate of 187,500
      units for $100. The units issuable upon exercise of these options are identical
      to those sold in the Public Offering. These options will
      be exercisable at $8.80 per unit commencing on the later of the
      consummation of a business combination or one year from January 24, 2006, and
      expiring January 24, 2011. The options to purchase the 187,500 units and the
      Securities underlying such units have been deemed compensation by the National
      Association of Securities Dealers (NASD) and are therefore subject to a 180-day
      lock-up pursuant to Rule 2710(g) (1) of the NASD Conduct Rules. Additionally,
      these options may not be sold, transferred, assigned, pledged, or hypothecated
      for a one-year period (including the foregoing 180-day period) following
      January 24, 2006. However, these options may be transferred to any
      underwriter and selected dealer participating in the offering and their bona
      fide officers or partners.


21




Argyle
      accounted for these purchase options as a cost of raising capital and included
      the instrument as equity in its consolidated balance sheet. Accordingly,
      there is no net impact on Argyle’s financial position or results of
      operations, except for the recording of the $100 proceeds from the sale. Argyle
      has estimated, based upon a Black-Scholes model, that the fair value of the
      purchase options on the date of sale was approximately $3.40 per unit, (a total
      value of approximately $0.6 million) using an expected life of five years,
      volatility of 44%, and a risk-free rate of 5%. However, because Argyle’s units
      did not have a trading history, the volatility assumption was based on
      information currently available to management. The volatility estimate was
      derived using historical data of public companies in the proposed industry.
      Argyle believes the volatility estimate calculated from these companies was
      a
      reasonable benchmark to use in estimating the expected volatility of our units;
      however, the use of an index to estimate volatility may not necessarily be
      representative of the volatility of the underlying securities.




***2007
      Incentive Plan***




The
      2007
      Incentive Plan provides for the grant of distribution equivalent rights,
      incentive stock options, nonqualified 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.




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.




In
      August
      2007, the Company awarded a grant of 90,000 restricted common shares (one-third
      vests on December 31 of each 2008, 2009, and 2010) and 90,000 performance unit
      shares (vests on December 31, 2010 if certain performance goals to be determined
      by the Board of Directors are achieved) to various members of the executive
      management team.




The
      Company has estimated that the fair value of the restricted shares was
      approximately $4.45 per unit, (a total value of approximately $0.4 million)
      using a discount rate of 40%. The discount estimate was derived using historical
      data of public companies in the related industry. The Company believes the
      discount rate estimate calculated from these companies was a reasonable
      benchmark to use in estimating the expected discount of our shares of common
      stock.




In
      August
      2007, the Company awarded a grant of 125,000 stock options to various employees,
      of which 91,000 were ISO and 34,000 were non-qualified. The options have a
      strike price of $7.80 and vest one-third on December 31 of each of 2008, 2009,
      and 2010.




The
      Company has estimated, based upon a Black Scholes model, that the fair value
      of
      the stock options on the date of grant was approximately $2.10 per unit, (a
      total value of approximately $0.3 million), using an expected life of three
      years, volatility of 49%, and a risk-free rate of 4%. However, because the
      shares did not have a trading history, the volatility assumption was based
      on
      information currently available to management. The volatility estimate was
      derived using historical data of public companies in the related industry.
      The
      Company believes the volatility estimate calculated from these companies was
      a
      reasonable benchmark to use in estimating the expected volatility of our units;
      however, the use of an index to estimate volatility may not necessarily be
      representative of the volatility of the underlying securities.


22




**Note
      16 - Income Taxes**




The
      following temporary differences gave rise to the deferred tax liability at
      September 30, 2007:




Deferred
                Tax Liabilities:Intangibles
                (non-amortizable)
            
            $
            (7,325,578
            )Property
                and Equipment
            
            
            (456,586
            )Construction
                Contracts
            
            
            (315,069
            )Prepaid
                Assets
            
            
            (69,449
            )Other
            
            
            (11,401
            )Total
                Deferred Tax Liabilities
            
            
            (8,178,083
            )Deferred
                Tax Assets:Net
                Operating Loss / Capital Loss Carry-forwards
            
            
            878,682Allowance
                for Doubtful Accounts
            
            
            421,686Loan
                Origination Fees
            
            
            117,423Capital
                Leases
            
            
            89,604Stock
                -based Compensation
            
            
            61,546Total
                Gross Deferred Tax Assets
            
            
            1,568,940Valuation
                Allowance
            
            
            (98,894
            )Total
                Deferred Tax Assets
            
            
            1,470,046Net
                Deferred Tax Liabilities
            
            $
            (6,708,037
            )





The
      valuation allowance is related to capital losses incurred by the Company which
      can only be used to offset future capital gains. At September 30, 2007, we
      had
      net operating loss/charitable contributions carryovers of $2.1 million and
      capital loss carryovers of $0.2 million that expire September 30, 2026 and
      September 30, 2009, respectively.




**Note
      17 - Related-Party Transactions**




Other
      receivables include $81,577 of receivables from related parties, of which
      $47,577 is attributable to ISI. Amounts represent monies or other assets
      advanced to employees. Amounts have been paid on these receivables and
      management believes they are fully collectible.




Argyle
        has notes payable totaling $1.9 million to stockholders discussed in Note
        6.


23




**Note
      17 - Related-Party Transactions (continued)**




In
      conjunction with the major refinancing of ISI in 2004, the majority stockholders
      formed a new company in 2004 (ISI*MCS, Ltd.) which was used as the contracting
      entity on all future bonded contracts. ISI transferred certain existing bonded
      contracts at their remaining contract values, and no gain or loss was recognized
      on the transfers to ISI*MCS, Ltd. at the time of its formation. All contracts
      of
      ISI*MCS, Ltd. were subcontracted to ISI for the full contract amount, less
      a 2%
      fee. ISI recorded contract revenue based on the ISI*MCS, Ltd.’s contract amount,
      net of the 2% fee. Contract receivables from ISI*MCS, Ltd. at September 30,
      2007
      totaled $11.5 million, which is disclosed as contract receivables - related
      party on the face of the consolidated balance sheet since ISI*MCS, Ltd. is
      not
      consolidated in the balance sheet. Argyle has agreed to indemnify the
      shareholders of ISI*MCS, Ltd. from claims brought by the bonding company against
      their personal guarantees for those contracts that have not been paid in full
      as
      of the closing of the merger. The merger agreement provides that these
      indemnification obligations will survive for a period of four years after the
      closing date of the merger and the obligations are not subject to cap, or
      maximum amount.




As
      of
      July 31, 2007 ISI will receive 100% of the remaining contract amounts and
      ISI*MCS, Ltd. will forego its 2% fee. Remaining amounts to be billed on these
      contracts as of September 30, 2007 totaled $25.0 million. All future contracts,
      bonded and unbonded, will be contracted directly by ISI without involvement
      by
      ISI*MCS, Ltd.




**Unsecured
      Debt - Related Party**




As
      part
      of the ISI merger transaction, a shareholder of ISI had debt totaling $16.0
      million of which $10.0 million was paid prior to its original terms. The
      shareholder became a shareholder of Argyle as part of the merger and holds
      486,237 shares of Argyle common stock as of July 31, 2007 and as such, became
      a
      related party. The remaining debt to the shareholder (see Note 6) **** totals
      $6.0 million.




**Note
      18 - Segment Information**




The
      Company’s segments are strategic business units that offer different products
      and services and are managed accordingly. Under GAAP segment reporting rules,
      management analyzes the various operating segments based on segment income
      before income taxes. The customers and long-lived assets of the reportable
      segments are in the United States. The Company has three reportable segments
      that reflect the current management of its business: (1) ISI Detention; (2)
      MCS
      Detention; and (3) MCS Commercial.




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, 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.




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, assembles, 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 of ISI that lack their own in-house electronic
      solutions.


24




**Note
      18 - Segment Information (continued)**




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
          results for the three and nine month ended September 30, 2007 represent
          the two
          months of activity for the Company since the date of the acquisition of
          ISI on
          July 31, 2007. The predecessor information for the three and nine months
          ended
          September 30, 2006 represent the full results for those respective time
          periods.





**Argyle
                Security, Inc.****Segment
                Information for the Nine Months Ended 2007 &
                2006****(unaudited)**




**Predecessor
                (ISI)****Three
                Months Ended**
            
            **Nine
                Months Ended**
            
            **Three
                Months Ended**
            
            **Nine
                Months Ended****September
                30, 2007**
            
            **September
                30, 2007**
            
            **September
                30, 2006**
            
            **September
                30, 2006****Industry
                Segment (in $)****Net
                Revenues:****ISI
                Detention**
            
            $
            9,340,490
            
            $
            9,340,490
            
            $
            9,753,455
            
            $
            21,326,269**MCS
                Detention**
            
            
            4,501,561
            
            
            4,501,561
            
            
            2,889,179
            
            
            9,919,561**MCS
                Commercial**
            
            
            5,423,640
            
            
            5,423,640
            
            
            6,570,854
            
            
            16,599,478**Corporate**
            
            
            —
            
            
            —
            
            
            —
            
            
            —**Eliminations**
            
            
            (2,173,217
            )
            
            (2,173,217
            )
            
            (3,759,184
            )
            
            (6,611,503
            )**Total**
            
            $
            17,092,474
            
            $
            17,092,474
            
            $
            15,454,304
            
            $
            41,233,805**Operating
                Income / (Loss):****ISI
                Detention**
            
            $
            344,024
            
            $
            344,024
            
            $
            539,912
            
            $
            268,331**MCS
                Detention**
            
            
            24,728
            
            
            24,728
            
            
            (69,441
            )
            
            1,295,906**MCS
                Commercial**
            
            
            156,201
            
            
            156,201
            
            
            457,451
            
            
            636,322**Corporate**
            
            
            (890,723
            )
            
            (1,411,042
            )
            
            —
            
            
            —**Eliminations**
            
            
            411,316
            
            
            411,316
            
            
            99,891
            
            
            210,870**Total**
            
            $
            45,547
            
            $
            (474,773
            )
            $
            1,027,813
            
            $
            2,411,429**Total
                Assets:****ISI
                Detention**
            
            $
            72,904,116
            
            $
            72,904,116
            
            $
            23,866,660
            
            $
            23,866,660**MCS
                Detention**
            
            
            5,091,536
            
            
            5,091,536
            
            
            2,421,830
            
            
            2,421,830**MCS
                Commercial**
            
            
            6,811,175
            
            
            6,811,175
            
            
            4,358,558
            
            
            4,358,558**Corporate**
            
            
            5,363,150
            
            
            5,363,150
            
            
            —
            
            
            —**Eliminations**
            
            
            (8,753,433
            )
            
            (8,753,433
            )
            
            473,500
            
            
            473,500**Total**
            
            $
            81,416,544
            
            $
            81,416,544
            
            $
            31,120,548
            
            $
            31,120,548




25


**Note
        19 - Subsequent Events**
  Stock-Based
        Compensation
  In
        October 2007, the Company awarded a grant of 35,000 restricted
        shares 1 and
        15,000 performance unit shares 2 to
        various members of the executive management team.
  In
          January 2008, the Company awarded a grant of 61,000
          restricted shares1 and 60,000 performance unit shares2 to
          various members of the executive management team.
  1 One-third
        vests on December 31 of each of 2008, 2009, and 2010.
  2 Vests
        on
        December 31, 2010 if certain performance goals to be determined by the Board
        of
        Directors are achieved.
  **Related
          Party Transaction**
  On
          January 2, 2008 ISI entered
          into and consummated a Third Amendment to Note and Warrant Purchase Agreement
          (“Note Purchase Agreement”) with a related party and
          existing lender (Note 6) of ISI and Argyle, pursuant to which ISI
          issued and sold to the party a
          Senior
          Subordinated Promissory Note (“Note A”) in the aggregate principal amount of
          $5,000,000, due and payable on January 31, 2010, with interest thereon
          at 11.58%
          per annum, payable quarterly in arrears beginning March 31, 2008, deferred
          interest at the rate of 8.42% per annum, and default interest at 2% per
          annum. Argyle
          and each of ISI’s subsidiaries are parties to the Note Purchase Agreement as
          guarantors.
  **Entry
          into a Material Definitive Agreement.**
  On
          January 7, 2008, ISI Controls, Ltd. (“ISI-Controls”), a wholly owned subsidiary
          of ISI Security Group, Inc. (“ISI”), which in turn is wholly owned by Argyle
          Security, Inc. (“Argyle”), entered into a Unit Purchase Agreement (the “Unit
          Purchase Agreement”) with the holders of units (the “Seller”) in Com-Tec
          Security, LLC (“Com-Tec”) and Jeffery E. Corcoran, as representative of the
          Seller, pursuant to which ISI-Controls will acquire 100% of the units of
          Com-Tec, resulting in Com-Tec becoming a wholly owned subsidiary of
          ISI-Controls. Com-Tec is engaged in the business of custom design, manufacture
          and installation of electronic security and communication systems.
  In
          consideration for the sale of the units to ISI-Controls, the Seller will
          receive
          cash in the amount of $3,000,000 and a secured subordinated promissory
          notes in
          the aggregate principal amount of $3,515,000. The aggregate principal amount
          of
          the promissory notes may be reduced depending on the occurrence of certain
          events described in the Unit Purchase Agreement. The promissory notes will
          be
          secured by the assets of ISI Security and Argyle, will bear interest at
          the rate
          of 7% per year and will become due and payable on April 1, 2011. Events
          of
          default under the promissory notes will consist of failure to pay, bankruptcy
          or
          insolvency.
  The
          Seller and the Company make certain representations and warranties in the
          Unit
          Purchase Agreement and the transaction is anticipated to close on or prior
          to
          January 31, 2008, subject to satisfaction of closing conditions,
          including:
  l
                ISI-Controls
                    completing its due diligence and the Seller and Com-Tec having
                    complied in
                    all material respects with the terms of the agreement;
                    and
 l
                ISI-Controls
                    making the applicable payment to the Seller and having complied
                    in all
                    material respects with the terms of the Unit Purchase
                    Agreement.
  If
          the
          transaction is not consummated by January 31, 2008, either party may terminate
          the Agreement at any time.
  The
          description of the Asset Purchase Agreement, Promissory Notes and Employment
          Agreements contained in Section 2.01 are incorporated by reference into
          this
          Item 1.01.
  26
  **Completion
          of Acquisition or Disposition of Assets**
  On
          January 4, 2008, ISI Detention Contracting Group, Inc. (“ISI-Detention”), a
          California corporation and wholly owned subsidiary of ISI, entered into
          an Asset
          Purchase Agreement (the “Asset Purchase Agreement”) with Peterson Detention,
          Inc. (“Peterson Detention”), effective January 1, 2008, pursuant to which
          ISI-Detention acquired substantially all of the business assets and liabilities
          of Peterson Detention. Michael Peterson and Leonard Peterson, each an officer
          of
          Peterson Detention and principal shareholders of Peterson Detention, and
          Argyle
          and ISI were signatory to the Asset Purchase Agreement for certain limited
          purposes. Peterson Detention is engaged in the business of manufacturing
          and selling steel products .
  In
          consideration for the sale of its assets to ISI-Detention, Peterson Detention
          will receive cash in the amount of $1,500,000 and convertible promissory
          notes
          (the “Promissory Notes”) in the aggregate principal amount of $3,000,000. The
          aggregate principal amount of the Promissory Notes may be reduced depending
          on
          the occurrence of certain events described in the Asset Purchase Agreement.
          The
          Promissory Notes will bear interest at the rate of 6% per year and will
          become
          due and payable on December 31, 2012. Events of default under the Promissory
          Notes consist of the failure to pay, bankruptcy or insolvency. On February
          28,
          2008 the holders of the Promissory Notes may convert up to $1,500,000 of
          the
          outstanding balance of the Promissory Notes into shares of Argyle’s common stock
          at the average closing price of Argyle’s common stock for the 20 trading days
          preceding the conversion date, provided that the conversion price may be
          no less
          than $8.00 per share. At any time on or after June 1, 2009, but before
          November
          15, 2009, ISI-Detention may, in its sole discretion, require the holders
          of the
          Promissory Notes to choose one of the following options: (i) the conversion
          of
          an aggregate of $500,000 of the outstanding principal amounts of the Promissory
          Notes into Argyle’s common stock at 95% of the average closing price of Argyle’s
          common stock for the 20 trading days preceding delivery of the election
          notice;
          or (ii) ISI Detention’s payment to Holder of an aggregate of $7,500 in exchange
          for which the payment schedule of the Promissory Notes will be amended
          such that
          $500,000 of the principal due in 2010 will be due and payable on January
          3,
          2011, with interest continuing to accrue on all unpaid principal amounts.
          The
          payment of the Promissory Notes is guaranteed by Argyle, ISI and ISI Detention
          Contracting Group, Inc. a Texas corporation and wholly owned subsidiary
          of
          ISI.
  Pursuant
          to the Asset Purchase Agreement, ISI-Detention entered into employment
          agreements (the “Employment Agreements”) with each of Michael Peterson and
          Leonard Peterson, pursuant to which each of them will receive a salary
          of
          $291,000 per year for services to ISI-Detention as General Manager and
          Operations Manager, respectively. Each would also be entitled to receive
          a bonus
          and benefits in accordance with ISI-Detention’s policies. The term of each
          Employment Agreement is three years, after which employment will become
          at-will.
          In the event of a termination without cause, ISI-Detention would be required
          to
          pay each executive his full compensation for 18 months or until the term
          of the
          Employment Agreements was set to expire, whichever was earlier.
  **Other
          Events Related to Acquisitions or Disposal of Assets**
  On
          January 3, 2008, MCFSA, Ltd. (“MCFSA”), all of the partnership interests of
          which are directly or indirectly wholly owned by ISI, entered into an Asset
          Purchase Agreement (the “Asset Purchase Agreement”) with Fire Quest, Inc. (“Fire
          Quest”) and William L. Calvin, a shareholder of Fire Quest, effective January
          1,
          2008, pursuant to which MCFSA acquired substantially all of the business
          assets
          and liabilities of Fire Quest. Fire Quest is engaged in the business of
          alarm
          system sales and service.
  In
          consideration for the sale of its assets to MCFSA, Fire Quest will receive
          cash
          in the amount of $750,000 and a promissory note in the aggregate principal
          amount of $250,000 (“Fire Quest Promissory Note”). The aggregate principal
          amount of the Fire Quest Promissory Note may be increased or reduced depending
          on the occurrence of certain events described in the Asset Purchase Agreement.
          The Promissory Notes will bear interest at the rate of 7.25% per year and
          will
          become due and payable on January 1, 2009. Events of default under the
          Promissory Notes consist of the failure to pay, bankruptcy or insolvency.


27




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





**Forward
      Looking Statements**





This
      Quarterly Report on Form 10-Q/A includes forward-looking statements within
      the
      meaning of Section 27A of the Securities Act of 1933, as amended, and Section
      21E of the Securities Exchange Act of 1934, as amended. We have based these
      forward-looking statements on our current expectations and projections about
      future events. These forward-looking statements are subject to known and unknown
      risks, uncertainties and assumptions about us that may cause our actual results,
      levels of activity, performance or achievements to be materially different
      from
      any future results, levels of activity, performance or achievements expressed
      or
      implied by such forward-looking statements. In some cases, you can identify
      forward-looking statements by terminology such as “may,” “should,” “could,”
“would,” “expect,” “plan,” “anticipate,” “believe,” “estimate,” “continue,” or
      the negative of such terms or other similar expressions. Factors that might
      cause or contribute to such a discrepancy include, but are not limited to,
      those
      described in our other Securities and Exchange Commission filings. The following
      discussion should be read in conjunction with our unaudited Financial Statements
      and related Notes thereto included elsewhere in this report.




**Overview**





Argyle
      Security Acquisition Corporation (the “Company” or “Argyle”) 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 with a company in the
      security industry.




On
      December 8, 2006, Argyle, Argyle’s wholly-owned subsidiary ISI Security Group,
      Inc. (the "Merger Subsidiary") and ISI Detention Contracting Group, Inc. (“ISI”)
      entered into a merger agreement, as amended on June 29, 2007 and July 11, 2007,
      pursuant to which the Merger Subsidiary would merge into ISI and ISI would
      become a wholly-owned subsidiary of Argyle.





On
      July
      30, 2007, the stockholders of the Company **** approved
      the Company's acquisition of ISI. Stockholders also approved (i) an amendment
      to
      the Company's Certificate of Incorporation to change its name to "Argyle
      Security, Inc.," (ii) the Company's 2007 Omnibus Incentive Compensation Plan,
      and (iii) an amendment to the Company’s certificate of incorporation to remove
      certain provisions from the certificate that were no longer applicable after
      the
      business combination was consummated.





On
      July
      31, 2007, pursuant to the terms of the merger agreement, the Company acquired
      all of the assets and liabilities of ISI through the merger of its Merger
      Subsidiary into ISI. As a result of the merger, ISI became a wholly-owned
      subsidiary of the Company. Prior to the acquisition of ISI, Argyle had no
      operations and was considered a developmental stage enterprise. ISI is deemed
      to
      be a “predecessor” to the Company. The accompanying unaudited consolidated
      financial statements include the results of operations for ISI from August
      1,
      2007 to September 30, 2007.


28




ISI
      is a
      provider of security solutions to commercial, governmental, and correctional
      customers and specializes in turnkey installations, including design,
      engineering, supply, and the installation of various security-related equipment.
      As a security solutions provider, ISI has the ability to interview a customer
      that needs security for a project and determine that customer’s needs in light
      of the products and technology available within the customer’s budget. ISI,
      using its expertise in the security industry, then develops security systems
      that answer the customer’s needs using hardware and software that is available
      in the marketplace from third party vendors, as well as its own proprietary
      software. The work is performed under fixed-price contracts. The length of
      the
      contracts varies but is typically less than two years.





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. ISI also provides 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.





Under
      the
      purchase method of accounting, the total purchase price is allocated to the
      net
      tangible and intangible assets acquired and liabilities assumed, based on
      various estimates of their respective fair values. We have engaged a third
      party
      appraiser to assist us in performing a valuation of ISI's assets and
      liabilities in accordance with SFAS No. 141. The depreciation and amortization
      expense adjustments are based on preliminary valuation estimates of ISI's
      tangible and intangible assets described in Note 4 to the unaudited consolidated
      financial statements. The final valuation, and any interim updated preliminary
      valuation estimates, may differ materially from these preliminary valuation
      estimates and, as a result, the final allocation of the purchase price may
      result in reclassifications of the allocated amounts that are materially
      different from the purchase price allocations reflected herein. Any material
      change in the valuation estimates and related allocation of the purchase price
      could materially impact our depreciation and amortization expenses and our
      actual and pro forma results of operations. The accompanying unaudited
      consolidated statements of operations reflect the operating results of ISI
      since
      August 1, 2007.





**Critical
      Accounting Policies**





Our
      discussion and analysis of our financial condition and results of operations
      is
      based on the accompanying unaudited consolidated financial statements, which
      have been prepared in accordance with U.S. generally accepted accounting
      principles. As such, we are required 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 consolidated financial
      statements and the reported amounts of revenues and expenses during the
      reporting period. By their nature, these estimates and judgments are subject
      to
      an inherent degree of uncertainty. Our management reviews its estimates on
      an
      on-going basis, including those related to revenue recognition based on the
      percentage-of-completion methodology, sales allowances, recognition of service
      sales revenues, the allowance for doubtful accounts, inventories and related
      reserves, long-lived assets, investments and income taxes. We base our estimates
      and assumptions on historical experience, knowledge of current conditions and
      our understanding of what we believe to be reasonable that might occur in the
      future considering available information. Actual results may differ from these
      estimates, and material effects on our operating results and financial position
      may result.





*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:




29




Construction
      Contracts:




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 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.
      Revenues from construction contracts are recognized on the
      percentage-of-completion method in accordance with SOP 81-1. ISI recognizes
      revenues on signed contracts and change orders. ISI generally
      recognizes revenues 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.
      ISI generally considers contracts to
      be
      substantially complete upon departure from the work site and acceptance by
      the
      customer. If any jobs are identified during the review process which are
      estimated to be a loss job (where estimated costs
      exceed contract price), the entire estimated loss is recorded in full, without
      regard to the computed percentage of completion.





These
      estimates of percentage completion of a project determine the amounts of
      revenues and gross margin that are 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 revenues and $10,000 in
      gross
      margin. If the percentage completed is adjusted to 25%, then the revenues 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 percentage 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 (overruns 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.





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.





*Service
      Sales -* ****** Service
      revenues are recognized when the services have been delivered to and
      accepted by the customer. These are generally short-term projects which are
      evidenced by signed service agreements or customer work orders or purchase
      orders. These sales agreements/customer orders generally provide for
      billing to customers based on time at quoted hourly or project rates, plus
      costs
      of materials and supplies furnished by the Company.




30




*IBNR
      Estimates for Health Insurance* - On an
      annual basis, the Company estimates its health insurance cost, for its self
      insured employee base at the acquired company ISI, based upon expected health
      insurance claims for the current year. The insurance company which provides
      both
      the stop loss and total aggregate insurance coverages also provides the average
      or expected and maximum claims for each class. The average and maximum claims
      are based on our demographics and prior claim history. The Company uses the
      average claims history for the trailing the twelve months as its basis for
      accruing health care cost. This accrual is automated and is part of the payroll
      function for each pay period.





*Deferred
      income taxes* -
      Deferred income taxes are provided for temporary differences between the
      carrying amount of assets and liabilities for financial reporting purposes
      and
      the amounts for tax purposes. Valuation allowances are provided against the
      deferred tax asset amounts when the realization is uncertain.




*Allowance
      for Doubtful Accounts* - Argyle
      provides an allowance for bad debt through an analysis in which the bad debts
      that had been written off over a trailing five year period are compared on
      a
      percentage basis to the aggregate sales for the same period. The resulting
      percentage is applied to the sales for year to date and a monthly reserve is
      accrued accordingly. Additionally, management analyzes specific customer
      accounts receivable for any potentially uncollectible accounts and will add
      such
      accounts to the reserve or write them off if warranted, after considering lien
      and bond rights, and then considers the adequacy of the remaining unallocated
      reserve compared to the remaining accounts receivable balance (net of specific
      doubtful accounts).





*Non
      Cash Compensation Expense* - On
      January 1, 2006, the Company adopted SFAS No. 123 (revised 2004), *Share
      Based Payment* .
      SFAS
      No. 123(R) requires all share-based payments to employees, including grants
      of
      employee stock options, to be recognized in the financial statements based
      on
      their fair values.





Purchase
      options (ISO / non-qualified) grants:





On
      a
      quarterly basis, the Company computes the value of newly issued purchase options
      (ISO and non-qualified) by utilizing the Black Scholes valuation model based
      upon their expected life vesting period, industry comparables for volatility
      and
      the risk-free rate on US Government securities with matching maturities. The
      value of the purchase options are then straight-line expensed over the life
      of
      the purchase options.





Restricted
      and performance stock grants:





On
      a
      quarterly basis, the Company computes the value of newly issued stock grants
      by
      discounting the share price as of the award date. The discount rate is
      determined by management by utilizing similar rates for industry and security
      type as provided by various valuation firms. The value of the common shares
      are
      then straight-line expensed over the life of the corresponding vesting period.




31





**Pro
      Forma and Adjusted Pro Forma Financial Information**


The
        acquisition of ISI is our first business combination and accordingly we do
        not believe a comparison of the results of operations and cash flows for
        the quarter and nine months ended September 30, 2007 versus September 30,
        2006
        is very beneficial to our stockholders. In order to assist investors in better
        understanding the changes in our business between the quarters and nine months
        ended September 30, 2007 and September 30, 2006 we are presenting in
        management’s discussion and analysis section below in the pro forma and adjusted
        pro forma results of operations for the Company and ISI for the three and
        nine
        months ended September 30, 2007 and September 30, 2006 as if the acquisition
        of
        ISI occurred on January 1, 2007 and January 1, 2006, respectively. We derived
        the pro forma results and adjusted pro forma of operations from (i) the
        unaudited consolidated financial statements of ISI for the period from January
        1, 2007 to July 31, 2007 (the date of the ISI acquisition) and the three
        months
        and nine months ended September 30, 2006, and (ii) our unaudited
        consolidated financial statements for the three and nine months ended September
        30, 2007 and September 30, 2006. We
        are
        presenting the pro forma and the adjusted pro forma information in order
        to
        provide a more meaningfulcomparison
        of our operating results with prior periods. The adjusted pro forma financial
        statements differ fromthe
        pro
        forma financial statements in that they exclude the amortization of intangible
        assets associated with themerger
        in
        determining adjusted proforma net income.
  Adjusted
          pro forma net income is an alternative view
          of performance
          used by management and
          we
          believe that investors' understanding of our performance is enhanced by
          disclosing this performance measure. We report adjusted pro forma net income
          in
          order to portray the results of our major operations - the
          construction, installation, marketing, and sale of various electronic security
          systems for commercial accounts and detention hardware (including security
          doors
          and frames, jail furniture, security glazing, and other security-based
          systems)
          and electronic control systems for correctional facilities - prior
          to
          considering certain income statement
          elements, principally amortization of intangible assets. We have defined
          adjusted pro forma net income
          as
          net income before the impact of purchase accounting for acquisitions,
          acquisition-related costs, discontinued
          operations and certain significant itettis including one time expenses
          associated with stock appreciation rights. The adjusted pro forma net income
          measure is not, and should not be viewed as, a substitute for
          U.S.
          GAAP net income.
  The
          adjusted pro forma net income measure is an important internal measurement
          for
          us. We intend to measure the performance of the overall Company on this
          basis.
          The following are examples of how the adjusted
          pro forma net income measure is planned to be utilized:
  ·
                Senior management receives a monthly analysis
                  of our
                  operating results that is prepared on an adjusted
                  pro forma net income basis;  ·
                Our annual budgets are prepared on an adjusted
                    pro forma
                    net income basis; and  ·
                Annual
                    and long-term compensation, including annual cash bonuses, merit-based
                    salary adjustment,and
                    share-based payments for various levels of management will consider
                    financial measures thatinclude
                    adjusted pro forma net income. The adjusted pro forma net income
                    measure
                    will represent asignificant
                    portion of target objectives that are utilized to determine the
                    annual
                    compensation forvarious
                    levels of management, although the actual weighting of the objective
                    may
                    vary by level ofmanagement
                    and job responsibility and may be considered in the determination
                    of
                    certain long-termcompensation
                    plans.
  Despite
          the importance of this measure to management in goal setting and performance
          measurement, we stress
          that adjusted pro forms net income is a non-GAAP financial measure that
          has no
          standardized meaning prescribed
          by US- GAAP and therefore, has limits in its usefulness to investors. Because
          of
          its non- standardized
          definition, adjusted pro forma net income (unlike U.S. GAAP net income)
          may not
          be comparable with the calculation of similar measures for other companies.
          Adjusted pro forma net income is presented
          solely to permit investors to more fully understand how management assesses
          our
          performance-
  We
          also
          recognize that, as an internal measure of performance, the adjusted pro
          forma
          net income mea sure
          has
          limitations and we do not restrict our performance-management process solely
          to
          this metric. A limitation
          of the adjusted pro forma net income measure is that it provides a view
          of our
          operations without including all events during a period such as the effects
          of
          an acquisition or amortization of purchased intan gibles
          and does not provide a comparable view of our performance to other companies
          in
          the security detention
          and construction industry.
  In
          addition, annual and long-term compensation, including annual cash bonuses,
          merit-based salary adjustments and share-based payments for various levels
          of
          management that will be made in future years will likely
          include a non-discretionary formula that measures our performance using
          revenue
          growth and rela tive
          total shareholder return.
  The
          adjusted pro forma results of operations are not necessarily indicative
          of the
          results of operations that may have actually occurred had the merger taken
          place
          on the dates noted, or the future financial position or operating
          results of us or ISI. The pro forma adjustments are based upon available
          information and assumptions that we believe are reasonable. The presentation
          of
          EBITDA (earnings before interest, taxes, depreciation and
          amortization) and adjusted pro forms results is not intended to be considered
          in
          isolation or as a substitute for
          the
          financial information prepared and presented in accordance with
          GAAP.
  EBITDA
          is
          used by management as a performance measure for benchmarking against the
          Company's peers and competitors. The Company believes EBITDA is useful
          to
          investors because it is frequently used by securities analysts, investors
          and
          other interested parties to evaluate companies in the security industry. EBITDA
          is
          not a recognized term under GAAP. Argyle and ISI compute EBITDA using the
          same consistent method
          from quarter to quarter. Below is a reconciliation of EBITDA to net loss.
          The
          presentation of EBITDA
          is
          not intended to be considered in isolation or as a substitute for the financial
          information prepared and
          presented in accordance with GAAP.


32





**Argyle
      Security, Inc**


**Adjusted
        Pro Forma Consolidated Statements of Operations**


**(unaudited)**




Three
                  Months Ended
                September
                  30,
              
              Nine
                  Months Ended
                September
                  30,2007
              
              2006
              
              2007
              
              2006Net
                  revenues:Contract
                  revenues
              
              $
              12,836,317
              
              $
              5,874,343
              
              $
              30,617,766
              
              $
              18,867,183Contract
                  revenues - related party
              
              
              8,132,200
              
              
              7,689,881
              
              
              21,298,650
              
              
              17,447,945Service
                  and other revenues
              
              
              2,618,961
              
              
              1,890,081
              
              
              8,309,825
              
              
              4,918,677$
              23,587,478
              
              $
              15,454,305
              
              $
              60,226,241
              
              $
              41,233,805Cost
                  of revenues:Contract
                  costs
              
              
              16,117,788
              
              
              10,807,659
              
              
              40,212,278
              
              
              29,018,321Service
                  and other costs, excluding amortization of intangibles
              
              
              1,810,152
              
              
              1,341,557
              
              
              6,169,651
              
              
              3,554,67017,927,940
              
              
              12,149,216
              
              
              46,381,929
              
              
              32,572,991Gross
                  profit
              
              
              5,659,538
              
              
              3,305,089
              
              
              13,844,312
              
              
              8,660,814Selling,
                  general and administrative expenses
              
              
              4,226,857
              
              
              2,841,152
              
              
              10,958,813
              
              
              8,069,396Operating
                  income / (loss)
              
              
              1,432,681
              
              
              463,937
              
              
              2,885,499
              
              
              591,419Other
                  income / (expense):Bank
                  interest income
              
              
              65,706
              
              
              62,297
              
              
              187,339
              
              
              182,755Interest
                  expense
              
              
              (479,379
              )
              
              (390,811
              )
              
              (1,305,854
              )
              
              (1,062,968
              )(413,673
              )
              
              (328,514
              )
              
              (1,118,514
              )
              
              (880,213
              )Income
                  / (loss) before provision for income taxes
              
              
              1,019,008
              
              
              135,424
              
              
              1,766,985
              
              
              (288,794
              )Provision
                  for income taxes
              
              
              387,223
              
              
              51,461
              
              
              671,454
              
              
              (109,742
              )Net
                  income / (loss)
              
              $
              631,785
              
              $
              83,963
              
              $
              1,095,531
              
              $
              (179,052
              )Weighted-average
                  number of shares outstanding:Basic
              
              
              5,749,342
              
              
              5,749,342
              
              
              5,749,342
              
              
              5,310,111Diluted
              
              
              6,838,828
              
              
              6,673,141
              
              
              6,817,980
              
              
              6,274,709Net
                  income / (loss) per share:Basic
              
              $
              0.11
              
              $
              0.01
              
              $
              0.19
              
              $
              (0.03
              )Diluted
              
              $
              0.09
              
              $
              0.01
              
              $
              0.16
              
              $
              (0.03
              )Weighted-average
                  number of shares outstanding exclusiveof
                  shares subject to possible redemption:Basic
              
              
              5,749,342
              
              
              5,749,342
              
              
              5,749,342
              
              
              5,310,111Diluted
              
              
              6,838,828
              
              
              6,673,131
              
              
              6,817,980
              
              
              6,274,709Net
                  income / (loss) per share exclusive of shares and relateddeferred
                  interest subject to possible redemption:Basic
              
              $
              0.11
              
              $
              0.01
              
              $
              0.19
              
              $
              (0.03
              )Diluted
              
              $
              0.09
              
              $
              0.01
              
              $
              0.16
              
              $
              (0.03
              )


See
                notes to unaudited financial
                statements




33


**Reconciliation
        of GAAP Net Income / (Loss) to Adjusted Pro Forma Net Income / (Loss) and
        Adjusted Pro Forma EBITDA**
 **(unaudited)**


Three
                  Months Ended
                September
                  30,
              
              Nine
                  Months Ended
                September
                  30,2007
              
              2006
              
              2007
              
              2006**GAAP
                  Net Income**
              
              **$**
              **(116,119**
              **)**
              **$**
              **63,060**
              
              **$**
              **(14,725**
              **)**
              **$**
              **(81,875**
              **)****Pro
                  Forma Adjustments - Addbacks / (Reductions):**Argyle
                  Salary Expense (Increase) for Management Team for 2006 and
                  2007
              
              
              (50,000
              )
              
              (222,000
              )
              
              (350,000
              )
              
              (666,000
              )Non-Cash
                  Compensation Expense (Increase) for 2006 amd 2007
              
              
              (26,693
              )
              
              (80,078
              )
              
              (186,848
              )
              
              (240,233
              )SARS
                  Adjustment Expense Reduction for 2007
              
              
              1,363,645
              
              
              —
              
              
              1,363,645
              
              
              —Depreciation
                  Expense (Increase) for 2006 and 2007
              
              
              —
              
              
              (34,833
              )
              
              (69,667
              )
              
              (104,500
              )Amortization
                  of Intangibles Expense in COGS (Increase) for 2007 &
                  2006
              
              
              (280,063
              )
              
              (840,189
              )
              
              (1,960,441
              )
              
              (2,520,567
              )Amortization
                  of Intangibles Expense in SG&A (Increase) for 2007 &
                  2006
              
              
              (111,019
              )
              
              (333,057
              )
              
              (777,133
              )
              
              (999,171
              )Interest
                  Income (Reduction) for 2006 and 2007
              
              
              (108,882
              )
              
              (325,549
              )
              
              (762,820
              )
              
              (781,609
              )Interest
                  Expense Reduction for 2006 and 2007
              
              
              154,736
              
              
              623,399
              
              
              2,127,162
              
              
              1,915,936GAAP
                  Net Income / (Loss) for July
              
              
              364,698
              
              
              70,310
              
              
              364,698
              
              
              70,310GAAP
                  Net Income / (Loss) for January - June
              
              
              —
              
              
              —
              
              
              (495,811
              )
              
              (448,619
              )Change
                  in Taxes from GAAP versus Pro Forma Net Income / (Loss)
              
              
              (1,285,930
              )
              
              435,487
              
              
              (324,767
              )
              
              1,495,038**Pro
                  Forma Net Income / (Loss)**
              
              **$**
              **(95,627**
              **)**
              **$**
              **(643,450**
              **)**
              **$**
              **(1,086,707**
              **)**
              **$**
              **(2,361,290**
              **)**Amortization
                  of Intangibles Expense in COGS Reduction for 2007 &
                  2006
              
              
              840,189
              
              
              840,189
              
              
              2,520,567
              
              
              2,520,567Amortization
                  of Intangibles Expense in SG&A Reduction for 2007 &
                  2006
              
              
              333,057
              
              
              333,057
              
              
              999,171
              
              
              999,171Change
                  in Taxes from GAAP versus Pro Forma Net Income / (Loss)
              
              
              (445,833
              )
              
              (445,833
              )
              
              (1,337,500
              )
              
              (1,337,500
              )**Adjusted
                    Pro Forma Net Income / (Loss)**
              
              **$**
              **631,785**
              
              **$**
              **83,963**
              
              **$**
              **1,095,531**
              
              **$**
              **(179,052**
              **)**Interest,
                  net
              
              
              413,673
              
              
              328,514
              
              
              1,118,514
              
              
              880,213Non-cash
                  compensation expense (123R)
              
              
              80,078
              
              
              80,078
              
              
              240,233
              
              
              240,233Depreciation
              
              
              227,010
              
              
              261,843
              
              
              771,865
              
              
              806,143Amortization
              
              
              87,360
              
              
              87,360
              
              
              262,080
              
              
              262,080Taxes,
                  net
              
              
              387,223
              
              
              51,461
              
              
              671,454
              
              
              (109,742
              )**Pro
                  Forma EBITDA**
              
              **$**
              **1,827,128**
              
              **$**
              **893,218**
              
              **$**
              **4,159,677**
              
              **$**
              **1,899,875**
 **Nine
                          months ended:****9/30/2007**
                      
                      
                      
                      
                      
                      
                      
                      **9/30/2006**
                      
                      **Percent
                          increase <decrease>****ISI**
                      
                      **MCS**
                      
                      **Commercial**
                      
                      **Total**
                      
                      **ISI**
                      
                      **MCS**
                      
                      **Commercial**
                      
                      **Total**
                      
                      **ISI**
                      
                      **MCS**
                      
                      **Commercial**
                      
                      **Total**RevenuesContract
                          Revenues
                      
                      
                      22,714,661
                      
                      
                      13,480,360
                      
                      
                      15,721,396
                      
                      
                      51,916,417
                      
                      
                      14,650,895
                      
                      
                      9,795,347
                      
                      
                      11,868,887
                      
                      
                      36,315,129
                      
                      
                      55.0
                      %
                      
                      37.6
                      %
                      
                      32.5
                      %
                      
                      43.0
                      %Service
                          Revenues
                      
                      
                      42,093
                      
                      
                      144,663
                      
                      
                      8,106,088
                      
                      
                      8,292,844
                      
                      
                      82,064
                      
                      
                      122,750
                      
                      
                      4,677,065
                      
                      
                      4,881,879
                      
                      
                      -48.7
                      %
                      
                      17.9
                      %
                      
                      73.3
                      %
                      
                      69.9
                      %Other
                          Revenue
                      
                      
                      12,764
                      
                      
                      1,586
                      
                      
                      2,630
                      
                      
                      16,980
                      
                      
                      22,090
                      
                      
                      1,464
                      
                      
                      13,243
                      
                      
                      36,797
                      
                      
                      -42.2
                      %
                      
                      8.3
                      %
                      
                      -80.1
                      %
                      
                      -53.9
                      %**Total
                          Revenue**
                      ****
                      ****
                      **22,769,518**
                      ****
                      ****
                      **13,626,609**
                      ****
                      ****
                      **23,830,114**
                      ****
                      ****
                      **60,226,241**
                      ****
                      ****
                      **14,755,049**
                      ****
                      ****
                      **9,919,561**
                      ****
                      ****
                      **16,559,195**
                      ****
                      ****
                      **41,233,805**
                      ****
                      ****
                      54.3
                      %
                      
                      37.4
                      %
                      
                      43.9
                      %
                      
                      46.1
                      %***%
                          of Total***
                      
                      
                      37.8
                      %
                      
                      22.6
                      %
                      
                      39.6
                      %
                      
                      100.0
                      %
                      
                      35.8
                      %
                      
                      24.1
                      %
                      
                      40.2
                      %
                      
                      100.0
                      %Cost
                          of RevenuesContract
                          Cost
                      
                      
                      17,299,439
                      
                      
                      10,151,676
                      
                      
                      12,761,162
                      
                      
                      40,212,277
                      
                      
                      11,691,659
                      
                      
                      7,295,635
                      
                      
                      10,031,027
                      
                      
                      29,018,321
                      
                      
                      48.0
                      %
                      
                      39.1
                      %
                      
                      27.2
                      %
                      
                      38.6
                      %Service
                          Cost
                      
                      
                      27,788
                      
                      
                      136,590
                      
                      
                      6,005,274
                      
                      
                      6,169,652
                      
                      
                      65,419
                      
                      
                      114,394
                      
                      
                      3,374,857
                      
                      
                      3,554,670
                      
                      
                      -57.5
                      %
                      
                      19.4
                      %
                      
                      77.9
                      %
                      
                      73.6
                      %Other
                          Cost
                      
                      
                      —
                      
                      
                      —**Total
                          Cost**
                      ****
                      ****
                      **17,327,227**
                      ****
                      ****
                      **10,288,266**
                      ****
                      ****
                      **18,766,436**
                      ****
                      ****
                      **46,381,929**
                      ****
                      ****
                      **11,757,078**
                      ****
                      ****
                      **7,410,029**
                      ****
                      ****
                      **13,405,884**
                      ****
                      ****
                      **32,572,991**
                      ****
                      ****
                      47.4
                      %
                      
                      38.8
                      %
                      
                      40.0
                      %
                      
                      42.4
                      %Gross
                          MarginGM
                          -
                          Revenue
                      
                      
                      5,415,222
                      
                      
                      3,328,684
                      
                      
                      2,960,234
                      
                      
                      11,704,140
                      
                      
                      2,959,236
                      
                      
                      2,499,712
                      
                      
                      1,837,860
                      
                      
                      7,296,808
                      
                      
                      83.0
                      %
                      
                      33.2
                      %
                      
                      61.1
                      %
                      
                      60.4
                      %GM
                          -
                          Service
                      
                      
                      14,305
                      
                      
                      8,073
                      
                      
                      2,100,814
                      
                      
                      2,123,192
                      
                      
                      16,645
                      
                      
                      8,356
                      
                      
                      1,302,208
                      
                      
                      1,327,209
                      
                      
                      -14.1
                      %
                      
                      -3.4
                      %
                      
                      61.3
                      %
                      
                      60.0
                      %GM
                          -
                          Other
                      
                      
                      12,764
                      
                      
                      1,586
                      
                      
                      2,630
                      
                      
                      16,980
                      
                      
                      22,090
                      
                      
                      1,464
                      
                      
                      13,243
                      
                      
                      36,797
                      
                      
                      -42.2
                      %
                      
                      8.3
                      %
                      
                      -80.1
                      %
                      
                      -53.9
                      %**Total
                          Gross Margin**
                      ****
                      ****
                      **5,442,291**
                      ****
                      ****
                      **3,338,343**
                      ****
                      ****
                      **5,063,678**
                      ****
                      ****
                      **13,844,312**
                      ****
                      ****
                      **2,997,971**
                      ****
                      ****
                      **2,509,532**
                      ****
                      ****
                      **3,153,311**
                      ****
                      ****
                      **8,660,814**
                      
                      
                      81.5
                      %
                      
                      33.0
                      %
                      
                      60.6
                      %
                      
                      59.9
                      %***%
                          of Total***
                      
                      
                      39.3
                      %
                      
                      24.1
                      %
                      
                      36.6
                      %
                      
                      100.0
                      %
                      
                      34.6
                      %
                      
                      29.0
                      %
                      
                      36.4
                      %
                      
                      100.0
                      %Gross
                          Margin %GM
                          -
                          Revenue
                      
                      
                      23.8
                      %
                      
                      24.7
                      %
                      
                      18.8
                      %
                      
                      22.5
                      %
                      
                      20.2
                      %
                      
                      25.5
                      %
                      
                      15.5
                      %
                      
                      20.1
                      %
                      
                      18.0
                      %
                      
                      -3.2
                      %
                      
                      21.6
                      %
                      
                      12.2
                      %GM
                          -
                          Service
                      
                      
                      34.0
                      %
                      
                      5.6
                      %
                      
                      25.9
                      %
                      
                      25.6
                      %
                      
                      20.3
                      %
                      
                      6.8
                      %
                      
                      27.8
                      %
                      
                      27.2
                      %
                      
                      67.6
                      %
                      
                      -18.0
                      %
                      
                      -6.9
                      %
                      
                      -5.8
                      %GM
                          -
                          Other
                      
                      
                      100.0
                      %
                      
                      100.0
                      %
                      
                      100.0
                      %
                      
                      100.0
                      %
                      
                      100.0
                      %
                      
                      100.0
                      %
                      
                      100.0
                      %
                      
                      100.0
                      %
                      
                      0.0
                      %
                      
                      0.0
                      %
                      
                      0.0
                      %
                      
                      0.0
                      %**Total
                          Gross Margin**
                      
                      
                      23.9
                      %
                      
                      24.5
                      %
                      
                      21.2
                      %
                      
                      23.0
                      %
                      
                      20.3
                      %
                      
                      25.3
                      %
                      
                      19.0
                      %
                      
                      21.0
                      %
                      
                      17.6
                      %
                      
                      -3.2
                      %
                      
                      11.6
                      %
                      
                      9.4
                      %


Pro
        forma
        results for the nine months ended at September 2007 ISI Detention segment
        revenues increased by 2.0% of total Company revenues from the same period
        in
        2006. This increase for ISI Detention was mainly offset by the 1.5% reduction
        of
        revenues in MCS Detention. The total Company margin increase from 21.0% to
        23.0%
        was directly attributable to the increased margins in the IS Detention
        (increased 3.6%) and MCS Commercial (increased 2.2%) which had the largest
        portion of revenues. As previously discussed the reduction in the MCS Detention
        revenue mix of 1.5% of total revenues with its decreased margins of 0.8%
        only
        minimally impacted the overall Company increase.
  **Discussion
        of Financial Results**


*Revenues*




More
      than
      85% of ISI’s revenues are 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.


34




ISI
        also
        generates service revenues. These are generally short-term projects which
        are
        evidenced by signed service agreements, customer work orders or purchase
        orders.
        These sales agreements/customer orders generally provide for billing to
        customers based on time at quoted hourly or project rates, plus costs of
        materials and supplies furnished by ISI. Service revenues are recognized
        when
        the services have been delivered to and accepted by the customer.
  This
        is
        our first quarter of reportable revenues. Prior to our acquisition of ISI,
        we
        had no revenues.
 
 *Cost
        of Revenues*
  Cost
        of
        revenues consists the direct costs to complete a material fixed-price contract
        and include variable costs related to the project, such as material, direct
        labor, project management costs, travel related expenses to the projects,
        hotel
        costs spent while the project is on-going, truck expenses utilized on those
        projects and cell phones of the personnel while they are on those projects.
        We
        also review our inventories for indications of obsolescence or impairment
        and
        provide reserves as deemed necessary. Cost of revenues also includes
        depreciation and amortization expense on assets used in the manufacturing
        process.




*Selling,
      General and Administrative Expenses*




Selling,
      general and administrative expenses consist primarily of salaries and benefits
      for selling and administrative personnel, including the human resources,
      executive, finance and legal. These expenses also include fees for professional
      services and other administrative expenses.





**Results
      of Operations for the nine-month periods ended September 30, 2007 and
      2006**





For
      the
      nine months ended September 30, 2007, we had a net loss of ($14,725) compared
      to
      a net loss of ($81,875) for the corresponding period in 2006. The results of
      operations for the nine months ended September 30, 2007 include the results
      of
      operations for ISI from August 1, 2007 through September 30, 2007. Our primary
      source of income prior to the consummation of our initial business combination
      with ISI was interest earned on the funds held in the trust
      account.


For
          the
          nine months ended September 30, 2007, we had pro forma net loss of ($1,086,707)
          compared to a pro forma net loss of ($2,361,290) for the corresponding
          period in
          2006. For the nine months ended September 30, 2007, we had a adjusted pro
          forma
          net income of $1,095,531 compared to a adjusted pro forma net loss of ($179,052)
          for the corresponding period in 2006. The results for the nine months ended
          September 30, 2007 include the results of operations for ISI from January
          1,
          2007 through September 30, 2007. Our primary source of income prior to
          the
          consummation of our initial business combination with ISI was interest
          earned on
          the funds held in a trust account.
  **Revenues**




This
      is
      our first quarter of reportable revenues. Prior to our acquisition of ISI,
      we
      had no revenues.


*Pro
        Forma Net Revenues*


The
        following table presents adjusted pro forma net revenues for the nine months
        ended September 30, 2007 and September 31, 2006:




**Pro
                    Forma Net Revenues****Nine
                  Months Ended**
              
              **Nine
                  Months Ended**
              
              **Year
                    to Year****September
                  30, 2007**
              
              **September
                  30, 2006**
              
              **Increase
                  / (Decrease)****%
                  of**
                **Net**
              
              
              
              **%
                  of**
                **Net**
              
              
              
              **%
                  Inc /****Amount**
              
              **Revenue**
              
              **Amount**
              
              **Revenue**
              
              **Amount**
              
              **(Decr)****Contract
                  revenues**
              
              $
              30,617,766
              
              
              50.8
              
              $
              18,867,183
              
              
              45.8
              
              $
              11,750,583
              
              
              62.3
              %**Contract
                  revenues - related party**
              
              
              21,298,650
              
              
              35.4
              
              
              17,447,945
              
              
              42.3
              
              
              3,850,705
              
              
              22.1
              %**Service
                  and other revenues**
              
              
              8,309,825
              
              
              13.8
              
              
              4,918,677
              
              
              11.9
              
              
              3,391,148
              
              
              68.9
              %**Net
                    revenues**
              
              $
              60,226,241
              
              
              100.0
              
              $
              41,233,805
              
              
              100.0
              
              $
              18,992,436
              
              
              46.1
              %


On
          a pro forma basis, ISI had revenues of $60.2 million (including related
          party
          revenue of $21.3 million) and $41.2 million (including related party
          revenue of $17.4 million) for the nine months ended September 30, 2007 and
          2006, respectively, representing an increase of $19.0 million or 46.1%.
          The
          significant increase in contract revenues is primarily due to several major
          factors including, but not limited to, the addition of new products through
          the
          development of internal software applications that has allowed the company
          to
          capture a larger part of the market. Also, the Company has focused on building
          service revenue base by adding salespeople and improving performance to
          retain
          more customers, which has contributed to the increase in service revenues
          by
          approximately 68.9% over the same period last year.
  As
          used
          in this analysis, “related party” revenue is that revenue that is generated by
          work sub-contracted from ISI*MCS (an entity owned 67.0% by Sam Youngblood,
          CEO
          of ISI, and 33.0% by Don Carr, President of ISI).  Messrs. Youngblood and
          Carr created ISI*MCS in 2004 to provide bonding on contracts that require
          bonding. The performance of those contracts is subcontracted to ISI as
          a
          subcontractor to ISI*MCS.  The sub-contracted work is for third party
          customers of ISI*MCS that require bonded contracts.  After the merger,
          ISI*MCS will no longer provide bonding and subcontract work to ISI and
          ISI will
          secure its own bonding capacity and use that bonding capacity to directly
          enter
          into bonded contracts with third party customers, thereby eliminating the
          need
          to contract for the work as a subcontractor to ISI*MCS. After the merger,
          the
          amount of “Revenues - related party” will decrease annually as the contracts
          with ISI*MCS, outstanding at the time of the merger, are completed.
 
 The
          pro
          forma revenue mix was 86.2% contract revenues and 13.8% service revenues
          for the
          nine months ended September 30, 2007 compared to 88.1% and 11.9%, respectively,
          for the corresponding period in 2006.
  35
  **Cost
          of Revenues**


This
        has
        been our first quarter of reportable cost of revenues. Prior to our acquisition
        of ISI, we had no cost of revenues.
  *Adjusted
        Pro Forma Cost of Revenues*
  The
        following table presents adjusted pro forma cost of revenues for the nine
        months
        ended September 30, 2007 and September 31, 2006:


**Adjusted
                  Pro Forma Cost of Revenues****Nine
                  Months Ended September 30, 2007**
              
              **Nine
                  Months Ended September 30, 2006**
              
              **Year
                  to Year Increase / (Decrease)****Amount**
              
              **%
                  of**
                **Net**
                **Revenue**
              
              **Amount**
              
              **%
                  of**
                **Net**
                **Revenue**
              
              **Amount**
              
              **%
                  Inc / (Decr)****Contract
                  costs**
              
              $
              40,212,278
              
              
              66.8
              
              $
              29,018,321
              
              
              70.4
              
              $
              11,193,957
              
              
              38.6
              %**Service
                  and other costs, excluding amortization of
                  intangibles**
              
              
              6,169,651
              
              
              10.2
              
              
              3,554,670
              
              
              8.6
              
              
              2,614,981
              
              
              73.6
              %**Adjusted
                  pro forma total cost of revenues**
              
              $
              46,381,929
              
              
              77.0
              
              $
              32,572,991
              
              
              79.0
              
              $
              13,808,938
              
              
              42.4
              %**Amortization
                  of intangibles**
              
              
              2,520,567
              
              
              4.2
              
              
              2,520,567
              
              
              6.1
              
              
              —
              
              
              —**Pro
                  forma cost of revenues**
              
              $
              48,902,496
              
              
              81.2
              
              $
              35,093,558
              
              
              85.1
              
              $
              13,808,938
              
              
              39.3
              %


On
        a pro
        forma basis, cost of revenues increased by $13.8 million, or 39.3%, to $48.9
        million for the nine months ended September 30, 2007, compared to $35.1 million
        for the corresponding period in 2006. On a adjusted pro forma basis, cost
        of
        revenues increased by $13.8 million, or 42.4%, to $46.4 million for the nine
        months ended September 30, 2007, compared to $32.6 million for the corresponding
        period in 2006. The increase in cost of sales resulted from ISI working on
        a
        greater number of projects in 2007 than in 2006. However, while the number
        of
        projects rose from 2006, the relative percentage of material cost and labor
        cost
        remained relatively constant between the two periods.
  The
        amortization of acquired backlog has been allocated to cost of revenues and
        primarily relates to the developed technology acquired from the acquisition
        of
        ISI on July 31, 2007. The impact of this amortization (which was excluded
        from
        pro forma cost of sales for the adjusted cost of sales) for the nine months
        ended September 30, 2007 was $2.5 million.




**Gross
      Margin**




This
      has
      been our first quarter of reportable gross margin. Prior to our acquisition
      of
      ISI, we had no gross margin.


*Adjusted
        Pro Forma Gross Margin*
  The
        following table presents adjusted pro forma gross margin for the nine months
        ended September 30, 2007 and September 31, 2006:
 **Adjusted
                    Pro Forma Gross Margin****Nine
                    Months Ended**
                  **September
                    30, 2007**
                
                **Nine
                    Months Ended**
                  **September
                    30, 2006**
                
                **Year
                    to Year**
                  **Increase
                    /**
                  **(Decrease)****Amount**
                
                **%
                    of**
                  **Net**
                  **Revenue**
                
                **Amount**
                
                **%**
                  **of
                    Net**
                  **Revenue**
                
                **Amount**
                
                **%
                    Inc / (Decr)****Adjusted
                    pro forma gross margins**
                
                $
                13,844,312
                
                
                23.0
                
                $
                8,660,814
                
                
                21.0
                
                $
                5,183,498
                
                
                59.9
                %**Amortization
                    of intangibles**
                
                
                (2,520,567
                )
                
                (4.2
                )
                
                (2,520,567
                )
                
                (6.1
                )
                
                —
                
                
                —**Pro
                    forma gross margins**
                
                $
                11,323,745
                
                
                18.8
                
                $
                6,140,247
                
                
                14.9
                
                $
                5,183,498
                
                
                84.4
                %
 On
          a pro
          forma basis for the nine months ended September 30, 2007, there was gross
          margin
          of $11.3 million compared to a gross margin of $6.1 million for the
          corresponding period in 2006. On a adjusted pro forma basis for the nine
          months
          ended September 30, 2007, there was gross margin of $13.8 million compared
          to a
          gross margin of $8.7 million for the corresponding period in 2006. The
          increase
          in adjusted gross margin was directly attributable to  the Company's
          stronger pricing position which provides higher margins and development
          of
          software to automate production, which allows for efficiencies in production
          and
          thus lowers costs, thus increasing gross margins. A major contributor to
          the
          increase in gross margin is the increase in service revenues as a
          percentage of the overall revenues. The service revenues enjoy a higher
          gross
          margin than the contract revenues. The company also increased gross margin
          by
          controlling costs through the upgrading of project management processes
          to
          support installations and services.


36


The
        amortization of acquired backlog in the cost of sales section has been allocated
        to cost of revenues and represents the only difference between pro forma
        gross
        margins and adjusted pro forma gross margins for the nine months ended September
        30, 2007 and 2006.
 
 **Selling,
        General and Administrative Expenses**
  Selling,
        general, and administrative expenses consist primarily of salaries and benefits
        for selling and administrative personnel, including human resources, executive,
        finance, and legal. These expenses also include fees for professional services
        and other administrative expenses. Selling, general, and administrative expenses
        increased to $4.1 million for the nine months ended September 30, 2007, compared
        to $0.8 million for the corresponding period in 2006. The expense increase
        is
        attributed to the acquisition of ISI on July 31, 2007.
 
 *Adjusted
        Pro Forma Selling, General and Administrative Expenses*
  The
        following table presents adjusted pro forma selling, general and administrative
        expenses for the nine months ended September 30, 2007 and September 31,
        2006:


**Adjusted
                  Pro Forma Operating Expenses****Nine
                  Months Ended September 30, 2007**
              
              **Nine
                  Months Ended September 30, 2006**
              
              **Year
                  to Year Increase / (Decrease)****Amount**
              
              **%
                  of**
                **Net**
                **Revenue**
              
              **Amount**
              
              **%
                  of**
                **Net**
                **Revenue**
              
              **Amount**
              
              **%
                  Inc / (Decr)****Adjusted
                  pro forma total operating expenses**
              
              $
              10,958,813
              
              
              18.2
              
              $
              8,069,396
              
              
              19.6
              
              $
              2,889,418
              
              
              35.8
              %**Amortization
                  of intangible assets**
              
              
              999,171
              
              
              1.7
              
              
              999,171
              
              
              2.4
              
              
              —
              
              
              0.0
              %**Pro
                  forma total operating expenses**
              
              $
              11,957,984
              
              
              19.9
              
              $
              9,068,567
              
              
              22.0
              
              $
              2,889,418
              
              
              31.9
              %


On
        a pro
        forma basis, selling, general and administrative expenses increased $2.9
        million
        to $12.0 million for the nine months ended September 30, 2007 from $9.1 million
        for the corresponding period in 2006. On a adjusted pro forma basis, selling,
        general and administrative expenses increased $2.9 million to $10.9 million
        for
        the nine months ended September 30, 2007 from $8.0 million for the corresponding
        period in 2006. The increase is primarily due to additional expenses needed
        to
        support the increased number of projects on which ISI is working, increased
        sales and marketing efforts to promote future growth, and corporate services
        expenses associated with the parent company entity.
  Additionally,
        $1.4 million in compensation expense related to stock appreciation rights
        granted in connection with the acquisition that were recorded by ISI in July
        2007 have been excluded from pro forma and adjusted pro forma selling, general
        and administrative expenses. The amortization of customer base and software
        has
        been allocated to selling, general, and administrative expenses and primarily
        relates to the acquisition of ISI on July 31, 2007. The impact of this
        amortization, which was excluded from pro forma selling, general, and
        administrative expenses for the adjusted pro forma selling, general, and
        administrative expenses, for the nine months ended September 30, 2007 and
        2006
        was $1.0 million.




37




**Other
      Income/Expense**




Total
      other income/expense represents interest earned on the net proceeds of our
      initial public offering and the private placement held in trust through the
      date
      of the acquisition and interest expense for interest on our line of credit,
      unsecured subordinated debt, and our bridge notes issued in April 2007. Total
      other income/expense for the nine months ended September 30, 2007 was $0.5
      million compared to $0.9 million for the corresponding period in 2006.


*Pro
        Forma Interest Income and Interest Expense*
 
 The
        following table presents adjusted pro forma interest and other income for
        the
        nine months ended September 30, 2007 and September 31, 2006:


**Pro
                  Forma Other Income/Expense****Nine
                  Months Ended September 30, 2007**
              
              **Nine
                  Months Ended September 30, 2006**
              
              **Year
                  to Year Increase / (Decrease)****Amount**
              
              **%
                  of**
                **Net**
                **Revenue**
              
              **Amount**
              
              **%
                  of**
                **Net**
                **Revenue**
              
              **Amount**
              
              **%
                  Inc / (Decr)****Interest
                  on cash and cash equivalents held in trust**
              
              $
              187,339
              
              
              0.3
              
              $
              182,755
              
              
              0.4
              
              $
              4,584
              
              
              2.5
              %**Interest
                  expense**
              
              
              (1,305,854
              )
              
              (2.2
              )
              
              (1,062,968
              )
              
              (2.6
              )
              
              (242,886
              )
              
              22.8
              %**Interest,
                  net**
              
              $
              (1,118,514
              )
              
              (1.9
              )
              $
              (880,213
              )
              
              (2.2
              )
              $
              (238,302
              )
              
              27.1
              %


Pro
          forma net interest for the nine months ended September 30, 2007 mainly
          represents interest earned on the net proceeds of our initial public offering
          and the private placement held in trust through the date of the acquisition.
          Interest expense increased to $(1.3) million from for the three months
          ended
          September 30, 2007 from $(1.1) million for the corresponding period in
          2006.
          Interest expense for the nine months ended September 30, 2007 and 2006
          mainly
          represents interest on our line of credit, unsecured subordinated debt,
          and our
          bridge notes issued in April 2007.
 
 **Earnings
          before Interest, Taxes, Depreciation and Amortization
          (“EBITDA”)**


**Pro
                  Forma EBITDA****Nine
                  Months Ended September 30, 2007**
              
              **Nine
                  Months Ended September 30, 2006**
              
              **Year
                  to Year Increase / (Decrease)****Amount**
              
              **%****of**
                **Net**
                **Revenue**
              
              **Amount**
              
              **%
                  of**
                **Net**
                **Revenue**
              
              **Amount**
              
              **%
                  Inc / (Decr)****Pro
                  Forma EBITDA**
              
              $
              4,159,677
              
              
              6.9
              
              $
              1,899,875
              
              
              4.6
              
              $
              2,259,802
              
              
              118.9
              %


Pro
          forma
          and adjusted pro forma EBITDA rose by 118.9% to $4.2 million in the third
          quarter of 2007, compared to $1.9 in the prior year period. The EBITDA
          margin
          increased to 6.9% from 4.6%.




38




**Results
      of Operations for the three-month periods ended September 30, 2007 and 2006**





For
      the
      three months ended September 30, 2007, we had a net loss of ($116,119) compared
      to a net income of $63,060 for the corresponding period in 2006. The results
      of
      operations for the three months ended September 30, 2007 include the results
      of
      operations for ISI from August 1, 2007 through September 30, 2007. Our primary
      source of income prior to the consummation of our initial business combination
      with ISI was interest earned on the funds held in the trust
      account.


For
        the
        three months ended September, 2007, we had a pro forma net loss of ($95,627)
        compared to a pro forma net loss of ($643,450) for the corresponding period
        in
        2006. For the three months ended September, 2007, we had a adjusted pro forma
        net income of $631,755 compared to a adjusted pro forma net income of $83,963
        for the corresponding period in 2006. The results for the three months ended
        September 30, 2007 include the results of operations for ISI from August
        1, 2007
        through September 30, 2007. Our primary source of income prior to the
        consummation of our initial business combination with ISI was interest earned
        on
        the funds held in a trust account.


**Revenues**




This
      is
      our first quarter of reportable revenues. Prior to our acquisition of ISI,
      we
      had no revenues.


*Pro
        Forma Net Revenues*
  The
        following table presents adjusted pro forma net revenues for the three months
        ended September 30, 2007 and September 31, 2006:
 **Pro
                    Forma Net Revenues****Three
                    Months Ended September 30, 2007**
                
                **Three
                    Months Ended September 30, 2006**
                
                **Year
                    to Year Increase / (Decrease)****Amount**
                
                **%
                    of**
                  **Net**
                  **Revenue**
                
                **Amount**
                
                **%
                    of**
                  **Net**
                  **Revenue**
                
                **Amount**
                
                **%
                    Inc / (Decr)****Contract
                    revenues**
                
                $
                12,836,317
                
                
                54.4
                
                $
                5,874,343
                
                
                38.0
                
                $
                6,961,974
                
                
                118.5
                %**Contract
                    revenues - related party**
                
                
                8,132,200
                
                
                34.5
                
                
                7,689,881
                
                
                49.8
                
                
                442,319
                
                
                5.8
                %**Service
                    and other revenues**
                
                
                2,618,961
                
                
                11.1
                
                
                1,890,081
                
                
                12.2
                
                
                728,880
                
                
                38.6
                %**Net
                    revenues**
                
                $
                23,587,478
                
                
                100.0
                
                $
                15,454,305
                
                
                100.0
                
                $
                8,133,173
                
                
                52.6
                %
 On
          a pro
          forma basis, ISI had revenues of $23.6 million (including related party
          revenue
          of $8.1 million) and $15.4 million (including related party revenue of $8
          million) for the three months ended September 30, 2007 and 2006,
          respectively, representing an increase of $8.1 million or 52.6%. The increase
          in
          revenues is largely attributable to the company participating in a greater
          number of new projects due to better market conditions.


As
      used
      in this analysis, “related party” revenue is that revenue that is generated by
      work sub-contracted from ISI*MCS (an entity owned 67.0% by Sam Youngblood,
      CEO
      of ISI, and 33.0% by Don Carr, President of ISI).  Messrs. Youngblood and
      Carr created ISI*MCS in 2004 to provide bonding on contracts that require
      bonding. The performance of those contracts is subcontracted to ISI as a
      subcontractor to ISI*MCS.  The sub-contracted work is for third party
      customers of ISI*MCS that require bonded contracts.  After the merger,
      ISI*MCS will no longer provide bonding and subcontract work to ISI and ISI
      will
      secure its own bonding capacity and use that bonding capacity to directly enter
      into bonded contracts with third party customers, thereby eliminating the need
      to contract for the work as a subcontractor to ISI*MCS. After the merger, the
      amount of “Revenues - related party” will decrease annually as the contracts
      with ISI*MCS, outstanding at the time of the merger, are completed.


The
        pro
        forma revenue mix at 88.9% contract revenues and 11.1% service revenues for
        the
        three months ended September 30, 2007 compared to 87.8% and 12.2%, respectively,
        for the corresponding period in 2006.


39




**Cost
      of Revenues**




This
      has
      been our first quarter of reportable cost of revenues. Prior to our acquisition
      of ISI, we had no cost of revenues.


*Adjusted
        Pro Forma Cost of Revenues*
  The
        following table presents adjusted pro forma cost of revenues for the three
        months ended September 30, 2007 and September 31, 2006:


**Adjusted
                  Pro Forma Cost of Revenues****Three
                  Months Ended September 30, 2007**
              
              **Three
                  Months Ended September 30, 2006**
              
              **Year
                  to Year Increase / (Decrease)****Amount**
              
              **%
                  of**
                **Net**
                **Revenue**
              
              **Amount**
              
              **%
                  of**
                **Net**
                **Revenue**
              
              **Amount**
              
              **%
                  Inc / (Decr)****Contract
                  costs**
              
              $
              16,117,788
              
              
              68.3
              
              $
              10,807,659
              
              
              69.9
              
              $
              5,310,129
              
              
              49.1
              %**Service
                  and other costs, including amortization of
                  intangibles**
              
              
              1,810,152
              
              
              7.7
              
              
              1,341,557
              
              
              8.7
              
              
              468,595
              
              
              34.9
              %**Adjusted
                  pro forma total cost of revenues**
              
              $
              17,927,940
              
              
              76.0
              
              $
              12,149,216
              
              
              78.6
              
              $
              5,778,724
              
              
              47.6
              %**Amortization
                  of intangibles**
              
              
              840,189
              
              
              3.6
              
              
              840,189
              
              
              5.5
              
              
              —
              
              
              —**Pro
                  forma cost of revenues**
              
              $
              18,768,129
              
              
              79.6
              
              $
              12,989,405
              
              
              84.1
              
              $
              5,778,724
              
              
              44.5
              %


On
        a pro
        forma basis, cost of revenues increased by $5.8 million or 44.5% to $18.8
        million for the three months ended September 30, 2007, compared to $13.0
        million
        for the corresponding period in 2006. On a adjusted pro forma basis, cost
        of
        revenues increased by $5.8 million or 47.6% to $17.9 million for the three
        months ended September 30, 2007, compared to $12.1 million for the corresponding
        period in 2006. Adjusted pro forma revenues increased 52.6%; however, the
        corresponding pro forma cost of revenues as a percentage of revenue decreased
        resulting in an increase in the overall gross margin. The increase in cost
        of
        sales resulted from ISI working on a greater number of projects in 2007 than
        in
        2006. However, while the number of projects rose from 2006, the relative
        percentage of material cost and labor cost remained relatively constant between
        the two periods.
 
 The
        amortization of acquired backlog has been allocated to cost of revenues and
        primarily relates to the developed technology acquired from the acquisition
        of
        ISI on July 31, 2007. The impact of this amortization, which was excluded
        from
        pro forma cost of sales for the adjusted cost of sales, for the three months
        ended September 30, 2007 and 2006 was $0.8 million.


**Gross
      Margin**




This
      has
      been our first quarter of reportable gross margin. Prior to our acquisition
      of
      ISI, we had no gross margin.


*Adjusted
        Pro Forma Gross Margin*
 
 The
        following table presents adjusted pro forma gross margin for the three months
        ended September 30, 2007 and September 31, 2006:
 **Adjusted
                    Pro Forma Gross Margin****Three
                    Months Ended September 30, 2007**
                
                **Three
                    Months Ended September 30, 2006**
                
                **Year
                    to Year Increase / (Decrease)****Amount**
                
                **%****of
                    Net Revenue**
                
                **Amount**
                
                **%
                    of Net Revenue**
                
                **Amount)**
                
                **%****Inc
                    / (Decr)****Adjusted
                    pro forma gross margins**
                
                $
                5,659,538
                
                
                24.0
                
                $
                3,305,089
                
                
                21.4
                
                $
                2,354,449
                
                
                71.2
                %**Amortization
                    of intangibles**
                
                
                (840,189
                )
                
                (3.6
                )
                
                (840,189
                )
                
                (5.5
                )
                
                —
                
                
                —**Pro
                    forma gross margins**
                
                $
                4,819,349
                
                
                20.4
                
                $
                2,464,900
                
                
                15.9
                
                $
                2,354,449
                
                
                95.5
                %
 40





On
      a pro
      forma basis for the three months ended September 30, 2007, there was gross
      margin of $4.8 million compared to a gross margin of $2.5 million for the
      corresponding period in 2006. On a adjusted pro forma basis for the three months
      ended September 30, 2007, there was gross margin of $5.7 million compared to
      a
      gross margin of $3.3 million for the corresponding period in 2006. The increase
      in adjusted gross margin was directly attributable to  the Company's
      stronger pricing position which provides higher margins and development of
      software to automate production, which allows for efficiencies in production
      and
      thus lowers costs, thus increasing gross margins. A major contributor to the
      increase in gross margin is the increase in service revenues as a
      percentage of the overall revenues. The service revenues enjoy a higher gross
      margin than the contract revenues. The company also increased gross margin
      by
      controlling costs through the upgrading of project management.





The
      aforementioned amortization of acquired backlog in the cost of sales section
      has
      been allocated to cost of revenues and represents the only difference between
      pro forma gross margins and adjusted pro forma gross margins for the three
      months ended September 30, 2007 and 2006.




**Selling,
      General and Administrative Expenses**




Selling,
      general, and administrative expenses consist primarily of salaries and benefits
      for selling and administrative personnel, including human resources, executive,
      finance, and legal. These expenses also include fees for professional services
      and other administrative expenses. Selling, general and administrative expenses
      increased to $3.6 million for the three months ended September 30, 2007,
      compared to $0.2 million for the corresponding period in 2006. The expense
      increase is attributed to the acquisition of ISI on July 31, 2007.


*Adjusted
          Pro Forma Selling, General, and Administrative Expenses*
  The
          following table presents adjusted pro forma selling, general and administrative
          expenses for the three months ended September 30, 2007 and September 31,
          2006:


**Adjusted
                  Pro Forma Operating Expenses****Three
                  Months Ended September 30, 2007**
              
              **Three
                  Months Ended September 30, 2006**
              
              **Year
                  to Year Increase / (Decrease)****Amount**
              
              **%
                  of Net Revenue**
              
              **Amount**
              
              **%
                  of Net Revenue**
              
              **Amount**
              
              **%
                  Inc / (Decr)****Adjusted
                  pro forma total operating expenses**
              
              $
              4,226,857
              
              
              17.9
              
              $
              2,841,152
              
              
              18.4
              
              $
              1,385,705
              
              
              48.8
              %**Amortization
                  of intangible assets**
              
              
              333,057
              
              
              1.4
              
              
              333,057
              
              
              2.2
              
              
              —
              
              
              0.0
              %**Pro
                  forma total operating expenses**
              
              $
              4,559,914
              
              
              19.3
              
              $
              3,174,209
              
              
              20.5
              
              $
              1,385,705
              
              
              43.7
              %


On
        a pro
        forma basis, selling, general, and administrative expenses increased $1.4
        million to $4.6 million for the three months ended September 30, 2007 from
        $3.2
        million for the corresponding period in 2006. On a adjusted pro forma basis,
        selling, general, and administrative expenses increased $1.4 million to $4.2
        million for the three months ended September 30, 2007 from $2.8 million for
        the
        corresponding period in 2006. The increase is primarily due to additional
        expenses needed to support the increased number of projects on which ISI is
        working, increased sales and marketing efforts to promote future growth,
        and
        corporate services expenses associated with the parent company.
 Additionally,
            $1.4 million in compensation expense related to stock appreciation rights
            granted in connection with the acquisition that were recorded by ISI
            in July
            2007 have been excluded from pro forma and adjusted pro forma selling,
            general
            and administrative expenses. The amortization of customer base and software
            has
            been allocated to selling, general, and administrative expenses and primarily
            relates to the acquisition of ISI on July 31, 2007. The impact of this
            amortization, which was excluded from pro forma selling, general, and
            administrative expenses for the adjusted pro forma selling, general,
            and administrative expenses, for the three months ended September 30,
            2007 and
            2006 was $0.3 million.


41




**Other
      Income/Expenses**





Total
      other income/expenses represents interest earned on the net proceeds of our
      initial public offering and the private placement held in trust through the
      date
      of the acquisition and interest expense interest on our line of credit,
      unsecured subordinated debt, and our bridge notes issued in April 2007. Total
      other income/expenses for the three months ended September 30, 2007 was
      ($0.2) million compared to $0.4 million for the corresponding period in
      2006.


*Pro
        Forma Interest Income and Interest Expense*
  The
        following table presents adjusted pro forma interest and other income for
        the
        three months ended September 30, 2007 and September 31, 2006:


**Pro
                      Forma Other Income/Expenses****Three
                    Months Ended September 30, 2007**
                
                **Three
                    Months Ended September 30, 2006**
                
                **Year
                    to Year Increase / (Decrease)****Amount**
                
                **%****of Net Revenue**
                
                **Amount**
                
                **%****of Net Revenue**
                
                **Amount**
                
                **%Inc / (Decr)****Interest
                    on cash and cash equivalents held in trust**
                
                $
                65,706
                
                
                0.3
                
                $
                62,297
                
                
                0.4
                
                $
                3,409
                
                
                5.5
                %**Interest
                    expense**
                
                
                (479,379
                )
                
                (2.0
                )
                
                (390,811
                )
                
                (2.5
                )
                
                (88,568
                )
                
                22.7
                %**Interest,
                    net**
                
                $
                (413,673
                )
                
                (1.7
                )
                $
                (328,514
                )
                
                (2.1
                )
                $
                (85,159
                )
                
                25.9
                %
 Pro
          forma net interest for the three months ended September 30, 2007 mainly
          represents interest earned on the net proceeds of our initial public offering
          and the private placement held in trust through the date of the acquisition.
          Interest expense, increased to $(0.5) million from for the three months
          ended
          September 30, 2007 from $(0.4) million for the corresponding period in
          2006.
          Interest expense for the three months ended September 30, 2007 and 2006
          mainly
          represents interest on our line of credit, unsecured subordinated debt,
          and
          bridge notes issued in April 2007.


**Earnings
        before Interest, Taxes, Depreciation and Amortization
        (“EBITDA”)**


**Pro
                    Forma EBITDA****Three
                    Months Ended September 30, 2007**
                
                **Three
                    Months Ended September 30, 2006**
                
                **Year
                    to Year Increase / (Decrease)****Amount**
                
                **%
                    of**
                  **Net**
                  **Revenue**
                
                **Amount**
                
                **%
                    of**
                  **Net**
                  **Revenue**
                
                **Amount**
                
                **%
                    Inc / (Decr)****Pro
                    Forma EBITDA**
                
                $
                1,827,128
                
                
                7.7
                
                $
                893,218
                
                
                5.8
                
                $
                933,910
                
                
                104.6
                %
 Pro
          forma
          and adjusted pro forma EBITDA rose 104.6% to $1.8million, compared to $0.9
          million for the same three quarters. The EBITDA margin increased to 7.7%,
          up
          from 5.8%.




42




**Liquidity
      and Capital Resources**




Argyle
      Security, Inc. (formerly Argyle Security Acquisition Corporation) was
      incorporated in Delaware in June 2005 as a blank check company formed to
      acquire, through merger, capital stock exchange, asset acquisition, or other
      similar business combination, a business in the security industry. In January
      2006, Argyle completed a private placement of 125,000 units to its executive
      officers and their affiliates and received net proceeds of approximately $0.9
      million. On January 30, 2006, Argyle consummated its initial public offering
      of
      3,700,046 units (which included 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 September 2, 2006.




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 Public Offering and the Private Placement
      were placed in a trust account for Argyle’s benefit. Except for $0.6 million 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 released
      to Argyle for the payment of taxes, Argyle was not able to access the amounts
      held in the trust until it consummated a business combination. The amounts
      held
      outside of the trust account were used by Argyle to provide for business, legal,
      and accounting due diligence on prospective acquisitions and continuing general
      and administrative expenses. Prior to releasing the funds held in trust, the
      trust account contained $1.4 million reserved for the compensation of Argyle’s
      underwriters in its Public Offering which was paid to them upon completion
      of
      the business combination. All amounts held in trust were released at July 31,
      2007 to fund the ISI acquisition.





In
      connection with the Public Offering and the Private Placement, Argyle’s officers
      and directors placed all the shares owned by them before the Private Placement
      and the Public Offering into an escrow account. Except in certain circumstances,
      the shares held in escrow may not be released prior to January 24, 2009.





On
      April
      16, 2007, Argyle’s officers and directors, an affiliate of Bob Marbut, Argyle’s
      Chairman and Co-Chief Executive Officer, and certain of Argyle’s consultants,
      pursuant to a note and warrant acquisition agreement, loaned Argyle an aggregate
      of $.3 million and in exchange received promissory notes in the aggregate
      principal amount of $.3 million and warrants to purchase an aggregate of 37,500
      shares of Argyle’s common stock. The promissory notes were repaid in full plus
      accrued interest in August 2007.





On
      July
      31, 2007, Argyle consummated a business combination, acquiring 100% of the
      outstanding capital stock of ISI Detention Contracting Group, Inc. and its
      subsidiaries (ISI), the value of which the Board of Directors determined was
      greater than 80% of Argyle’s assets at the time of the merger. Prior to the
      acquisition of ISI, Argyle had no operations and was considered a developmental
      stage enterprise. ISI is deemed to be a “predecessor” to the combined company.
      The accompanying consolidated balance sheet includes the assets and liabilities
      related to the acquisition of ISI, adjusted to fair value pursuant to Statement
      of Financial Accounting Standards (SFAS) No. 141, *Business
      Combinations* .


43




Argyle
      has used an estimated $20.5 million (excluding Argyle and ISI transaction costs)
      of the net proceeds of the initial public offering to acquire ISI. Additionally,
      Argyle has incurred total transaction costs of approximately $1.7 million,
      including legal costs paid to Loeb and Loeb of $0.5 million, $0.6 million
      related to certain Macquarie Securities (USA) Inc.’s (formerly Giuliani Capital
      Advisors) advisory fees and fairness opinion, $0.3 million paid in M&A fees
      to WFG Investments and additional costs of $0.3 million related to accountants,
      consultants, printer fees and other miscellaneous expenses. Such costs do not
      include transaction costs of approximately $1.0 million incurred by ISI (related
      primarily to attorney, brokerage and accounting fees).





As
      part
      of the ISI merger, public stockholders holding 211,965 of the aggregate number
      of shares sold in the Public Offering elected to redeem such shares **.** The per
      share redemption price was equal to $7.80 per share including interest earned
      thereon in the trust account, net of taxes paid and payable, $0.6 million of
      interest income which was released from the trust account in September 2006
      to
      fund our working capital, and amounts owed to the underwriter for the Private
      Placement (approximately $0.5 million plus interest). Approximately $1.6 million
      was paid to redemptive shareholders in August of 2007.





In
      the
      2006 annual report on Form 10-K, Argyle disclosed that declining cash available
      outside the trust account and the lack of assurance that the Company would
      be
      able to successfully complete a business combination within the required time
      frame raised substantial doubt about Argyle’s ability to continue as a going
      concern. Subsequent to the acquisition, management believes that cash on hand,
      after payments to redeeming stockholders, in addition to cash provided by the
      operations of ISI, will be sufficient to meet Argyle's working capital
      requirements for the next twelve months.





*Working
      Capital*





Argyle’s
      primary liquidity needs are for financing ISI’s working capital (including
      premiums and fees incurred in connection with bid and performance bonds) and
      their 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 its working capital
      requirements.





At
      September 30, 2007, we had current assets of $40.9 million and current
      liabilities of $21.5 million resulting in a working capital surplus of
      approximately $19.4 million compared to a surplus of $6.1 million based upon
      ISI’s current assets and liabilities at December 31, 2006.





*Long-Term
      Debt*





Notes
      payable and long-term debt consists of the following:




Collateral
            
            Monthly
                Installments
            
            Interest
                Rate
            
            Payable
                Through
            
            September
                30, 2007Notes
                payable:Vehicles
                and equipment
            
            
            $430
                to $3,864
            
            
            (A)
            
            
            2008-2011
            
            $
            233,869Unsecured
                debt - related party
            
            
            
            
            
            11.58%
            
            
            2010
            
            
            5,951,609Unsecured
                convertible debt - stockholders
            
            
            
            
            
            5.00%
            
            
            2012
            
            
            1,925,0018,110,479Less
                current maturities
            
            
            
            
            
            
            
            
            
            
            
            79,497Long-term
                debt for notes - less current maturities
            
            
            
            
            
            
            
            
            
            
            $
            8,030,982Line
                of credit
            
            
            
            
            
            Prime
                + 0.50% or LIBOR + 350 bps
            
            
            2009
            
            $
            7,538,850




(A)
            Amounts
                include notes related to Company vehicles and various equipment.
                Vehicle
                and equipment notes are staggered in regards to their maturity, amortizing
                over a 36-48 month period. Interest rates on the individual notes
                range
                from a fixed rate of 7% up to Prime plus 1.0%. Included with the
                equipment
                is a note related to the phone system with a fixed rate of interest
                at
                9.0% which matures in 2008.




44




*Unsecured
      Debt - Related Party*




All
        notes
        are unsecured and subordinated to the line of credit facility. The unsecured
        note agreement contains prepayment options without prepayment penalties.
        Interest accrues at 11.58% per annum and is payable quarterly. The total
        debt of
        $6.0 million is due and payable in one single payment on January 31, 2010.
        There
        are both financial and restrictive covenants associated with the note agreement.
        As of September 30, 2007, the Company was in compliance with all covenants
        except the covenants related to capital expenditures and vehicle purchases.
        The
        covenant limits capital expenditures to $0.6 million, and the Company had
        spent
        approximately $1.4 million as of September 30, 2007. The Company obtained
        a
        waiver from the lender curing the default through December 31, 2007, provided
        that capital expenditures do not exceed $1,8 million for fiscal year 2007.
        The
        Company obtained a waiver from the lender curing the vehicle purchase default
        through October 31, 2007. The Company has cured the default as of November
        14,
        2007 by prepaying a portion of the vehicle loan indebtedness.




On
        January 2,
        2008 an additional $5.0 million in unsecured debt was funded by the same
        related
        party for which 6.0 million is due. The aforementioned debt is due on January
        31, 2010 with interest accruing at 11.58% annum and payable
        quarterly.


*Unsecured
      Convertible Debt - Stockholders*





As
      part
      of the merger consideration, the Company issued unsecured convertible debt
      to
      the stockholders in the amount of $1.9 million which bears interest at 5% per
      annum, paid semiannually. The notes mature five years from the date of issuance
      on July 31, 2012. The notes may be converted in whole or in part into shares
      of
      the Company’s common stock at the election of the note holder at a share price
      of $10 any time after January 1, 2008. The debt may be redeemed by the Company
      at $10 per share any time after January 1, 2009.





*Unsecured
      Debt - Stockholders*





In
      April
      2007, Argyle’s officers and directors, an affiliate of Argyle’s Chairman and
      Co-Chief Executive Officer, and certain of Argyle’s consultants, pursuant to a
      note and warrant acquisition agreement, loaned Argyle an aggregate of $0.3
      million and in exchange received promissory notes in the aggregate principal
      amount of $0.3 million and warrants to purchase an aggregate of 37,500 shares
      of
      Argyle’s common stock. The warrants are exercisable at $5.50 per share of common
      stock and expire on January 24, 2011. The warrants also may be exercised on
      a
      net-share basis by the holders of the warrants. The Company has estimated,
      based
      upon a Black-Scholes model, that the fair value of the warrants on the date
      of
      issue was approximately $2.48 per warrant (a total value of approximately $.09
      million) using an expected life of 2 years, volatility of 2.39%, and a risk-free
      rate of 5%. However, because the Company’s warrants have a limited trading
      history, the volatility assumption was based on information currently available
      to management. The promissory notes had an interest rate of 4% per year and
      were
      repayable 30 days after the consummation of a business combination. The notes
      and the associated accrued interest was paid in full in August
      2007.





*Line
      of Credit Facility*





The
      Company has a line of credit facility totaling $9.0 million. 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. 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 September 30, 2007 was $7.5 million due December 31,
      2009
      with an interest rate of prime plus 0.5%. The agreement contains both financial
      and restrictive covenants, including a restriction on the payment of dividends.
      At September 30, 2007, the Company was in compliance with such covenants .
      The
      Company has agreed to pay an annual commitment fee of 0.5% per year on the
      unused borrowing capacity, which was $1.5 million at September 30, 2007.




45




Aggregate
      maturities required on all debt at September 30, 2007 are as
      follows:




Year
                Ending December 312007
                (remaining 3 months)
            
            $
            24,4382008
            
            
            79,4972009
            
            
            7,595,5792010
            
            
            5,995,1432011
            
            
            29,671Thereafter
            
            
            1,925,001Total
                commitment outstanding
            
            $
            15,649,329




*Capitalization
      of Leases*




ISI
      sold
      its owner-occupied real estate to a partnership owned by ISI’s stockholders
      during 2004 and entered into a leaseback of the properties with the partnership.
      ISI entered into a second lease on another property owned by the same
      partnership in 2006. Both leases were triple net leases A triple net lease
      is a
      lease agreement on a property where the tenant or lessee agrees to pay all
      real
      estate taxes, building insurance, and maintenance (the three 'Nets') on the
      property in addition to any normal fees that are expected under the agreement
      (rent, etc.). In such a lease, the tenant or lessee is responsible for all
      costs
      associated with repairs or replacement of the structural building elements
      of
      the property.





The
      leased property, included in property and equipment in the accompanying
      consolidated balance sheet, amounted to $1.8 million **** at
      September 30, 2007. This amount represents the fair value of the assets in
      accordance with the purchase accounting performed by the Company net of 2 months
      depreciation of $27,907.





The
      terms
      of the aforementioned leases were modified on July 31, 2007 to extend the
      expiration date from 2018 to 2019 and increase the monthly rental from $23,667
      to $24,000. The modification did not materially affect the carrying value of
      the
      assets or related liabilities recorded in the accompanying consolidated balance
      sheet. The Company reassessed these leases for proper classification under
      SFAS
      No. 13, Accounting for Leases, and determined they remain properly classified
      as
      capital leases.





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
      September 30, 2007:





Year
                Ending December 312007
                (remaining 3 months)
            
            $
            72,0002008
            
            
            288,0002009
            
            
            288,0002010
            
            
            288,0002011
            
            
            288,000Thereafter
            
            
            2,208,000Future
                minimum lease payments
            
            
            3,432,000Less
                amount of net minimum lease payments attributable to
                interest
            
            
            (1,394,252
            )Present
                value of net minimum lease payments
            
            
            2,037,748Current
                portion of capitalized lease obligations
            
            $
            96,960Long-term
                portion of capitalized lease obligations
            
            
            1,940,788$
            2,037,748


46




*Commitments*





The
      Company leases office space and equipment under operating leases expiring
      through 2011.





Minimum
      rental commitments at September 30, 2007 are as follows:





Year
                Ending December 312007
                (remaining 3 months)
            
            $
            67,4502008
            
            
            224,1042009
            
            
            104,1882010
            
            
            60,3522011
            
            
            17,272Thereafter
            
            
            —Total
                commitment outstanding
            
            $
            473,366





The
      corporate office lease space of Argyle expired as of July 31, 2007 and Argyle
      currently operates under a month-to-month lease arrangement. No lease agreements
      contain bargain purchase options or similar clauses in which management intends
      to execute or that are considered material requiring disclosure.





In
      August
      2007 the Company entered into a letter of credit facility with a financial
      institution. The letter of credit may not exceed $500,000. **** The
      facility requires a 1% annual commitment fee on the unused portion of the letter
      of credit facility. The commitment fee is to be paid quarterly.




**Off
      Balance Sheet Arrangements**




Argyle
      does not have any off-balance sheet arrangements.




**Contractual
      Obligations**




**Contractual
                Obligations as of September 30, 2007****(unaudited)**




**Less
                than**
            
            
            
            
            
            
            
            
            **More
                than****Contractual
                Obligations**
            
            
            **Total**
            
            
            **1
                year**
            
            
            **1-3
                years**
            
            
            **3-5
                years**
            
            
            **5
                years**Principal
                on Long Term Debt Obligations
            
            $
            6,185,478
            
            $
            85,440
            
            $
            6,100,038
            
            $
            —
            
            
            —Capital
                Lease Obligations
            
            
            2,037,748
            
            
            108,722
            
            
            345,832
            
            
            462,761
            
            
            1,120,433Operating
                Lease Obligations
            
            
            473,366
            
            
            255,554
            
            
            194,783
            
            
            23,029
            
            
            —Purchase
                Obligations
            
            
            N/A
                — none
            
            
            —
            
            
            —
            
            
            —
            
            
            —Other
                Long Term Liabilities Reflected on Registrant's Balance
                Sheet
            
            
            7,538,850
            
            
            —
            
            
            7,538,850
            
            
            —
            
            
            —Promissory
                notes - shareholders
            
            
            1,925,001
            
            
            —
            
            
            —
            
            
            1,925,001
            
            
            —Interest
                on Long Term Debt Obligations
            
            
            3,535,439
            
            
            989,704
            
            
            1,754,682
            
            
            496,730
            
            
            294,323**Total**
            
            $
            21,695,882
            
            $
            1,439,420
            
            $
            15,934,185
            
            $
            2,907,521
            
            $
            1,414,756


47




**ITEM
      3.**  **QUANTITATIVE
      AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**




Market
      risk is the sensitivity of income to changes in interest rates, foreign
      exchanges, commodity prices, equity prices, and other market-driven rates or
      prices.





The
      Company has a line of credit facility totaling $9.0 million. The line of credit
      is secured by all tangible and intangible assets of the Company excluding
      vehicles. 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 September 30, 2007 was $7.5 with an interest rate of prime plus 0.5%. The
      facility has a maturity date of million **** due
      December 31, 2009.




Changes
        in market rates may impact the banks’ LIBOR rate or prime rate. For instance, if
        either the LIBOR or prime rate were to increase or decrease by one percentage
        point (1.0%), our annual interest expense would change by approximately $9,000
        based upon our total credit facility.




**ITEM
      4. CONTROLS AND PROCEDURES**


We
        maintain disclosure controls and procedures designed to ensure that information
        required to be disclosed in our reports under the Securities and Exchange
        Act of
        1934, as amended, is recorded, processed, summarized and reported within
        the
        time periods specified in the SEC’s rules and forms, and that such information
        is accumulated and communicated to our management, including our principal
        executive officers and principal financial officer, as appropriate, to allow
        timely decisions regarding required disclosure. Our management, with the
        participation and oversight of our principal executive officers and principal
        financial officer, evaluated the design and effectiveness of our disclosure
        controls and procedures as of the end of the period covered by this report.
        Based on that evaluation, our principal executive officers and our principal
        financial officer concluded that our disclosure controls and procedures were
        effective as of September 30, 2007.


Our
      disclosure controls and procedures are designed to provide reasonable assurance
      of achieving their objectives, and our chief executive officer and our chief
      financial officer have concluded that these controls and procedures are
      effective at the “reasonable assurance” level. We believe that a control system,
      no matter how well designed and operated, cannot provide absolute assurance
      that
      the objectives of the control system are met, and no evaluation of controls
      can
      provide absolute assurance that all control issues and instances of fraud,
      if
      any, within a company have been detected.




The
      following material weaknesses were identified in connection with our audit
      of
      the July 31, 2007 balance sheet in connection with the closing of the
      transaction with ISI:





·
            Our
                financial statement close process was ineffective, resulting in audit
                adjustments related to proper elimination of intercompany balances
                and a
                material payroll adjustment. In addition, we did not have a formal
                process
                for accruing for items received but not
                invoiced.





·
            We
                had inadequate procedures for monitoring compliance with debt
                covenants.





A
      deficiency in internal control over financial reporting exists when the design
      or operation of a control does not allow management or employees, in the normal
      course of performing their assigned functions, to prevent or detect
      misstatements on a timely basis. A material weakness is a deficiency, or a
      combination of deficiencies, in internal control over financial reporting,
      such
      that there is a reasonable possibility that a material misstatement of the
      company’s annual or interim financial statements will not be prevented or
      detected on a timely basis.





We
      took
      the following corrective measures to remediate the material weaknesses
      :


·
              A
                  Corporate Controller has been put in place to implement and manage
                  effective financial statement reporting processes. These processes
                  include
                  a timeline and list of schedules to be completed in conjunction
                  with the
                  monthly and quarterly financial statement preparation activities.
 
 ·
              All
                  major asset and liability accounts are reconciled on a monthly
                  basis.
 
 ·
              Unpaid
                  payroll is accrued at month-end to ensure correct statement of
                  liabilities.
 
 ·
              Processes
                  have established to contact major vendors to ensure unbilled liabilities
                  are accrued for on a monthly basis.
 
 ·
              A
                  debt covenant checklist has been established and is now being monitored
                  on
                  a monthly basis to ensure compliance with those
                  covenants.
 
 Our
        principal executive officers and principal financial officer have concluded
        that
        our disclosure controls and procedures (as defined in Rules 13a-15(e)
        and15d-15(e) under the Securities Exchange Act of 1934, as amended (the
        "Exchange Act")) were effectively remedied as of the end of the period covered
        by this report.




**ITEM
      4T. CONTROLS AND PROCEDURES**





Not
      Applicable.


48




**PART
      II - OTHER INFORMATION**




**ITEM
      1. LEGAL PROCEEDINGS**




None.




**ITEM
      1A. RISK FACTORS**


In
        addition to the other information set forth in this report, you should carefully
        consider the factors, relating to ISI’s business, as discussed on pages 15 - 20
        in our Definitive Proxy Statement filed with the SEC on July 13, 2007, which
        could materially affect our business, financial condition or future results.
        Such risk factors are incorporated by reference into this quarterly report
        on
        Form 10-Q/A. Such risks are not the only risks facing our Company. Additional
        risks and uncertainties not currently known to us or that we currently deem
        to
        be immaterial also may materially adversely affect our business, financial
        condition and/or operating results.




**ITEM
      2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF
      PROCEEDS**





On
      January 24, 2006, we consummated a private placement of 125,000 units. On
      January 30, 2006, we consummated our initial public offering of 3,700,046 units
      (which includes 75,046 units sold pursuant to the exercise of a portion of
      the
      underwriter’s over-allotment option). Each unit consists of one share of common
      stock and one redeemable common stock purchase warrant. Each warrant entitles
      the holder to purchase from us one share of our common stock at an exercise
      price of $5.50. The units were sold at an offering price of $8.00 per unit,
      generating total gross proceeds of $30,600,368. Rodman & Renshaw, LLC acted
      as lead underwriter. The securities sold in our initial public offering were
      registered under the Securities Act of 1933 on a registration statement on
      Form
      S-1 (No. 333-126569). The Securities and Exchange Commission declared the
      registration statement effective on January 24, 2006.





At
      the
      time of our offering, we incurred a total $1,836,022 in underwriting
      discounts and commissions and placement agent fees, $1,377,017 of which was
      placed in the trust account and will only be paid to the underwriters in the
      event that we consummate a business combination. The total expenses in
      connection with the sale of our units in the private placement and the initial
      public offering were $2,424,001. No expenses of the offering were paid to any
      of
      our directors or officers or any of their respective affiliates. We did,
      however, repay Argyle New Ventures, an affiliate of Bob Marbut, and Ron
      Chaimovski for loans they made to us prior to the consummation of the private
      placement and the initial public offering. The aggregate amount of principal
      and
      interest on such loans that we repaid was $158,177. All the funds held in the
      trust account have been invested in either Treasury Bills or Money Market
      Accounts.





After
      deducting the underwriting discounts and commissions, placement agent fees
      and
      the offering expenses, the total net proceeds to us from the private placement
      and the initial public offering were $28,176,367, of which $27,344,346 was
      deposited into the trust account for our benefit (exclusive of the amounts
      for
      the benefit of the undewriters discussed above). The remaining proceeds
      were available to be used to provide for business, legal and accounting due
      diligence on prospective business combinations and continuing general and
      administrative expenses. The amounts held in the trust account could only
      be used by us upon the consummation of a business combination, with the
      exception of amounts due for income taxes and $600,000 of the interest earned
      on
      the trust account, which was released to us in September 2006 to fund our
      working capital.





On
      December 8, 2006, Argyle, Argyle’s wholly-owned subsidiary ISI Security Group,
      Inc. (the "Merger Subsidiary") and ISI Detention Contracting Group, Inc. (ISI)
      entered into a merger agreement, as amended on June 29, 2007 and July 11, 2007,
      pursuant to which the Merger Subsidiary would merge into ISI and ISI will become
      a wholly-owned subsidiary of Argyle.




On
      July
      31, 2007, pursuant to the terms of the merger agreement, the Company acquired
      all of the assets and liabilities of ISI through the merger of its Merger
      Subsidiary into ISI. As a result of the merger, ISI became a wholly owned
      subsidiary of the Company.





At
      the
      closing of the merger, the following consideration was paid by the Company
      to
      the stockholders of ISI:





·
            $18.6
                million in cash from the Trust Account;·
            1,180,000
                shares of common stock of Argyle (valued at approximately $9.2 million);
                and;·
            $1.9
                million of unsecured promissory notes convertible into shares of
                common
                stock of the Company at a conversion price of $10 per
                share.


In
        addition, the Company paid approximately $1.9 million to an entity created
        by
        two executive officers of ISI in connection with the issuance of performance
        and
        payment bonds to ISI. Argyle incurred transactions costs of approximately
        $1.7
        million in connection with the merger. The Company paid approximately $1.7
        million to redeeming stockholders and the remainder will be retained by the
        Company for working capital purposes.




The
      Company also assumed approximately $6.0 million of long-term debt, approximately
      $7.6 million outstanding pursuant to a $9.0 million line of credit, and $2.1
      million of capitalized leases as of March 31, 2007.




**ITEM
      3. DEFAULTS UPON SENIOR SECURITIES**




None.


49


**ITEM
      4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**




On
      or
      about July 17, 2007, we distributed our Definitive Proxy Statement to each
      stockholder of record as of July 6, 2007, for our Special Meeting of
      Stockholders held on July 30, 2007 at 8:30 a.m. local time (the “Special
      Meeting”). At the Special Meeting, the stockholders were asked to consider four
      proposals.




The
      first
      proposal involved the vote on the acquisition of ISI by Argyle, resulting in
      ISI
      becoming a wholly owned subsidiary of Argyle. The voting results were:




For:
            
            
            3,619,698Against:
            
            
            424,065Abstain:
            
            
            0Broker
                Non-Votes:
            
            
            0





In
      addition, holders of 211,965 shares of Argyle’s common stock elected to redeem
      their shares for a pro-rata portion of the trust account.




The
      second proposal involved 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. The voting results were:




For:
            
            
            3,641,182Against:
            
            
            369,551Abstain:
            
            
            29,000Broker
                Non-Votes:
            
            
            0




The
      third
      proposal involved an amendment to Argyle’s Second Amended and Restated
      Certificate of Incorporation to change Argyle’s corporate name to Argyle
      Security, Inc.. The voting results were:




For:
            
            
            3,641,182Against:
            
            
            369,551Abstain:
            
            
            29,000Broker
                Non-Votes:
            
            
            0




The
      fourth proposal involved an 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
      consummation of a business combination that would no longer be operative upon
      consummation of the merger. The voting results were:




For:
            
            
            3,641,182Against:
            
            
            369,551Abstain:
            
            
            29,000Broker
                Non-Votes:
            
            
            0




**ITEM
      5. OTHER INFORMATION**




None.




50




**ITEM
      6. EXHIBITS**





Exhibit
                No.
            
            Description10.1
            
            Executive
                Services Agreement between Argyle and Tatum, LLC., dated September
                7, 2007
                (Incorporated by reference to the registrant’s current report on Form 8-K
                dated September 13, 2007)10.2
            
            Second
                Fully Restated Commercial Lease Agreement by and between Green Wing
                Management, Ltd. and ISI Security Group, Inc., dated July 31,
                2007.10.3
            
            First
                  Fully Restated Commercial Lease Agreement by and between Green
                  Wing
                  Management, Ltd. and ISI Security Group, Inc., dated July 31,
                  2002.10.4
            
            Form
                of Non-Qualified Option Agreement10.5
            
            Form
                of Restricted Stock Agreement10.6
            
            Form
                of Incentive Stock Option Agreement10.7
            
            Sixth Amendment
              to Loan
              and Security Agreement by and between LaSalle Bank National Association
              and ISI Security Group, Inc., dated September 14, 2007.10.8
            
            Allonge to
              Second
              Agreement and Restated Senior Subordinated Promissory Note by and between
              ISI Security Group, Inc., and William Blair Mezzanine Capital Fund
              III,
              LP, dated September 14, 2007.31.1
            
            Certification
                    of the Co-Chief Executive Officer (Principal Executive Officer)
                    pursuant
                    to Rule 13a-14(a) of the Securities Exchange Act, as
                    amended31.2
            
            Certification
                of the Co-Chief Executive Officer and (Principal Executive Officer)
                pursuant to Rule 13a-14(a) of the Securities Exchange Act, as
                amended31.3
            
            Certification
                of the Chief Financial Officer (Principal Accounting Officer) pursuant
                to
                Rule 13a-14(a) of the Securities Exchange Act, as
                amended32.1
            
            Certification
                of the Co-Chief Executive Officers and Chief Financial Officer pursuant
                to
                18 U.S.C. 1350, as adopted pursuant to Section 906 of the
                Sarbanes-Oxley Act of 2002.




51




**SIGNATURES**




In
      accordance with the requirements of the Exchange Act, the registrant caused
      this
      report to be signed on its behalf by the undersigned, thereunto duly authorized.






ARGYLE
                SECURITY, INCJanuary
                21, 2008
            By:
            /s/ Bob
                MarbutBob
                MarbutCo-Chief
                Executive Officer
              (Principal
                Executive Officer)







January
                  21, 2008
            By:
            /s/ Ron
                ChaimovskiRon
                ChaimovskiCo-Chief
                Executive Officer
              (Principal
                Executive Officer)






January
                  21, 2008
            By:
            /s/ Donald
                F. NevilleDonald
                F. NevilleChief
                Financial Officer
              (Principal
                Accounting and Financial Officer)




52


**Exhibit
      Index**


Exhibit
                  No.
              
              Description10.1
              
              Executive
                  Services Agreement between Argyle and Tatum, LLC., dated September
                  7, 2007
                  (Incorporated by reference to the registrant’s current report on Form 8-K
                  dated September 13, 2007)10.2
              
              Second
                  Fully Restated Commercial Lease Agreement by and between Green
                  Wing
                  Management, Ltd. and ISI Security Group, Inc., dated July 31,
                  2007.10.3
              
              First
                    Fully Restated Commercial Lease Agreement by and between Green
                    Wing
                    Management, Ltd. and ISI Security Group, Inc., dated July 31,
                    2002.10.4
              
              Form
                  of Non-Qualified Option Agreement10.5
              
              Form
                  of Restricted Stock Agreement10.6
              
              Form
                  of Incentive Stock Option Agreement10.7
              
              Sixth Amendment
                to Loan
                and Security Agreement by and between LaSalle Bank National Association
                and ISI Security Group, Inc., dated September 14, 2007.10.8
              
              Allonge
                to Second
                Agreement and Restated Senior Subordinated Promissory Note by and
                between
                ISI Security Group, Inc., and William Blair Mezzanine Capital Fund
                III,
                LP, dated September 14, 2007.31.1
              
              Certification
                      of the Co-Chief Executive Officer (Principal Executive Officer)
                      pursuant
                      to Rule 13a-14(a) of the Securities Exchange Act, as
                      amended31.2
              
              Certification
                  of the Co-Chief Executive Officer and (Principal Executive Officer)
                  pursuant to Rule 13a-14(a) of the Securities Exchange Act, as
                  amended31.3
              
              Certification
                  of the Chief Financial Officer (Principal Accounting Officer) pursuant
                  to
                  Rule 13a-14(a) of the Securities Exchange Act, as
                  amended32.1
              
              Certification
                  of the Co-Chief Executive Officers and Chief Financial Officer
                  pursuant to
                  18 U.S.C. 1350, as adopted pursuant to Section 906 of the
                  Sarbanes-Oxley Act of 2002.


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