**UNITED
      STATES**




**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**











**FORM
      10-Q**





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





For
      the
      quarterly period ended June 30, 2006


or





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





For
      the
      transition period from __________ to __________





Commission
      file number: 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          o No




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


Large
      accelerated filer o    Accelerated
      filer o     Non-accelerated
      filer x





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


o Yes x No





As
      of
      August 11, 2006 there were 53,198,974 shares of the registrant’s common stock
      outstanding.









**GVI
      Security Solutions, Inc.**


**FORM
      10-Q**




**TABLE
      OF CONTENTS**




**PART
                I. FINANCIAL INFORMATION**
            
            **3**Item
                1.
            Financial
                Statements.
            
            3Item
                2.
            Management’s
                Discussion and Analysis of Financial Condition and Results of
                Operations
            
            14Item
                3.
            Quantitative
                and Qualitative Disclosures About Market Risk
            
            19Item
                4.
            Controls
                and Procedures.
            
            19**PART
                II. OTHER INFORMATION**
            
            **19**Item
                1A.
            Risk
                Factors
            
            19Item
                2.
            Unregistrered
                Sales of Equity Securities and Use of Proceeds.
            
            20Item
                4.
            Submission
                of Matters to a Vote of Security Holders
            
            21Item
                6.
            Exhibits.
            
            22




2




**PART
      I. FINANCIAL INFORMATION**





**Item
      1. Financial Statements.**





**GVI
      Security Solutions, Inc.**


**Condensed
      Consolidated Balance Sheet**




(In
      thousands, except share and per share amounts)




(Unaudited)
              June
                30,
              2006
            
            December
                31,
              2005**ASSETS**Current
                AssetsCash
            
            $
            1,833
            
            $
            3,284Accounts
                receivable, net
            
            
            8,203
            
            
            7,688Inventory
            
            
            9,992
            
            
            7,127Refundable
                income tax receivable
            
            
            -
            
            
            643Other
                current assets
            
            
            492
            
            
            917Current
                assets of discontinued operations
            
            
            625
            
            
            2,850Total
                Current Assets
            
            
            21,145
            
            
            22,509Property
                and Equipment, net
            
            
            592
            
            
            748Deferred
                loan origination fee, net of accumulated amortization
            
            
            509
            
            
            809Goodwill
            
            
            544
            
            
            544Intangibles,
                net
            
            
            466
            
            
            532Other
                assets
            
            
            84
            
            
            84Total
                Assets
            
            $
            23,340
            
            $
            25,226**LIABILITIES
                AND STOCKHOLDERS' EQUITY**Current
                LiabilitiesAccounts
                payable
            
            $
            10,524
            
            $
            7,035Accrued
                expenses
            
            
            1,949
            
            
            1,490Capitalized
                lease obligations, current
            
            
            75
            
            
            118Convertible
                revolving credit facility, current
            
            
            8,574
            
            
            -Convertible
                term note, current
            
            
            2,125
            
            
            2,080Liabilities
                of discontinued operations
            
            
            1,530
            
            
            70Total
                Current Liabilities
            
            
            24,777
            
            
            10,793Capital
                lease obligations, net of current portion
            
            
            101
            
            
            139Convertible
                revolving credit facility
            
            
            -
            
            
            8,495Convertible
                term note , net of current portion
            
            
            -
            
            
            1,195Total
                Liabilities
            
            
            24,878
            
            
            20,622Commitments
                and ContingenciesStockholders'
                (Deficit) 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; 50,258,003
                shares
                issued and outstanding at December 31, 2005 and 53,160,791 at June
                30,
                2006
            
            
            53
            
            
            50Additional
                paid-in capital
            
            
            23,689
            
            
            22,837Accumulated
                deficit
            
            
            (25,280
            )
            
            (18,283
            )Total
                Stockholders' (Deficit) Equity
            
            
            (1,538
            )
            
            4,604Total
                Liabilities and Stockholders' Equity
            
            $
            23,340
            
            $
            25,226





The
      Notes
      to 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 June 30
            
            Six
                Months Ended June 302006
            
            2005
            
            2006
            
            2005Revenues
            
            $
            11,155
            
            $
            10,058
            
            $
            22,851
            
            $
            20,213Cost
                of Revenues
            
            
            8,713
            
            
            8,379
            
            
            17,928
            
            
            16,265Gross
                Profit
            
            
            2,442
            
            
            1,679
            
            
            4,923
            
            
            3,948Selling,
                General and Administrative Expenses
            
            
            4,448
            
            
            4,230
            
            
            8,057
            
            
            7,878Operating
                Loss
            
            
            (2,006
            )
            
            (2,551
            )
            
            (3,134
            )
            
            (3,930
            )Interest
                Expense
            
            
            170
            
            
            280
            
            
            567
            
            
            393Loss
                from continuing operations before income taxes and (loss) income
                on
                discontinued operations
            
            
            (2,176
            )
            
            (2,831
            )
            
            (3,701
            )
            
            (4,323
            )Income
                Tax Expense
            
            
            23
            
            
            21
            
            
            46
            
            
            23Loss
                from continuing operations before (loss) income from discontinued
                operations
            
            
            (2,199
            )
            
            (2,852
            )
            
            (3,747
            )
            
            (4,346
            )(Loss)
                Income from discontinued operations, net of taxes
            
            
            (2,288
            )
            
            2
            
            
            (3,250
            )
            
            986Net
                loss
            
            $
            (4,487
            )
            $
            (2,850
            )
            $
            (6,997
            )
            $
            (3,360
            )Basic
                and diluted loss per shareContinuing
                operations
            
            $
            (0.04
            )
            $
            (0.06
            )
            $
            (0.07
            )
            $
            (0.09
            )Discontinued
                operations
            
            $
            (0.04
            )
            $
            (0.00
            )
            $
            (0.07
            )
            $
            0.02Net
                loss per share (basic and diluted)
            
            $
            (0.09
            )
            $
            (0.06
            )
            $
            (0.14
            )
            $
            (0.07
            )Shares
                Used in Calculation of Net Loss per share
            
            
            51,097
            
            
            50,077
            
            
            51,064
            
            
            50,077




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





4




**GVI
      Security Solutions, Inc.**


**Condensed
      Consolidated Statements of Cash Flows**


**(unaudited)**




(In
                thousands)Six
                Months Ending June 30Cash
                Flows From (Used) by Operating Activities
            
            
            2006
            
            
            2005Net
                Income (Loss)
            
            $
            (6,997
            )
            $
            (3,360
            )Adjustments
                to Reconcile Net Income (Loss) to Net Cash Used In Operating
                Activities(Income)
                loss from discontinued operations, net of tax
            
            
            3,250
            
            
            (986
            )Depreciation
                and amortization from continuingoperations
            
            
            268
            
            
            440Amortization
                of deferred loan origination fee
            
            
            300
            
            
            300Stock
                based compensation
            
            
            555
            
            
            --Changes
                in Assets and LiabilitiesAccounts
                receivable
            
            
            (515
            )
            
            (406
            )Inventory
            
            
            (2,865
            )
            
            (2,286
            )Refundable
                income tax receivable
            
            
            643
            
            
            -Other
                current assets
            
            
            425
            
            
            (1
            )Accounts
                payable
            
            
            3,488
            
            
            (1,419
            )Accrued
                expenses
            
            
            459
            
            
            (740
            )Net
                cash (used in) provided by operating activities from continuing
                operations
            
            
            (989
            )
            
            (8,458
            )Net
                cash (used in) provided by operating activities ofof
                discontinued operations
            
            
            435
            
            
            (2,814
            )Net
                cash used in operating activities
            
            
            (554
            )
            
            (11,272
            )Cash
                Flows From (Used) by Investing ActivitiesPurchase
                of property and equipment
            
            
            (45
            )
            
            (37
            )Net
                Cash Used in Investing Activities
            
            
            (45
            )
            
            (37
            )Cash
                Flows From (Used) by Financing ActivitiesNet
                proceeds from revolving credit facility
            
            
            79
            
            
            3,660Principal
                payments of term note
            
            
            (850
            )
            
            (458
            )Repayments
                of capitalized lease obligations
            
            
            (81
            )
            
            (83
            )Net
                Cash Provided (Used) by Financing Activities
            
            
            (852
            )
            
            3,119Net
                Decrease in Cash
            
            
            (1,451
            )
            
            (8,190
            )Cash,
                Beginning of Period
            
            
            3,284
            
            
            13,398Cash,
                End of Period
            
            $
            1,833
            
            $
            5,208**SUPPLEMENTARY
                CASH FLOW INFORMATION**Cash
                paid for interest
            
            $
            504
            
            $
            26Cash
                paid for income taxes
            
            
            2
            
            
            2**SUPPLEMENTAL
                SCHEDULE OF NONCASH INVESTING AND****FINANCING
                ACTIVITIES**Debt
                principal payment converted to common stock
            
            $
            300
            
            $
            67Restricted
                cash paid to satisfy stock repurchase obligation
            
            
            —
            
            
            10,000




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





5




**GVI
      Security Solutions, Inc.**


**Notes
      to Consolidated Financial Statements**





**NOTE
      1 ~ SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**





**Nature
      of Business**





The
      Company provides complete video surveillance and security solutions
      incorporating a complete line of video surveillance, access control and
      detection systems to the homeland security, professional and
      business-to-business market segments, including distributors and system
      integrators that specialize in video surveillance and security products and
      services, government agencies and private sector businesses.





**Basis
      of Presentation**





These
      consolidated financial statements should be read in conjunction with a reading
      of the Company's Annual Report on Form 10-KSB for the fiscal year ended December
      31, 2005.





The
      accompanying unaudited 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.





Certain
      reclassifications have been made to the 2005 financial statements for
      consistency purposes, including reclassifications of certain revenue and expense
      amounts relating to the three and six month periods ending June 30, 2005. These
      reclassifications include (1) classification of net freight billed to customers
      as a reduction of costs of revenue, and (2) classification of certain
      warehousing expenses as costs of revenue.





**Principles
      of Consolidation**





The
      accompanying consolidated financial statements include the accounts of GVI
      Security Solutions, Inc., and its wholly-owned subsidiaries GVI Security, Inc.
      and Rapor, Inc. All material inter-company transactions, balances and profits
      have been eliminated.





**Going
      Concern Considerations**





The
      accompanying financial statements have been presented in accordance with U.S.
      GAAP, which assumes the continuity of the Company as a going concern. During
      the
      years ended December 31, 2005 and 2004, and the six months ended June 30, 2006,
      the Company experienced, and continues to experience, negative cash flow and
      operating losses, as well as losses from discontinued operations, which have
      resulted in a significant reduction in the Company’s cash balances. These
      factors raise substantial doubt about the Company’s ability to continue as a
      going concern. Management believes that the Company will need to raise
      additional capital in the third quarter ended September 30, 2006 to finance
      its
      operations and sustain its business model. If the Company is successful in
      securing additional capital, which may be in the form of debt, equity, or some
      combination thereof, the Company may experience further negative impact on
      its
      future profitability and cash flow, due to the costs of obtaining and servicing
      such capital. Furthermore, any capital transaction may result in substantial
      dilution to the Company’s current shareholders, depending on the nature and
      terms of the capital raised.





**Discontinued
      Operations**





In
      the
      first quarter of 2006, the Company’s board approved a plan to discontinue its
      Retail Channel business. This business is accounted for as discontinued
      operations and, accordingly, its operations are segregated in the accompanying
      financial statements. The Company expects to complete the disposition of all
      related assets and liabilities by the end of 2006. In connection with the
      discontinuance of the Retail Channel business for the six months ended June
      30,
      2006 and the year ended December 31, 2005, the Company wrote down assets
      identified with the retail business by approximately $2.2 million and $1.4
      million, respectively, net of applicable tax benefit, to net realizable value.
      In addition, net returns and allowances recorded for the discontinued Retail
      Channel business for the six months ended June 30, 2006 were approximately
      $900,000. The write down to net realizable value as of December 31, 2005 was
      based on management’s best estimates of the amounts expected to be realized on
      the disposition of all related assets and liabilities held for disposition
      from
      the discontinued operations. The additional reserves and returns recorded in
      2006 were based on facts and circumstances not known by Company management
      at
      December 31, 2005, and the Company believes that it has reflected all
      anticipated expenses associated with the closing of the retail operations at
      June 30, 2006. The amounts the Company will ultimately realize, if any, could
      differ from the amounts assumed in arriving at the loss anticipated on disposal
      of the assets and liabilities of the discontinued operations. The results of
      the
      discontinued operations do not include any allocation of corporate overhead
      from
      the Company during the periods presented.





6





**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.





Income
      tax expense for the three and six month periods ending June 30, 2006 and 2005
      relate to state franchise taxes that are due to various states in which the
      Company is licensed and transacts business.





**Concentration
      of Risks**





***Samsung
      Electronics Distribution Agreement***




The
      Company was party to a product distribution agreement with Samsung that gave
      the
      Company the exclusive right to sell Samsung products in the professional
      channel, as well as the exclusive right to sell Samsung products in the retail
      channel to a major national retailer. The exclusive right to sell Samsung
      products to the major national retailer expired on December 31, 2005. In January
      2006 Samsung also terminated the remaining exclusivity portion of its
      agreement with the Company as a result of the Company’s failure to achieve
      minimum purchase requirements in accordance with the distribution agreement.
      In
      the first quarter of 2006, Company management elected to discontinue its retail
      business, and no longer sells Samsung retail  products.
      However, the Company continues to sell Samsung products in the professional
      channel, albeit on a non-exclusive basis. In addition, as before, the Company
      continues to distribute to the professional channel security products
      manufactured by companies other than Samsung.





***Credit
      Risk Concentration***




At
      June
      30, 2006, approximately $2,318,000 (24%) and $1,602,000 (17%), respectively,
      of
      the Company's accounts receivable were due from two particular customers. The
      Company performs ongoing credit evaluations of its customers and generally
      requires no collateral from them. ****





**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, accrued
      liabilities and the useful lives of property and equipment.




**Stock-Based
      Compensation**




In
      December 2004, the Financial Accounting Standards Board (“FASB”) issued
      Statement of Financial Accounting Standards (“SFAS”) 123R, “Share-Based
      Payment.” This statement requires that the cost resulting from all share-based
      payment transactions be recognized in the financial statements. This statement
      establishes fair value as the measurement objective in accounting for
      share-based payment arrangements and requires all entities to apply a fair-value
      based measurement method in accounting for share-based payment transactions
      with
      employees except for equity instruments held by employee share ownership plans.




7




Prior
      to
      the January 1, 2006 adoption of SFAS 123R, the Company accounted for
      stock-based compensation using the intrinsic value method prescribed in
      Accounting Principles Board Opinion No. 25 (“APB 25”), “Accounting for
      Stock Issued to Employees” and related interpretations. Accordingly, no
      compensation expense had been recognized for stock options since all options
      granted had an exercise price equal to the market price on the date of grant.
      As
      permitted by SFAS 123, “Accounting for Stock-Based Compensation,” stock-based
      compensation was included as a pro forma disclosure in the notes to the
      consolidated financial statements.




Effective
      January 1, 2006, the Company adopted the fair value recognition provisions
      of SFAS 123R, using the modified prospective method. Under this method, the
      provisions of SFAS 123R apply to all awards granted or modified after the date
      of adoption and all previously granted awards not yet vested as of the date
      of
      adoption. Prior periods have not been restated.




The
      following table illustrates the effect on operating results and per share
      information had the Company accounted for share-based compensation in accordance
      with SFAS 123 for the six and three month periods ending June 30, 2005 (in
      thousands, except per share amounts):




SixMonths
                  Ended
                June
                  30, 2005
              
              Three
                  Months Ended June 30, 2005Net
                  loss as reported
              
              $
              (3,360
              )
              $
              (2,850
              )Option-based
                  employee compensation, net of related taxes
              
              
              34
              
              
              21Pro
                  forma net loss
              
              $
              (3,394
              )
              $
              (2,871
              )Basic
                  and diluted net loss per share-as reported
              
              $
              (0.01
              )
              $
              (0.06
              )Basic
                  and diluted net loss per share-pro forma
              
              $
              (0.01
              )
              $
              (0.06
              )





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




**Six Months Ended**
              **June
                30,****2006**
            
            **2005**Dividend
                yield
            
            
            -
            %
            
            -
            %Risk-free
                factors
            
            
            4.7
            %
            
            3.5
            %Volatility
                factors
            
            
            47
            %
            
            74
            %Option
                Lives in Years
            
            
            6.0
            
            
            3.0





As
      a
      result of adopting SFAS 123(R) on January 1, 2006, the Company’s quarterly
      loss before taxes, and its net loss for the three and six months ended June
      30,
      2006, were approximately $21,000 and  $261,000
      lower, respectively, than if the Company had continued to account for options
      under the combination of APB Opinion No. 25 and SFAS 123 for its stock
      option plans. The change to basic and diluted loss per share was less than
      ($0.01).




**NOTE
      2 ~ CREDIT FACILITIES**





**Laurus
      Debt/Lines of Credit**




On
      May
      27, 2004, the Company closed a $15 million convertible debt financing with
      Laurus Master Fund, Ltd. under which the Company was provided with a $5 million
      term loan and a $10 million revolving credit facility. At closing, the Company
      borrowed $5 million under the term loan and $10 million under the revolving
      credit facility, and used $10,016,000 of the proceeds to repay in full the
      indebtedness outstanding under the prior revolving credit agreement with
      Comerica Bank. Additional proceeds of the financing were used to increase
      working capital, pay closing fees to Laurus in the aggregate amount of $617,500,
      and pay a finder's fee in the amount of $800,000. As part of the transaction,
      Laurus was also issued a seven-year warrant to purchase 940,000 shares of Common
      Stock at a price of $3.50 per share. The Company also issued a similar warrant
      to purchase 94,000 shares of Common Stock to the finder. Borrowings under the
      Laurus financing are secured by all assets of the Company. At June 30, 2006,
      $2.1 million in principal was outstanding under the Term Loan and $ 8.6 million
      in principal was outstanding under the revolving credit facility. The agreements
      with Laurus prohibit the payment of dividends on the Company’s common stock, and
      contain other customary affirmative and negative covenants.




8




The
      loan
      documents with Laurus required the Company’s Common Stock to be quoted on the
      NASD Over the Counter Bulletin Board by July 27, 2004, which date was extended
      to September 27, 2004 and further extended to December 31, 2004. In
      consideration for extending the deadlines, the Company issued Laurus additional
      seven-year warrants to purchase an aggregate of 400,000 shares of Common Stock
      at a price of $3.50 per share. The fair value of these warrants at date of
      issue
      was expensed. The Company’s Common Stock began being quoted on the NASD Over the
      Counter Bulletin Board on December 13, 2004.




The
      term
      loan is evidenced by a Secured Convertible Term Note and, subject to monthly
      adjustments as set forth below, bears interest at an initial rate per annum
      equal to the prime rate (as reported in the Wall Street Journal), plus two
      percent, subject to a floor of six percent. Interest on the term loan is payable
      monthly.




The
      interest rate under the Term Note is subject to downward adjustment at the
      end
      of each month as follows. If at the end of the applicable month the Company
      has
      registered the shares of Common Stock underlying the Term Note with the SEC,
      interest payable on the term loan will be adjusted downward by 200 basis points
      (two percent) for each incremental 25 percent increase in the market price
      of
      the Common Stock, at the end of the month, in excess of the conversion price
      under the Term Note.





Amounts
      outstanding under the Term Note were initially convertible into Common Stock
      at
      Laurus's option at a conversion price initially equal to $2.70 per share. In
      December 2004 the conversion price was reduced to $1.91 under the terms of
      the
      anti-dilution feature of the Term Note. In addition, subject to (i) having
      an
      effective registration statement with respect to the shares of Common Stock
      underlying the Term Note, and (ii) limitations based on trading volume of the
      Common Stock, scheduled principal and interest payments under the Term Note
      will
      be made in shares of Common Stock valued at the conversion price. Prepayments
      under the Term Note are subject to a premium in the amount of 20% of the
      principal being prepaid.





Pursuant
      to an amendment, dated as of May 26, 2006, between the Company and Laurus,
      (i)
      payments of principal due to Laurus for the months of June 2006 through December
      2006 under the Term Note were reduced from $190,000 per month to $100,000 per
      month, (ii) the final payment of principal due to Laurus under the Term Note
      on
      May 27, 2007 was correspondingly increased from $435,000 to $1,065,000, and
      (iii) the exercise price of warrants previously issued to Laurus to purchase
      an
      aggregate of 1,340,000 shares of the Company’s common stock was reduced from
      $3.50 to $0.60. Pursuant to a further Amendment, dated as of June 22, 2006,
      the
      conversion price of $300,000 of principal under the Term Note was reduced to
      $0.15 from $1.91, and Laurus converted such amount of principal into 2,000,000
      shares of the Company’s common stock. The principal so converted was applied to
      the payments of principal that would otherwise have been due under the Term
      Note
      for the months of July, August and September 2006. Accordingly, after giving
      effect to these amendments, amortizing payments of principal on the Term Note,
      which commenced September 1, 2004, are provided below as follows:





Period
            
            Principal
                AmountJuly
                2006 through September 2006
            
            $0
                per monthOctober
                2006 through December 2006
            
            $100,000
                per monthJanuary
                2007 through April 2007
            
            $190,000
                per monthMay
                2007
            
            $1,065,000




9




In
      the
      quarter ended June 30, 2006, the Company also recorded an interest charge of
      approximately $76,000 as a result of the reduction in the exercise price of
      the
      warrants pursuant to the May 26, 2006 Amendment discussed above, as
      well
      as approximately $20,000 from the reduction of the conversion price of $300,000
      in convertible term note debt exercised in June 2006 .





Subject
      to monthly adjustments as set forth below, borrowings under the revolving credit
      facility bear interest at a rate per annum equal to the prime rate plus two
      percent. In addition, the interest rate under the revolving credit facility
      is
      subject to downward adjustment at the end of each month in the same manner
      as
      provided for under the Term Note. If the market price of the Common Stock
      exceeds the fixed conversion price at the end of a month, the interest rate
      under the revolving credit facility will be reset to equal the prime rate minus
      two percent. The revolving credit facility terminates, and borrowings thereunder
      become due, on May 27, 2007.





Amounts
      outstanding under the revolving credit facility were convertible to Common
      Stock
      at Laurus's option at a conversion price initially equal to $3.38 per share.
      In
      December 2004 the conversion price was reduced to $2.22 under the terms of
      the
      anti-dilution feature of the facility. To the extent the Company repays loans
      outstanding under the revolving credit facility and/or Laurus converts loans
      under the revolving credit facility into Common Stock, the Company may reborrow
      or make additional borrowings under the revolving credit facility, provided
      that
      aggregate loans outstanding under the revolving credit facility at any time
      may
      not exceed the lesser of $10 million or a borrowing base equal to the sum of
      83.7% of "eligible accounts" plus 60% of "eligible inventory" (with borrowings
      based on eligible inventory limited to $3.5 million). Eligible accounts are
      generally gross accounts receivable less foreign receivables and domestic
      receivables over 90 days from invoice date. Eligible inventory is substantially
      all finished goods inventory. Prepayment of the entire revolving credit facility
      is subject to a premium of 20% of the minimum revolving credit facility of
      $5
      million plus 3% of the entire outstanding revolving credit at the time of
      prepayment.





**Loan
      Origination Fees**





The
      Company incurred and capitalized origination and finders fees associated with
      the Laurus credit facility of approximately $1.8 million. These fees are
      amortized into interest expense on the straight line basis over the initial
      term
      of the loan of three years. Also included in the capitalized origination fees
      is
      compensation of approximately $112,000 relating to the issuance of warrants
      to
      purchase 1,034,000 shares of the Company’s common stock as described
      above.





**Capitalized
      Leases**





The
      Company has entered into separate capital lease obligations in conjunction
      with
      the acquisition of warehouse racking and office furniture. These assets have
      original capitalized values of $316,000, and have payment terms ranging from
      48
      to 60 months.





Future
      minimum lease payments under noncancelable capital lease obligations at June
      30,
      2006 were as follows ($ in thousands):




2006
            
            $
            422007
            
            
            832008
            
            
            532009
            
            
            12190Less
                amounts relating to interest
            
            
            14Total
                capital lease obligations
            
            
            176Less
                current portion
            
            
            75Capital
                lease obligations, noncurrent
            
            $
            101




**NOTE
      3 ~ COMMITMENTS & CONTINGENCIES**





***Agreement
      with Retail Agent***





The
      Company is party to an alliance agreement with a retail distribution agent
      through which it supplied retail surveillance and security products to a major
      retailer. In the first quarter of 2006 the Company’s management approved the
      discontinuance of its business in the retail channel in order to focus its
      efforts on sales in the professional channel and sales by the Company’s
      Enterprise Solutions Group. The Company is currently is dispute with the retail
      distribution agent regarding product returns and other terms of its alliance
      agreement. The agent has informed the Company that it expects to return
      additional retail merchandise that would result in additional obligations to
      the
      Company of approximately $1.1 million. The Company is currently evaluating
      its
      obligations to accept future product returns from this distributor in the retail
      channel, and management believes it has recorded liabilities in its financial
      statements to completely reflect its estimated remaining obligations under
      the
      terms of the alliance agreement.




10




The
      Company has recently engaged in settlement discussions with the distribution
      agent, which to date have not been successful in resolving their respective
      disputes. If such disputes are not ultimately resolved, the Company may be
      forced to settle this issue through legal remedies, which may include
      litigation. In the event this occurs, the Company expects to vigorously pursue
      an equitable outcome.





***Lease
      and Rents***





The
      Company leases warehouse and office space under an operating lease agreement
      which expires on September 30, 2009. Under the terms of the lease, the Company
      paid no rent for six months, and then pays monthly rent of $25,704 for the
      remainder of the sixty-six month lease. Accordingly, the effects of the rent
      deferral have been accrued.





The
      minimum annual rentals under the non-cancelable lease for the remaining periods
      ended years ended December 31 are as follows ($ in thousands):





2006
            
            $
            1542007
            
            
            3082008
            
            
            3082009
            
            
            258$
            1,028




***Termination
      Agreement with Nazzareno E. Paciotti***





On
      March
      28, 2006, the Company and Nazzareno E. Paciotti, entered into a Mutual
      Separation Agreement whereby the parties mutually agreed to the termination
      of
      Mr. Paciotti’s employment with the Company and to his resignation as a director
      and officer of the Company and its subsidiaries. Under the terms of the Mutual
      Separation Agreement, Mr. Paciotti will receive severance payments equal to
      one
      year of his annual base salary of $300,000 payable over 12 months. In addition,
      under the separation agreement, Mr. Paciotti is entitled to continue to receive
      medical benefits through January 24, 2008. At December 31, 2005, approximately
      $335,000 had been accrued for this obligation, and at June 30, 2006
      approximately $250,000 remained on the obligation. The Company also agreed
      that
      Mr. Paciotti’s options to purchase 625,000 shares of Common Stock would vest in
      full and be exercisable in full until December 31, 2006. Mr. Paciotti agreed
      to
      release the Company in full from any and all claims and to continue to be bound
      by the confidentiality and non-solicitation terms of his employment
      agreement.





***Accrued
      Severance***





The
      Company has recorded liabilities associated with unpaid severance costs totaling
      approximately $881,000 at June 30, 2006 related to the termination of various
      previous members of the Company’s management, including approximately $250,000
      payable to Mr. Paciotti noted above. These amounts are reflected in accrued
      expenses at June 30, 2006.





***Sales
      Tax***





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 estimates that any liability that it may have for
      sales
      taxes would not have a material effect on its financial condition or results
      of
      operations.





The
      Company is also a 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.





11




**NOTE
      4 ~ 2004 STOCK INCENTIVE PLAN**





In
      February 2004, the Company adopted its 2004 Long-Term Stock Plan and reserved
      up
      to 5,939,913 shares of Common Stock for issuance thereunder. In June 2006 the
      Company’s Board of Directors increased the shares available under this Plan from
      5,939,913 to 10,000,000.





In
      March
      2006, the Company granted to certain employees options of 3,750,000 shares
      of
      Common Stock exercisable at $.16 to $.80 per share. These options were not
      granted under a plan.




A
      summary
      of the status of the Company’s stock options as of December 31, 2005, and the
      changes during the six months ended June 30, 2006, is presented below.





Number
                of Shares
            
            Range
                of Exercise PricesOutstanding
                at January 1, 2006
            
            
            4,221,874
            
            $
            0.32-65.00Granted
            
            
            3,750,000
            
            $
            0.16-0.80Exercised
            
            
            —
            
            $
            —Forfeited
            
            
            (503,741
            )
            $
            0.32-2.60Outstanding
                at June 30, 2006
            
            
            7,468,133
            
            $
            0.16-65.00Options
                Exercisable at June 30, 2006
            
            
            5,350,216Weighted-average
                fair value of options remaining exercisable at June 30,
                2006
            
            $
            0.05





The
      following table summarizes information about stock options outstanding as of
      June 30, 2006:




Outstanding
                Options
            
            Exercisable
                OptionsNumber
            
            Weighted-Outstanding
            
            average
            
            Numberat
            
            Remaining
            
            Outstanding
                atExercise
            
            June
                30,
            
            Contractual
            
            June
                30,Prices
            
            2006
            
            Life
            
            2006$0.16
            
            
            250,000
            
            
            9.7
                years
            
            
            125,0000.30
            
            
            1,000,000
            
            
            9.7
                years
            
            
            1,000,0000.32
            
            
            610,903
            
            
            7.3
                years
            
            
            610,9030.50
            
            
            250,000
            
            
            9.7
                years
            
            
            125,0000.52
            
            
            1,000,000
            
            
            9.7
                years
            
            
            500,0000.78
            
            
            250,000
            
            
            9.7
                years
            
            
            125,0000.80
            
            
            1,000,000
            
            
            9.7
                years
            
            
            500,0000.85
            
            
            460,000
            
            
            8.1
                years
            
            
            257,5001.50
            
            
            815,000
            
            
            8.7
                years
            
            
            668,3332.60
            
            
            1,825,000
            
            
            7.8
                years
            
            
            1,431,250Over
                $32.00
            
            
            7,230
            
            
            3.4
                years
            
            
            7,2307,468,133
            
            
            
            
            
            5,350,216





12




**NOTE
      5 ~ WARRANTS**





Summary
      of the Company’s outstanding warrants at June 30, 2006 are as
      follows:





Description
            
            Shares
            
            Approx.
              Remaining
                Term
              (Years)
            
            Exercise
                PriceLaurus
                Master Fund
            
            
            1,340,000
            
            
            5.5
            
            $
            0.60Laurus
                Finder’s Fee
            
            
            94,000
            
            
            5.5
            
            $
            3.50Vendor
            
            
            3,000,000
            
            
            4.2
            
            $
            1.50Rapor
                shareholders
            
            
            1,353,925
            
            
            6.0
            
            $
            3.04Oct.
                2004 bridge financing
            
            
            766,665
            
            
            4.0
            
            $
            1.50Consultant
            
            
            175,000
            
            
            3.3
            
            $
            3.50
                - 5.00Other
            
            
            13,743
            
            
            1.0
            
            $
            7.80
                - 32.506,833,333





13


**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: ability to continue as a going
      concern; uncertainty of future profitability, reliance on primary supplier;
      outstanding indebtedness; effective integration of recently acquired operations
      and personnel; expansion risks; effective internal processes and systems; the
      ability to attract and retain high quality employees; changes in the overall
      economy; rapid change in technology; the number and size of competitors in
      its
      markets; 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 2005 Annual Report on Form 10-KSB.*




*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.*





**THREE
      MONTHS ENDED JUNE 30, 2006 COMPARED TO THREE MONTHS ENDED JUNE 30, 2005**




**NET
      REVENUES FROM CONTINUING OPERATIONS**




Net
      revenues increased approximately $1.1 million, or 10.9% to approximately $11.2
      million in the three months ended June 30, 2006 from approximately $10.1 million
      in the three months ended June 30, 2005. Sales of professional products
      increased approximately $1.6 million, or 16.3%, and enterprise solutions
      revenues decreased approximately $500,000, or 97%. The increase in revenues
      of
      our professional products reflected increased sales to distributors, integrators
      and installers of a variety of products manufactured by Samsung Electronics,
      as
      well as other manufacturers. The reduction in enterprise solutions revenues
      reflects sales of our Rapor portal during the three months ended June 30, 2005,
      with no corresponding sales in the three months ended June 30, 2006. We continue
      to introduce new products to complement our existing lines, and will continue
      to
      focus on the professional market through various channels.





**COST
      OF GOODS SOLD FROM CONTINUING OPERATIONS**




Total **** cost
      of
      goods sold increased approximately $300,000 or 4.0% to approximately $8.7
      million for the three months ended June 30, 2006, from approximately $8.4
      million in the three months ended June 30, 2005. This increase was due to the
      increased revenue volume, offset partially by improved gross margins generated
      from the sale of new camera and digital video recorder products.





As
      a
      result of the changes described above in revenues and cost of goods sold, gross
      profit for the three months ended June 30, 2006 increased to approximately
      $2.4
      million from approximately $1.7 for the three months ended June 30, 2005, and
      gross profit as a percentage of revenues increased to 21.9% for the three months
      ended June 30, 2006 compared with 16.7% for the three months ended June 30,
      2005.





**SELLING,
      GENERAL AND ADMINISTRATIVE EXPENSES**





Selling,
      general, and administrative expenses increased 5.2% to approximately $4.4
      million in the three months ended June 30, 2006 from approximately $4.2 million
      in the three months ended June 30, 2005, as follows:





**Sales
      and Marketing.** Sales
      and
      marketing expenses decreased approximately 30.3% to approximately $1.9 million
      in the three months ended June 30, 2006 from approximately $2.7 million in
      the
      three months ended June 30, 2005. The decrease was primarily due to (i) the
      elimination of approximately $190,000 of quarterly expense related to the
      licensing agreement with Cybasec Ltd. entered into January 1, 2005, which was
      not renewed for 2006, (ii) decreases of approximately $182,000 in sales and
      marketing staff salaries and related benefits, as well as a decrease in
      associated staff travel expenses of approximately $91,000, (iii) a decrease
      of
      approximately $182,000 in direct advertising costs, and (iv) a decrease in
      sample and demo equipment expense of approximately $141,000.





14




**General
      and Administrative.** General
      and administrative expenses increased 65.6% to approximately $2.6 million for
      the three months ended June 30, 2006 from approximately $1.5 million for the
      three months ended June 30, 2005.  Major items resulting in
      the increased general and administrative expense were (i) approximately
      $487,000 in personnel termination costs during the quarter, (ii) an increase
      in
      bad debt expenses of approximately $393,000, (iii) $57,000 of non-employee
      directors’ fees for which there was not an equivalent expense in 2005, and (iv)
      increases in accounting, legal and other professional fees of approximately
      $178,000.





**INTEREST
      EXPENSE**





Net
      interest expense for the three months ended June 30, 2006 decreased 39.2% to
      approximately $170,000 from approximately $280,000 in the three months ended
      June 30, 2005. The decrease reflects an adjustment, during the three months
      ended June 30, 2006, of $320,000 of interest expense that had been accrued
      in
      prior periods as due to Laurus. We had accrued this amount following the
      adjustment of the interest rate under our provision of our agreements with
      Laurus. However, because Laurus waived our payment of the increased interest
      amount through April 30, 2006, we adjusted the amount of interest we had accrued
      that we were not required to pay to Laurus. The effects of this interest
      adjustment were partially offset by a charge of approximately $76,000 resulting
      from the reduction in the exercise price of warrants issued to Laurus, a charge
      of approximately $20,000 from the reduction of the conversion price of $300,000
      the convertible term note debt exercised in June 2006, as well as higher average
      interest rates during the three months ended June 30, 2006 compared with the
      three months ended June 30, 2005. The higher average interest rates resulted
      from a higher prime interest rate during the period as well as the interest
      rate
      provisions applicable to borrowings under the revolving credit facility. The
      amount of net interest expense for the three months ended June 30, 2006 also
      reflects an offset of approximately $5,000 of interest income earned on bank
      balances during the period. Interest income earned for the three months ended
      June 30, 2005 was approximately $37,000.





**INCOME
      TAX EXPENSE (BENEFIT)**





We
      recorded a provision for federal, state and local income tax of approximately
      $23,000 for the three months ended June 30, 2006, which was 9.2% higher as
      compared to an expense of approximately $21,000 for the three months ended
      June
      30, 2005. The $23,000 tax expense relates to state franchise taxes that are
      from
      various states in which we are licensed and transact business. We believe that
      any provision for federal and state tax benefits due to our loss for the three
      months ended June 30, 2006 would be offset by an equal increase in a valuation
      allowance as a result of our past recurring operating losses.





**DISCONTINUED
      OPERATIONS**





Loss
      from
      discontinued operations, net of tax, was approximately $2.3 million for the
      three months ended June 30, 2006, compared to income from discontinued
      operations of approximately $2,000 for the three months ended June 30, 2005.
      The
      loss for the three months ended June 30, 2006 reflects negative revenues and
      reserves we have accrued in connection with returns of retail products sold
      in
      prior periods, and write downs of returned retail inventories. These additional
      reserves and returns were based on facts and circumstances not known by Company
      management at March 31, 2006, and we believe that we have reflected all
      anticipated expenses associated with the closing of the retail operations at
      June 30, 2006. We are currently evaluating our obligations to accept product
      returns from our former distributor in the Retail Channel. In comparison to the
      negative revenues for the three months ended June 30, 2006, we had net revenues
      of approximately $250,000 for the three months ended June 30, 2005. Operating
      results from discontinued operations do not include any allocation of corporate
      overhead.





**NET
      INCOME**





As
      a
      result of the items discussed above there was a net loss of approximately $4.5
      million for the three months ended June 30, 2006 compared with a net loss of
      approximately $2.9 million for the three months ended June 30,
      2005.





**SIX
      MONTHS ENDED JUNE 30, 2006 COMPARED TO SIX MONTHS ENDED JUNE 30,
      2005** ****




**NET
      REVENUES FROM CONTINUING OPERATIONS**





Net
      revenues increased approximately $2.6 million, or 13.1%, to approximately $22.9
      million in the six months ended June 30, 2006 from approximately $20.2 million
      in the six months ended June 30, 2005. Sales of professional products increased
      approximately $3.3 million, or 16.3%, and enterprise solutions revenues
      decreased approximately $700,000, or 88.9%. The increase in revenues of our
      professional products reflected increased sales to distributors, integrators
      and
      installers of a variety of products manufactured by Samsung Electronics as
      well
      as other manufacturers. The reduction in enterprise solutions revenue reflects
      sales of our Rapor portal during the six months ended June 30, 2005, with no
      corresponding sales in the six months ended June 30, 2006. We continue to
      introduce new products to complement our existing lines, and will continue
      to
      focus on the professional market through various channels.





15




**COST
      OF GOODS SOLD FROM CONTINUING OPERATIONS**





Total **** cost
      of
      goods sold increased approximately $1.7 million, or 10.2% to approximately
      $17.9
      million for the six months ended June 30, 2006, from approximately $16.3 million
      in the six months ended June 30, 2005. This increase was due to the increased
      revenue volume and increases in other indirect costs of sales including
      technical support costs, warranty costs and other logistical costs.





As
      a
      result of the changes described above in revenues and cost of goods sold, gross
      profit for the six months ended June 30, 2006 increased to approximately $4.9
      million from approximately $3.9 million for the six months ended June 30, 2005,
      and gross profit as a percentage of revenues increased to 21.5% for the six
      months ended June 30, 2006 compared with 19.5% for the six months ended June
      30,
      2005.





**SELLING,
      GENERAL AND ADMINISTRATIVE EXPENSES**





Selling,
      general, and administrative expenses increased 2.3% to approximately $8.1
      million for the six months ended June 30, 2006 from approximately $7.9 million
      for the six months ended June 30, 2005, as follows:




**Sales
      and Marketing.** Sales
      and
      marketing expenses decreased approximately 26.4% to approximately $3.3 million
      in the six months ended June 30, 2006 from approximately $4.6 million in the
      six
      months ended June 30, 2005. The decrease was primarily due to (i) the
      elimination of approximately $370,000 of expense related to the licensing
      agreement with Cybasec Ltd. entered into January 1, 2005, which was not renewed
      for 2006, (ii) decreases of approximately $267,000 in sales and marketing staff
      salaries and related benefits, as well as a decrease in associated staff travel
      expenses of approximately $132,000, (iii) a decrease of approximately $241,000
      in direct advertising costs, and (iv) a decrease in sample and demo equipment
      expense of approximately $244,000.





**General
      and Administrative.** General
      and administrative expenses increased 42.0% to approximately $4.7 million for
      the six months ended June 30, 2006 from approximately $3.3 million for the
      six
      months ended June 30, 2005.  Major items resulting in the increased
      general and administrative expense were (i) approximately $694,000 in personnel
      termination costs during the six-month period, (ii) stock based compensation
      expense of approximately $261,000 recorded due to the adoption of SFAS 123R
      effective January 1, 2006, with no comparable expense  in
      2005,
      (iii) $111,000 of non-employee directors fees for which there was not an
      equivalent expense in 2005, and (iv) an increase in bad debt expenses of
      approximately $397,000.





**INTEREST
      EXPENSE**





Interest
      expense for the six months ended June 30, 2006 increased 44.2% to approximately
      $567,000 from approximately $393,000 in the six months ended June 30, 2005.
      The
      increase was due to higher outstanding borrowings and a higher average interest
      rate during the six months ended June 30, 2006 compared with the six month
      period ended June 30, 2005, as well as a charge, during the six-months ended
      June 30, 2006, of approximately $76,000 resulting from the reduction in the
      exercise price of warrants previously issued to Laurus, as well as approximately
      $20,000 from the reduction of the conversion price of $300,000 the convertible
      term note debt exercised in June 2006. The higher average interest rates
      resulted from a higher prime interest rate during the period as well as the
      interest rate provisions applicable to borrowings under the revolving credit
      facility. As a result of the conversion price under the facility exceeding
      the
      market price of our Common Stock for the six months ended June 30, 2006, the
      interest rate for the period was equal to the prime rate plus two percent.
      The
      combined effect of these factors resulted in increased interest charges of
      approximately $400,000 for the six-month period ended June 30, 2006. However,
      interest expense for the six months ended June 30, 2006 also reflects the
      adjustment , during the six months ended June 30, 2006, of $320,000 of interest
      expense that had been accrued in prior periods as due to Laurus but was waived
      by Laurus, as described above. The amount of net interest expense for the six
      months ended June 30, 2006 additionally reflects an offset of approximately
      $23,000 of interest income earned on bank balances during the period. Interest
      income earned for the six months ended June 30, 2005 was approximately $97,000.





16




**INCOME
      TAX EXPENSE (BENEFIT)**





We
      recorded a provision for federal, state and local income tax of approximately
      $46,000 for the six months ended June 30, 2006, as compared to an expense of
      approximately $23,000 for the six months ended June 30, 2005. The $46,000
      expense relates to state franchise taxes from various states in which we are
      licensed and transact business. We believe that any provision for federal and
      state tax benefits due to our loss for the six months ended June 30, 2006 would
      be offset by an equal increase in a valuation allowance as a result of our
      history of recurring operating losses.





**DISCONTINUED
      OPERATIONS**





Loss
      from
      discontinued operations, net of tax, was approximately $3.3 million for the
      six
      months ended June 30, 2006, compared to income from discontinued operations
      of
      approximately $986,000 for the six months ended June 30, 2005. The loss for
      the
      six months ended June 30, 2006 reflects negative revenues and reserves recorded
      in connection with returns of retail products sold in prior periods, and write
      downs of returned retail inventories. These additional reserves and returns
      were
      based on facts and circumstances not known by Company management at December
      31,
      2005. We are currently evaluating our obligations to accept additional product
      returns from our former distributor in the Retail Channel. In comparison to
      our
      negative revenues for the six months ended June 30, 2006, we had net revenues
      of
      approximately $13.9 million for the six months ended June 30, 2005. Operating
      results from discontinued operations do not include any allocation of corporate
      overhead.





**NET
      INCOME**





As
      a
      result of the items discussed above there was a net loss of approximately $7.0
      million for the six months ended June 30, 2006 compared with a net loss of
      approximately $3.4 million for the six months ended June 30, 2005.





**LIQUIDITY
      AND CAPITAL RESOURCES**




At
      June
      30, 2006, we had cash and equivalents of approximately $1.8 million, a working
      capital deficit of approximately $3.6 million, outstanding balances of $2.1
      million under the Laurus term loan, and outstanding balances of $8.6 million
      under the Laurus revolving credit facility. In comparison, at December 31,
      2005,
      we had cash and equivalents of approximately $3.3 million, working capital
      of
      approximately $11.7 million, an outstanding balance of $3.3 million under the
      Laurus term loan, and outstanding balances under the Laurus revolving credit
      facility of approximately $8.5 million. Both the term loan and the revolving
      credit facility are due within 12 months and are classified as current on our
      balance sheet at June 30, 2006. Additionally, we had borrowing availability
      of
      $300,000 at June 30, 2006, with no such availability at December 31, 2005.




Cash
      decreased from $3.3 million at December 31, 2005 to $1.8 million at June 30,
      2006 primarily as a result of (i) cash operating losses from continuing
      operations of approximately $1.2 million, and (ii) term loan payments of $1.4
      million. These factors were partially by offset cash generated from discontinued
      operations of approximately $400,000, and receipt of refundable income taxes
      of
      approximately $650,000 from December 31, 2005 to June 30, 2006.




Historically,
      we have funded our operations primarily through cash generated from operations,
      the proceeds of borrowings under secured revolving credit facilities and with
      the proceeds of equity offerings. As a result of recurring cash losses from
      operations and our cash needs, which are described further below under “Going
      Concern Considerations,” management has been engaged in efforts to raise
      additional capital in order to fund our operations.




**Laurus
      Financing**




On
      May
      27, 2004, we closed a $15 million convertible debt financing with Laurus Master
      Fund, Ltd. under which we were provided with a $5 million term loan and a $10
      million revolving credit loan facility. Borrowings from Laurus are secured
      by
      all of our assets.




The
      term
      loan is evidenced by a Secured Convertible Term Note and, subject to monthly
      adjustments as set forth below, bears interest at an initial rate per annum
      equal to the prime rate (as reported in the Wall Street Journal), plus two
      percent, subject to a floor of six percent. Interest on the term loan is payable
      monthly.




17




The
      interest rate under the Term Note is subject to downward adjustment at the
      end
      of each month as follows. Interest payable on the term loan will be adjusted
      downward by 200 basis points (two percent) for each incremental 25 percent
      increase in the market price of our Common Stock, at the end of the month,
      in
      excess of the conversion price under the Term Note.




Amounts
      outstanding under the Term Note are convertible into Common Stock at Laurus's
      option at a conversion price initially equal to $2.70 per share, and currently
      equal to $1.91 per share. In addition, subject to (i) having an effective
      registration statement with respect to the shares of Common Stock underlying
      the
      Term Note, and (ii) limitations based on trading volume of the Common Stock,
      scheduled principal and interest payments under the Term Note will be made
      in
      shares of Common Stock valued at the conversion price. Prepayments under the
      Term Note are subject to a premium in the amount of 20% of the principal being
      prepaid. At June 30, 2006 and December 31, 2005, the company had outstanding
      borrowings under the provisions of the Term Note totaling $2.1 million and
      $3.3
      million, respectively, of which $2.1 million and $2.1 million, respectively,
      were reflected as current.




Pursuant
      to an Amendment we entered into with Laurus dated as of May 26, 2006 (i)
      payments of principal due to Laurus for the months of June 2006 through December
      2006 under the Term
      Note were
      reduced from $190,000 per month to $100,000 per month, (ii) the final payment
      of
      principal due to Laurus under the Term
      Note on May
      27, 2007 was correspondingly increased from $435,000 to $1,065,000, and (iii)
      t he
      exercise price of warrants previously issued to Laurus to purchase an aggregate
      of 1,340,000 shares of our common stock was reduced from $3.50 to
      $.60 . Pursuant
      to a further Amendment we entered into with Laurus dated as of June 22, 2006,
      the conversion price of $300,000 of principal under the Term Note  was
      reduced to $.15 from $1.91, and Laurus converted such amount of principal into
      2,000,000 shares of our common stock. The principal so converted was applied
      to
      the payments of principal that would otherwise have been due under the Term
      Note for the
      months of July, August and September 2006. Accordingly, after giving effect
      to
      these amendments, a mortizing
      payments of principal on the Term Note, which commenced September 1, 2004,
      are
      as set forth in the table below.




Period
            Principal
                AmountJuly
                2006 through September 2006
            $0
                per monthOctober
                2006 through December 2006
            $100,000
                per monthJanuary
                2007 through April 2007
            $190,000
                per monthMay
                2007
            $1,065,000





Subject
      to monthly adjustments as set forth below, borrowings under the revolving credit
      facility bear interest at a rate per annum equal to the prime rate plus two
      percent. If the market price of Common Stock exceeds the conversion price at
      the
      end of a month, the interest rate under the revolving credit facility will
      be
      reduced to equal the prime rate minus two percent. In addition, the interest
      rate under the revolving credit facility is subject to downward adjustment
      at
      the end of each month in the same manner as provided for under the Term Note.
      The revolving credit facility terminates, and borrowings thereunder become
      due,
      on May 27, 2007. At June 30, 2006 and December 31, 2005, the Company had
      outstanding borrowings under the provisions of the revolving credit facility
      of
      $8.6 million and $8.5 million, respectively, of which $8.6 million and $0,
      respectively, were reflected as current. Prepayment of the entire revolving
      credit facility is subject to a premium of 20% of the minimum revolving credit
      facility of $5 million plus 3% of the entire outstanding revolving credit at
      the
      time of prepayment.




Amounts
      outstanding under the revolving credit facility are convertible to Common Stock
      at Laurus's option at a conversion price initially equal to $3.38 per share,
      and
      currently equal to $2.22 per share. To the extent the Company repays loans
      outstanding under the revolving credit facility and/or Laurus converts loans
      under the revolving credit facility into Common Stock, the Company may reborrow
      or make additional borrowings under the revolving credit facility, provided
      that
      aggregate loans outstanding under the revolving credit facility at any time
      may
      not exceed the lesser of $10 million or a borrowing base equal to the sum of
      83.7% of "eligible accounts" plus 60% of "eligible inventory" (with borrowings
      based on eligible inventory limited to $3.5 million). Eligible accounts are
      generally gross accounts receivable less foreign receivables and domestic
      receivables over 90 days from invoice date. Eligible inventory is substantially
      all finished goods inventory.




18




The
      conversion prices under the Term Note and the revolving credit facility are
      subject to equitable adjustment for stock splits, stock dividends and similar
      events, and "weighted average" adjustment for future stock issuances (other
      than
      stock issuances in specifically excepted transactions) in accordance with a
      formula specified under our agreements with Laurus.




**Going
      Concern Considerations**





The
      accompanying unaudited condensed consolidated financial statements have been
      presented in accordance with U.S. GAAP, which assumes our continuity as a going
      concern. However, during the six months ended June 30, 2006 and in the prior
      fiscal years, we experienced, and we continue to experience, negative cash
      flow
      and operating losses, as well as losses from discontinued operations, which have
      resulted in a significant reduction in our cash balances. These factors raise
      substantial doubt about our ability to continue as a going concern. Management
      believes that the Company will need to raise additional capital in the third
      quarter ending September 30, 2006 to finance operations and sustain our business
      model. The failure to timely raise adequate funding will most likely result
      in
      the cessation of our operations. We may not be able to obtain additional
      financing on acceptable terms, or at all. If we are successful in securing
      additional capital, which may be in the form of debt, equity, or some
      combination thereof, the Company may experience further negative impact on
      its
      future profitability and cash flow, due to the costs of obtaining and servicing
      such capital. Furthermore, any capital transaction may result in substantial
      dilution to the Company’s current shareholders, depending on the nature and
      terms of the capital raised.




**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
      respect **** to
      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 six months ended June 30, 2006. 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 Laurus bear interest at a fluctuating rate
      of
      interest related to the “prime” rate in effect from time to time. Accordingly,
      increases in the prime rate will increase our interest expense under our
      agreements with Laurus. We do not use interest rate hedging contracts to manage
      our exposure to changes in interest rates.




**Item
      4. Controls and Procedures.**




Our
      Chief
      Executive and Chief Financial Officers have concluded, based on their evaluation
      as of June 30, 2006, that our disclosure controls and procedures are effective
      to reasonably ensure that information required to be disclosed in the reports
      filed or submitted under the Securities Exchange Act of 1934, as amended, is
      recorded, processed, summarized and reported within the time periods specified
      in the SEC’s rules and forms.




There
      were no significant changes in our internal controls over financial reporting
      that occurred during the second fiscal
      quarter that has materially affected, or is reasonably likely to materially
      affect, our internal
      control over financial reporting.




**PART
      II. OTHER INFORMATION**




**Item
      1A. Risk Factors**





In
      addition to the risk factors set forth below and the disclosures in this report
      under “Going Concern Considerations,” care should be considered in evaluating
      the “Risk Factors” discussed in Part I, Item 1 of our Annual Report on Form
      10-KSB for the year ended December 31, 2005, which could materially affect
      our
      business, financial condition and future results. The risks described in this
      report and in the Annual Report on Form 10-KSB 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 **.**





19





**RETURNS
      OF PRODUCTS WE PREVIOUSLY SOLD IN THE RETAIL CHANNEL MAY RESULT IN ADDITIONAL
      LOSSES FROM DISCONTINUED OPERATIONS IN FUTURE PERIODS**





Following
      the discontinuance of our Retail Channel operations, we have continued to
      receive returns of retail products from the distributor to whom we previously
      sold those products. In addition, following the returns of these products,
      we
      have written down the value of the inventory returned to us to reflect its
      net
      estimated realizable value. As a result of these product returns and the
      inventory write-downs, we have generated losses from discontinued operations,
      net of tax, of approximately $3.2 million for the six months ended June 30,
      2006. This distributor has informed us that it expects to return additional
      retail merchandise to us that may result in additional obligations of up to
      approximately $1.1 million. However, as discussed below, we have informed this
      distributor that we will no longer accept product returns unless certain
      conditions are met as described below. Nevertheless, to the extent we are
      required or otherwise agree to accept returns of products from this distributor,
      we will generate additional losses from discontinued operations in future
      periods.





**WE
      ARE IN A DISPUTE WITH OUR FORMER DISTRIBUTOR TO** **THE
      RETAIL CHANNEL** **WITH
      RESPECT TO AMOUNTS CONTRACTUALLY OWED BY US TO THAT
      DISTRIBUTOR**





We
      are
      currently in a dispute with our former distributor to the Retail Channel with
      respect to our respective contractual obligations under the Alliance Agreement
      we entered into. Our former distributor contends that we are contractually
      obligated to it under the Alliance Agreement in the amount of approximately
      $2.6
      million. We believe that these claims (other than with respect to certain
      limited amounts for returns which we have accepted and which are reflected
      on
      our balance sheet) are without merit and conflict with the express terms of
      the
      Alliance Agreement.





This
      distributor has also informed us that it expects to return retail merchandise
      to
      us which would result in an additional obligation of ours in the amount of
      approximately $1.1 million. However, we have informed the distributor that
      we
      will not accept any further product returns unless and until we are provided
      with evidence acceptable to us that those products were in fact purchased from
      us and meet the criteria for product returns set forth in the Alliance
      Agreement.





We
      have
      recently engaged in settlement discussions with the distributor, which to date
      have not been successful in resolving our disputes. It may be necessary to
      commence legal action to resolve all claims and settle this dispute. In the
      event this occurs by either party, we expect to vigorously pursue an equitable
      outcome. However, litigation can be costly and time-consuming, and there can
      be
      no assurance that our litigation expenses will not be significant or that the
      outcome of any potential litigation will be favorable to us.





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





Pursuant
      to our Nonemployee Directors Stock Plan adopted by our board of Directors in
      October 2005, we issued shares of our Common Stock to our nonemployee directors
      during the period of April 1 to June 30, 2006 as set forth in the table below.
      These issuances were exempt from registration under Section 4(2) of the
      Securities Act of 1933, as amended.




Date
                of Issuance
            
            Number
                of Shares Issued to eachNon-Employee
                Director
            
            Total
                Number of Shares
              Issued
                to Non-Employee DirectorsApril
                15, 2006
            
            
            3,448
            
            
            20,688May
                15, 2006
            
            
            3,846
            
            
            30,768June
                15, 2006
            
            
            5,000
            
            
            40,000





20


**Item
      4. Submission of Matters to a Vote of Security Holders**




Our
      Annual Meeting of Stockholders was held on June 27, 2006. A majority of our
      voting shares were present at the meeting, either in person or by proxy. At
      the
      Annual Meeting, as set forth in the table below, our stockholders elected Howard
      Safir, Richard J. Berman, Victor A. DeMarines, Bruce Galloway (who subsequently
      resigned), John Gutfreund, Asa Hutchinson, Kenneth A. Minihan, Joseph R. Rosetti
      and Steven Walin to the Board of Directors.




Directors
              
              Votes
                  For
              
              Votes
                  WithheldHoward
                  Safir
              
              
              32,290,585
              
              
              1,480,450Richard
                  J. Berman
              
              
              32,324,975
              
              
              1,446,060Victor
                  A. DeMarines
              
              
              32,324,986
              
              
              1,446,049Bruce
                  Galloway
              
              
              32,324,975
              
              
              1,446,060John
                  H. Gutfreund
              
              
              32,324,986
              
              
              1,446,049Asa
                  Hutchinson
              
              
              32,324,975
              
              
              1,446,060Kenneth
                  A. Minihan
              
              
              32,324,986
              
              
              1,446,049Joseph
                  R. Rosetti
              
              
              32,324,986
              
              
              1,446,049Steven
                  Walin
              
              
              32,324,986
              
              
              1,446,049




In
      addition, as set forth below, at the Annual Meeting, stockholders approved




·
            an
                amendment to our Certificate of Incorporation increasing the number
                of our
                authorized shares of Common Stock from 75,000,000 to 200,000,000,




·
            An
                increase in the number of shares of Common Stock available under
                our 2004
                Long-Term Incentive Plan from 5,939,913 to 10,000,000, and




·
            The
                appointment of Mercadien, P.C., Certified Public Accountants, as
                our
                independent auditors for 2006.




Proposal
      To Increase Authorized Shares To 200,000,000




For
              
              Against
              
              Abstain30,889,143
              
              
              2,805,881
              
              
              76,011
  Proposal
        To Increase Shares Under 2004 Plan to 10,000,000
  For
              
              
              Against
              
              
              Abstain
              
              
              Broker
                  Non-Votes13,656,204
              
              
              2,406,663
              
              
              82,511
              
              
              17,625,657
  Proposal
        To Ratify Appointment Of Auditors
  For
              
              
              Against
              
              
              Abstain32,483,553
              
              
              174,479
              
              
              1,113,003





21




**Item
      6. Exhibits.**




Number
            
            Description31.1
            
            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





22




**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:
              August 15, 2006
            By:
            /s/ Joseph
              RestivoName:
              Joseph RestivoTitle:
              Chief Financial Officer




23




**EXHIBIT
      INDEX**




Number
            
            Description31.1
            
            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





24