UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549









FORM
10-Q





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


For the
quarterly period ended September 30, 2009


or





 ̈
            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: 0-21295





GVI
Security Solutions, Inc.


(Exact
name of registrant as specified in its charter)





Delaware
            77-0436410(State
      or other jurisdiction of
              incorporation
      or organization)
            (I.R.S.
      Employer Identification No.)2801
      Trade Center Drive, Suite 120, Carrollton, Texas
            75007(Address
      of principal executive offices)
            (Zip
      code)





(972)
245-7353


(Registrant’s
telephone number, including area code)





(Former
Name or Former Address, if Changed Since Last Report)





Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.


þ
Yes                       ̈ No




Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files).


 ̈
Yes                       ̈ No




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





Large
      accelerated filer  ̈
              Accelerated
      filer  ̈Non-accelerated
      filer  ̈
                (Do
      not check if a smaller reporting company)
              Smaller
      reporting company þ





Indicate
by check mark whether the Registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act).


 ̈  Yes                      þNo





As of
November  14, 2009 there were 27,225,312 shares of the registrant’s
common stock outstanding.











GVI
Security Solutions, Inc.


FORM
10-Q




TABLE
OF CONTENTS




PART
      I. FINANCIAL INFORMATION
                            3Item
      1.  Financial Statements
                            3Item
      2.  Management’s Discussion and Analysis of Financial Condition
      and Results of Operations
                            17Item
      3.  Quantitative and Qualitative Disclosures About Market
      Risk
                            24Item
      4T.  Controls and Procedures
                            24PART
      II.  OTHER INFORMATION
                            25Item
      1. Legal proceedings
                            25Item
      1A. Risk Factors
                            25Item
      2.  Unregistered Sales of Equity Securities and Use of
      Proceeds
                            26Item
      6.  Exhibits
                            26





2





PART
I. FINANCIAL INFORMATION





Item
1.  Financial Statements.





GVI
Security Solutions, Inc.


Condensed
Consolidated Balance Sheets


(In
thousands, except share and per share amounts)





September 30,
                2009
              
              
              December 31,
                2008(Unaudited)ASSETS:Current
      AssetsCash
      and equivalents
              
              $
              67
              
              
              $
              46Accounts
      receivable, net of allowances for doubtfulaccounts
      of $411 and $426, respectively
              
              
              8,036
              
              
              
              7,129Inventory,
      net
              
              
              11,212
              
              
              
              15,249Deferred
      Tax Assets, Current
              
              
              738
              
              
              
              869Prepaid
      and other current assets
              
              
              1,494
              
              
              
              920Total
      Current Assets
              
              
              21,547
              
              
              
              24,213Property
      and Equipment, net of accumulated depreciation of $1,579 and $1,520
      respectively
              
              
              105
              
              
              
              158Deferred
      tax assets, non-current
              
              
              532
              
              
              
              178Deferred
      loan origination fee, net
              
              
              37
              
              
              
              61Other
      assets
              
              
              72
              
              
              
              51Total
      Assets
              
              $
              22,293
              
              
              $
              24,661LIABILITIES
      AND STOCKHOLDERS' EQUITY:Current
      LiabilitiesAccounts
      payable to primary supplier
              
              $
              5,426
              
              
              $
              7,132Other
      trade accounts payable
              
              
              1,199
              
              
              
              1,105Accrued
      expenses
              
              
              2,179
              
              
              
              1,799Capitalized
      lease obligations, current
              
              
              -
              
              
              
              12Total
      Current Liabilities
              
              
              8,804
              
              
              
              10,048Deferred
      tax liability, non-current
              
              
              739
              
              
              
              739Revolving
      credit facility
              
              
              8,551
              
              
              
              9,862Total
      Liabilities
              
              
              18,094
              
              
              
              20,649Commitments
      and ContingenciesStockholders'
      EquityPreferred
      stock, undesignated, $.001 par value, 3,000,000 shares authorized, none
      issued or outstanding
              
              
              -
              
              
              
              -Common
      stock, $.001 par value, 200,000,000 shares authorized, 28,197,106 shares
      issued at September 30, 2009 and December 31,
      2008
              
              
              28
              
              
              
              28Shares
      held in treasury, 971,794 at September 30, 2009
              
              
              (246
              )
              
              
              -Additional
      paid-in capital
              
              
              34,888
              
              
              
              34,826Accumulated
      deficit
              
              
              (30,471
              )
              
              
              (30,842
              )Total
      Stockholders' Equity
              
              
              4,199
              
              
              
              4,012Total
      Liabilities and Stockholders' Equity
              
              $
              22,293
              
              
              $
              24,661





The Notes
to Condensed Consolidated Financial Statements are an integral part of these
statements





3





GVI
Security Solutions, Inc.


Condensed
Consolidated Statements of Operations


(unaudited)


(in
thousands, except per share amounts)





Three Months Ended September 30
                  
                  
                  Nine Months Ended September 302009
                  
                  
                  2008
                  
                  
                  2009
                  
                  
                  2008Revenues
                  
                  $
                  11,989
                  
                  
                  $
                  12,229
                  
                  
                  $
                  34,083
                  
                  
                  $
                  36,393Cost
      of Revenues
                  
                  
                  8,594
                  
                  
                  
                  8,559
                  
                  
                  
                  24,276
                  
                  
                  
                  25,496Gross
      Profit
                  
                  
                  3,395
                  
                  
                  
                  3,670
                  
                  
                  
                  9,807
                  
                  
                  
                  10,897Selling,
      General and Administrative Expenses
                  
                  
                  3,094
                  
                  
                  
                  2,989
                  
                  
                  
                  8,903
                  
                  
                  
                  8,699Operating
      Income
                  
                  
                  301
                  
                  
                  
                  681
                  
                  
                  
                  904
                  
                  
                  
                  2,198Interest
      Expense
                  
                  
                  115
                  
                  
                  
                  176
                  
                  
                  
                  351
                  
                  
                  
                  559Income
      before income taxes
                  
                  
                  186
                  
                  
                  
                  505
                  
                  
                  
                  553
                  
                  
                  
                  1,639Income
      Tax
                  
                  
                  102
                  
                  
                  
                  251
                  
                  
                  
                  182
                  
                  
                  
                  690Net
      Income
                  
                  $
                  84
                  
                  
                  $
                  254
                  
                  
                  $
                  371
                  
                  
                  $
                  949Basic
      income per common share:Net
      income per common share
                  
                  $
                  0.00
                  
                  
                  $
                  0.01
                  
                  
                  $
                  0.01
                  
                  
                  $
                  0.03Weighted
      average common shares outstanding
                  
                  
                  27,225,313
                  
                  
                  
                  28,197,107
                  
                  
                  
                  27,646,431
                  
                  
                  
                  28,177,070Diluted
      net income per common share:Net
      income per common share
                  
                  $
                  0.00
                  
                  
                  $
                  0.01
                  
                  
                  $
                  0.01
                  
                  
                  $
                  0.03Weighted
      average common shares outstanding
                  
                  
                  27,965,413
                  
                  
                  
                  32,265,182
                  
                  
                  
                  29,559,847
                  
                  
                  
                  33,238,644





The Notes
to Condensed Consolidated Financial Statements are an integral part of these
statements





4





GVI
Security Solutions, Inc.


Condensed
Consolidated Statements of Cash Flows


(unaudited)


(In thousands)




Nine Months Ending September 30,2009
                    
                    
                    2008Cash
      Flows Provided by Operating ActivitiesNet
      Income
                    
                    $
                    371
                    
                    
                    
                    949Adjustments
      to Reconcile Net Income to Net Cash Used In Operating
      Activities:Depreciation
      and amortization
                    
                    
                    60
                    
                    
                    
                    125Amortization
      of deferred loan origination fee
                    
                    
                    24
                    
                    
                    
                    24Compensation
      costs and expenses for stock and options issued
                    
                    
                    61
                    
                    
                    
                    210Changes
      in Assets and Liabilities:Accounts
      receivable, net
                    
                    
                    (907
                    )
                    
                    
                    (1,207
                    )Inventory
                    
                    
                    4,037
                    
                    
                    
                    (152
                    )Prepaid
      and other current assets
                    
                    
                    (575
                    )
                    
                    
                    450Other
      Assets, non-current
                    
                    
                    (20
                    )
                    
                    
                    -Deferred
      tax assets and liabilities, net
                    
                    
                    (224
                    )
                    
                    
                    653Accounts
      payable
                    
                    
                    (1,612
                    )
                    
                    
                    247Accrued
      expenses
                    
                    
                    381
                    
                    
                    
                    6Net
      cash provided by operating activities
                    
                    
                    1,596
                    
                    
                    
                    1,305Cash
      Flows Used In Investing ActivitiesPurchase
      of property and equipment
                    
                    
                    (7
                    )
                    
                    
                    (145
                    )Net
      Cash Used In Investing Activities
                    
                    
                    (7
                    )
                    
                    
                    (145
                    )Cash
      Flows Used in Financing ActivitiesIssuance
      of common stock upon exercise of warrants
                    
                    
                    -
                    
                    
                    
                    10Payments
      for purchase of treasury stock
                    
                    
                    (246
                    )
                    
                    
                    -Net
      payments for revolving credit facility
                    
                    
                    (1,310
                    )
                    
                    
                    (1,406
                    )Principal
      payments of capitalized lease obligations
                    
                    
                    (12
                    )
                    
                    
                    (45
                    )Net
      Cash Used in Financing Activities
                    
                    
                    (1,568
                    )
                    
                    
                    (1,441
                    )Net
      increase (decrease) in cash and equivalents
                    
                    
                    21
                    
                    
                    
                    (282
                    )Cash
      and equivalents, beginning of period
                    
                    
                    46
                    
                    
                    
                    313Cash
      and equivalents, end of period
                    
                    $
                    67
                    
                    
                    
                    31SUPPLEMENTARY
      CASH FLOW INFORMATIONCash
      paid for interest
                    
                    $
                    115
                    
                    
                    
                    579Cash
      paid for income taxes
                    
                    
                    95
                    
                    
                    
                    61





The Notes
to Condensed Consolidated Financial Statements are an integral part of these
statements





5





GVI
Security Solutions, Inc.


Notes
to Condensed Consolidated Financial Statements (unaudited)


Nine
Months Ended September 30, 2009 and 2008





NOTE
1 ~ SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES





Nature
of Business





GVI
Security Solutions (“GVI” or “Company”) provides video surveillance and security
solutions products, incorporating a complete line of video surveillance and
detection systems, to the homeland security, professional and
business-to-business market segments.  The Company provides a strong
combination of closed circuit televisions (CCTVs), digital video recorders
(DVRs), software systems and networking products that enhance life safety for
both government agencies and the private sector.




The
Company’s customers include distributors and system integrators that specialize
in video surveillance and security products and services, government agencies
and private sector businesses.





On
October 21, 2009, the Company entered into an Agreement and Plan of Merger with
GenNx360 GVI Holding, Inc. (“Parent”), and GenNx360 GVI Acquisition Corp., a
wholly-owned subsidiary of Parent (“Merger Sub”), pursuant to which Merger Sub
commenced a tender offer (the “Tender Offer”) on November 3, 2009 to acquire all
of the Company’s  outstanding shares of common stock for $0.38 per
share payable net to the seller in cash.  The proposed merger is
detailed further in Note 8, “Subsequent Events,” of the condensed consolidated
financial statements.





Basis
of Presentation





The
accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with generally accepted accounting principles applicable
to interim financial information and with the requirements of Form 10-Q of the
Securities and Exchange Commission. Accordingly, they do not include all of the
information and footnotes required by accounting principles generally accepted
in the United States of America for complete financial statements. Interim
results are not necessarily indicative of results for a full year. In the
opinion of management, all adjustments considered necessary for a fair
presentation of the financial position and the results of operations and cash
flows for the interim periods have been included.





These
condensed consolidated financial statements should be read in conjunction with
the Company's Annual Report on Form 10-K for the fiscal year ended December 31,
2008.





Principles
of Consolidation





The
accompanying condensed consolidated financial statements include the accounts of
GVI Security Solutions, Inc., and its wholly-owned subsidiary. Intercompany
transactions, balances and profits have been eliminated.





Revenue
Recognition





The
Company’s primary source of revenue is from sales of its
products.  The Company recognizes revenue when the sales process is
deemed complete and associated revenue has been earned. The Company’s policy is
to recognize revenue when products have been shipped, risk of loss and title to
the product transfers to the customer, the selling price is fixed and
determinable and collectibility is reasonably assured.  Net sales is
comprised of gross revenue less expected returns, trade discounts and customer
allowances, which include costs associated with off-invoice mark downs and other
price reductions, as well as trade promotions. Related incentive costs are
recognized at the later of the date on which the Company recognizes the related
revenue or the date on which the Company offers the incentive.





The
Company allows customers to return defective products when they meet certain
established criteria as outlined in its sales terms and conditions. It is the
Company’s practice to regularly review and revise, when deemed necessary, its
estimates of sales returns, which are based primarily on actual historical
return rates. The Company records estimated sales returns as reductions to
sales, cost of sales, and accounts receivable and an increase to
inventory.  Returned products which are recorded as inventory are
valued based upon the amount the Company expects to realize upon its subsequent
disposition. The Company considers the physical condition and marketability of
the returned products as major factors in estimating realizable value. Actual
returns, as well as realized values on returned products, may differ
significantly, either favorably or unfavorably, from Company estimates if
factors such as customer inventory levels or competitive conditions differ from
estimates and expectations and, in the case of actual returns, if economic
conditions differ significantly from Company estimates and
expectations.





6





At the
time revenue is recognized, the Company also records reductions to revenue for
customer incentive programs in accordance with guidance of the Financial
Accounting Standards Board.  Such incentive programs include cash and
volume discounts, price protection, promotional, cooperative and other
advertising allowances.  For those incentives that require the
estimation of sales volumes or redemption rates, such as for volume rebates, the
Company uses historical experience and internal and customer data to estimate
the sales incentive at the time the revenue is recognized.  In the
event that the actual results of these items differ from the estimates,
adjustment to the sales incentive accruals would be recorded.





Inventory





Inventory
is stated at the lower of cost (first-in, first-out method) or market and
consists of goods held for resale and parts used for repair work. Reserves are
recorded for slow-moving, obsolete, nonsaleable or unusable items based upon a
product-level review, in order to reflect inventory balances at their net
realizable value. Inventory reserve balances at September 30, 2009 and December
31, 2008 were approximately $2,041,000 and $2,251,000,
respectively.





Advertising





Advertising
costs are expensed as incurred.  Certain advertising costs, which
include various promotional incentives and trade show participation, for the
nine months ended September 30, 2009 and 2008 were reimbursed by Samsung in the
form of marketing incentives and partial reimbursement for trade show
participation. Advertising costs, net of reimbursements, during the three month
period ended September 30, 2009 and 2008 were $251,000 and $169,000,
respectively, and during the nine month period ended September 30, 2009 and 2008
were $526,000 and $587,000, respectively.





Income
Taxes




Income
taxes consist of taxes currently payable plus deferred taxes related primarily
to differences between the basis of property and equipment, inventory, and
accounts receivable for financial and income tax reporting.  Deferred
taxes represent the future tax return consequences of those differences, which
will be taxable or deductible when the assets and liabilities are recovered or
settled.





Deferred
tax liabilities and assets are classified as current or noncurrent based on the
classification of the related asset or liability for financial reporting, or
according to the expected reversal date of temporary differences not related to
an asset or liability for financial reporting.  Also, a valuation
allowance is used, if necessary, to reduce deferred tax assets by the amount of
any tax benefits that are not expected to be realized in the future based on
available evidence.





Credit
Risk Concentration




During
the nine months ended September 30, 2009, two customers accounted for $4,485,000
(13%) and $4,200,000 (12%), respectively, of the Company’s
sales.  During the nine months ended September 30, 2008, two customers
accounted for $7,410,000 (20%) and $4,213,000 (12%), respectively, of the
Company’s sales.  During the three months ended September 30, 2009,
three customers accounted for $1,502,000 (13%), $1,473,000 (12%), and $1,434,000
(12%) respectively, of the Company’s sales.  During the three months
ended September 30, 2008, two customers accounted for $1,754,000 (14%) and
$1,671,000 (14%), respectively, of the Company’s sales.





As of
September 30, 2009, two customers comprised $1,434,000 (18%), and $1,424,000
(18%), respectively, of the Company’s total outstanding gross accounts
receivable balance.  As of December 31, 2008, these two significant
customers comprised $1,772,000 (22%) and $985,000 (12%), respectively, of
Company’s total outstanding accounts receivable balance.





International
sales accounted for approximately 39%, and 34% of the Company's sales during the
nine months ended September, 2009 and 2008, respectively, and 40% and 41% for
the three months ended September 30, 2009 and 2008, respectively.  All
international sales took place in Latin America and Canada with the majority
occurring in Latin America.  During the nine months ended September
30, 2009 and 2008, approximately 22% and 17%, respectively, of the Company’s
sales took place in Mexico. As of
September 30, 2009, 46% of the Company’s accounts receivable are from
international customers.





7





The
Company performs ongoing credit evaluations of its customers and generally
requires no collateral from them.  In addition, the Company maintains
a credit insurance policy covering foreign receivables.





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 revenues and expenses during the reporting
period.  Actual results could differ from those
estimates.  Significant estimates include those that relate to the
valuation of inventory, accounts receivable, certain accruals and liabilities
and the useful lives of property and equipment




Earnings
per Share





The
Financial Accounting Standard Board requires presentation of basic earnings per
share ("Basic EPS") and diluted earnings per share ("Diluted EPS"). Basic
earnings (loss) per share is computed by dividing earnings (loss) available to
common stockholders by the weighted average number of common shares outstanding
during the period.




Diluted
earnings per share reflects the potential dilution, using the treasury stock
method, that could occur if securities or other contracts to issue common stock
were exercised or converted into common stock or resulted in the issuance of
common stock that then shared in the earnings of the Company. In computing
diluted earnings per share, the treasury stock method assumes that outstanding
options and warrants are exercised and the proceeds are used to purchase common
stock  at the average market price during the
period.  Options and warrants will have a dilutive effect under the
treasury stock method only when the average market price of the common stock
during the period exceeds the
exercise  price  of  the  options and
warrants.





The  following  is
a reconciliation of the calculation of basic and diluted earnings per share for
the three and nine months ended September 30, 2009 and 2008.





Three
      Months Ended
                          September
      30,
                        
                        
                        Nine
      Months Ended
                          September
      30,2009
                        
                        
                        2008
                        
                        
                        2009
                        
                        
                        2008NumeratorNet
      income, as reported
                        
                        $
                        84
                        
                        
                        $
                        254
                        
                        
                        $
                        371
                        
                        
                        $
                        949DenominatorWeighted
      average common shares outstanding, basic
                        
                        
                        27,225
                        
                        
                        
                        28,197
                        
                        
                        
                        27,646
                        
                        
                        
                        28,177Effect
      of dilutive securities:Warrants
                        
                        
                        191
                        
                        
                        
                        1,065
                        
                        
                        
                        497
                        
                        
                        
                        1,310Common
      stock options
                        
                        
                        549
                        
                        
                        
                        3,003
                        
                        
                        
                        1,416
                        
                        
                        
                        3,751Weighted
      average common shares outstanding, dilutive
                        
                        
                        27,965
                        
                        
                        
                        32,265
                        
                        
                        
                        29,560
                        
                        
                        
                        33,238Earnings
      per share – basicNet
      income (loss), as reported
                        
                        $
                        0.00
                        
                        
                        $
                        0.01
                        
                        
                        $
                        0.01
                        
                        
                        $
                        0.03Earnings
      per share – dilutiveNet
      income (loss), as reported
                        
                        $
                        0.00
                        
                        
                        $
                        0.01
                        
                        
                        $
                        0.01
                        
                        
                        $
                        0.03





8





Options
and warrants to purchase approximately 659,000 and 885,000 shares of common
stock, respectively, at various prices exceeding $0.31 per share were
outstanding during the three and nine months ended September 30, 2009 but were
not included in the computation of diluted earnings per share for those periods
because the respective warrant exercise prices were greater than the average
market price of the shares of common stock during those periods, and their
effect would be anti-dilutive.





Options
and warrants to purchase approximately 885,000 and 735,000 shares of common
stock, respectively, at various prices exceeding $0.48 per share and $0.69 per
share were outstanding during the three and nine months ended September 30, 2008
but were not included in the computation of diluted earnings per share for those
periods because the respective warrant exercise prices were greater than the
average market price of the shares of common stock during those periods, and
their effect would be anti-dilutive.




Stock-Based
Compensation





The
Company periodically issues stock options and warrants to employees and
non-employees in capital raising transactions, for services and for financing
costs.  Stock-based compensation is measured at the grant date, based
on the fair value of the award, and is recognized as expense over the requisite
service period.  Options vest and expire according to terms
established at the grant date.





The
Company uses the Black-Scholes option pricing model to estimate the fair value
of warrants and option awards with the following weighted average assumptions
for the period indicated:





Nine
      Months Ended
                    September
      30,2009
                  
                  
                  2008Dividend
      yield
                  
                  
                  -
                  
                  
                  
                  -Risk-free
      factors
                  
                  
                  4.0
                  %
                  
                  
                  4.0
                  %Volatility
      factors
                  
                  
                  63
                  %
                  
                  
                  63
                  %Option
      Lives in Years
                  
                  
                  6.0
                  
                  
                  
                  6.0





Recent
Accounting Pronouncements





In June
2009, the FASB issued authoritative guidance on accounting standards
codification and the hierarchy of generally accepted accounting principles.” The
FASB Accounting Standards CodificationTM (“Codification”) has become the source
of authoritative accounting principles recognized by the FASB to be applied by
nongovernmental entities in the preparation of financial statements in
accordance with GAAP. All existing accounting standard documents are superseded
by the Codification and any accounting literature not included in the
Codification will not be authoritative. However, rules and interpretive releases
of the Securities Exchange Commission (“SEC”) issued under the authority of
federal securities laws will continue to be sources of authoritative GAAP for
SEC registrants. The FASB authoritative guidance is effective for interim and
annual reporting periods ending after September 15, 2009. Therefore, beginning
with the Company’s quarter ending September 30, 2009, all references made by it
to GAAP in its consolidated financial statements now use the new Codification
numbering system. The Codification does not change or alter existing GAAP and,
therefore, it does not have an impact on the Company’s financial position,
results of operations and cash flows.





On July
1, 2009, the Company adopted authoritative guidance issued by the FASB on
business combinations. The guidance retains the fundamental requirements that
the acquisition method of accounting (previously referred to as the purchase
method of accounting) be used for all business combinations, but requires a
number of changes, including changes in the way assets and liabilities are
recognized and measured as a result of business combinations. It also requires
the capitalization of in-process research and development at fair value and
requires the expensing of acquisition-related costs as incurred. The Company has
not completed any business combinations since July 1,
2009.  Accordingly, adoption of the new guidance has not impacted the
Company’s financial statements.





In May
2009, the FASB issued new requirements for reporting subsequent events. These
requirements set forth the period after the balance sheet date during which
management of a reporting entity should evaluate events or transactions that may
occur for potential recognition or disclosure in the financial statements, the
circumstances under which an entity should recognize events or transactions
occurring after the balance sheet date in its financial statements, and
disclosures that an entity should make about events or transactions that
occurred after the balance sheet date. Disclosure of the date through which an
entity has evaluated subsequent events and the basis for that date is also
required.





9





In
October 2009, the FASB issued authoritative guidance on revenue recognition that
will become effective for the Company beginning July 1, 2010, with earlier
adoption permitted.  Under the new guidance on arrangements that
include software elements, tangible products that have software components that
are essential to the functionality of the tangible product will no longer be
within the scope of the software revenue recognition guidance, and
software-enabled products will now be subject to other relevant revenue
recognition guidance.  The Company believes adoption of this new
guidance will not have a material impact on its financial
statements.




Other
recent accounting pronouncements issued by the FASB did not or are not believed
by management to have a material impact on the Company's present or future
consolidated financial statements.





NOTE
2 ~ CREDIT FACILITY





On
November 20, 2007, the Company entered into a Credit and Security Agreement with
Wells Fargo Bank, National Association under which the Company was provided with
a $15 million revolving credit facility. Borrowings under the credit facility
are secured by all of the Company’s assets.  Outstanding loans under
the credit facility will become due on November 20, 2010.  The
Company’s borrowings under the credit facility as of September 30, 2009 and
December 31, 2008, were approximately $8.6 million and $9.9 million,
respectively.  The Company has classified the note as a long-term
liability based upon management’s current projections of available borrowing
base and utilization.




Pursuant
to the Credit and Security Agreement, among other things:




·
            Interest
      currently accrues on outstanding loans under the credit facility, at the
      Company’s option, at a per annum rate equal to the prime rate from time to
      time in effect (3.25% at September 30, 2009) plus .25% percent, or a LIBOR
      rate selected by the Company, plus 2.75%.   Because the
      Company achieved Net Income (as defined in the Credit Agreement), in
      excess of $1,000,000 in the year ending December 31, 2008, the current
      interest rate reflects a reduction by .50% per annum from the original
      interest rate provided for under the Credit and Security
      Agreement.





·
            The
      Company pays Wells Fargo an annual fee equal to .25% of the average daily
      unused portion of the credit
facility.





·
            Aggregate
      loans (plus the face amount of letters of credit) outstanding under the
      credit facility at any time may not exceed the lesser of $15 million or a
      borrowing base equal to the sum of 85% of “Eligible Accounts” plus the
      lesser of (i) 60% of “Eligible Inventory” (valued at the lower of cost or
      market), (ii) 85% of the “Net Orderly Liquidation Value of Eligible
      Inventory,” and (iii) $8.5 million. As of September 30, 2009, the
      Company’s borrowing base supported approximately $14.3 million of
      borrowings.





·
            The
      Company will be required to pay a prepayment fee to Wells Fargo if the
      credit facility is terminated prior to maturity. Such fee is $150,000 if
      the credit facility is terminated prior to November 20, 2009 and $37,500
      if the credit facility is terminated after November 20,
    2009.





·
            The
      Company is required to comply with a number of affirmative, negative and
      financial covenants. Among other things, these covenants restrict the
      Company’s ability to pay dividends, requires the Company to achieve
      minimum quarterly Net Income as set forth in the Credit Agreement, and
      requires the Company to maintain a minimum Debt Service Coverage Ratio (as
      defined in the Credit Agreement) as of the last day of each quarter of not
      less than 1.25 to 1.0.  As of September 30, 2009, the Company
      was in compliance with all such
covenants.





NOTE
3 ~ INCOME TAXES





The
reconciliation of the federal statutory rate to the effective income tax rate
applicable to income is as follows:





10





Three
      Months Ended
                    September
      30:
                  
                  
                  Nine
      Months Ended
                    September
      30:2009
                  
                  
                  2008
                  
                  
                  2009
                  
                  
                  2008US
      Statutory tax rate – provision (benefit)
                  
                  
                  34.0
                  %
                  
                  
                  34.0
                  %
                  
                  
                  34.0
                  %
                  
                  
                  34.0
                  %Increases
      (decreases) resulting from:State
      income taxes
                  
                  
                  1.5
                  
                  
                  
                  12.4
                  
                  
                  
                  0.5
                  
                  
                  
                  4.6Change
      in prior year deferred items
                  
                  
                  218.0
                  
                  
                  
                  -
                  
                  
                  
                  59.5Changes
      in Valuation Reserve
                  
                  
                  (206.9
                  )
                  
                  
                  -
                  
                  
                  
                  (73.0
                  )
                  
                  
                  -Net
      operating loss deductions
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Depreciation
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Other
      – net
                  
                  
                  8.0
                  
                  
                  
                  3.3
                  
                  
                  
                  11.9
                  
                  
                  
                  3.3Effective
      income tax rate
                  
                  
                  54.6
                  %
                  
                  
                  49.7
                  %
                  
                  
                  32.9
                  %
                  
                  
                  41.9
                  %





The
Company records income taxes using the asset and liability approach, whereby
deferred tax assets, net of valuation allowances, and liabilities are recorded
for the future tax consequences of temporary differences between financial
statement and tax bases of assets and liabilities and for the benefit of net
operating loss carry forwards.





The
Company incurred significant operating losses during the three years prior to
2007, which generated net operating loss carry-forwards which may be available
for future utilization. Internal Revenue Code Section 382 places a limitation on
the utilization of Federal net operating loss and other credit carry-forwards
when an ownership change, as defined by the tax law,
occurs.  Generally, this occurs when a greater than 50 percentage
point change in ownership occurs. In October 2006, as a result of the completion
of the Company’s private placement transaction, the investors in the private
placement as a group became the beneficial owners of approximately 96% of the
Company’s outstanding shares, after consideration of the conversion of
convertible promissory notes issued to those investors in conjunction with the
transaction. Accordingly, the actual utilization of net operating loss
carry-forwards and other deferred tax assets for tax purposes will be limited
annually under Code Section 382 to a percentage of the fair market value of the
Company at the date of this ownership change, and this effect has reduced the
amount of these loss carry-forwards which the Company will be able to utilize to
offset against future taxable income. As a result, at December 31, 2008,
the Company has a federal net operating loss carry-forward of approximately $1.5
million expiring 2026.  The $1.5 million can be utilized at a rate of
approximately $89,000 annually over the following 17 years ending
2026.  A partial valuation allowance has been provided against the net
deferred tax assets, due to the uncertainty of the Company’s ability to generate
long-term taxable income, particularly as it relates to the current economic
environment.  The Company has reported profits over the past two years
and expects to have a profit in 2009.  Thus, management has concluded
that a portion of its deferred tax assets is realizable.  Management
has decided to recognize deferred tax assets equal to the tax on three years of
taxable income, based on projected 2009 taxable income.  Because of
uncertainty due to the current economic climate, the Company has decided to set
a valuation allowance against its remaining deferred tax assets.  No
valuation allowance will be placed on deferred tax assets based on gross receipt
taxes assessed by States such as Texas and Michigan.


Authoritative
guidance issued by the  Financial Accounting Standards Board addresses
the determination of whether tax benefits claimed or expected to be claimed on a
tax return should be recorded in the financial statements. Under the current
accounting guidelines, the Company may recognize the tax benefit from an
uncertain tax position only if it is more likely than not that the tax position
will be sustained on examination by the taxing authorities, based on the
technical merits of the position. The tax benefits recognized in the financial
statements from such a position should be measured based on the largest benefit
that has a greater than fifty percent likelihood of being realized upon ultimate
settlement. It also provides guidance on derecognition, classification, interest
and penalties on income taxes, accounting in interim periods and requires
increased disclosures. At the date of adoption, and as of December 31, 2008, the
Company does not have a liability for unrecognized tax benefits.


The
Company files income tax returns in the U.S. federal jurisdiction and various
states. The Company is subject to U.S. federal or state income tax examinations
by tax authorities for five years after 2002. During the periods open to
examination, the Company has net operating loss and tax credit carry forwards
for U.S. federal and state tax purposes that have attributes from closed
periods. Since these NOLs and tax credit carry forwards may be utilized in
future periods, they remain subject to examination.





11








The
Company’s policy is to record interest and penalties on uncertain tax provisions
as income tax expense. As of September 30, 2009, the Company had no accrued
interest or penalties related to uncertain tax positions.





NOTE
4 ~ COMMITMENTS & CONTINGENCIES





General





Sales to
certain consumers of video surveillance and other security products may be
subject to sales tax requirements and possible audits by state taxing
authorities.  The Company records its estimated sales tax liability
and includes that amount as an accrued obligation until paid.





The
Company is also party to other disputes in the normal course of business.
Management believes the ultimate resolution of such disputes will not have a
material effect on the financial statements.





Lease
and Rents





The
Company leases warehouse and office space under an operating lease agreement
which expires on April 30, 2015.  The Company signed a five year
extension to this lease in July of 2009.  Under the terms of the lease
extension, the Company will pay (i) no rent for five months commencing December
1, 2009, (ii) monthly rent of $25,017 for the following 36 months, and (iii)
monthly rent of $25,753 for the remaining 24 months. The Company records rent on
a straight-line basis over the life of the lease and records the difference
between amounts paid and expense recorded as a deferred lease
liability.





Vendor
Agreement





On
October 2, 2006, the Company entered into a Distribution Agreement (“Agreement”)
with Samsung, under which the Company was granted the right to distribute
Samsung’s complete line of professional video surveillance and security products
in North, Central and South America (“Territory”) through December 31, 2010.
Pursuant to the Agreement, Samsung has agreed to a limited non-compete in the
Territory. In November 2008, the Distribution Agreement was amended to lower the
minimum amounts the Company is required to purchase from Samsung.  As
amended, the Agreement provides for minimum annual purchase amounts of $27
million, $25 million, $32.4 million, and $42 million for the years ending
December 31, 2007, 2008, 2009, and 2010, respectively. Samsung may terminate the
Agreement at any time if the Company does not achieve the annual minimum
purchase amounts, as well as upon the Company’s breach of any of its other
obligations thereunder. For the years ended December 31, 2007, and December 31,
2008, the Company exceeded its minimum purchasing commitment under the
agreement. For the years ended December 31, 2007 and December 31, 2008, the
Company purchased approximately $28 million and $26 million respectively under
the Distributorship Agreement with Samsung.  During the nine months
ended September 30, 2009, the Company had purchased approximately $14.2 million
under the Distributor Agreement with Samsung.   The Company will
not meet its minimum purchase commitment under the agreement for the year ending
December 31, 2009, and there is no assurance that Samsung will amend the
agreement to enable the Company to meet such commitment as it has in the
past.  In such event, Samsung would be entitled to terminate the
Distributor Agreement.




Samsung
has established a credit limit, currently in the amount of approximately $10
million, under which the Company purchases products.  The Company must
pay in advance of shipment when the credit limit has been met or
exceeded.  As of September 30, 2009, $5.4 million was due to Samsung
under this agreement.




Software
Purchase Agreement





On May
18, 2009, the Company entered into (i) an Intellectual Property Assignment
Agreement with PacketNVR, LLP and Omeon, Inc., and (ii) an Option Agreement with
PNVR and Omeon, and related agreements.




Pursuant
to these Agreements, the Company has acquired video management software and
related technology and intellectual property from PacketNVR, which will be
further developed and supported for the Company by Omeon.  The Company
made an initial payment of $116,000 to PacketNVR upon execution of the
agreements.  Under the terms of the agreements, the Company is
obligated to make the following payments; $630,000 upon delivery and acceptance
of Version 1.1, $146,000 upon delivery and acceptance of Version 1.2, $121,000
upon delivery and acceptance of Version 1.3, $247,000 upon delivery and
acceptance of Version 2.0, and $411,000 for on-going development over a period
of twenty four months commencing twelve months after completion of Version
1.1.  Further, the Company would be required to pay up to an
additional $440,000 based upon the achievement of certain sales
milestones.  As of September 30, 2009, the Company has capitalized
$746,000 of payments that were made or became due upon delivery of and
acceptance of Version 1.1.





12





In
addition, in connection with this transaction, the Company issued to the
developers of the technology a warrant to purchase 200,000 shares of common
stock at an exercise price of $.75 per share, and 60,000 shares of restricted
shares of common stock.  Both the warrant and restricted stock are
subject to vesting upon the achievement of specified sales
targets.  In addition, the Company has entered into an employee
agreement with one of the principals of PacketNVR as of May 18,
2009.




The
Company analyzed Financial Accounting Standards Board guidelines regarding the
accounting for the costs of the acquired technology, and has determined that the
initial payments of $746,000 associated with the delivery and acceptance of
Version 1.1 should be capitalized.  As of September 30, 2009, the
Company has not amortized any of this cost since there have not yet been
associated revenues.  All R&D expenditures, such as the consulting
expenses associated with the product, have been expensed in accordance with
current accounting guidance.  As further costs and expenses are
incurred by the Company under the foregoing agreements and in developing the
related technology, the Company will determine whether such costs should be
capitalized or expensed.





The
Company further determined that there was no consideration received by it for
the 200,000 warrants and 60,000 shares of common stock granted under the
agreements, as both the warrant and restricted shares are subject to vesting
upon the achievement of specified sales targets.  The Company will
review and estimate the probability of reaching such milestones at each
reporting date, and will determine the allocable amount of cost to be recognized
based upon the probabilities at such dates.  As of September 30, 2009,
no such cost has been recognized by the Company for these issuances as the
probabilities are not yet determinable.




NOTE
5 ~ 2004 STOCK INCENTIVE PLAN





In
February 2004, the Company adopted its 2004 Long-Term Stock Plan and reserved
118,798 shares of common stock for issuance thereunder.  In September
2006 the shares available under this Plan increased from 118,798 to 200,000, in
October 2006 the shares available were increased under this Plan to
5,900,000.  In July 2008, the Company adopted its 2008 Long-Term Stock
Plan and reserved 1,000,000 shares of common stock for issuance
thereunder.





A summary
of the status and activity of the Company’s stock options for the nine months
ended September 30, 2009 is presented below:





Nine
      Months Ended
                          September
      30, 2009Shares
                        
                        
                        Weighted
                          Ave
                          Exercise
                          PriceOutstanding
      at January 1, 2009:
                        
                        
                        6,042,218
                        
                        
                        $
                        1.06Granted
                        
                        
                        -
                        
                        
                        
                        -Exercised
                        
                        
                        -
                        
                        
                        
                        -Forfeited
                        
                        
                        100,000
                        
                        
                        $
                        0.80Outstanding
      at September 30, 2009:
                        
                        
                        5,942,218
                        
                        
                        $
                        1.07Options
      Exercisable at September 30, 2009:
                        
                        
                        5,459,715
                        
                        
                        $
                        1.19





The
aggregate intrinsic values of outstanding and exercisable stock options at
September 30, 2009 were approximately $475,523 and $386,363
respectively.





13








The
following table summarizes information about stock options outstanding as of
September 30, 2009:





Outstanding
      Options
                          
                          Exercisable
      OptionsExercise
      Prices
                          
                          Shares
                            Outstanding
                            at
      September
                            30,
      2009
                          
                          Weighted-average
                            Remaining
                            Contractual
      Life
                          
                          Number
                            Outstandingat
                            September
      30,
                            2009$  0.20
                          
                          
                          5,283,590
                          
                          7.0
      years
                          
                          
                          4,953,366.46
                          
                          
                          110,000
                          
                          3.7
      years
                          
                          
                          73,333.60
                          
                          
                          350,000
                          
                          2.4
      years
                          
                          
                          295,416.80
                          
                          
                          50,000
                          
                          8.2
      years
                          
                          
                          27,416.95
                          
                          
                          100,000
                          
                          8.2
      years
                          
                          
                          61,55615.93
                          
                          
                          4,637
                          
                          3.8
      years
                          
                          
                          4,63742.50
                          
                          
                          2,000
                          
                          5.5
      years
                          
                          
                          2,00075.00
                          
                          
                          13,366
                          
                          5.2
      years
                          
                          
                          13,366>
      130.00
                          
                          
                          28,625
                          
                          4.3
      years
                          
                          
                          28,6255,942,218
                          
                          6.7
      years
                          
                          
                          5,459,715





There
were no stock options exercised during the nine months ended September 30, 2009.
The Company recognized compensation expense from the vesting of issued stock
options of approximately $61,000 for the nine months ended September 30, 2009,
and had estimated future compensation expense from these stock options of
approximately $79,000 at September 30, 2009 which will be recognized over the
remaining estimated weighted useful life of 24 months.





NOTE
6 ~ WARRANTS





A summary
of the activity and status of the Company’s warrants for the nine months ended
September 30, 2009 is presented below.





Nine
      Months Ended
                              September
      30, 2009Shares
                            
                            
                            Weighted
                              Ave
                              Exercise
                              PriceOutstanding
      at January 1, 2009:
                            
                            
                            2,709,592
                            
                            
                            $
                            4.67Granted
                            
                            
                            -
                            
                            
                            
                            -Exercised
                            
                            
                            -
                            
                            
                            
                            -Forfeited
                            
                            
                            -
                            
                            
                            
                            -Outstanding
      at September 30, 2009
                            
                            
                            2,709,592
                            
                            
                            $
                            4.67Exercisable
      at September 30, 2009:
                            
                            
                            2,634,592
                            
                            
                            $
                            4.78





The
aggregate intrinsic value of outstanding warrants at September 30, 2009 was
approximately $273,750.





A summary
of the Company’s outstanding warrants at September 30, 2009 is as
follows:





14





Description
                    
                    Shares
                    
                    
                    Approx.
                      Remaining
                      Term
                      (Years)
                    
                    
                    Exercise
      PriceLaurus
      Master Fund
                    
                    
                    26,800
                    
                    
                    
                    1.6
                    
                    
                    $
                    30.00Laurus
      finder’s fee
                    
                    
                    1,880
                    
                    
                    
                    1.6
                    
                    
                    $
                    175.00ESI
                    
                    
                    60,000
                    
                    
                    
                    2.1
                    
                    
                    $
                    75.00Rapor
      shareholders
                    
                    
                    27,079
                    
                    
                    
                    2.1
                    
                    
                    $
                    152.00Oct.
      2004 bridge financing
                    
                    
                    15,333
                    
                    
                    
                    0.1
                    
                    
                    $
                    75.00Consultant
                    
                    
                    3,500
                    
                    
                    
                    0.1
                    
                    
                    $
                    175.00
      – $ 250.00Consulting
      fee paid to director
                    
                    
                    1,825,000
                    
                    
                    
                    3.0
                    
                    
                    $
                    0.20Consultant
                    
                    
                    100,000
                    
                    
                    
                    2.5
                    
                    
                    $
                    0.60Consultant
                    
                    
                    150,000
                    
                    
                    
                    3.0
                    
                    
                    $
                    0.82Consultant
                    
                    
                    300,000
                    
                    
                    
                    1.2
                    
                    
                    $
                    1.15Consultant
                    
                    
                    50,000
                    
                    
                    
                    3.8
                    
                    
                    $
                    0.60Consultant
                    
                    
                    150,000
                    
                    
                    
                    3.9
                    
                    
                    $
                    0.852,709,592





NOTE
7 ~ STOCK REPURCHASE PLAN





On
December 3, 2008, the Company announced that its Board of Directors had
authorized a share repurchase program for the repurchase of up to $1 million of
common stock.  The Company’s senior lender has provided its consent to
the repurchase of up to $250,000 of common stock.  During the first
nine months of 2009, the Company repurchased 971,794 shares of common stock at a
cost of approximately $246,000.  At September 30, 2009, the Company
had remaining Board authorization to repurchase up to approximately $754,000 of
common stock.





NOTE
8 ~ SUBSEQUENT EVENTS





For the
purposes of these financial statements, the Company has evaluated subsequent
events occurring between the end of its fiscal quarter ended September 30, 2009
and November 13, 2009, which is the date these financial statements were
issued.




Proposed Merger




On
October 21, 2009, the Company, GenNx360 GVI Holding, Inc., a Delaware
corporation (“Parent”), and GenNx360 GVI Acquisition Corp., a Delaware
corporation and a wholly-owned subsidiary of Parent (“Merger Sub”), entered into
an Agreement and Plan of Merger (the “Merger Agreement”), pursuant to which,
among other things, Merger Sub commenced a tender offer on November 3, 2009 (the
“Tender Offer”) to acquire all of the Company’s outstanding shares of common
stock for $0.38 per share payable net to the seller in cash, without interest
and subject to any tax withholding (the “Offer Price”). The Merger Agreement
also provides that following completion of the Tender Offer, Merger Sub will be
merged with and into the Company (the “Merger”) with the Company surviving the
Merger as a wholly-owned subsidiary of Parent. At the effective time of the
Merger, all remaining outstanding shares of common stock not tendered in the
Tender Offer (other than shares of common stock (i) owned by Parent, Merger
Sub, and the Company and (ii) for which appraisal has been properly
demanded under Delaware law) will be acquired for cash at the Offer Price and on
the terms and conditions set forth in the Merger Agreement.




Neither
the Tender Offer nor the Merger is subject to a financing condition.
Simultaneously with the execution of the Merger Agreement, GenNx360 Capital
Partners, L.P. (the “Sponsor”), a private equity investment fund which is
affiliated with Parent and Merger Sub and managed by GenNx360 Management
Company, LLC, a Delaware limited liability company (“GenNx360”), provided a
commitment and guarantee letter (the “Commitment Letter”) to Parent, Merger Sub
and the Company, obligating the Sponsor to (i) provide funds to Parent and
Merger Sub sufficient to permit Parent and Merger Sub to pay the consideration
in the Tender Offer and the Merger and to pay certain other monetary obligations
that may be owed pursuant to the Merger Agreement and (ii) guarantee the payment
of certain monetary obligations that may be owed pursuant to the Merger
Agreement, including funds related to any damages or liabilities incurred or
suffered by the Company in the event of a breach of the Merger
Agreement.




Merger
Sub’s obligation to accept for payment and pay all shares of common stock
validly tendered and not withdrawn pursuant to the Tender Offer is subject to
the satisfaction or waiver of a number of customary closing conditions including
the condition that the number of shares of common stock validly tendered and not
withdrawn represents at least a majority of the total number of shares of common
stock outstanding, assuming the exercise of all outstanding options (the
“Minimum Tender Condition”).





15




The
Company has also granted to Parent an irrevocable option (the “Top-Up Option”),
which Parent may exercise at the time of or immediately after the acceptance for
payment of, and payment by Merger Sub for, any shares of common stock pursuant
to the Tender Offer, to purchase from the Company the number of shares of common
stock equal to the lesser of (i) that number of shares of common stock that,
when added to the number of shares of common stock owned by Merger Sub as of
immediately prior to the exercise of the Top-Up Option, constitutes one share
more than 90% of the number of shares of common stock then outstanding on a
fully diluted basis (after giving effect to the issuance of the Top-Up Option
shares) or (ii) the aggregate of the number of shares of common stock held as
treasury shares by the Company and its subsidiaries and the number of shares of
common stock that the Company is authorized to issue under its certificate of
incorporation but that are not issued and outstanding (and are not reserved for
issuance pursuant to the exercise of options) as of immediately prior to the
exercise of the Top-Up Option. If Parent or Merger Sub acquires more than 90% of
the outstanding shares of common stock, including through exercise of the Top-Up
Option, it will complete the Merger through the “short form” procedures
available under Delaware law.




The
Merger Agreement contains certain termination rights by the Company and Parent
including, with respect to the Company, in the event that the Company receives a
superior proposal. In connection with the termination of the Merger Agreement
under specified circumstances, including with respect to the acceptance of a
superior proposal by the Company, the Company may be required to pay Parent a
termination fee equal to $1,000,000. In the event the Merger Agreement is
terminated in certain other circumstances, including as a result of the failure
of the Minimum Tender Condition to be satisfied at the scheduled expiration of
the Tender Offer, the Company’s breach of the Merger Agreement, or the
termination of the Tender Offer by Parent without any purchase of shares of
common stock, the Company shall pay all costs and expenses up to $500,000
incurred by Parent and Merger Sub in connection with the Merger Agreement and
the Tender Offer. The Merger Agreement also provides that the Company may
specifically enforce Parent’s and Merger Sub’s obligations under the Merger
Agreement.




Stockholder
Litigation




On
November 9, 2009, a class action complaint was filed in the Court of Chancery of
the State of Delaware, by Stephen Haberkorn, as Trustee of the Haberkorn Family
Trust, against the Company and all of its directors, as well as GenNx360, the
Sponsor and their affiliates. The complaint alleges, among other things, that
the Company’s directors breached their fiduciary duties to the Company’s
stockholders in connection with the negotiation and execution of the Merger
Agreement and the Offer. The complaint seeks an order that the action may be
maintained as a class action, preliminarily and permanently enjoining defendants
from proceeding with and consummating the proposed transactions, rescinding the
proposed transactions in the event they are consummated, an accounting by the
defendants to plaintiffs for damages sustained by them, and requiring payment of
plaintiff’s costs and attorneys’ fees. The Company is currently evaluating the
complaint.





16





Item
2.  Management’s Discussion and Analysis or Plan of
Operation.





Statements
contained in this Quarterly Report on Form 10-Q, other than the historical
financial information, constitute “forward-looking statements” within the
meaning of the Private Securities Litigation Reform Act of 1995. All such
forward-looking statements involve known and unknown risks, uncertainties or
other factors which may cause actual results, performance or achievement of the
Company to be materially different from any future results, performance or
achievement expressed or implied by such forward-looking statements. Primary
risk factors include, but are not limited to: reliance on primary supplier;
reliance on two key customers; changes in the overall economy; credit limits
imposed by primary supplier; outstanding indebtedness; rapid change in
technology; the number and size of competitors in its markets; effective
integration of recently acquired operations and personnel; expansion risks;
effective internal processes and systems; the ability to attract and retain high
quality employees; law and regulatory policy; the mix of products and services
offered in the Company's target markets; and other risks described herein and in
the Company’s 2008 Annual Report on Form 10-K.




The following discussion of results of
operations and financial condition is based upon, and should be read in
conjunction with, our consolidated condensed financial statements and
accompanying notes thereto included elsewhere herein.





Summary
of Our Business





We
provide video surveillance products and systems for a variety of applications
and for use in numerous markets including educational institutions, retail
stores and warehouses, gaming establishments, theme parks, public works
projects, bank branches and offices, and many other homeland security
applications.





Our
product line includes cameras designed for specific applications, recording
systems, displays, management software and other necessary ancillary
products.  These products can be configured as a system that is
scalable as customer needs expand or become more complex in nature.





We
primarily target the middle market where a typical customer’s need is for a
system that incorporates from four cameras to ninety-four cameras in any one
location.  We offer a premium brand and a wide product range with an
attractive product feature set that is backed by a strong service and support
platform.  Our customers include distributors and system integrators
that specialize in the supply and/or installation of video surveillance and
other physical security products, such as access control and intrusion
detection.





We
represent Samsung Electronics as the primary distributor of their branded
security and surveillance products in the Americas. We also sell a line of
complementary products under the GVI brand in those
territories.  Samsung Electronics has been and continues to be our
primary supplier of the video security products that we distribute. In October
2006, we entered into a new agreement with Samsung under which we have been
granted the right to distribute Samsung’s complete line of professional video
surveillance and security products in North, Central and South America through
December 31, 2010. Samsung has agreed to a limited non-compete in these
territories.





In order
to serve our customers with timely delivery and after sales service, we operate
sales and distribution centers in Dallas, Texas, Mexico City, Mexico, Sao Paulo,
Brazil and Bogotá, Colombia.  We also operate a customer call center
in Dallas Texas.





Our
Products





Our suite
of video surveillance and integrated security solutions includes a full line of
cameras, which include motion detection, low-light and Infrared illuminated,
day/night and high resolution, waterproof and weather-resistant cameras, vandal
resistant domes; high-speed, remote-controlled dome cameras and casings; as well
as a complete range of lenses; all of which can be fully integrated into
existing security systems. Our full product line includes a range of displays;
real-time and time-lapse DVR’s, video transmission equipment; digital video
processors, switchers and video management systems; digital video recording
software; and hardware and software that enable intelligent video
surveillance.





17








Strategies





Our
objective is to provide our customers and partners with a wide range of security
products designed to install, operate and service with relative ease while
meeting the needs of the end user. Our goal is to provide our customers with
excellent service and superior technology at competitive prices.





We
believe that by delivering the highest levels of customer service along with
effective solutions for the markets that we address, we can strengthen our
reputation as a reliable and cost-effective provider in the electronic security
systems industry and develop customer loyalty. We strive to anticipate and meet
our customers’ needs by increasing the range of products and services we offer,
by entering into new business alliances and by pursuing acquisitions of
complementary businesses enabling us to offer new products and services. Our
goals include further developing our expertise and products in the security
video sector, as well as developing other security or ancillary products to
supplement and complement our existing product line.  However, there
can be no assurance that we will consummate any additional acquisitions or that
any business we acquire will be successful. In addition, the acquisition of a
business through the issuance of our securities will result in dilution to our
existing stockholders.





Distribution
and Marketing





We offer
our products and services through local, regional and national system
integrators and distributors who resell our products to professional security
providers. System integrators utilize our products to develop and install a
fully integrated security suite for end users. We also utilize regional sales
executives who often support sales across all of our product offerings. We use a
combination of our internal sales force and independent representatives to sell
our products to our customers.





Proposed
Merger




On
October 21, 2009, we entered into an Agreement and Plan of Merger with GenNx360
GVI Holding, Inc. (“Parent”), and GenNx360 GVI Acquisition Corp., a wholly-owned
subsidiary of Parent (“Merger Sub”), pursuant to which Merger Sub commenced a
tender offer (the “Tender Offer”) on November 3, 2009 to acquire all of our
outstanding shares of common stock for $0.38 per share payable net to the seller
in cash.  The proposed merger is detailed further in Note 8,
“Subsequent Events,” of the condensed consolidated financial
statements.





THREE
MONTHS ENDED SEPTEMBER 30, 2009 COMPARED TO THREE MONTHS ENDED SEPTEMBER 30,
2008




NET
REVENUES





Net
revenues decreased approximately $241,000, or 2% to approximately $12.0 million
in the three months ended September 30, 2009 from approximately $12.2 million in
the three months ended September 30, 2008. The decrease in revenue reflects
decreased sales to distributors, integrators and installers of a variety of
products manufactured by Samsung Electronics as well as other manufacturers,
generally as a result of weakening economic conditions.





COST
OF GOODS SOLD





Totalcost of goods sold
increased approximately $35,000, or 1% to approximately $8.6 million for the
three months ended September 30, 2009, from approximately $8.6 million in the
three months ended September 30, 2008. This increase was primarily due to lower
average sale prices received for our products.





As a
result of the changes described above in revenues and cost of goods sold, gross
profit for the three months ended September 30, 2009 decreased approximately
$275,000 to approximately $3.4 million from approximately $3.7 million for the
three months ended September 30, 2008, and gross profit as a percentage of
revenues increased to approximately 28.3% for the three months ended September
30, 2009 compared with approximately 30.0% for the three months ended September
30, 2008.





18





SELLING,
GENERAL AND ADMINISTRATIVE EXPENSES





Selling,
general, and administrative expenses increased approximately $105,000, or 4%, to
approximately $3.1 million in the three months ended September 30, 2009 from
approximately $3.0 million in the three months ended September 30, 2008, as
follows:





Sales and Marketing.Sales and
marketing expenses increased approximately $155,000, or 9%, to approximately
$1.9 million in the three months ended September 30, 2009 from approximately
$1.7 million in the three months ended September 30, 2008. The increase was
primarily due to an increase in expenses to operate international offices and
higher net marketing expenses.





General and Administrative.General and administrative expenses decreased approximately $50,000, or
4% to $1.2 million in the three months ended September 30 2009 from
approximately $1.3 million in the three months ended September 30, 2008. The
decrease was primarily due to a decrease in personnel expense.





INTEREST
EXPENSE





Net
interest expense for the three months ended September 30, 2009 decreased 35% to
approximately $115,000 from approximately $176,000 in the three months ended
September 30, 2008. The decrease was primarily a result of a lower interest rate
on the Wells Fargo credit facility for the three months ended September 30, 2009
as compared to the three months ended September 30, 2008.





INCOME
TAX EXPENSE





We
reflected a provision for federal, state and local income tax expense of
approximately $102,000 for the three months ended September 30, 2009, as
compared to recording an expense of approximately $251,000 for the three months
ended September 30, 2008. Provisions for tax recorded in the three months ended
September 30, 2009 relates to both federal income taxes and state franchise
taxes that were estimated to be due in various states in which we are licensed
and transact business.  The Company’s estimated effective tax rate for
the three months ended September 30, 2009 was 54.9% as compared to an effective
tax rate of 49.7% for the three months ended September 30, 2008.





NET
INCOME





As a
result of the items discussed above, we earned net income of approximately
$84,000 for the three months ended September 30, 2009 compared with net income
of approximately $254,000 for the three months ended September 30,
2008.





NINE
MONTHS ENDED SEPTEMBER 30, 2009 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30,
2008




NET
REVENUES





Net
revenues decreased approximately $2,310,000, or 6% to approximately $34.1
million in the nine months ended September 30, 2009 from approximately $36.4
million in the nine months ended September 30, 2008. The decrease in revenue
reflects decreased sales to distributors, integrators and installers of a
variety of products manufactured by Samsung Electronics as well as other
manufacturers, generally as a result of weakening economic
conditions.





COST
OF GOODS SOLD





Totalcost of goods sold
decreased approximately $1,220,000 or 5% to approximately $24.3 million for the
nine months ended September 30, 2009, from approximately $25.5 million in the
nine months ended September 30, 2008. This decrease was primarily due to lower
net revenues.





As a
result of the changes described above in revenues and cost of goods sold, gross
profit for the nine months ended September 30, 2009 decreased approximately
$1,090,000 to approximately $9.8 million from approximately $10.9 million for
the nine months ended September 30, 2008, and gross profit as a percentage of
revenues decreased to approximately 28.8% for the nine months ended September
30, 2009 compared with approximately 29.9% for the nine months ended September
30, 2008.





19





SELLING,
GENERAL AND ADMINISTRATIVE EXPENSES





Selling,
general, and administrative expenses increased $204,000, or 2%, to approximately
$8.9 million in the nine months ended September 30, 2009 from approximately $8.7
million in the nine months ended September 30, 2008, as follows:





Sales and Marketing.Sales and
marketing expenses increased approximately $316,000, or 6%, to approximately
$5.3 million in the nine months ended September 30, 2009 from approximately $5.0
million in the nine months ended September 30, 2008. The increase was
primarily due to increased net marketing expense and an increase in expenses to
operate international offices.





General and Administrative.General and administrative expenses decreased approximately $112,000, or
3% to $3.6 million in the nine months ended September 30 2009 from approximately
$3.7 million in the nine months ended September 30, 2008. The decrease was
primarily due to a decrease in personnel expense and stock compensation
expense.





INTEREST
EXPENSE





Net
interest expense for the nine months ended September 30, 2009 decreased 37% to
approximately $351,000 from approximately $559,000 in the nine months ended
September 30, 2008. The decrease was primarily a result of a lower interest rate
on the Wells Fargo credit facility for the nine months ended September 30, 2009
as compared to the nine months ended September 30, 2008.





INCOME
TAX EXPENSE





We
reflected a provision for federal, state and local income tax expense of
approximately $182,000 for the nine months ended September 30, 2009, as compared
to recording an expense of approximately $690,000 for the nine months ended
September 30, 2008. Provisions for tax recorded in the nine months ended
September 30, 2009 relates to both federal income taxes and state franchise
taxes that were estimated to be due in various states in which we are licensed
and transact business.  The Company’s estimated effective tax rate for
the nine months ended September 30, 2009 was 32.9%, as compared to an effective
tax rate of 42.1% for the nine months ended September 30, 2008.





NET
INCOME





As a
result of the items discussed above, we earned net income of approximately
$371,000 for the nine months ended September 30, 2009 compared with net income
of approximately $949,000 for the nine months ended September 30,
2008.





LIQUIDITY
AND CAPITAL RESOURCES





At
September 30, 2009, we had cash and equivalents of approximately $67,000, a
working capital surplus of approximately $12.7 million, and an outstanding
balance of $8.6 million under the Wells Fargo revolving credit facility. In
comparison, at December 31, 2008, we had cash and equivalents of approximately
$46,000, a working capital surplus of approximately $14.2 million, and an
outstanding balance under the Wells Fargo revolving credit facility of
approximately $9.9 million. Additionally, we had borrowing availability under
the credit facility of approximately $4.8 million at September 30, 2009, as
compared with borrowing availability of $4.7 million at December 31,
2008.




Cash
increased from $46,000 at December 31, 2008 to $67,000 at September 30, 2009
primarily as a result of (i) a decrease of approximately $4.0 million in
inventory, and (ii) net income of approximately $371,000; offset by (i) a
reduction of accounts payable of approximately $1.6 million, (ii) net payments
under the revolving credit facility of $1.3 million, and (iii) an increase in
accounts receivable of approximately $0.9 million.




Management
believes that cash generated from operations, together with borrowings available
under the credit agreement with Wells Fargo, will provide us with adequate
financing to fund operations and meet our cash requirements through the end of
2009.




$15
Million Wells Fargo Revolving Credit Facility




On
November 20, 2007, through our wholly-owned subsidiary GVI Security, Inc., we
entered into a Credit and Security Agreement with Wells Fargo Bank, National
Association under which we were provided with a $15 million revolving credit
facility.  Borrowings under the credit facility are secured by all of
our assets. Outstanding loans under the credit facility will become due on
November 20, 2010.





20




Pursuant
to the Credit and Security Agreement, among other things:




·
            Interest
      accrues on outstanding loans under the credit facility, at our option, at
      a per annum rate equal to the prime rate from time to time in effect
      (3.25% at September 30, 2009) plus .25% percent, or a LIBOR rate selected
      by us, plus 2.75%.   Because we achieved Net Income (as
      defined in the Credit and Security Agreement), in excess of $1,000,000 in
      the year ending December 31, 2008, the current interest rate reflects a
      reduction by .50% per annum from the original interest rate provided for
      under the Credit and Security
Agreement.





·
            We
      also pay Wells Fargo an annual fee equal to .25% of the average daily
      unused portion of the credit
facility.





·
            Aggregate
      loans (plus the face amount of letters of credit) outstanding under the
      credit facility at any time may not exceed the lesser of $15 million or a
      borrowing base equal to the sum of 85% of “Eligible Accounts” plus the
      lesser of (i) 60% of “Eligible Inventory” (valued at the lower of cost or
      market), (ii) 85% of the “Net Orderly Liquidation Value of Eligible
      Inventory,” and (iii) $8.5 million.  As of September 30, 2009,
      the Company’s borrowing base supported approximately $14.3 million of
      borrowings  under the line of credit agreement, of which
      approximately $11.5 million was
outstanding.





·
            We
      will be required to pay a prepayment fee to Wells Fargo if the credit
      facility is terminated prior to maturity. Such fee would be $150,000 if
      the credit facility is terminated prior to November 20, 2009 or $37,500 if
      the credit facility is terminated after November 20,
  2009.





·
            We
      are required to comply with a number of affirmative, negative and
      financial covenants. Among other things, these covenants restrict our
      ability to pay dividends, requires us to achieve minimum quarterly Net
      Income as set forth in the Credit Agreement, and requires us to maintain a
      minimum Debt Service Coverage Ratio (as defined in the Credit Agreement)
      as of the last day of each quarter of not less than 1.25 to
      1.0.  As of September 30, 2009, we were in compliance with all
      such covenants.





Software
Purchase Agreement





On May
18, 2009, the Company entered into (i) an Intellectual Property Assignment
Agreement with PacketNVR, LLP and Omeon, Inc., and (ii) an Option Agreement with
PNVR and Omeon, and related agreements.




Pursuant
to these agreements, the Company has acquired video management software and
related technology and intellectual property from PacketNVR, which will be
further developed and supported for the Company by Omeon.  The Company
made an initial payment of $116,000 to PacketNVR upon execution of the
agreements.  Under the terms of the agreements, the Company is
obligated to make the following payments; $630,000 upon delivery and acceptance
of Version 1.1 (of which $472,000 has been paid), $146,000 upon delivery and
acceptance of Version 1.2, $121,000 upon delivery and acceptance of Version 1.3,
$247,000 upon delivery and acceptance of Version 2.0, and $411,000 for on-going
development over a period of twenty four months commencing twelve months after
completion of Version 1.1.    Further, the Company would be
required to pay up to an additional $440,000 based upon the achievement of
certain sales milestones.  As of September 30, 2009, the Company has
made payments of $588,000 associated with these agreements.




CRITICAL
ACCOUNTING POLICIES AND ESTIMATES




Our
condensed consolidated financial statements have been prepared in accordance
with generally accepted accounting principles. To prepare these financial
statements, we must make estimates and assumptions that affect the reported
amounts of assets and liabilities. These estimates also affect our reported
revenues and expenses. Judgments must be made about the disclosure of contingent
liabilities as well. Actual results could be significantly different from these
estimates. We believe that the following discussion addresses the critical
accounting policies that are necessary to understand and evaluate our reported
financial results.





21





Revenue
Recognition





The
Company’s primary source of revenue is from sales of its
products.  The Company recognizes revenue when the sales process is
deemed complete and associated revenue has been earned. The Company’s policy is
to recognize revenue when products have been shipped, risk of loss and title to
the product transfers to the customer, the selling price is fixed and
determinable and collectibility is reasonably assured.  Net sales is
comprised of gross revenue less expected returns, trade discounts and customer
allowances, which include costs associated with off-invoice mark downs and other
price reductions, as well as trade promotions. Related incentive costs are
recognized at the later of the date on which the Company recognizes the related
revenue or the date on which the Company offers the incentive.





The
Company allows customers to return defective products when they meet certain
established criteria as outlined in its sales terms and conditions. It is the
Company’s practice to regularly review and revise, when deemed necessary, its
estimates of sales returns, which are based primarily on actual historical
return rates. The Company records estimated sales returns as reductions to
sales, cost of sales, and accounts receivable and an increase to
inventory.  Returned products which are recorded as inventory are
valued based upon the amount the Company expects to realize upon its subsequent
disposition. The Company considers the physical condition and marketability of
the returned products as major factors in estimating realizable value. Actual
returns, as well as realized values on returned products, may differ
significantly, either favorably or unfavorably, from Company estimates if
factors such as customer inventory levels or competitive conditions differ from
estimates and expectations and, in the case of actual returns, if economic
conditions differ significantly from Company estimates and
expectations.


At the
time revenue is recognized, the Company also records reductions to revenue for
customer incentive programs in accordance with current accounting
guidance.  Such incentive programs include cash and volume discounts,
price protection, promotional, cooperative and other advertising
allowances.  For those incentives that require the estimation of sales
volumes or redemption rates, such as for volume rebates, the Company uses
historical experience and internal and customer data to estimate the sales
incentive at the time the revenue is recognized.  In the event that
the actual results of these items differ from the estimates, adjustment to the
sales incentive accruals would be recorded.


Inventory





Inventory
is stated at the lower of cost (first-in, first-out method) or market and
consists of goods held for resale and parts used for repair work. Reserves are
recorded for slow-moving, obsolete, nonsaleable or unusable items based upon a
product-level review, in order to reflect inventory balances at their net
realizable value.





Advertising





Advertising
costs are expensed as incurred.  Certain advertising costs, which
includes various promotional incentives and trade show participation, are
reimbursed by Samsung in the form of marketing incentives and partial
reimbursement for trade show participation.





Long-Lived
Assets




The
acquisition of long-lived assets, including furniture and fixtures, office
equipment, plant equipment, leasehold improvements, computer hardware and
software and in-store fixtures, is recorded at cost and this cost is depreciated
over the asset’s estimated useful life. We continually evaluate whether events
and circumstances have occurred that indicate the remaining estimated useful
life of long-lived assets may warrant revision or that the remaining balance may
not be recoverable. These factors may include a significant deterioration of
operating results, changes in business plans or changes in anticipated cash
flows. When factors indicate that an asset should be evaluated for possible
impairment, we review long-lived assets to assess recoverability from future
operations using undiscounted cash flows. Impairments are recognized in earnings
to the extent that the carrying value exceeds fair value.




Income
Taxes




We
estimate and record a quarterly income tax provision in accordance with the
expected effective annual tax rate. As the year progresses, we continually
refine our estimate based upon actual events and earnings during the year. This
process may result in a change to our expected effective tax rate for the year.
When this occurs, we adjust income tax expense during the quarter in which the
change in estimate occurs so that the year-to-date provision equals the expected
effective annual tax rate.





22





For the
three and nine month periods ended September 30, 2009 and 2008, income tax
expense relates to federal income tax along with state and local franchise taxes
that are due to various states and municipalities in which the Company is
licensed and transacts business.




Stock-Based
Compensation


The
Company periodically issues stock options and warrants to employees and
non-employees in capital raising transactions, for services and for financing
costs.  Stock-based compensation is measured at the grant date, based
on the fair value of the award, and is recognized as expense over the requisite
service period.  Options vest and expire according to terms
established at the grant date.
  Determining
the appropriate fair value model and calculating the fair value of stock-based
payment awards require the input of highly subjective assumptions, including the
expected life of the stock-based payment awards and stock price volatility. We
use the Black-Scholes option-pricing model to value compensation expense. The
assumptions used in calculating the fair value of stock-based payment awards
represent management’s best estimates, but the estimates involve inherent
uncertainties and the application of management judgment. As a result, if
factors change and we use different assumptions, our stock-based compensation
expense could be materially different in the future.


New
Accounting Pronouncements





In June
2009, the FASB issued authoritative guidance on accounting standards
codification and the hierarchy of generally accepted accounting principles.” The
FASB Accounting Standards CodificationTM (“Codification”) has become the source
of authoritative accounting principles recognized by the FASB to be applied by
nongovernmental entities in the preparation of financial statements in
accordance with GAAP. All existing accounting standard documents are superseded
by the Codification and any accounting literature not included in the
Codification will not be authoritative. However, rules and interpretive releases
of the Securities Exchange Commission (“SEC”) issued under the authority of
federal securities laws will continue to be sources of authoritative GAAP for
SEC registrants. The FASB authoritative guidance is effective for interim and
annual reporting periods ending after September 15, 2009. Therefore, beginning
with our quarter ending September 30, 2009, all references made by us to GAAP in
our consolidated financial statements now use the new Codification numbering
system. The Codification does not change or alter existing GAAP and, therefore,
it does not have an impact on our financial position, results of operations and
cash flows.





On July
1, 2009, we adopted authoritative guidance issued by the FASB on business
combinations. The guidance retains the fundamental requirements that the
acquisition method of accounting (previously referred to as the purchase method
of accounting) be used for all business combinations, but requires a number of
changes, including changes in the way assets and liabilities are recognized and
measured as a result of business combinations. It also requires the
capitalization of in-process research and development at fair value and requires
the expensing of acquisition-related costs as incurred. Because we did not
complete any business combinations since July 1, 2009,  adoption of
the new guidance did not have any impact on our financial
statements.





In May
2009, the FASB issued new requirements for reporting subsequent events. These
requirements set forth the period after the balance sheet date during which
management of a reporting entity should evaluate events or transactions that may
occur for potential recognition or disclosure in the financial statements, the
circumstances under which an entity should recognize events or transactions
occurring after the balance sheet date in its financial statements, and
disclosures that an entity should make about events or transactions that
occurred after the balance sheet date. Disclosure of the date through which an
entity has evaluated subsequent events and the basis for that date is also
required.





In
October 2009, the FASB issued authoritative guidance on revenue recognition that
will become effective for us beginning July 1, 2010, with earlier adoption
permitted.  Under the new guidance on arrangements that include
software elements, tangible products that have software components that are
essential to the functionality of the tangible product will no longer be within
the scope of the software revenue recognition guidance, and software-enabled
products will now be subject to other relevant revenue recognition
guidance.  We believe adoption of this new guidance will not have a
material impact on our financial statements.





23




Other
recent accounting pronouncements issued by the FASB (including its Emerging
Issues Task Force), the AICPA, and the SEC did not or are not believed by
management to have a material impact on the Company's present or future
consolidated financial statements.




Item
3.  Quantitative and Qualitative Disclosures About Market
Risk




Foreign Currency Exchange
Risk





Our
results of operations and cash flows are not subject in any material
respectto
fluctuations due to changes in foreign currency exchange
rates.   We do not currently have any foreign currency hedging
contracts in place, nor did we enter into any such contracts during the three
months ended September 30, 2009. To date, exchange rate fluctuations have had
little impact on our operating results and cash flows.





Interest Rate
Sensitivity




As
disclosed above, our loans with Wells Fargo bear interest at a fluctuating rate
of interest related to the “prime” and LIBOR rates in effect from time to
time.  Accordingly, increases in these rates will increase our
interest expense.   We do not use interest rate hedging contracts
to manage our exposure to changes in interest rates.




Item
4T.  Controls and Procedures.




Evaluation
of Disclosure Controls and Procedures





We
carried out an evaluation, under the supervision and with the participation of
our management, including our principal executive officer and principal
financial officer, of the effectiveness of our disclosure controls and
procedures (as defined  in  Rules  13a-15(e) and
15d-15(e) of the  Exchange  Act (defined  below)).
Based upon that evaluation, our principal executive officer and principal
financial officer concluded that, as of the end of the period covered in this
report, our disclosure controls and procedures were effective to ensure that
information required to be disclosed in reports filed under the Securities
Exchange Act of 1934, as amended (the "Exchange Act") is recorded, processed,
summarized and reported within the required time periods and is accumulated and
communicated to our management, including our principal executive officer and
principal financial officer, as appropriate to allow timely decisions regarding
required disclosure.





Our
management, including our principal executive officer and principal financial
officer, does not expect that our disclosure controls and procedures or our
internal controls will prevent all error or fraud. A control system, no
matter how well conceived and operated, can provide only reasonable, not
absolute, assurance that the objectives of the control system are met. Further,
the design of a control system must reflect the fact that there are resource
constraints and the benefits of controls must be considered relative to their
costs. Due to the inherent limitations in all control systems, no
evaluation of controls can provide absolute assurance that all control issues
and instances of fraud, if any, have been detected. Accordingly, management
believes that the financial statements included in this report fairly present in
all material respects our financial condition, results of operations and cash
flows for the periods presented.





Changes
in Internal Control Over Financial Reporting





In
addition, our management with the participation of our principal executive
officer and principal financial officer have determined that no change in our
internal control over financial reporting (as that term is defined in Rules
13(a)-15(f) and 15(d)-15(f) of the Exchange Act) occurred during or subsequent
to the quarter ended September 30, 2009 that has materially affected, or is
reasonably likely to materially affect, our internal control over financial
reporting.





24




PART
II.  OTHER INFORMATION





Item
1. Legal proceedings





On
November 9, 2009, a class action complaint was filed in the Court of Chancery of
the State of Delaware, by Stephen Haberkorn, as Trustee of the Haberkorn Family
Trust, against the Company and all of its directors, as well as GenNx360, the
Sponsor and their affiliates. The complaint alleges, among other things, that
the Company’s directors breached their fiduciary duties to the Company’s
stockholders in connection with the negotiation and execution of the Merger
Agreement and the Offer. The complaint seeks an order that the action may be
maintained as a class action, preliminarily and permanently enjoining defendants
from proceeding with and consummating the proposed transactions, rescinding the
proposed transactions in the event they are consummated, an accounting by the
defendants to plaintiffs for damages sustained by them, and requiring payment of
plaintiff’s costs and attorneys’ fees. The Company is currently evaluating the
complaint.





Item
1A. Risk Factors





In
addition to the risk factor set forth below, the “Risk Factors” discussed in
Part I, Item 1A of our Annual Report on Form 10-K for the year ended December
31, 2008, could materially affect our business, financial condition and future
results. The risks described in this report and in the Annual Report on Form
10-K are not the only risks we face. 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.




The
Market Price of our Common Stock Has Been, and May Continue to Be, Materially
Affected by the Tender Offer




The
current market price of our common stock may reflect, among other things, the
announcement and anticipated completion of the Tender Offer. The current market
price of our common stock is higher than the price before the proposed Tender
Offer was announced on October 22, 2009. The price of our common stock could
decline if the Tender Offer is not consummated.  The closing of the
Tender Offer is subject to uncertainties and matters beyond the control of the
Company, including the closing conditions set forth in the Merger
Agreement.




We may
also be subject to additional risks, whether or not the Tender Offer is
completed, including:




•
            
            our
      management having spent a significant amount of their time and efforts
      directed toward the proposed Tender Offer, which time and efforts
      otherwise would have been spent on our business and other opportunities
      that could have been beneficial to
us;




•
            
            costs
      relating to the Tender Offer, such as legal, financial, and accounting
      fees, much of which must be paid regardless of whether the Tender Offer is
      completed; and




•
            
            uncertainties
      relating to the Tender Offer may adversely affect our relationships with
      our employees, suppliers, and other key
  constituencies.




Investors
should not place undue reliance on the occurrence of the Tender Offer. The
realization of any of these risks may materially adversely affect our business,
financial condition, results of operations or the market price of our common
stock.




In
certain circumstances, the Merger Agreement requires us to pay a termination fee
of $1 million or to reimburse up to $500,000 of expenses of GenNx360 GVI
Holding, Inc.




Under the
Merger Agreement, we may be required to pay to GenNx360 GVI Holding, Inc. a
termination fee of $1 million or reimburse up to $500,000 million of expenses
incurred by GenNx360 GVI Holding, Inc. if the Merger Agreement is terminated
under certain circumstances. Should the Merger Agreement be terminated in
circumstances under which the termination fee or such expense reimbursement are
payable, the payment could have material and adverse consequences to our
financial condition and operations.





25




Item
2.  Unregistered Sales of Equity Securities and Use of
Proceeds




On
December 3, 2008, we announced that our Board of Directors  authorized
a share repurchase program for the repurchase of up to $1 million of our common
stock.  Our senior lender has provided its consent to our repurchase
of up to $250,000 of common stock.  During the first nine months of
2009, we repurchased 971,794 shares of common stock at a cost of approximately
$245,000.  At September 30, 2009, we had remaining Board authorization
to repurchase up to approximately $755,000 of common stock.  We did
not repurchase any shares of common stock under the repurchase program during
the three months ended September 30, 2009.




Item
6.  Exhibits.




Number
            
            Description10.1
            
            Agreement
      and Plan of Merger, dated as of October 21, 2009, by and among GenNx360
      GVI Holding, Inc., GenNx360 GVI Acquisition Corp. and GVI Security
      Solutions, Inc. (incorporated by reference to Exhibit 2.1 to the Company’s
      Current Report on Form 8-K filed with the Securities and Exchange
      Commission on October 23, 2009).10.2
            
            Commitment
      Letter, dated October 21, 2009, made by GenNx360 Capital Partners, L.P. in
      favor of GenNx360 GVI Holding, Inc., GenNx360 GVI Acquisition Corp. and
      GVI Security Solutions, Inc. (incorporated by reference to Exhibit 2.2 to
      the Company’s Current Report on Form 8-K filed with the Securities and
      Exchange Commission on October 23, 2009).31.1
            
            Certification
      of Steven Walin, Chief Executive Officer of the Registrant, pursuant to
      Rules 13a-14(a) and 15(d)-14(a) of the Securities Exchange Act of
      193431.2
            
            Certification
      of Joseph Restivo, Chief Financial Officer of the Registrant, pursuant to
      Rules 13a-14(a) and 15(d)-14(a) of the Securities Exchange Act of
      193432.1
            
            Certification
      of Steven Walin, Chief Executive Officer of the Registrant, pursuant to
      Rules 13a-14(B) and 15(d)-14(b) of the Securities Exchange Act of
      193432.2
            
            Certification
      of Joseph Restivo, Chief Financial Officer of the Registrant, pursuant to
      Rules 13a-14(B) and 15(d)-14(b) of the Securities Exchange Act of
      1934





26





SIGNATURES




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




GVI
      SECURITY SOLUTIONS, INC.Date:  November
      13, 2009
                By:
                /s/ Joseph RestivoName:  Joseph
      Restivo
                  Title:  Chief
      Financial Officer




27





EXHIBIT
INDEX




Number
                        
                        Description10.1
                        
                        Agreement
      and Plan of Merger, dated as of October 21, 2009, by and among GenNx360
      GVI Holding, Inc., GenNx360 GVI Acquisition Corp. and GVI Security
      Solutions, Inc. (incorporated by reference to Exhibit 2.1 to the Company’s
      Current Report on Form 8-K filed with the Securities and Exchange
      Commission on October 23, 2009).10.2
                        
                        Commitment
      Letter, dated October 21, 2009, made by GenNx360 Capital Partners, L.P. in
      favor of GenNx360 GVI Holding, Inc., GenNx360 GVI Acquisition Corp. and
      GVI Security Solutions, Inc. (incorporated by reference to Exhibit 2.2 to
      the Company’s Current Report on Form 8-K filed with the Securities and
      Exchange Commission on October 23, 2009).31.1
                        
                        Certification
      of Steven Walin, Chief Executive Officer of the Registrant, pursuant to
      Rules 13a-14(a) and 15(d)-14(a) of the Securities Exchange Act of
      193431.2
                        
                        Certification
      of Joseph Restivo, Chief Financial Officer of the Registrant, pursuant to
      Rules 13a-14(a) and 15(d)-14(a) of the Securities Exchange Act of
      193432.1
                        
                        Certification
      of Steven Walin, Chief Executive Officer of the Registrant, pursuant to
      Rules 13a-14(B) and 15(d)-14(b) of the Securities Exchange Act of
      193432.2
                        
                        Certification
      of Joseph Restivo, Chief Financial Officer of the Registrant, pursuant to
      Rules 13a-14(B) and 15(d)-14(b) of the Securities Exchange Act of
      1934





28