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1.

NOTE 1 – REFERENCESS, ORGANIZATION AND BUSINESS

References

Unless the context requires otherwise, the “ Company ” and similar terms collectively refer to Universal Guardian Holdings, Inc. and its subsidiaries, while the term “ Universal Holdings ” refers to Universal Guardian Holdings, Inc. in its individual corporate capacity.  The terms “ common shares ”, “ preferred shares ”, “ series ‘ A ’ preferred shares ” and “ series ‘ B ’ preferred shares ” used in these financial statement refer to the Company’s common stock, par value $0.001 per share, “blank check” preferred stock, par value $.001 per share, series ‘A’ convertible preferred stock, par value $0.001 per share; and series ’B’ convertible preferred stock, par value $0.001 per share, respectively.  The term “ UGC series ‘A’ preferred shares ” refers to series ’A’ convertible preferred stock, par value $0.001 per share, issued by the Company’s Universal Guardian Corporation subsidiary.

Line of Business

The Company is a holding company which provides security products, systems and services to mitigate terrorist, criminal and security threats for governments and businesses worldwide through its various operating subsidiaries, broken-down into three different operating group—the UG Services Group, the UG Products Group, and the UG Systems Group.

UG Services Group

The Company’s service group of operating subsidiaries (collectively the “ UG Services Group ”), provide comprehensive risk mitigation solutions as well as tactical and strategic security services to protect commercial and government personnel and assets worldwide. These services include threat assessment, risk analysis, country risk management, business intelligence, corporate investigations, information assurance, kidnap and ransom insured services, as well as tactical security including executive and diplomatic protection.  The Company provides these services through various operating subsidiaries in the group which consist of Universal Guardian Services PTE, Ltd., formerly known as Secure Risks Singapore, PTE.(“ UG Services ”); Secure Risks, Ltd (“ Secure Risks ”); Universal Guardian Services, Ltd., formerly known Secure Risks-Strategic Security Solutions International Ltd. (“ SSSI ”); Secure Risks Pakistan, Ltd.; and Secure Risks Asia Pacific, Ltd. The companies comprising the UG Services Group deliver services through regional branch offices located in London, Kabul, Pakistan, Hong Kong, Singapore, Dubai and Los Angeles (Newport Beach).  The vast majority of the Company’s revenues from January 1, 2004 to date have been generated by the UG Services Group from operations outside of the United States.

UG Products Group

The Company’s products group of operating subsidiaries (collectively the “ UG Products Group ”), focus on designing, producing and marketing non-lethal or less-lethal personal protection devices and projectiles for use by military, law enforcement, private security and consumer personal protection markets throughout the world.  The Company has recently completed development of two products which the Company is currently introducing to the market. The

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first of these products, the Cobra StunLight™, is a heavy-duty high-intensity LED flashlight designed to provide escalating use-of-force options to the user by illuminating its target and launching a laser-aimed, ballistic stream OC (pepper spray) which causes temporarily blindness, respiratory breathing difficulty and a burning sensation of the skin that can debilitate assailants from safe stand-off distances up to 20 feet.

The second product, the Riot Defender™, is for use by law enforcement and military as a non-lethal use-of-force compliance tool for suspects and to control civil disturbances. The Riot Defender™, is a semi-automatic projectile launcher which can debilitate an assailant using its RiotBall™ proprietary and patent pending frangible projectile at an effective range of more than 50 feet.  A frangible projectile is one which breaks-up upon impact, thereby reducing the risk of injury to the suspect. The Riot Defender™ is designed to have the capacity of ten projectiles in the pistol configuration, and 180 projectiles in the carbine configuration, and can be equipped with a laser-aiming device for better precision and accuracy. The device can use several projectile variants, including OC powder, marking powder and inert powder. Each projectile has a specific use ranging from temporarily incapacitating individual suspects to crowd control. The Company is currently developing international manufacturing, sales and marketing channels to facilitate the introduction of these products to targeted markets.

The Company has recently shipped the Cobra StunLight™ to several law enforcement agencies and distributors in Australia, France, Germany, Mexico, Saudi Arabia, Singapore, Turkey and the United States for testing, evaluation and purchase. The Company has recently completed a pilot program for the Cobra StunLight™ with the Los Angeles Sheriff’s Departments, resulting in the Department approving the purchase of the Cobra StunLight™ by its deputies.  The Company is currently conducting a similar pilot program with the San Diego County Sheriff’s Department.

As between the various subsidiaries in the group, Shield Defense Corporation (“ SDC ”) focuses on sales and marketing activities in the United States and Canada; Shield Defense Europe GmbH (“ SDE ”) focuses on sales and marketing activities in the European market; and Universal Guardian Products, Ltd. (“ UG Products ”) focuses on supervising the manufacturing of the Cobra StunLight™ and the Riot Defender™ products, research and development activities on the Cobra StunLight™ and the Riot Defender™ products, as well as sales to rest of the world.

UG Systems Group

The Company’s Systems Group of operating subsidiaries (collectively the “ UG Systems Group ”), provide proprietary integrated and interoperable asset tracking and monitoring systems for use in government and commercial global supply chain logistics, inter-modal transportation, maritime and seaport security. The Company is in the process of introducing to market its Total Asset Guardian™ (“ TAG ”) platform which provides multifaceted solutions for global asset tracking, asset visibility and data management throughout the supply chain.

The TAG platform is comprised of a proprietary software application and processes which provide secure supply chain data collection, real-time network and security monitoring and notification. The TAG platform is a scaleable system that can be deployed on a global basis.  Our TAGeasy™ e-commerce RFID label system is a subscription-based system that provides pre-printed RFID labels and delivers them to Department of Defense and retail suppliers.  The TAGstation™ is a hosted-system designed to provide on-site RFID capability for small to medium-sized government and retail suppliers.   TAGcentral™ consists of an enterprise level software application for major international retailers and government suppliers. In addition to

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the revenue generated upon the licensing and/or sale of these systems, each solution provides recurring revenue based upon subscription fees.

On October 1, 2006 the Company entered into a Joint Venture Agreement with Spheres Technologies, a Saudi Arabian company (“ Spheres ”), to form Universal Guardian (Saudi Arabia) to market and distribute the Company’s products, systems and services within the Kingdom of Saudi Arabia.  Spheres Technologies possesses a “Class A license” to provide security products and systems to commercial and government agencies in the Saudi Arabia.  Spheres plans to transfer existing contracts to Universal Guardian (Saudi Arabia).  

Organization

Universal Holdings was incorporated under the laws of Delaware during 1989 under the name Guideline Capital Corporation.  Effective September 13, 1999, pursuant to a Share Exchange and Reorganization Agreement, the Company acquired all of the issued and outstanding shares of Hollywood Partners, Inc., and changed its name to Hollywood Partners.com, Inc.

On December 6, 2002, the Company changed its name from Hollywood Partners.com to Universal Guardian Holdings, Inc.  Effective December 31, 2002, pursuant to a Share Exchange and Reorganization Agreement between the Company and Guardian Corporation, the former shareholders of Guardian Corporation acquired 11,300,000 newly issued common shares.  At the date of consummation of this transaction, these shareholders effectively controlled 70% of the Company’s outstanding common shares and 69.1% of the Company’s total capital stock after taking into consideration outstanding shares of series ‘A’ preferred stock. Since the shareholders of Guardian Corporation obtained control of the Company, according to FASB Statement No. 141, “ Business Combinations ,” this acquisition was treated as a recapitalization for accounting purposes, in a manner similar to reverse acquisition accounting.  In accounting for this transaction:  (1) Guardian Corporation is deemed for accounting purposes to be the purchaser and surviving company.  Accordingly, Guardian Corporation’s net assets are included in the balance sheet at their historical book values and the results of operations of Guardian Corporation have been presented in these financial statements for the comparative prior period; and (2) control of the net assets and business of the Company was acquired by the shareholders of Guardian Corporation effective December 31, 2002.  This transaction has been treated for accounting purposes as a purchase of the assets and liabilities of the Company by Guardian Corporation.  The historical cost of the Company’s net liabilities assumed by Guardian Corporation was $103,855.

Guardian Corporation was incorporated under the laws of the state of Nevada on March 28, 2001. Guardian Corporation was in the business of protecting human life and military, government and commercial assets, by providing services, systems and technology to detect, assess and defend against security and terrorists threats worldwide.  

Prior to the share exchange transaction, the Company had 4,848,014 and 600 common shares and series ‘A’ preferred shares outstanding, respectively, and 1,779,875 common share purchase options/warrants outstanding.  Guardian Corporation had 11,300,000 and 350,000 common shares and series ‘A’ preferred shares outstanding, respectively, and 2,175,000 common share purchase options/warrants outstanding.  Pursuant to the transaction, the 11,300,000 Guardian Corporation common shares were converted into 11,300,000 Universal Holdings common shares.  Additionally, the Company agreed that the 350,000 Guardian Corporation series ‘A’ preferred shares outstanding could be converted into common shares of the Company on a one for one basis, and that the 2,175,000 Guardian Corporation common share purchase options/warrants

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outstanding could be exercised for a like number of Universal Holdings common share purchase options/warrants on the same terms.

2.

NOTE 2 – PRESENTATION; SIGNIFICANT ACCOUNTING POLICIES

Going Concern; Management’s Plans

The accompanying consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America, which contemplate the Company’s continuation as a going concern.  The Company incurred a net loss for the year ended December 31, 2006 of $8,396,950, used cash for operating activities of $5,419,553 for the year ended December 31, 2006 and at December 31, 2006, had an accumulated deficit of $24,463,040.  While the Company’s UG Services Group has generated significant increases in revenue and gross profit over the past several fiscal years, these gains have been offset by significant continuing selling, general and administrative costs attributable to supporting the Company’s UG Products and UG Systems Groups pending the delayed introduction of their products and services to market.  As a consequence of those continuing costs and delays, the Company now anticipates that it will need to raise approximately $2 million in additional capital to fully execute its plan of operation over the next twelve months, including ramping-up sales of UG Products and UG Systems Group products and services in order to generating revenues to make a significant contribution toward covering their proportionate share of selling, general and administrative costs.  We are currently airing Cobra StunLight™ infomercials and commercials on local and national television in the United States.  The Company will seek to raise the additional capital required through the public or private sale of debt or equity securities, the procurement of advances on contracts or licenses, funding from joint-venture or strategic partners, debt financing or short-term loans, or a combination of the foregoing.  The Company may also seek to satisfy indebtedness without any cash outlay through the private issuance of debt or equity securities.  The Company currently does not have any binding commitments for, or readily available sources of, additional financing. The Company cannot give any assurance that it will be able to secure the additional cash or working capital it may require to continue its operations.  Should the Company be unable to raise the additional working capital required to fully execute its plan of operation over the next twelve months, the Company may be forced to reduce or suspend its operations in the meantime.  The foregoing circumstances raise substantial doubt about the Company’s ability to continue as a going concern in the event it is unable to raise the additional capital required. These consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty These consolidated financial statements do not include any adjustments relating to the recoverability and classification of recorded asset amounts, or amounts and classification of liabilities that might be necessary should the Company be unable to continue as a going concern.

Principles of Consolidation

The accompanying consolidated financial statements include the accounts of the Company and its wholly-owned active  operating subsidiaries:   Universal Guardian Services PTE, Ltd. (formerly known as Secure Risks Singapore, PTE.); Secure Risks Ltd. (“ Secure Risks ”); Secure Risks-Strategic Security Solutions International Ltd. (“ SSSI ”); Secure Risk Pakistan, Ltd.; Secure Risks Asia Pacific, Ltd.; Universal Guardian Products, Ltd., formerly known as Shield Defense International Ltd. (“ UG Products ”); Shield Defense Corporation (“ SDC .; Shield Defense Europe GmbH (“ SDE ”); ISR Systems Corporation (“ ISR Systems ”); and Universal Guardian Systems, Ltd., formerly known as MeiDa Information Technologies, Ltd. (“ UG Systems ”).  UG Systems was treated as a variable

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interest entity from October 7, 2005 to January 1, 2006.  ”); The accompanying consolidated financial statements also include the accounts of the Company’s two inactive subsidiaries Shield Defense Technologies, Inc  and Shield Defense (Macao) Ltd.  The accompanying consolidated financial statements also include the accounts of the Company’s dormant 88.7%-owned subsidiary Universal Guardian Corporation (including its dormant wholly-owned subsidiary, The Harbour Group, Inc.).  All material inter-company accounts and transactions have been eliminated.  Secure Risks has pledged to Universal Holdings the shares of SSSI owned by Secure Risks as security for intercompany loans and advances made by Universal Holdings to both of those subsidiaries.  

Reclassification

Certain reclassifications have been made to the balances as of December 31, 2005 to conform to the December 31, 2006 presentation.

Intellectual Property

The intellectual property acquired with the acquisition of UG Systems is being amortized over seven years.  Annual amortization of intellectual property is expected to be approximately $466,000.  Amortization expense amounted to $466,156 and $0 for the years ended December 31, 2006 and 2005, respectively.

Stock Based Compensation

The Company adopted SFAS No. 123 (Revised 2004), Share Based Payment (“SFAS No. 123R”), under the modified-prospective transition method on January 1, 2006.  SFAS No. 123R requires companies to measure and recognize the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value.  Share-based compensation recognized under the modified-prospective transition method of SFAS No. 123R includes share-based compensation based on the grant-date fair value determined in accordance with the original provisions of SFAS No. 123, Accounting for Stock-Based Compensation, for all share-based payments granted prior to and not yet vested as of January 1, 2006 and share-based compensation based on the grant-date fair-value determined in accordance with SFAS No. 123R for all share-based payments granted after January 1, 2006. SFAS No. 123R eliminates the ability to account for the award of these instruments under the intrinsic value method prescribed by Accounting Principles Board (“APB”) Opinion No. 25, Accounting for Stock Issued to Employees , and allowed under the original provisions of SFAS No. 123.  Prior to the adoption of SFAS No. No. 123, the Company accounted for its stock option plans using the intrinsic value method in accordance with the provisions of APB Opinion No. 25 and related interpretations.

Primarily as a result of adopting SFAS No. 123R, the Company recognized $3,189,842 in share-based compensation expense for the year ended December 31, 2006.  There were 3,550,000 new employee options granted during the year ended December 31, 2006.  The expense recognized of $3,189,842 relates to the vesting of options issued to employees prior to January 1, 2006 and the options issued during the year ended December 31, 2006 that vested during the same period.  The impact of this share-based compensation expense on the Company’s basic and diluted earnings per share was $0.07 per share.  The fair value of the Company’s stock options was estimated using the Black-Scholes option pricing model.

For periods presented prior to the adoption of SFAS No. 123R, pro forma information regarding net income and earnings per share as required by SFAS No. 123R has been determined as if the

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Company had accounted for its employee stock options under the original provisions of SFAS No. 123.  The fair value of these options was estimated using the Black-Scholes option pricing model.  For purposes of pro forma disclosure, the estimated fair value of the options is amortized to expense over the option’s vesting period.  The pro forma expense to recognize during the year ended December 31, 2005 is as follows:

The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted-average assumptions for the years ended December 31, 2006 and 2005:  risk-free interest rate of 4.5% and 4.5%; dividend yields of 0% and 0%; volatility factors of the expected market price of the Company’s common shares of  163% and 340%; and a weighted average expected life of the options of 5 and 10 years, respectively.

Use of Estimates

The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting periods.  As of December 31, 2006, the Company used estimates in determining the realization of its accounts receivable, fixed assets, intangible assets, accrued expenses, and the fair value of equity instruments issued for services.  Actual results could differ from these estimates.

Fair Value of Financial Instruments

For certain of the Company’s financial instruments, none of which are held for trading purposes, including cash, accounts receivable, notes payable, accounts payable and accrued expenses, the carrying amounts approximate fair value due to their short maturities.

The amounts shown for notes payable also approximate fair value because current interest rates and terms offered to the Company for similar debt are substantially the same.

Cash and Cash Equivalents

For purposes of the statements of cash flows, the Company defines cash equivalents as all highly liquid debt instruments purchased with a maturity of three months or less, plus all certificates of deposit.

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Inventory

Inventories are stated at the lower of cost or market on a first-in, first-out basis.  The Company’s inventory balance at December 31, 2006 principally consists of Cobra StunLights™ available for sale.

Concentration of Credit Risk

Financial instruments, which potentially subject the Company to concentrations of credit risk, consist of cash and accounts receivables.  The Company places its cash with high quality financial institutions and at times may exceed the FDIC $100,000 insurance limit.  The Company has not experienced a loss in such accounts.  The Company extends credit based on an evaluation of the customer’s financial condition, generally without collateral. Exposure to losses on receivables is principally dependent on each customer’s financial condition.  The Company monitors its exposure for credit losses and maintains allowances for anticipated losses, as required.  For the year ended December 31, 2006, 91% of the Company’s revenue was generated from 14 customers.  For the year ended December 31, 2005, 95% of the Company’s revenue was generated from 17 customers.

The Company conducts substantial operations outside of the United States in Singapore, Indonesia and Afghanistan.  The following table contains a summary of the respective operations in those locales:

Included in the Company’s contracts are contracts with International Relief and Development, Inc. (IRD), the U.S. Army and CDM Constructors, each of which contract (or set of contracts) would constitute more than 10% of the Company’s revenues.

Impairment of Long-Lived Assets

In accordance with SFAS 144, Accounting for the Impairment or Disposal of Long-Lived Assets, The Company reviews its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.  Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net cash flows expected to be generated by the asset.  If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amount of the assets exceeds the fair value of the assets.  Assets to be disposed of are reported at the lower of the carrying amount or fair value less costs to sell.  No impairment loss was recorded in 2006 or 2005.

Property and Equipment

Property and equipment are stated at cost.  Depreciation is computed using the straight-line method based on estimated useful lives from 3 to 7 years.  Expenditures for maintenance and

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repairs are charged to operations as incurred while renewals and betterments are capitalized.  Gains and losses on disposals are included in the results of operations.  

Intangible Assets

Intangible assets consist of goodwill purchased in connection with the acquisition of SSSI.  In accordance with SFAS No. 142, “ Goodwill and Other Intangible Assets ,” the Company evaluates intangible assets and other long-lived assets for impairment, at least on an annual basis and whenever events or changes in circumstances indicate that the carrying value may not be recoverable from its estimated future cash flows.  Recoverability of intangible assets and other long-lived assets is measured by comparing their net book value to the related projected undiscounted cash flows from these assets, considering a number of factors including past operating results, budgets, economic projections, market trends and product development cycles.  If the net book value of the asset exceeds the related undiscounted cash flows, the asset is considered impaired, and a second test is performed to measure the amount of impairment loss.  No impairment was recorded in 2006 or 2005.

Allowance for Doubtful Accounts

The Company maintains an allowance for doubtful accounts resulting from the inability, failure or refusal of customers to make required payments.  The Company determines the adequacy of this allowance by regularly reviewing the accounts receivable aging and applying various expected loss percentages to certain accounts receivable categories based upon historical bad debt experience.  The Company generally writes-off accounts receivable balances deemed uncollectible.

Revenue Recognition

The Company generates revenue by providing business risk solutions and strategic and tactical security services to protect governmental and commercial assets worldwide.  Generally, the Company enters into contracts with its customers to provide certain services.  When an initial set up fee is charged, this fee is recognized as revenue over the terms of the contracts.  The Company recognizes revenue for the service fee on a monthly basis as services are performed.  Revenue, billed monthly, is only recognized if the Company deems that collection is probable and other criteria of SFAS No. 48, ETIF 00-21 and SAB No. 104 are met.

The Company generally recognizes product revenue upon delivery or shipment of product unless there are significant post-delivery obligations or collection is not considered probable at the time of sale.  When significant post-delivery obligations exist, revenue is deferred until such obligations are fulfilled.

The Company recognizes revenue related to the Company’s software arrangements pursuant to the provisions of Statement of Position (SOP) 97-2, “ Software Revenue Recognition ”, as amended by SOP 98-4 and SOP 98-9, and related interpretations, as well as the SEC Staff Accounting Bulletin No. 104 “ Revenue Recognition .”

Software Related Revenue Recognition:

The Company earns revenue from software licenses, post-contract customer support (“PCS” or “maintenance”), hardware, and software related services.  PCS includes telephone support, bug fixes, and rights to upgrades on a when-and-if available basis.  The Company provides services

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that range from installation, training, and basic consulting to software modification and customization to meet specific customer needs.  In software arrangements that include rights to multiple software products, specified upgrades, PCS, and/or other services, the Company allocates the total arrangement fee among each deliverable based on the relative fair value of each.

The Company typically enters into multiple element arrangements, which include software licenses, software services, PCS and occasionally hardware.  The majority of the Company’s software arrangements are multiple element arrangements, but for those arrangements that include customization or significant modification of the software, or where software services are otherwise considered essential to the functionality of the software in the customer’s environment, the Company uses contract accounting and applies the provisions of SOP 81-1.  No such revenues have been recognized through December 31, 2006.

If the arrangement does not require significant modification or customization, revenue is recognized when all of the following conditions are met: (i) persuasive evidence of an arrangement exists; (ii) delivery has occurred; (iii) the Company’s fee is fixed or determinable; and collectibility is probable.

For multiple element arrangements, each element of the arrangement is analyzed and the Company allocates a portion of the total arrangement fee to the elements based on the fair value of the element using vendor-specific evidence of fair value (“VSOE”), regardless of any separate prices stated within the contract for each element.  Fair value is considered the price a customer would be required to pay if the element was sold separately based on the Company’s historical experience of stand-alone sales of these elements to third parties.  For PCS, the Company uses renewal rates for continued support arrangements to determine fair value.  For software services, the Company uses the fair value charged to customers when those services are sold separately.  In software arrangements in which the Company has the fair value of all undelivered elements but not of a delivered element, the “residual method” is applied as allowed under SOP 98-9 in accounting for any element of a multiple-element arrangement involving software that remains undelivered such that any discount inherent in a contract is allocated to the delivered element.  Under the residual method, if the fair value of all undelivered elements is determinable, the fair value of the undelivered elements is deferred and the remaining portion of the arrangement fee is allocated to the delivered element(s) and is recognized as revenue assuming the other revenue recognition criteria are met.  In software arrangements in which the Company does not have VSOE for all undelivered elements, revenue is deferred until fair value is determined or all elements for which the Company does not have VSOE have been delivered.  Alternatively, if sufficient VSOE does not exist and the only undelivered element is services that do not involve significant modification or customization of the software, the entire fee is recognized over the period during which the services are expected to be performed.  No such revenues have been recognized through December 31, 2006.

Software Licenses

The Company recognizes the revenue allocable to software licenses and specified upgrades upon delivery of the software product or upgrade to the customer, unless the fee is not fixed or determinable or collectibility is not probable. If the fee is not fixed or determinable, including new customers whose payment terms are three months or more from shipment, revenue is generally recognized as payments become due from the customer.  If collectibility is not considered probable, revenue is recognized when the fee is collected.  Arrangements that include

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software services, such as training or installation, are evaluated to determine whether those services are essential to the product’s functionality.

A majority of the Company’s software arrangements will involve “off-the-shelf” software.  The Company considers software to be off-the-shelf software if it can be added to an arrangement with minor changes in the underlying code and it can be used by the customer for the customer’s purpose upon installation.  For off-the-shelf software arrangements, the Company recognizes the software license fee as revenue after delivery has occurred, customer acceptance is reasonably assured, that portion of the fee represents a non-refundable enforceable claim and is probable of collection, and the remaining services such as training are not considered essential to the product’s functionality.

For arrangements that include customization or modification of the software, or where software services are otherwise considered essential, the Company recognizes revenue using contract accounting.  The Company generally uses the percentage-of-completion method to recognize revenue from these arrangements.  The Company measures progress-to-completion primarily using labor hours incurred, or value added.  The percentage-of-completion methodology generally results in the recognition of reasonably consistent profit margins over the life of a contract since the Company has the ability to produce reasonably dependable estimates of contract billings and contract costs.  The Company uses the level of profit margin that is most likely to occur on a contract.  If the most likely profit margin cannot be precisely determined, the lowest probable level of profit in the range of estimates is used until the results can be estimated more precisely.  These arrangements are often implemented over an extended time period and occasionally require us to revise total cost estimates.  Amounts recognized in revenue are calculated using the progress-to-completion measurement after giving effect to any changes in the Company’s cost estimates.  Changes to total estimated contract costs, if any, are recorded in the period they are determined.  Estimated losses on uncompleted contracts are recorded in the period in which the Company first determines that a loss is apparent.  No such revenues have been recognized through December 31, 2006.

Software Services

Some of the Company’s software arrangements will include services considered essential for the customer to use the software for the customer’s purposes.  For these software arrangements, both the software license revenue and the services revenue are recognized as the services are performed using the percentage-of-completion contract accounting method.  When software services are not considered essential, the fee allocable to the service element is recognized as revenue as the Company performs the services.  No such revenues have been recognized through December 31, 2006.

Deferred Revenue

Certain contracts include need assessment analysis fees which are charged to the customer.  For revenue recognition purposes, the Company defers these fees and amortizes these fees into income on a straight-line basis over the life of the contract in accordance with EITF 00-21.

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Advertising and Marketing Costs

The Company expenses costs of advertising and marketing as incurred.  Advertising and marketing expense for the years ended December 31, 2006 and 2005 were $1,072,669 and $141,907, respectively.

Income Taxes

The Company accounts for income taxes in accordance with SFAS No. 109, “ Accounting for Income Taxes .”  Deferred taxes are provided on the liability method whereby deferred tax assets are recognized for deductible temporary differences, and deferred tax liabilities are recognized for taxable temporary differences.

Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases.  Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will be realized.  Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment.

Loss Per Share

In accordance with SFAS No. 128, “ Earnings Per Share ,” the basic loss per common share is computed by dividing net loss available to common stockholders by the weighted average number of common shares outstanding.  Diluted loss per common share is computed similar to basic loss per common share except that the denominator is increased to include the number of additional common shares that would have been outstanding if the potential common shares had been issued and if the additional common shares were dilutive.  At December 31, 2006 and 2005, the only potential dilutive securities were 10,755,000 and 7,760,000 common stock options, 7,692,308 shares of common stock issuable upon the conversion of outstanding convertible debentures and 13,275,826 and 7,015,812 common stock warrants/other options, respectively.  The Company’s potential dilutive securities also included eight shares of common stock that are issuable upon the conversion of the Company’s series ‘A’ convertible preferred stock.  In addition at each of December 31, 2006 and 2005, the Company had outstanding 18,714 shares of Guardian Corporation’s series ‘A’ preferred stock that can be converted into 18,714 shares of the Company’s common stock, respectively.  Due to the net loss, none of the potentially dilutive securities were included in the calculation of diluted earnings per share since their effect would be anti-dilutive.

Comprehensive Income

SFAS No. 130, “Reporting Comprehensive Income,” requires the reporting of comprehensive income (loss) in addition to net income (loss) from operations. Comprehensive income (loss) is a more inclusive financial reporting methodology that includes disclosure of certain financial information that historically has not been recognized in the calculation of net income (loss).

The following table presents the components of other comprehensive income (loss):

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Recently Issued Accounting Pronouncements

In February 2006, the Financial Accounting Standards Board (“F ASB ”) issued Statements of Financial Accounting Standards (“ SFAS ”) No. 155, “ Accounting for Certain Hybrid Financial Instruments ”.  SFAS No. 155 amends SFAS No 133, “Accounting for Derivative Instruments and Hedging Activities”, and SFAS No. 140, “ Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities ”.  SFAS No. 155, permits fair value remeasurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation, clarifies which interest-only strips and principal-only strips are not subject to the requirements of SFAS No. 133, establishes a requirement to evaluate interest in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation, clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives, and amends SFAS No. 140 to eliminate the prohibition on the qualifying special-purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative financial instrument.  SFAS 155 is effective for all financial instruments acquired or issued after the beginning of the Company’s first fiscal year that begins after September 15, 2006.  Management believes that this statement will not have a significant impact on the Company’s consolidated financial statements.

In March 2006, the FASB issued SFAS 156 “ Accounting for Servicing of Financial Assets”.   SFAS No. 156 amends SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, with respect to the accounting for separately recognized servicing assets and servicing liabilities.  This statement: (1) requires an entity to recognize a servicing asset or servicing liability each time it undertakes an obligation to service a financial asset by entering into a servicing contract, (2) requires all separately recognized servicing assets and servicing liabilities to be initially measured at fair value, if practicable; (3) permits an entity to choose the ‘amortization method’ or ‘fair value measurement method’ for each class of separately recognized servicing assets and servicing liabilities; (4) at its initial adoption, permits a one-time reclassification of available-for-sale securities to trading securities by entities with recognized servicing rights, without calling into question the treatment of other available-for-sale securities under SFAS 115, provided that the available-for-sale securities are identified in some manner as offsetting the entity’s exposure to changes in fair value of servicing assets or servicing liabilities that a servicer elects to subsequently measure at fair value; and (5) requires separate presentation of servicing assets and servicing liabilities subsequently measured at fair value in the statement of financial position and additional disclosures for all separately recognized servicing assets and servicing liabilities.   SFAS No 156 is effective as of the beginning of the Company’s first fiscal year that begins after September 15, 2006.  Management believes that this statement will not have a significant impact on the Company’s consolidated financial statements.

In September 2006, the FASB issued SFAS No. 157, “ Fair Value Measurements .” This statement clarifies the definition of fair value, establishes a framework for measuring fair value and expands the disclosures on fair value measurements. SFAS No 157 is effective for fiscal years beginning after November 15, 2007. Management has not determined the effect, if any, the adoption of this statement will have on the Company’s consolidated financial statements.

In September 2006, the FASB issued SFAS No. 158, " Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans−An amendment of FASB Statements No. 87, 88, 106, and 132(R )".  One objective of this standard is to make it easier for investors, employees, retirees and other parties to understand and assess an employer's financial position and its ability to

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fulfill the obligations under its benefit plans. SFAS No. 158 requires employers to fully recognize in their financial statements the obligations associated with single−employer defined benefit pension plans, retiree healthcare plans, and other postretirement plans.  SFAS No. 158 requires an employer to fully recognize in its statement of financial position the overfunded or underfunded status of a defined benefit postretirement plan (other than a multiemployer plan) as an asset or liability and to recognize changes in that funded status in the year in which the changes occur through comprehensive income.  This statement also requires an employer to measure the funded status of a plan as of the date of its year−end statement of financial position, with limited exceptions.  SFAS No. 158 requires an entity to recognize as a component of other comprehensive income, net of tax, the gains or losses and prior service costs or credits that arise during the period but are not recognized as components of net periodic benefit cost pursuant to SFAS No. 87.  This statement requires an entity to disclose in the notes to financial statements additional information about certain effects on net periodic benefit cost for the next fiscal year that arise from delayed recognition of the gains or losses, prior service costs or credits, and transition asset or obligation.  The Company is required to initially recognize the funded status of a defined benefit postretirement plan and to provide the required disclosures for fiscal years ending after December 15, 2006.  Management believes that this statement will not have a significant impact on the Company’s consolidated financial statements.

FASB Interpretation No. 48, “ Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No.109 .” Interpretation No. 48 prescribes a recognition threshold and a measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return.  Benefits from tax positions should be recognized in the financial statements only when it is more likely than not that the tax position will be sustained upon examination by the appropriate taxing authority that would have full knowledge of all relevant information.  The amount of tax benefits to be recognized for a tax position that meets the more-likely-than-not recognition threshold is measured as the largest amount of benefit that is greater than fifty percent likely of being realized upon ultimate settlement.  Tax benefits relating to tax positions that previously failed to meet the more-likely-than-not recognition threshold should be recognized in the first subsequent financial reporting period in which that threshold is met or certain other events have occurred.  Previously recognized tax benefits relating to tax positions that no longer meet the more-likely-than-not recognition threshold should be derecognized in the first subsequent financial reporting period in which that threshold is no longer met.  Interpretation No. 48 also provides guidance on the accounting for and disclosure of tax reserves for unrecognized tax benefits, interest and penalties and accounting in interim periods.  Interpretation No. 48 is effective for fiscal years beginning after December 15, 2006.  The change in net assets as a result of applying this pronouncement will be a change in accounting principle with the cumulative effect of the change required to be treated as an adjustment to the opening balance of retained earnings on January 1, 2007, except in certain cases involving uncertainties relating to income taxes in purchase business combinations.  In such instances, the impact of the adoption of Interpretation No. 48 will result in an adjustment to goodwill.  While the Company analysis of the impact of adopting Interpretation No. 48 is not yet complete, it does not currently anticipate it will have a material impact on the Company’s consolidated financial statements.

In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 108, “ Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements ,” (“ SAB 108 ”),which provides interpretive guidance on the consideration of the effects of prior year misstatements in quantifying current year misstatements for the purpose of a materiality assessment.  The Company adopted SAB 108 in the fourth quarter of 2006 with no impact on its consolidated financial statements.

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In December 2006, the FASB issued FASB Staff Position (“ FSP ”) EITF 00-19-2, Accounting for Registration Payment Arrangements .  EITF 00-19-2 addresses an issuer's accounting for registration payment arrangements.  This FSP specifies that the contingent obligation to make future payments or otherwise transfer consideration under a registration payment arrangement, whether issued as a separate agreement or included as a provision of a financial instrument or other agreement, should be separately recognized and measured in accordance with FASB Statement No. 5, “ Accounting for Contingencies .”  The guidance in EITF 00-19-2 amends FASB Statements No. 133, “ Accounting for Derivative Instruments and Hedging Activities ,” and No. 150, “ Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity ,” and FASB Interpretation No. 45, “ Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others ”, to include scope exceptions for registration payment arrangements.  EITF 00-19-2further clarifies that a financial instrument subject to a registration payment arrangement should be accounted for in accordance with other applicable generally accepted accounting principles (GAAP) without regard to the contingent obligation to transfer consideration pursuant to the registration payment arrangement.   EITF 00-19-2 is effective for fiscal year beginning after December 15, 2006.  The Company has determined that this FSP will not have an impact on its December 31, 2006 financial statements.

NOTE 3 – ACQUISITIONS

Universal Guardian Systems, Ltd.

On October 7, 2005 the Company’s ISR Systems subsidiary acquired all the issued and outstanding common stock of UG Systems (then known as MeiDa Information Technology, Ltd.) from its stockholders pursuant to a Share Exchange Agreement and Plan of Reorganization entered into on August 31, 2005.  Pursuant to the terms of that agreement, the Company paid UG Systems’ shareholders a total of 2,272,727 Universal Holdings common shares, payable in two tranches, 1,000,000 shares delivered at the closing on October 7, 2005, and the balance delivered on January 30, 2006.  The fair market value of the common shares issued in this transaction was $3,000,000 in the aggregate, or $1.32 per share, based on the volume average weighted price (“VAWP”) of the Company’s common shares on the OTCBB for the 15 days preceding the entering into of the agreement.  For the transaction to be legally binding in Hong Kong, the Company was required to file and pay a stamp duty tax for the transfer of UG Systems shares to the Company.  As a result the Company did not issue the initial 1,000,000 shares that were to be issued on October 7, 2005.  The stamp duty tax was filed and paid in January 2006 at which time the transaction closed, the UG Systems shares were transferred to the Company and the 2,272,727 shares of the Company were issued to the former UG Systems shareholders.  This transaction has been accounted for by the purchase method of accounting; accordingly, the purchase price has been allocated to the assets acquired and liabilities assumed based on the estimated fair values at the date of acquisition.  The Company had not completed this transaction until 2006, but has effectively controlled UG Systems since October 7, 2005. Therefore, from the period from October 7, 2005 to January 1, 2006, the Company has accounted for UG Systems as a variable interest entity.

The fair value of the assets acquired and liabilities assumed and allocation of the purchase price is summarized as follows:

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UNIVERSAL GUARDIAN HOLDINGS, INC. AND SUBSIDIARIES

Notes To Consolidated Financial Statements

For The Years Ended December 31, 2006 and 2005

(continued)

Depreciation expense for the years ended December 31, 2006 and 2005 was $522,603 and $420,794, respectively.   

3.

NOTE 5 – RELATED PARTY TRANSACTIONS

Accrued Expenses – Related Party

Accrued expenses – related party consist of amounts due directors and management of the Company’s Universal Guardian Services PTE, Ltd and ISR Systems subsidiaries.

Due From Officer

Due From Officer at December 31, 2006 of $75,343 consists of an over-reimbursement of travel expenses to the Company’s CEO.  The over-reimbursement was discovered subsequent to December 31, 2006 and the officer made arrangements to repay this amount immediately following the discovery of the overpayment.

4.

NOTE 6 – CONVERTIBLE DEBENTURES

On January 14, 2005, as part of a single transaction, the Company sold short-term convertible debentures in the amount of $250,000 to The Hunter Fund Ltd. (“ Hunter Fund ”), $150,000 to IKZA Holding Corp. (“ IKZA ”) and $100,000 to Loman International SA (“ Loman ”).  The Company was obligated to pay the aggregate $500,000 in principal on the debentures, together with interest accrued thereon at the annualized rate of 24%, in cash to the debenture holders on June 30, 2005.  This amount was paid in full on February 8, 2005.

As additional consideration for the purchase of the debenture, the Company also granted to Hunter Fund, IKZA and Loman common share purchase warrants entitling them to

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purchase 125,000, 75,000 and 50,000 common shares, respectively, at the price of $2 per share.  These warrants lapse if unexercised by January 14, 2010.  In accordance with EITF 00-27, the Company first determined the value of the debenture and the fair value of the detachable warrants issued in connection with this debenture.  The estimated value of the warrants of $519,937 was determined using the Black-Scholes option pricing model and the following assumptions:  term of 5 years, a risk free interest rate of 3.5%, a dividend yield of 0% and volatility of 342%.  The face amount of the debenture of $500,000 was proportionately allocated to the debenture and the warrants in the amounts of $245,113 and $254,887, respectively.  The value of the debenture was then allocated between the debenture and the beneficial conversion feature, which amounted to $0 and $245,113, respectively.  The combined total discount was $500,000 and was being amortized over the term of the debenture. The entire debenture was repaid in February 2005 and the entire discount was charged to financing cost in the first quarter of 2005.

The aforesaid private placement was effected through Hunter World Markets, Inc. (“ Hunter ”), as placement agent.  Under the terms of the placement agency agreement, Hunter was paid $40,000 in cash and issued common share purchase warrants entitling it to purchase 250,000 restricted common shares at $2 per share that were valued at $519,937.  These warrants were valued using the Black-Scholes option pricing model using the following assumptions:  term of 5 years, a risk-free interest rate of 3.5%, a dividend yield of 0% and volatility of 342%.  The value of these warrants was charged to financing costs during the first quarter of 2005.  In addition, the Company agreed to reduce the exercise price on 625,000 common share warrants previously issued to Hunter in May 2004 from $1.50 to $1 per share, and on an additional 625,000 common share warrants previously issued at that time from $2 to $1.25 per share.  In the event the volume average weighted price for the common shares exceeds $5 per share five consecutive days, the exercise prices will revert to that originally agreed upon.  The Company recognized an expense of $12,516 related to the re-pricing of these warrants during the year ended December 31, 2005.

On December 4 and 8, 2006, the Company sold a total of $5,000,000 of convertible debentures to a total of 43 accredited investors in a $2 million-$5 million minimum-maximum private placement facilitated through the Maxim Group, LLC (“ Maxim Group ”), an NASD member Broker Dealer.  Interest on outstanding principal of the debentures accrues at the rate of 6% per annum (increased to 12% for so long as the company is in default under the terms of the debenture), and payable quarterly commencing March 31, 2007.  Outstanding principal on the debentures is payable 24 months from the closing date, subject to acceleration in the event of certain defaults or breaches of continuing covenants.  The holders of the debentures may convert unpaid principal on the debentures into common shares at the rate of $0.65 per share, equal to 80% of the VWAP for the Company’s common shares for the ten trading day period prior to the first closing.  Universal Holdings may also elect to pay interest in common shares in lieu of cash at a conversion rate equal to 80% of the VWAP for the Company’s common shares for the ten trading day period preceding the interest payment date.  As additional consideration for the purchase of the debenture, Universal Holdings also granted to the debenture holder stock purchase warrants entitling them to purchase a total of 3,846,159 common shares at the price of $0.81 per share, or 125% of the conversion price for the debenture.  These warrants contain cashless exercise provisions in the event the underlying shares are not registered with the SEC and lapse if unexercised five years from the closing date.  In the case of certain non-exempt issuances of securities below the conversion and exercise prices for the debenture and warrants, the holders of those securities will also entitled to full-ratchet anti-dilution protection for a period of one year, and standard weighted-average anti-dilution protection thereafter. As compensation for acting as placement agent for the offering, the Company agreed to pay Maxim Group a cash placement fee equal to 8% of the gross proceeds from the offering.  The Company further agreed to grant Maxim Group a five-year stock purchase warrant, exercisable at $0.65 per share, entitling it to

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purchase 769,231 common shares at $0.65 per share.  Maxim Group subsequently assigned this warrant to its principal member, Maxim Partners LLC.  The Company also agreed to pay Maxim Group a non-accountable expense allowance equal to 3% of the gross proceeds from the offering, and to reimburse Maxim Group for its expenses and legal fees incurred in connection with this offering, but not to exceed $15,000.

The warrants and conversion feature in the above transaction are not considered derivative instruments that need to be bifurcated from the original security since the convertible debentures have a floor on the conversion price which means the Company can determine the maximum shares that could be issued upon conversion.  Therefore, in accordance with EITF 00-27, the Company first determined the value of the debenture and the fair value of the detachable warrants issued in connection with this debenture.  The estimated value of the warrants of $2,223,827 was determined using the Black-Scholes option pricing model and the following assumptions:  term of 5 years, a risk free interest rate of 4.5%, a dividend yield of 0% and volatility of 96%.  The face amount of the debenture of $5,000,000 was proportionately allocated to the debenture and the warrants in the amounts of $3,461,228 and $1,538,772, respectively.  The value of the debenture was then allocated between the debenture and the beneficial conversion feature, which amounted to $928,225 and $2,533,003, respectively.  The combined total discount is $4,071,775 and is being amortized over the term of the debenture. During the year ended December 31, 2006, the Company amortized a total of $143,024 of this discount as other expense in the accompanying consolidated statements of operations.

The aforesaid private placement was effected through Maxim Group, as placement agent.  Under the terms of the placement agency agreement, Maxim Group was paid $550,000 in cash and issued to grant Maxim Group a five-year stock purchase warrant, exercisable at $0.65 per share, entitling it to purchase 769,231 common shares at $0.65 per share that were value at $444,762.  These warrants were valued using the Black-Scholes option pricing model using the following assumptions:  term of 5 years, a risk-free interest rate of 4.5%, a dividend yield of 0% and volatility of 96%.  In addition, the Company also paid $22,837 in costs associated with this offering.  The total offering cost of $1,017,599 have been capitalized as debt issue costs in the accompanying consolidated balance sheet and are being amortized to interest expense over the term of the debentures.  During the year ended December 31, 2006, the Company amortized $35,983 of the debt issue costs into interest expense.

The Company is obligated to register the common stock underlying the conversion of these convertible debentures and the exercise of the warrants under a registration rights agreement.  The Company is required to file a registration statement within 30 days of the closing date and the registration statement is to be declared effective by the SEC with 90 days of the closing date (120 days if the registration statement is reviewed by the SEC).  Failure to file the registration statement or have it declared effective by the SEC will result in a penalty of 1% of the outstanding principal amount of the convertible debenture for each 30 day period the Company is not in compliance with the registration rights agreement.  The Company filed a registration statement with the SEC on January 16, 2007, which was reviewed by the SEC.  The filing of the registration statement was not within the initial 30 days following the closing; however, due to an additional funding of $1,000,000 in January 2007, the Company obtained an extension to this initial deadline to January 15, 2007.  The Company expects the registration statement to be declared effective within 120 days of the closing date; and therefore; will not incur any penalties under the registration rights agreement.  In accordance with FSP EITF 00-19-2, upon the closing of this transaction the Company did not believe it was probable that a registration penalty will be incurred; therefore, the Company did not factor in a registration penalty in the allocation of the proceeds of the convertible debenture.  As of December 31, 2006 the Company continues to

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expect the registration statement to be declared effective within 120 days of the closing date, and therefore will not incur any penalties under the registration rights agreement.  In accordance with FSP EITF 00-19-2, the Company has not recorded a registration rights penalty to earnings as of December 31, 2006.

The Company agreed to register with the SEC the common shares issuable upon conversion of principal and interest under the debenture or the exercise of the warrants in each private placement.  In the event the Company fails to file a registration statement with the SEC within thirty days of the final closing date, or in the event such registration statement is filed but is not declared effective by the SEC within 90 days of the final closing date (or 120 days if subject to SEC or NASD review), then the Company will generally be obligated (with certain exceptions) to pay to each debenture holder damages in cash equal to 1% of his or her purchase price for each thirty-day period of such failure, or partial period thereof, subject to a 4% cap.  The debenture holders for the first private placement later agreed to extend the date to file the initial registration statement with the SEC until January 15, 2007, and the Company electronically submitted to the SEC on that date a registration statement covering both offerings.  The SEC has since reviewed that registration statement, and the Company anticipates that it will file an amended registration statement and that such registration statement will be declared effective prior to the 120-day date.

In accordance with FSP EITF 00-19-2, upon the closing of this transaction, the Company did not believe it was probable that a registration penalty would be incurred; therefore, the Company did not factor in a registration penalty in the allocation of the proceeds of the convertible debenture.  The Company continues to expect the registration statement to be declared effective within 120 days of the closing date, and therefore does expect it will incur any penalties under the registration rights agreement.  In accordance with FSP EITF 00-19-2, the Company has not recorded a registration rights penalty to earnings as of December 31, 2006.

The carrying amount of the convertible debentures at December 31, 2006 is as follows:

5.

NOTE 7 – STOCKHOLDERS’ EQUITY

Series ‘A’ Convertible Preferred Stock

At December 31, 2006, the Company had 600 series ‘A’ convertible preferred shares outstanding.

The series ‘A’ preferred shares carry a 7% cumulative dividend, and are convertible into common shares at the Company’s discretion if its common shares trading at $120 per share ($6 per share pre-split) for five consecutive days.  The series ‘A’ preferred shares are non-voting, carry no redemption rights, and carry a $300,000 liquidation preference, in additional to the payment of cumulative dividends.  As of December 31, 2006, there was $148,750 of dividends in arrears with respect to these shares.

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These shares were originally issued in or about December 1999 to Triple Tree, an affiliate of Terra Listed, Ltd.  In connection with that purchase, the Company purchased 4,100 shares of Triple Tree.  Based upon corporate minutes accompanying the transaction, the Company has the right to convert the 600 series ‘A’ preferred shares outstanding into eight common shares pursuant based an $80 per share conversion rate.  The Company also believes that Triple Tree may owe the Company up to $200,000 in connection with a put right and guarantee provided by Triple Tree to the Company in connection with Triple Tree shares purchased by the Company.  The Company reserves its rights to cancel some or all of the series ‘A’ preferred shares and the dividends accrued to date on those shares in connection with Triple Tree’s obligation.

Series ‘B’ Convertible Preferred Stock

At December 31, 2006, the Company had no series ‘B’ convertible preferred shares outstanding.  

On August 17, 2005, as part of a single private placement, the Company sold (1) 4,250 unregistered shares of series ‘B’ convertible preferred stock to Monarch Pointe Fund, Ltd. (“ Monarch ”) for the sum of $425,000, and (2) 1,000 unregistered shares of series ‘B’ convertible preferred stock to Mercator Momentum Fund III, LP (“ Mercator Fund III ”) for the sum of $100,000.  The 5,250 series ‘B’ preferred shares were convertible at the option of the holders into a total of 480,505 common shares in the ordinary course of conversion, or 533,862 common shares in the event of a default with respect to the Company’s obligations under the subscription agreement governing the sale of those shares.

The series ‘B’ preferred shares carried a $525,000 liquidation preference, are entitled to participate with the Company’s common shares with respect to dividends on an “as-if” converted basis The series ‘B’ preferred shares were non-voting, did not accrue dividends (other than the aforesaid right to participate with common shares), and carry no redemption rights.

The holders of the series ‘B’ preferred shares also had certain contractual rights separate from those inherent to those shares.  Specifically, under the terms of the subscription agreement, the Company was prohibited from using the proceeds of this transaction for payment of any dividends or other sums to holders of series ‘A’ preferred shares, or from reducing or retiring any insider note or convertible debt held by an officer or director of the Company.  The Company was also prohibited from entering into any debt or equity financing without the prior written approval of Monarch and Mercator Fund III until the common shares underlying the series ‘B’ preferred shares are registered.  The Company was also obligated to afford Monarch and Mercator Fund III a right of first refusal with respect to any capital raising financing (as opposed to joint ventures, acquisitions, compensatory or other non-capital raising financings) in which the Company sells debt or equity securities for cash until the earlier of August 17, 2006 or the conversion of the series ‘B’ preferred shares.

As part of the transaction, the Company paid to Mercator Advisory Group, LLC (“ MAG ”), as investment advisor for the purchasers, the sum of $12,000 in cash to cover due diligence and legal fees.  The issuance of the series ‘B’ preferred stock was convertible into shares of common stock at a rate of $1.09 per share which resulted in the recognition of a beneficial conversion feature at the date of the series ‘B’ shares were issued.  The Company calculated the beneficial conversion feature to be $99,657 which has been recorded directly to accumulated deficit.

On April 18, 2006, the holders of the series ‘B’ preferred shares converted all of those shares into 480,505 common shares.

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Common Stock

For The Year Ended December 31, 2006

In January 2006, the Company issued 2,272,727 shares of common stock in connection with the acquisition of UG Systems.  The value of these shares was $3,000,000.

In February 2006, the Company issued 28,894 shares of common stock for payment of legal and consulting services valued at $31,041.

In February 2006, Paulson Investment Company, Inc. exercised its share purchase warrant to purchase 1,420,000 common shares at $0.50 per share, resulting in gross proceeds to the Company of $710,000.

On April 20, 2006, the board of directors approved the grant of common share purchase options to various employees entitling them to purchase a total of 1,205,000 common shares at the price of $1.09 per share.  Certain of these options vest on December 31, 2006, and lapse to the extent not exercised on April 20, 2011, whereas others vest on December 31, 2006, and lapse to the extent not exercised on April 20, 2016.

On May 9, 2006, the Company issued 72,168 shares of common stock for payment of legal and consulting services valued at $66,681.

On May 12, 2006, the Company granted to Mr. Clifford Roth’s firm, The Wells-Roth Group, as compensation for Mr. Clifford Roth joining the Company’s board of advisors, a common share purchase option entitling it to purchase 100,000 restricted common shares at the exercise price of $0.95 per share.  One-half of these options vest on each of the first and second anniversaries of the grant date, respectively.  These options lapse to the extent unexercised on May 11, 2011.  These options were valued at $89,210 using the Black-Scholes option pricing model using the following assumptions: term of 5 years, a risk-free interest rate of 4.5%, a dividend yield of 0% and volatility of 163%.  The value of these options is being amortized to expenses over the two year vesting period of the options.  

On May 24, 2006, the Company granted to Messrs. Mel R. Brashears and Michael D. Bozarth, in their capacity as directors of Universal Holdings, common share purchase options entitling each of them to purchase 300,000 restricted common shares at the exercise price of $0.84 per share.  These options vested on December 31, 2006, and lapse to the extent unexercised on May 24, 2016.  

On May 24, 2006, the Company granted to Messrs. Michael J. Skellern and Mark V. Asdourian, in their capacity as executive officers of Universal Holdings, common share purchase options entitling each of them to purchase 300,000 restricted common shares at the exercise price of $0.84 per share.  These options vested on September 8, 2006, and lapse to the extent unexercised on May 24, 2016.  

On June 1, 2006, the Company granted to Rear Admiral Stephen Johnson’s firm SBS Consulting, Inc., as compensation for Rear Admiral Johnson providing services as director of strategic development, a common share purchase option entitling it to purchase 100,000 restricted common shares at the exercise price of $0.83 per share.  One-half of these options vest on each of the first and second anniversaries of the grant date, respectively.  These options lapse to the extent unexercised on May 31, 2011.    These options were valued at $77,942 using the

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Black-Scholes option pricing model using the following assumptions: term of 5 years, a risk-free interest rate of 4.5%, a dividend yield of 0% and volatility of 163%.  The value of these options is being amortized to expenses over the two year vesting period of the warrant.

On June 10, 2006, the Company granted to an employee, a common share purchase option entitling him to purchase 100,000 restricted common shares at the exercise price of $0.90 per share.  One-third of these options vest on the first through third anniversaries of the grant date, respectively.  These options lapse to the extent unexercised on June 10, 2011.  

On June 11, 2006, the Company issued a total of 175,745 shares of common stock for payment of a legal settlement valued at $159,928.

On June 20, 2006, the Company closed a private placement pursuant to which it sold (1) a total of 5,333,351 common shares, and (2) five-year stock purchase warrants entitling the holders to purchase a total of 2,666,681 common shares at $ 1.12½ per share, to forty accredited investors in consideration of gross cash proceeds of $4,000,000.  As part of that transaction, the Company paid the following compensation to Paulson Investment Company, Inc., as placement agent for the offering:  (1) cash compensation in the amount of $400,000, representing 10% of the gross proceeds of the offering; (2) a non-accountable expense allowance in the amount of $120,000, representing 3% of the gross proceeds of the offering; and (3) a five-year placement agent warrant entitling Paulson to purchase a total of 266,669 units at the price of $1.50 per unit, each unit comprised of two common shares and a five-year stock purchase warrant entitling Paulson to purchase one common share at $1.12½ per share.  The Company may accelerate the term of the aforesaid stock purchase warrants in the event that the fair market value of the common shares equals or exceeds $1.50 for five consecutive trading days.  In any such event, the holder of the warrant will have thirty days from notice to exercise the warrant.

On June 12, 2006, the Company granted to Mr. Keith Winsell, in his capacity as Vice President of Marketing pursuant to the terms of his employment agreement, a common share purchase option entitling him to purchase 100,000 restricted common shares at the exercise price of $0.90 per share. One-third of these options vest on the first through third anniversaries of the grant date, respectively.  These options lapse to the extent unexercised on June 12, 2011.  

On June 9, 2006, the Company granted to Mr. Kenneth A. Merchant, as an inducement for joining its board of directors, a common share purchase option entitling him to purchase 300,000 restricted common shares at the exercise price of $0.84 per share, reflecting the fair market value of the shares as of the date of the Company’s offer for Mr. Merchant to join the board.  These options vested on December 31, 2006, and lapse to the extent unexercised on June 22, 2016.  

On June 9, 2006, the Company granted to Mr. Kenneth A. Merchant, as an inducement for chairing the audit committee of its board of directors, a common share purchase option entitling him to purchase 100,000 restricted common shares at the exercise price of $0.90 per share, reflecting the fair market value of the shares as of the date of Mr. Merchant formally joining the board.  These options were fully vested upon grant, and lapse to the extent unexercised on June 22, 2016.  

On August 21, 2006, the Company granted to Mr. Randall A. Jones, in his capacity as Chief Financial Officer pursuant to the terms of his employment agreement, a common share purchase option entitling him to purchase 300,000 restricted common shares at the exercise price of $0.90 per share. One-third of these options vest on the first through third anniversaries of the grant date, respectively.  These options lapse to the extent unexercised on August 21, 2011.  In

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December 2006, Mr. Jones was terminated as the Company’s Chief Financial Officer and these options were canceled.  

On August 21, 2006, the Company granted to Mr. Michael J. Skellern, in his capacity as an executive officer of Universal Holdings, a common share purchase option entitling him to purchase 200,000 restricted common shares at the exercise price of $0.90 per share, reflecting the fair market value of the shares as of the date of grant.  These options vest on September 8, 2006, and lapse to the extent unexercised on August 28, 2016.  

On September 13, 2006, the Company issued 27,777 shares of common stock for payment of consulting services valued at $25,000.

In November, 2006 the Company issued 26,666 shares of common stock as partial payment of outstanding invoices for the production of its infomercial that will begin television broadcast in early December 2006 valued at $21,333.

In December 2006, the Company issued a total of 10,000 shares of common stock for payment of services valued at $7,500.

In December 2006, the Company issued a total of 250,000 shares of common stock for payment of a legal settlement  valued at $195,000.

On December 14, 2006, the Company granted to Rocco Diina, as compensation for joining the board of advisors, a common share purchase option entitling him to purchase 100,000 restricted common shares at the exercise price of $0.79 per share.  One-half of these options vest on each of the first and second anniversaries of the grant date, respectively.  These options lapse to the extent unexercised on December 14, 2011.    These options were valued at $55,551 using the Black-Scholes option pricing model using the following assumptions: term of 5 years, a risk-free interest rate of 4.5%, a dividend yield of 0% and volatility of 96%.  The value of these options is being amortized to expenses over the two year vesting period of the warrant.

For The Year Ended December 31, 2005

On January 4, 2005, as part of a single transaction, the Company sold 100,000 restricted common shares to Mr. Michael Weiss in a private placement for cash for total gross proceeds of $100,000.  As part of that transaction, the Company issued to Mr. Weiss fully vested common share purchase warrants entitling him to purchase, through January 4, 2010, 25,000 common shares at $2 per share and an additional 25,000 shares at $2.50 per share.  

In January 2005, the Company granted to a consultant as compensation for providing legal services in connection with regulatory and other approvals relating to the marketing of the Company’s products, fully vested common shares purchase options entitling him to purchase 100,000 shares of common stock at the exercise price of $1.60 per share that were valued at $159,942.  These options vest in equal amounts at the end of the first through twelfth month of the provision of services by the consultant.  These options expire January 11, 2010.  These warrants were valued using the Black-Scholes option pricing model using the following assumptions: term of 5 years, a risk-free interest rate of 3.5%, a dividend yield of 0% and volatility of 317%.  The value of these warrants was being amortized into expense over the twelve month period of the contract.

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On February 7, 2005, as part of a single private placement, the Company sold (1) a total of 1,884,375 common shares together with common share purchase warrants entitling the holder to purchase 753,750 restricted common shares to Monarch Pointe Fund, Ltd. (“ Monarch ”) for the sum of $3,015,000, and (2) a total of 928,125 common shares together with common share purchase warrants entitling the holder to purchase 371,250 restricted common shares to Mercator Momentum Fund, LP (“ Mercator Fund ”) for the sum of $1,485,000. As part of that transaction, the Company paid to Mercator Advisory Group, LLC (“ MAG ”), as investment advisor agent, the sum of $265,000 in cash for due diligence and legal fees and common share purchase warrants entitling it to purchase 281,250 restricted common shares.  One-half of the aforesaid warrants issued to Monarch, Mercator Fund and MAG are exercisable at $2.40 per share, while the balance are exercisable at $2 per share.  These warrants lapse if unexercised on February 7, 2008.

In April 2005, the Company granted to a consultant as compensation for providing accounting and financial related services common shares purchase options entitling him to purchase 100,000 shares of common stock at the exercise price of $1.40 per share that were valued at $99,759.  These options vest quarterly in equal amounts over a two year period.  These options expire April 28, 2010.  These options were valued using the Black-Scholes option pricing model using the following assumptions: term of 2 years, a risk-free interest rate of 4.2%, a dividend yield of 0% and volatility of 147%.  The value of these options is being amortized into expense over the twenty-four month vesting period.  

On April 1, 2005, the Company cancelled 51,908 unissued shares of common stock previously reserved for issuance to the prior shareholders of ISR Systems in payment of the $20,000 purchase price for their shares in ISR Systems as a result of the election by those shareholders of their right to require payment in cash in lieu of Company shares.

On August 28, 2005, the Company issued 18,519 shares of common stock with a value of $25,000 in settlement of litigation.

In August 2005, the Company granted to two consultants as compensation for providing investor relation services common shares purchase options entitling them to purchase an aggregate of 800,000 shares of common stock at exercise prices ranging from $1.35 to $1.85 per share.  These options expire in August 2007.  These options were valued at $1,007,216 using the Black-Scholes option pricing model using the following assumptions:  term of 2 years, a risk-free interest rate of 4.5%, a dividend yield of 0% and volatility of 341%.  The value of these options is being amortized into expense over the term of the consulting agreement.

On September 9, 2005, the Company issued 50,000 shares of common stock upon the exercise of common share purchase options.

On October 6, 2005, the Company sold 100,000 shares of common stock to Mr. Michael D. Bozarth, a director, for gross proceeds of $99,000, representing a 10% discount to market.

On December 14, 2005, the Company sold 1,420,000 unregistered common shares to Paulson Investment Company, Inc. in a private placement for cash for total gross proceeds of $710,000.  As part of that transaction, the Company issued to Paulson Investment Company fully vested common share purchase warrants entitling it to purchase 1,420,000 common shares at $0.50 per share.  These warrants were exercised in February 2006.

During the year ended December 30, 2005, the Company issued 199,926 common shares to consultants and professionals for services valued at $251,856.  During that year, the Company

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also issued 1,622,205 common shares upon the exercise of options and warrants:  50,000 shares for which the exercise price was paid for by services valued at $62,500; 1,143,905 shares upon the cashless exercise of 1,385,000 options and warrant shares; and 428,300 shares for $284,638 in cash.

Also during the year ended December 31, 2005, holders of the UGC series ‘A’ preferred shares converted 12,817 of those shares into 12,817 common shares of the Company.

Series ‘A’ Preferred Stock of Subsidiary - Universal Guardian Corporation

At December 31, 2005, Guardian Corporation had 18,714 UGC series ‘A’ preferred shares outstanding.  This has been presented on the accompanying financial statements in a manner similar to minority interest.

Description of Stock Plans

Universal Guardian Holdings, Inc. 2005 Stock Incentive Plan

On September 1, 2005, the Company’s board of directors adopted, and on October 6, 2005 the Company’s shareholders ratified, the Universal Guardian Holdings, Inc. 2005 Stock Incentive Plan (the “ 2005 Plan ”).  The purpose of the plan is to provide the company with a shareholder-approved vehicle to attract, retain and motivate employees, directors and non-employee consultants upon whose judgment, initiative and effort the successful conduct of the Company’s business will be largely dependent, and to align their interests with those of shareholders by providing incentive compensation opportunities tied to the performance of the Company’s common shares and by promoting increased ownership in the Company’s common shares by such persons.  The 2005 Plan was adopted with the intent to replace the 2002 Plan and 2003 Plan described below.  

Under the 2005 Plan, a total of 10,000,000 common shares will be available for issuance through the grant of a variety of common share-based awards under the plan.  Types of awards that may be granted under the 2005 Plan include stock awards, restricted stock awards and non-qualified and incentive stock options.  As of December 31, 2006, there were 3,580,000 common shares reserved for issuance and outstanding but unexercised common share purchase options under the 2005 Plan and 6,169,132 shares available for issuance.

Universal Guardian Holdings, Inc. 2002 Stock Compensation Program

On September 19, 2002, the Company’s board of directors and shareholders adopted the Universal Guardian Holdings, Inc. 2002 Stock Compensation Program, formerly known as the Hollywood Partners.com 2002 Stock Compensation Program (the “2002 Stock Program”), pursuant to which a total of 10,000,000 common shares were initially made available for issuance.  Effective as of October 6, 2005, as a result of the adoption of the 2005 Plan by the Company’s shareholders, no further grants will be made under the 2002 Stock Program.  

Universal Guardian Holdings, Inc. 2003 Incentive Equity Stock Plan

On April 21, 2003, the Company’s board of directors adopted the Universal Guardian Holdings, Inc. 2003 Incentive Equity Stock Plan (the “2003 Stock Plan”), pursuant to which a total of 10,000,000 common shares were initially made available for issuance.  As a result of the adoption of the 2005 Plan by the Company’s shareholders on October 6, 2005, no further grants will be made under the 2003 Stock Plan.  

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Stand-Alone Compensatory Grants

From time to time the Company’s board of directors grants common share purchase options or warrants to selected directors, officers, employees, consultants and advisors in payment of goods or services provided by such persons on a stand-alone basis outside of any of the Company’s formal stock plans.  The terms of these grants are individually negotiated.  As of December 31, 2006, there were a total of 9,857,120 shares reserved for issuance under various outstanding but unexercised compensatory common share purchase options granted on a stand-alone basis.

The weighted average remaining contractual life of compensatory options outstanding for directors, officers and employees is 4.91 years at December 31, 2006.  The intrinsic value of the outstanding options at December 31, 2006 was $1,398,000.  The exercise price for compensatory options outstanding for directors, officers and employees at December 31, 2006 were as follows:

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For compensatory options granted to directors, officers and employees during the year ended December 31, 2006 where the exercise price equaled the stock price at the date of the grant, the weighted-average fair value of such options was $0.89 and the weighted-average exercise price of such options was $0.95.  No options were granted during the year ended December 31, 2006, where the exercise price was less than the stock price at the date of the grant or the exercise price was greater than the stock price at the date of grant.

For compensatory options granted to directors, officers and employees during the year ended December 31, 2005 where the exercise price equaled the stock price at the date of the grant, the weighted-average fair value of such options was $1.08 and the weighted-average exercise price of such options was $1.02.  No options were granted during the year ended December 31, 2005, where the exercise price was less than the stock price at the date of the grant or the exercise price was greater than the stock price at the date of grant.

During the years ended December 31, 2006 and 2005, the Company issued a total of 300,000 and 1,000,000 common share purchase warrants to a consultant for services valued at $490,513 and $1,266,917, respectively.  

6.

NOTE 8 – INCOME TAXES

Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial statement purposes and the amounts used for income tax purposes. Significant components of the Company’s deferred tax liabilities and assets as of December 31, 2006 are as follows:

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