**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**WASHINGTON,
      D** . **C** . **20549**









**FORM
      10-KSB**


**ANNUAL
      REPORT PURSUANT TO SECTION 13 OR 15(d)**


**OF
      THE SECURITIES EXCHANGE ACT OF 1934**


**FOR
      THE FISCAL YEAR ENDED DECEMBER 31, 2005**


**COMMISSION
      FILE NUMBER 000-21295**









**GVI
      Security Solutions, Inc.**


(Name
      of
      Small Business Issuer in Its Charter)


**Delaware**
              (State
                or Other Jurisdiction of Incorporation or Organization)
            **77-0436410**
              (I.R.S.
                Employer identification number)


**2801
      Trade Center Drive, Suite 120**


**Carrollton,
      Texas 75007**


**(972)
      245-7353**


(Address,
      including zip code, and telephone number,


including
      area code, of registrant’s principal executive offices)







**Securities
      registered pursuant to Section 12(b) of the Act: None**





**Securities
      registered pursuant to Section 12(g) of the Act: Common Stock
      $0** . **001
      par value**





Check
      whether the issuer is not required to file reports pursuant to Section 13 or
      15
      (d) of the Exchange Act.   ̈









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


þ Yes  ̈ No




Check
      if
      there is no disclosure of delinquent filers in response to Item 405 of
      Regulation S-B contained herein, and no disclosure will be contained, to the
      best of registrant’s knowledge, in definitive proxy or information statements
      incorporated by reference in Part III of this Form 10-KSB. þ




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




The
      issuer had revenues of $41,166,000 for its fiscal year ended December 31,
      2005.





The
      aggregate market value of the voting and non-voting common equity held by
      non-affiliates of the registrant as of March 23, 2006 was approximately
      $10,200,000. The number of shares outstanding of the registrant’s Common Stock
      as of March 23, 2006 was 51,009,139.





Transitional
      Small Business Disclosure Format:  ̈ Yes  þ No




Portions
      of the Registrant’s Proxy Statement for the 2006 Annual Meeting of Stockholders,
      which is to be filed subsequent to the date hereof, are incorporated by
      reference into Part III of this Annual Report on Form 10-KSB.












**GVI
      SECURITY SOLUTIONS, INC** .


**2005
      FORM 10-KSB ANNUAL REPORT**


**TABLE
      OF CONTENTS**








PagePART
                I
            3Item
                1. Business.
            3Item
                2. Properties.
            14Item
                3. Legal Proceedings.
            14Item
                4. Submission of Matters to a Vote of Security Holders.
            14PART
                II
            15Item
                5. Market for Registrant’s Common Equity and Related Stockholder Matters
                and Small Business Issuer Purchases of Equity Securities.
            15Item
                6. Management’s Discussion and Analysis of Plan of
                Operation.
            16Item
                7. Financial Statements.
            23Item
                8. Changes in and Disagreements With Accountants on Accounting and
                Financial Disclosure.
            23Item
                8A. Controls and Procedures
            23Item
                8B. Other Information
            23PART
                III
            26Item
                9. Directors and Executive Officers of the Registrant.
            26Item
                10. Executive Compensation.
            26Item
                11. Security Ownership of Certain Beneficial Owners and Management
                and
                Related Stockholder Matters.
            26Item
                12. Certain Relationships and Related Transactions.
            26Item
                13. Exhibits
            27Item
                14. Principal Accountant Fees and Services.
            29











**CAUTIONARY
      NOTE REGARDING FORWARD-LOOKING STATEMENTS**




*This
      annual report on Form 10-KSB contains forward-looking statements relating to
      future events and our future performance within the meaning of Section 27A
      of
      the Securities Act of 1933, as amended, and Section 21E of the Securities
      Exchange Act of 1934, as amended, including, without limitation, statements
      regarding our expectations, assumptions, estimates, projections, beliefs,
      intentions or future strategies that are signified by the words “expects”,
“anticipates”, “intends”, “believes” or similar language. Actual results could
      differ materially from those anticipated in such forward-looking statements.
      All
      forward-looking statements included in this document are based on information
      available to us on the date hereof.*




**PART
      I**




**Item
      1.** **Business.**




General




Through
      our subsidiaries, we provide 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 .
      We provide
      a
      strong combination of closed
      circuit televisions ( CCTVs),
      digital video recorders (DVRs), access control, Rapid Access
      Portals, software
      systems and networking products that
      enhance life safety for both government agencies and the private sector. Our full
      service Enterprise Solutions Group provides turnkey solutions and integrated
      security systems for various government, homeland security, and Fortune 500
      companies.




Our
      customers include distributors and system integrators that specialize in video
      surveillance and security products and services, government agencies and private
      sector businesses. Our technology is available to the United States Government
      through a General Services Administration (GSA) contract.




Our
      business previously included the distribution of security products to the retail
      market manufactured by Samsung Electronics whose products we sold under an
      agreement that gave us the exclusive right to sell its products in the Retail
      Channel to a major national retailer. However,
      over the last three quarters of 2005, we had minimal sales of our products
      in
      the Retail Channel. Among other reasons, the recent decline in sales of our
      retail products resulted from the replacement of a substantial portion of our
      products by the major national retailer that accounted for substantially all
      of
      our Retail Channel sales with products manufactured by a competitor. In
      addition, our exclusive agreement to distribute Samsung products in the Retail
      Channel to this retailer expired on December 31, 2005. As a result, in the
      first
      quarter of 2006, our board of directors approved the discontinuance of our
      sales
      to the Retail Channel so that we can focus our efforts on sales to professionals
      and sales by our Enterprise Solutions Group. ****





We
      operate sales and distribution centers in Dallas, Texas, Washington D.C.,
      Toronto, Canada, Mexico City, Mexico, Sao Paulo, Brazil and Bogota,
      Colombia.





Corporate
      History




We
      were
      incorporated in Delaware in August 1996 as Thinking Tools, Inc. and initially
      engaged in developing and marketing business simulation software. In April
      1999,
      we eliminated substantially all of our operations and terminated substantially
      all of our personnel. In March 2000 we acquired the business of an Internet
      software and service provider. This business did not generate sufficient
      revenues to support our operations and was discontinued in December 2000.




From
      December 2000 until February 20, 2004, we had no active business. On February
      20, 2004, pursuant to an Agreement and Plan of Merger, GVI Security, Inc.,
      a
      Delaware corporation, merged with our newly-formed wholly-owned subsidiary,
      GVI
      Security Acquisition Corp., becoming our wholly owned subsidiary, and on April
      12, 2004, we changed our name to GVI Security Solutions, Inc.




3


On
      December 1, 2004, we acquired Rapor, Inc. in a merger for shares of our Common
      Stock. Rapor designs and manufactures high security building access portals.
      Rapor's patented Fast Trac TM Rapid
      Access Portal is intended for use in new, high security installations, and
      can
      also be integrated with existing access control and surveillance systems.




WorldSecurity
      Systems Markets




The
      worldwide market for security products and services is estimated at
      approximately $140 billion. The industry continues to see significant growth
      throughout the world fueled by increased fear of terrorism and crime, heightened
      expectation of safety in public places and institutions, and higher expectations
      of performance, reliability and architectural appeal. The world market is
      expected to continue to grow at an average annual rate in excess of 8% with
      the
      primary components of this growth being electronic integrated security systems.
      We believe that access control and video surveillance products represent the
      largest components of a typical integrated security system.




Access
      control systems, which include turnstiles and mantraps, may utilize traditional
      card readers but are increasingly becoming more sophisticated, incorporating
      biometrics (such as iris scan, retina scan, and fingerprint and facial
      recognition capabilities), and badging systems for visitor control and asset
      tracking.




Video
      surveillance has undergone significant changes over the last few years, from
      the
      introduction of affordable digital cameras to the birth of digital recording.
      Cost effective digital video recorders (DVR) have enabled a shift from human
      surveillance to more sophisticated computer-driven surveillance that utilizes
      archiving, data mining and artificial intelligence with predictive behavior
      algorithms. A DVR is a computer with special interface cards that accepts camera
      input and converts video signals to digital data and stores this data on the
      hard disk drive of the computer. The benefits of the DVR are its capacity to
      store large volumes of data, the clarity of its pictures, the lack of distortion
      of images and its capability to perform rapid searches based upon certain
      pre-defined parameters. We believe that over the next few years we will see
      a
      full shift in the video surveillance segment of the electronic security systems
      industry from analog to digital equipment.




Strategies




Our
      objective is to provide “total solutions” for our customers and partners by
      providing a range of products and engineering services designed to meet the
      specific needs of the end user. Our goal is to provide our customers with
      excellent service and superior technology at competitive prices.




We
      believe that by delivering the highest levels of customer service, we can
      strengthen our reputation as a reliable and cost-effective provider in the
      electronic security systems industry and develop customer loyalty. We strive
      to
      anticipate and meet our customers’ needs by increasing the range of products and
      services we offer by entering into new business alliances and by pursuing
      acquisitions of complementary businesses enabling us to offer new products
      and
      services. Our goals include further developing our expertise and products in
      the
      digital video recording sector, access control and detection product areas,
      with
      a focus on increasing sales of our products in the Professional Channel, which
      typically generate higher gross margins than Retail Channel sales, which we
      recently discontinued effective December 31, 2005. Further, we intend to grow
      our business by expanding and diversifying our distribution channels and
      capitalizing on domestic and international expansion opportunities.




Our
      growth strategy also includes identifying and acquiring businesses engaged
      in
      similar or complementary industries. However, there can be no assurance that
      we
      will consummate any additional acquisitions or that any business we acquire
      will
      be successful. In addition, the acquisition of a business through the issuance
      of our securities will result in dilution to our existing
      stockholders.




Products
      and Services




We
      are
      committed to setting new standards in quality, performance and value by
      providing “best of breed” integrated security products. We offer a range of
      video surveillance and security systems to our customers, including products
      that can be used on a stand-alone basis or that can be integrated into a larger
      more sophisticated security system. Through Rapor, we also design and
      manufacture high security building access portals (controlled door systems,
      with
      materials and substance detection options) for use in high security
      installations. These portals can also be integrated with existing access control
      and surveillance systems.




4


We
      serve
      the import, support, marketing, inventory, warranty and distribution needs
      of
      our Professional Channel customers. In addition, we provide a range of products
      and engineering services designed to meet the specific needs of the end user
      through our Enterprise Solutions Group.




*Professional
      Products*




Our
      objective is to provide complete security solutions for our professional
      customers, by providing a suite of fully-integrated products that is
      complemented by the extensive knowledge and expertise of our dedicated
      Enterprise Solutions Group. Our Enterprise Solutions Group works closely with
      our professional customers to assist them in submitting bids for projects,
      designing security systems and developing the specifications for a project.
      Our
      Enterprise Solutions Group also provides end-to-end project management,
      including oversight of installation and implementation of the security systems,
      and after-sale service and support.




We
      sell
      the following products separately and as part of our fully integrated suite
      of
      video surveillance and integrated security solutions:




·
            access
                control




·
            a
                full line of black and white and color cameras, which include motion
                detection, low light day/night and high resolution, all with systems
                integration capabilities




·
            a
                range of waterproof and weather resistant
                cameras




·
            high
                speed, remote controlled, dome and pinhole cameras and
                casings




·
            a
                complete range of lenses




·
            a
                range of black and white, color, plasma and flat screen
                monitors




·
            real
                time and time lapse videocassette and digital recorders and hard
                disk
                recorders




·
            digital
                watchdog ATM/point of service transaction verification
                software




·
            standalone
                digital recorders




·
            video
                transmission equipment




·
            digital
                processors (quads and multiplexers), switchers and video management
                systems




·
            digital
                video recording software




·
            hardware
                and software which enable intelligent video
                surveillance.




We
      rely
      on original equipment manufacturer relationships for a number of our standard
      products. In some instances, we purchase products that meet our specifications
      from a manufacturer and distribute these products under the GVI TM label.
      When assembly of our products is required, it is done in our Dallas, Texas
      facility, or in the case of our access portals at the job site.




5


*Access
        Portals*




Rapor's
      patented Fast Trac TM Rapid
      Access Portal units are intended for use in new, high security installations,
      and can also be seamlessly integrated with existing access control and
      surveillance systems. The Fast Trac TM unit
      controls access to secure areas through bi-folding doors with infrared sensors
      that can open or remain open for authorized personnel, and close or remain
      closed when necessary to prevent unauthorized access. We believe that the Fast
      Trac TM portal
      offers reliable security while allowing a more efficient flow of traffic than
      competing portal designs such as turnstiles, mantraps and revolving doors.
      Screening and monitoring functions can be added to the portal in a modular
      form
      to include a variety of metal and substance detection options. To date, Rapor’s
      Fast Trac TM portal
      has been installed in airports, manufacturing facilities and office
      buildings.




*Customer
      Support*




We
      believe that our ability to establish and maintain long-term relationships
      with
      our customers and differentiate ourselves from the competition depends
      significantly on the strength of our customer support operations and staff.
      We
      operate customer support centers in Dallas, Texas, Washington, D.C., Mexico
      City, Mexico, Sao Paulo, Brazil and Bogota, Colombia and also utilize a number
      of independent service providers in the other territories that we
      service.




Distribution
      and Marketing




We
      offer
      our products and services through local, regional and national system
      integrators and distributors who resell our products to professional security
      providers. System integrators, on their own, or with the assistance of our
      Enterprise Solutions Group, utilize our products to develop and install a fully
      integrated security suite for end users. Our Enterprise Solutions Group will
      engineer and deliver integrated security solutions to end users including
      airports, seaports, military installments, high security federal installations,
      Fortune 500 companies, casino and institutional end users.




We
      also
      utilize regional sales executives who often support sales across all of our
      product and service offerings. We use a combination of our internal sales force
      and independent representatives to sell our products to dealers and systems
      integrators.




For
      the
      years ended December 31, 2005 and 2004, 50% and 68%, respectively, of our
      revenues (excluding revenues from discontinued operations) were attributable
      to
      products manufactured by Samsung, whose products we distributed under an
      exclusive distribution agreement. Samsung terminated its agreement with us
      in
      January 2006. Samsung was entitled to terminate the distribution agreement
      because we did not purchase the minimum amounts required to be purchased
      thereunder during the 2005 calendar year. However, we believe that Samsung
      will
      continue to supply us with sufficient security products on a non-exclusive
      basis
      to meet our needs and the needs of our customers and that demand from our
      customers will not be materially affected by the termination of our exclusive
      contract with Samsung. As before, we will continue to distribute a full line
      of
      security products manufactured by manufacturers other than Samsung.




Competition




We
      believe that the range of our product and service offerings and our distribution
      channels enable us to compete favorably in the market for the security products
      and services that we offer. However, some of our competitors have greater name
      recognition, longer operational histories and greater financial, marketing
      and
      managerial resources than we do.




The
      key
      factors which drive competition in the video surveillance and security industry
      are price, quality, product performance, ease of integration and customer
      service and support. There are a number of distributors of highly sophisticated,
      technologically advanced security components. Very few of these distributors,
      however, offer fully integrated security suites that can be customized to meet
      the specific needs of the end user. We believe that we have distinguished
      ourselves in this market by providing our customers with superior levels of
      customer service and by giving them the flexibility to choose between purchasing
      our products separately or utilizing the expertise and knowledge of our
      Enterprise Solutions Group to design and implement a fully integrated customized
      security suite for their end users using our products. Our main competitors
      in
      the professional sector are Pelco and Panasonic.




6


Significant
      Vendor Relationship




Historically,
      Samsung Electronics has been our primary supplier for the security products
      that
      we distribute. For the years ended December 31, 2005 and 2004, 50% and 68%,
      respectively, of our revenues (excluding revenues from discontinued operations),
      were attributable to products manufactured by Samsung whose products we sold
      under an agreement that gave us the exclusive right to sell its products in
      the
      Professional Channel and the exclusive right to sell its products in the Retail
      Channel to a major national retailer. Our exclusive right to sell Samsung
      products to the major national retailer expired on December 31, 2005, and
      Samsung terminated the remaining portion of its agreement with us in January
      2006. Following the termination of our agreement with Samsung, our Board of
      Directors approved the discontinuation of sales to the Retail Channel. However,
      we expect to continue to sell Samsung products in the Professional Channel,
      albeit on a non-exclusive basis. In addition, as before, we will continue to
      distribute a full line of security products manufactured by manufactures other
      than Samsung.





To
      the
      extent we are unable to successfully transition our business as a result of
      Samsung’s termination of its agreement with us, our business, financial
      condition and results of operations will be materially adversely
      affected. ****





Intellectual
      Property




Rapor
      is
      the owner of patent number 5,845,692 issued on December 8, 1998. The patent
      describes Rapor’s Fast Trac TM portal
      as a *Rapid
      Access Portal* that
      utilizes a rapid access door system which allows authorized individuals passage
      through the doors and blocks the entry of unauthorized individuals, rerouting
      them to unsecured areas. We also have several pending trademark applications
      for
“GVI” in connection with the products we sell.




Employees




As
      of
      December 31, 2005, we had approximately 61 full-time employees. None of our
      employees are represented by a labor union or are subject to
      collective-bargaining agreements. We believe that we maintain good relationships
      with our employees.






7


**RISK
      FACTORS**




**Risks
      Related to Our Industry and Our Business**




*Any
      investment in our Common Stock involves a high degree of risk. You should
      consider carefully the risks described below, together with the other
      information contained in this report. If any of the following events actually
      occurs, our business, financial condition and results of operations may suffer
      materially. As a result, the market price of our Common Stock could decline,
      and
      you could lose all or part of your investment in our Common
      Stock.*




**THE
      REPORT OF OUR INDEPENDENT AUDITORS ON OUR FINANCIAL STATEMENTS CONTAINS AN
      EXPLANATORY PARAGRAPH ON OUR ABILITY TO CONTINUE AS A GOING
      CONCERN.**





The
      report of our independent auditors contains an explanatory paragraph raising
      substantial doubt about our ability to continue as a going concern because
      of
      our history of operating losses and limited capital resources. Our financial
      statements do not include any adjustments that might result from the outcome
      of
      this uncertainty. We have taken steps to reduce our costs and increase sales
      of
      our professional products. If we are not successful in improving our operating
      results in the near term we may need to raise additional capital to finance
      our
      operations and sustain our business model. We may not be able to obtain
      additional financing on acceptable terms, or at all. In addition, any financing
      we obtain in the future may result in dilution to our existing stockholders.
      Any
      failure to raise required capital will likely place us in significant financial
      jeopardy.








**WE
      CONTINUE TO EXPERIENCE OPERATING LOSSES AND MAY INCUR ADDITIONAL OPERATING
      LOSSES IN THE FUTURE.**





We
      incurred a net loss of approximately $13.0 million for the year ended December
      31, 2005, and a net loss of approximately $7.2 million for the year ended
      December 31, 2004. Significant items contributing to our net loss were the
      following:





In
      the
      Retail Channel:





·
            A
                decrease in retail sales of approximately $16.9 million, from $30.7
                million in 2004 to $13.8 million in
                2005.





·
            A
                decrease in the gross margin on retail
                sales.





·
            Write
                down of net assets of discontinued operations of approximately $1.4
                million.





In
      the
      Professional Channel:





·
            Increased
                interest expense of approximately $640,000, from approximately $660,000
                in
                2004 to approximately $1.3 million in 2005, resulting from higher
                average
                interest rates and higher
                borrowings.





·
            Increased
                conference and trade show expenses in 2005 of approximately
                $700,000.





·
            Fees
                associated with a licensing agreement for a network video system
                of
                approximately $600,000 which was entered into January 1, 2005. This
                agreement was terminated effective January 1,
                2006.





·
            Increased
                advertising costs in 2005 for print media and trade journals of
                approximately $200,000.





·
            Increased
                sample and demo expenses in 2005 of approximately $300,000.





8


We
      are
      taking steps to reduce our costs and increase the sales of our professional
      products. We have discontinued sales of retail products and intend to focus
      on
      our higher margin professional products. There can be no assurance that we
      will
      be successful and profitable in the future.





**WE
      HAVE DISCONTINUED SALES OF OUR PRODUCTS IN THE RETAIL CHANNEL, WHICH PREVIOUSLY
      CONSTITUTED A SIGNIFICANT PORTION OF OUR SALES.**





Historically,
      sales of our products in the Retail Channel have accounted for a large portion
      of our revenues. For the years ended December 31, 2005 and 2004, 25% and 46%
      of
      our revenues, including revenues from discontinued operations, were from sales
      in the Retail Channel. However, over the last three quarters of 2005, we had
      minimal sales of our products in the Retail Channel. Among other reasons, the
      recent decline in sales of our retail products resulted from the replacement
      of
      our products by the major national retailer that accounted for substantially
      all
      of our Retail Channel sales, with those manufactured by a competitor. In
      addition, our exclusive agreement to distribute Samsung products in the Retail
      Channel to this retailer expired on December 31, 2005.  As
      a
      result, in the first quarter of 2006 our board of directors approved the
      discontinuance of our sales to the Retail Channel so that we can focus our
      efforts on sales to the Professional Channel and sales by our Enterprise
      Solutions Group.





**A
      SUBSTANTIAL PORTION OF OUR BUSINESS HAS BEEN ATTRIBUTABLE TO A SINGLE SUPPLIER,
      WHICH RECENTLY TERMINATED ITS AGREEMENT WITH US.**





Historically,
      Samsung Electronics has been our primary supplier for the security products
      that
      we distribute. For the years ended December 31, 2005 and 2004, 50% and 68%,
      respectively, of our revenues (excluding revenues from discontinued operations)
      were attributable to products manufactured by Samsung, whose products we sold
      under an exclusive distribution agreement. Samsung terminated the remaining
      portion of its agreement with us in January 2006. Samsung was entitled to
      terminate the distribution agreement because we did not purchase the minimum
      amounts required to be purchased thereunder during the 2005 calendar year.
      However, we expect to continue to sell Samsung products, albeit on a
      non-exclusive basis. In addition, as before, we will continue to distribute
      a
      full line of security products manufactured by manufacturers other than Samsung.
      To the extent we are unable to successfully transition our business as a result
      of Samsung’s termination of its agreement with us, our business, financial
      condition and results of operations will be materially adversely
      affected.





**IF
      WE ARE UNABLE TO RESPOND TO THE RAPID TECHNOLOGICAL CHANGES IN OUR INDUSTRY
      AND
      CHANGES IN OUR CUSTOMERS' REQUIREMENTS AND PREFERENCES, OUR BUSINESS, FINANCIAL
      CONDITION AND RESULTS OF OPERATIONS COULD BE MATERIALLY ADVERSELY
      AFFECTED.**





If
      we are
      unable, for technological, legal, financial or other reasons, to adapt in a
      timely manner to changing market conditions or customer requirements, we could
      lose customers and market share. The electronic security systems industry is
      characterized by rapid technological change. Sudden changes in customer
      requirements and preferences, the frequent introduction of new products and
      services embodying new technologies and the emergence of new industry standards
      and practices could render our existing products, services and systems obsolete.
      The emerging nature of products and services in the electronic security systems
      industry and their rapid evolution will require that we continually improve
      the
      performance, features and reliability of our products and services. Our success
      will depend, in part, on our ability:


·
              to
                  enhance our existing products and
                  services;


·
            to
                anticipate changing customer requirements by designing, developing,
                and
                launching new products and services that address the increasingly
                sophisticated and varied needs of our current and prospective customers;
                and





·
            to
                respond to technological advances and emerging industry standards
                and
                practices on a cost-effective and timely
                basis.






9


The
      development of additional products and services involves significant
      technological and business risks and requires substantial expenditures and
      lead
      time. If we fail to introduce products with new technologies in a timely manner,
      or adapt our products to these new technologies, our business, financial
      condition and results of operations will be adversely affected. We cannot assure
      you that even if we are able to introduce new products or adapt our products
      to
      new technologies that our products will gain acceptance among our customers.
      In
      addition, from time to time, we or our competitors may announce new products,
      product enhancements or technological innovations that have the potential to
      replace or shorten the life cycles of our products and that may cause customers
      to defer purchasing our existing products, resulting in inventory
      obsolescence.





**WE
      MAY NOT BE ABLE TO MAINTAIN OR IMPROVE OUR COMPETITIVE POSITION BECAUSE OF
      STRONG COMPETITION IN THE ELECTRONIC SECURITY SYSTEMS INDUSTRY, AND WE EXPECT
      THIS COMPETITION TO CONTINUE TO INTENSIFY.**





The
      electronic security systems industry is highly competitive and has become more
      so over the last several years as security issues and concerns have become
      a
      primary consideration at both government and private facilities worldwide.
      Competition is intense among a wide range and fragmented group of product and
      service providers, including electronic security equipment manufacturers,
      distributors, providers of integrated security systems, systems integrators,
      consulting firms and engineering and design firms and others that provide
      competitive systems or individual elements of a system. Some of our competitors
      are larger than us and possess significantly greater name recognition, assets,
      personnel, sales and financial resources. These entities may be able to respond
      more quickly to changing market conditions by developing new products and
      services that meet customer requirements or are otherwise superior to our
      products and services and may be able to more effectively market their products
      than we can because they have significantly greater financial, technical and
      marketing resources than we do. They may also be able to devote greater
      resources to the development, promotion and sale of their products than we
      can.
      Increased competition could require us to reduce our prices, result in our
      receiving fewer customers orders, and result in our loss of market share. We
      cannot assure you that we will be able to distinguish ourselves in a competitive
      market. To the extent that we are unable to successfully compete against
      existing and future competitors, our business, operating results and financial
      condition would be materially adversely affected.





**WE
      DEPEND ON OUR MANUFACTURERS, SOME OF WHICH ARE OUR SOLE SOURCE FOR SPECIFIC
      PRODUCTS. OUR BUSINESS AND REPUTATION WOULD BE SERIOUSLY HARMED IF THESE
      MANUFACTURERS FAIL TO SUPPLY US WITH THE PRODUCTS WE REQUIRE AND ALTERNATIVE
      SOURCES ARE NOT AVAILABLE.**





We
      have
      relationships with a number of manufacturers for the supply of our products.
      Our
      success depends in part on whether our manufacturers are able to fill the orders
      we place with them and in a timely manner. If any of our manufacturers fail
      to
      satisfactorily perform their contractual obligations or fill purchase orders
      we
      place with them, we may be required to pursue replacement manufacturer
      relationships. If we are unable to find replacements on a timely basis, or
      at
      all, we may be forced to either temporarily or permanently discontinue the
      sale
      of certain products and associated services, which could expose us to legal
      liability, loss of reputation and risk of loss or reduced profit. Although
      we
      continually evaluate our relationships with our manufacturers and plan for
      contingencies if a problem should arise with a manufacturer, finding new
      manufacturers that offer a similar type of product would be a complicated and
      time consuming process and we cannot assure you that if we ever need to find
      a
      new manufacturer for certain of our products we would be able to do so on a
      completely seamless basis, or at all. Our business, results of operation and
      reputation would be adversely impacted if we are unable to provide our products
      to our customers in a timely manner. ****





**WE
      HAVE SUBSTANTIAL INDEBTEDNESS TO LAURUS MASTER FUND SECURED BY SUBSTANTIALLY
      ALL
      OF OUR ASSETS. IF AN EVENT OF DEFAULT OCCURS UNDER THE SECURED NOTES ISSUED
      TO
      LAURUS, LAURUS MAY FORECLOSE ON OUR ASSETS AND WE MAY BE FORCED TO CURTAIL
      OUR
      OPERATIONS OR SELL SOME OF OUR ASSETS TO REPAY THE NOTES.**





On
      May
      27, 2004, we borrowed $15,000,000 from Laurus pursuant to secured promissory
      notes and related agreements. Our indebtedness to Laurus as of December 31,
      2005
      was approximately $11.8 million. The notes and agreements provide for the
      following events of default (among others):




10




·
            failure
                to pay interest and principal when
                due,





·
            an
                uncured breach by us of any material covenant, term or condition
                in any of
                the notes or related agreements,





·
            a
                breach by us of any material representation or warranty made in any
                of the
                notes or in any related agreement,





·
            any
                money judgment or similar final process is filed against us for more
                than
                $250,000,





·
            any
                form of bankruptcy or insolvency proceeding is instituted by or against
                us, and





·
            our
                Common Stock is suspended from our principal trading market for five
                consecutive days or five days during any ten consecutive
                days.





Upon
      the
      occurrence of an event of default under our agreements with Laurus, Laurus
      may
      enforce its rights as a secured party and we may lose all or a portion of our
      assets, be forced to materially reduce our business activities or cease
      operations.





**OUR
      FUTURE SUCCESS DEPENDS IN PART ON ATTRACTING AND RETAINING KEY SENIOR MANAGEMENT
      AND QUALIFIED TECHNICAL AND SALES PERSONNEL. WE ALSO FACE CERTAIN RISKS AS
      A
      RESULT OF THE RECENT CHANGES TO OUR MANAGEMENT TEAM.**





Our
      future success depends in part on the contributions of our management team
      and
      key technical and sales personnel and our ability to attract and retain
      qualified personnel. In particular, our success depends on Steven Walin, who
      just recently joined us as our Chief Executive Officer in March 2006, and Joseph
      Restivo, who joined us as our Chief Financial Officer in March 2006. Mr. Walin
      and Mr. Restivo are each a party to employment agreements with us that expire
      in
      March 2009. There is significant competition in our industry for qualified
      managerial, technical and sales personnel and we cannot assure you that we
      will
      be able to retain our key senior managerial, technical and sales personnel
      or
      that we will be able to attract, integrate and retain other such personnel
      that
      we may require in the future. **** We
      also
      cannot assure you that our employees will not leave and subsequently compete
      against us. If we cannot work together effectively to overcome any operational
      challenges that arise during the integration process, if our new management
      team
      cannot master the details of our business and our market or if we are unable
      to
      attract and retain key personnel in the future, our business, financial
      condition and results of operations could be adversely affected.





**WE
      RELY ON INDEPENDENT DEALERS AND DISTRIBUTORS TO SELL OUR PRODUCTS. DISRUPTION
      TO
      THIS DISTRIBUTION CHANNEL WOULD HARM OUR BUSINESS.**





Because
      we sell a significant portion of our products to independent dealers and
      distributors, we are subject to many risks, including risks related to their
      inventory levels and support for our products. In particular, if dealers and
      distributors do not maintain sufficient levels of inventory to meet customer
      demand, our sales could be negatively impacted.




Our
      dealers and distributors also sell products offered by our competitors. If
      our
      competitors offer our dealers and distributors more favorable terms, those
      dealers and distributors may de-emphasize or decline to carry our products.
      In
      the future, we may not be able to retain or attract a sufficient number of
      qualified dealers and distributors. If we are unable to maintain successful
      relationships with dealers and distributors or to expand our distribution
      channels, our business could suffer.





11


**OUR
      BUSINESS AND REPUTATION AS A DISTRIBUTOR OF HIGH QUALITY VIDEO SURVEILLANCE
      AND
      SECURITY EQUIPMENT MAY BE ADVERSELY AFFECTED BY PRODUCT DEFECTS OR SUBSTANDARD
      PERFORMANCE.**





We
      believe that we offer state-of-the art products that are reliable and
      competitively priced. In the event that our products do not perform to
      specifications, we and/or the manufacturer of such products might be required
      to
      redesign or recall those products or pay substantial damages or warranty claims.
      Such an event could result in significant expenses, disrupt sales and affect
      our
      reputation and that of our products. In addition, product defects could result
      in substantial product liability. Although we currently maintain product
      liability insurance, we cannot assure you that it is adequate or that it will
      remain available on acceptable terms. If we face liability claims that exceed
      our insurance or that are not covered by our insurance, our business, financial
      condition and results of operation would be adversely affected.




**FAILURE
      TO MANAGE OUR GROWTH AND EXPANSION EFFECTIVELY COULD ADVERSELY AFFECT OUR
      BUSINESS.**





Our
      ability to successfully offer our products and implement our business plan
      in a
      rapidly evolving market requires an effective planning and management process.
      We have increased and plan to continue to increase the scope of our operations
      domestically and internationally and focus exclusively on sales of professional
      products. This growth has placed, and our anticipated growth in future
      operations will continue to place, a significant strain on our management
      systems and resources. If we are unable to effectively manage our growth, our
      business could be adversely affected.





**OUR
      GROWTH STRATEGY INCLUDES MAKING ACQUISITIONS IN THE FUTURE, WHICH COULD SUBJECT
      US TO SIGNIFICANT RISKS, ANY OF WHICH COULD HARM OUR
      BUSINESS.**





Our
      growth strategy includes identifying and acquiring or investing in suitable
      candidates on acceptable terms. In December 2004 we completed the acquisition
      of
      Rapor, Inc. In addition, over time, we may acquire or make investments in other
      providers of product offerings that complement our business and other companies
      in the security industry.





Acquisitions
      involve a number of risks and present financial, managerial and operational
      challenges, including:





·
            diversion
                of management's attention from running our existing
                business;





·
            increased
                expenses, including travel, legal, administrative and compensation
                expenses resulting from newly hired
                employees;





·
            increased
                costs to integrate personnel, customer base and business practices
                of the
                acquired company with our own;





·
            adverse
                effects on our reported operating results due to possible write-down
                of
                goodwill associated with
                acquisitions;





·
            potential
                disputes with sellers of acquired businesses, technologies, services
                or
                products; and





·
            dilution
                to stockholders if we issue securities in any
                acquisition.





Moreover,
      performance problems with an acquired business, technology, product or service
      could also have a material adverse impact on our reputation as a whole. In
      addition, any acquired business, technology, product or service could
      significantly under-perform relative to our expectations, and we may not achieve
      the benefits we expect from our acquisitions. For all these reasons, our pursuit
      of an acquisition and investment strategy or any individual acquisition or
      investment, could have a material adverse effect on our business, financial
      condition and results of operations.





12


**OUR
      PRODUCT OFFERINGS INVOLVE A LENGTHY SALES CYCLE AND WE MAY NOT ANTICIPATE SALES
      LEVELS APPROPRIATELY, WHICH COULD IMPAIR OUR
      PROFITABILITY.**





Some
      of
      our products and services are designed for medium to large commercial,
      industrial and government facilities desiring to protect valuable assets and/or
      prevent intrusion into high security facilities in the United States and abroad.
      Given the nature of our products and the customers that purchase them, sales
      cycles can be lengthy as customers conduct intensive investigations and
      deliberate between competing technologies and providers. For these and other
      reasons, the sales cycle associated with some of our products and services
      is
      typically lengthy and subject to a number of significant risks over which we
      have little or no control.





If
      sales
      in any period fall significantly below anticipated levels, our financial
      condition and results of operations could suffer. In addition, our operating
      expenses are based on anticipated sales levels, and a high percentage of our
      expenses are generally fixed in the short term. As a result of these factors,
      a
      small fluctuation in timing of sales can cause operating results to vary from
      period to period.





**WE
      FACE LABOR, POLITICAL AND CURRENCY RISKS BECAUSE SAMSUNG ELECTRONICS' FACTORIES
      ARE LOCATED IN KOREA, AND WE MAY FACE OTHER RISKS IF WE CONTINUE TO EXPAND
      OUR
      BUSINESS INTERNATIONALLY.**





Since
      our
      primary suppliers are located in Korea, we may face a number of additional
      risks, including those arising from the current political tension between North
      and South Korea. While we have not faced any problems to date, in the future,
      as
      we continue to expand our business internationally, we may face:





·
            regulatory
                limitations imposed by foreign
                governments,




·
            price
                increases due to fluctuations in currency exchange
                rates,




·
            political,
                military and terrorist risks,




·
            disruptions
                or delays in shipments caused by customs brokers or government
                agencies,




·
            unexpected
                changes in regulatory requirements, tariffs, customs, duties and
                other
                trade barriers, and




·
            potentially
                adverse tax consequences resulting from changes in tax
                laws.




We
      cannot
      assure you that one or more of the factors described above will not have a
      material adverse effect on our business, financial condition and results of
      operation.




**INVESTMENT
      RISKS**




**OUR
      COMMON STOCK IS THINLY TRADED ON THE**  **OTC
      BULLETIN BOARD, AND WE MAY BE UNABLE TO OBTAIN LISTING OF OUR COMMON STOCK
      ON A
      MORE LIQUID MARKET.**




Our
      Common Stock is quoted on the OTC
      Bulletin Board, which
      provides significantly less liquidity than a securities exchange (such as the
      American or New York Stock Exchange) or an automated quotation system (such
      as
      the NASDAQ National Market or NASDAQ Capital Market). There is uncertainty
      that
      we will ever be accepted for a listing on an automated quotation system or
      securities exchange.





**PENNY
      STOCK REGULATIONS MAY AFFECT YOUR ABILITY TO SELL OUR COMMON
      STOCK.**





To
      the
      extent the price of our Common Stock remains below $5.00 per share, our Common
      Stock will be subject to Rule 15g-9 under the Exchange Act, which imposes
      additional sales practice requirements on broker dealers which sell these
      securities to persons other than established customers and accredited investors.
      Under these rules, broker-dealers who recommend penny stocks to persons other
      than established customers and "accredited investors" must make a special
      written suitability determination for the purchaser and receive the purchaser's
      written agreement to a transaction prior to sale. Unless an exception is
      available, the regulations require the delivery, prior to any transaction
      involving a penny stock, of a disclosure schedule explaining the penny stock
      market and the associated risks. The additional burdens imposed upon
      broker-dealers by these requirements could discourage broker-dealers from
      effecting transactions in our Common Stock and may make it more difficult for
      holders of our Common Stock to sell shares to third parties or to otherwise
      dispose of them.





13





**SUBSTANTIALLY
      ALL OF OUR AUTHORIZED SHARES OF COMMON STOCK HAVE BEEN RESERVED FOR ISSUANCE
      PURSUANT TO OUTSTANDING OPTIONS, WARRANTS, CONVERTIBLE NOTES AND OTHER
      COMMITMENTS SO THAT ANY FUTURE EQUITY FINANCING OR USE OF COMMON STOCK FOR
      BUSINESS ACQUISITIONS MAY REQUIRE US TO AMEND OUR CERTIFICATE OF INCORPORATION
      TO INCREASE OUR AUTHORIZED COMMON STOCK. YOU SHOULD EXPECT THAT WE WILL SEEK
      STOCKHOLDER APPROVAL OF SUCH AN AMENDMENT AT OR BEFORE OUR NEXT ANNUAL MEETING
      OF STOCKHOLDERS.**





As
      of
      March 23, 2006, there were issued and outstanding 51,009,139 shares of Common
      Stock, and warrants, options and convertible notes to purchase, and commitments
      to issue, an aggregate of approximately 21,150,000 additional shares of Common
      Stock. We have a total of 75,000,000 shares of Common Stock authorized under
      our
      certificate of incorporation. The proposed issuance of approximately 2,750,000
      more shares of Common Stock in addition to those currently reserved for issuance
      would require us to amend our certificate of incorporation to increase our
      authorized Common Stock and/or effect a reverse stock split. You should expect
      that such an amendment will be proposed for stockholder approval at or before
      our next annual meeting of stockholders. No assurance can be given that any
      such
      increase will be approved by our stockholders. Failure to increase our
      authorized Common Stock could limit or restrict our ability to raise working
      capital in a future equity financing and severely limit our ability to use
      Common Stock for desirable business acquisitions.




**FUTURE
      SALES OF COMMON STOCK COULD RESULT IN A DECLINE IN THE MARKET PRICE OF OUR
      STOCK.**





Sales
      of
      a significant number of shares of our Common Stock in the public market could
      result in a decline in the market price of our Common Stock, particularly in
      light of the illiquidity and low trading volume in our Common Stock.




**OUR
      DIRECTORS, EXECUTIVE OFFICERS AND PRINCIPAL STOCKHOLDERS OWN A SIGNIFICANT
      PERCENTAGE OF OUR SHARES, WHICH WILL LIMIT YOUR ABILITY TO INFLUENCE CORPORATE
      MATTERS.**




Our
      directors, executive officers and principal stockholders beneficially owned
      approximately 30% of our outstanding Common Stock as of March 23, 2006.
      Accordingly, these stockholders could have a significant influence over the
      outcome of any corporate transaction or other matter submitted to our
      stockholders for approval, including mergers, consolidations and the sale of
      all
      or substantially all of our assets and also could prevent or cause a change
      in
      control. The interests of these stockholders may differ from the interests
      of
      our other stockholders. Third parties may be discouraged from making a tender
      offer or bid to acquire us because of this concentration of ownership.




**Item
      2.** **Properties.**




We
      currently lease approximately 58,850 square feet of office and warehouse space
      in Carrollton, Texas under a lease agreement which expires in September 2009.
      In
      the opinion of our management, the leased properties are adequately insured.
      Our
      existing properties are in good condition and suitable for the conduct of our
      business.




14


**Item
      3.** **Legal
      Proceedings.**




We
      are
      not party to any material pending legal proceedings.




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




No
      matter
      was submitted to a vote of security holders during the fourth quarter of
      2005.




**PART
      II**




**Item
      5.** **Market
      for Registrant’s Common Equity and Related Stockholder
      Matters** **and Small Business Issuer Purchases of Equity Securities.**




Our
      Common Stock trades in the over-the-counter-market under the symbol “GVIS.”
Prior to April 14, 2004, our Common Stock was quoted under the symbol “TSIM.”
Trades in our Common Stock were reported by the OTC Bulletin Board from January
      1, 2002 until June 9, 2002, and by Pink Sheets LLC from June 9, 2002 until
      December 13, 2004. Since December 13, 2004, trades of our Common Stock have
      been
      quoted on the OTC Bulletin Board. The following table sets forth the quarterly
      high and low bid prices of a share of our Common Stock as reported by the OTC
      Bulletin Board and Pink Sheets LLC, respectively. The quotations listed below
      reflect inter-dealer prices, without retail mark-ups, mark-downs or commissions
      and may not necessarily represent actual transactions. The prices below have
      not
      been adjusted for periods preceding April 12, 2004, the date we effected a
      one-for-65 reverse split of our Common Stock.




**Price****High**
            
            **Low****2004**First
                quarter
            
            $
            0.51
            
            $
            0.02Second
                quarter
            
            $
            32.51
            
            $
            0.10Third
                quarter
            
            $
            6.00
            
            $
            1.10Fourth
                quarter
            
            $
            8.00
            
            $
            1.15**2005**First
                quarter
            
            $
            5.70
            
            $
            1.80Second
                quarter
            
            $
            2.45
            
            $
            0.70Third
                quarter
            
            $
            1.09
            
            $
            0.27Fourth
                quarter
            
            $
            0.39
            
            $
            0.10





The
      number of holders of record for our Common Stock as of December 31, 2005 was
      approximately 155. This number excludes individual stockholders holding stock
      under nominee security position listings.




**Recent
      Sales of Unregistered Securities**




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 October 1 to December 31, 2005 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 SharesIssued
                to Non-Employee DirectorsOctober
                20, 2005
            9,375
            56,250November
                15, 2005
            6,410
            38,460December
                15, 2005
            6,250
            37,500






15


**DIVIDEND
      POLICY**




We
      have
      not paid any dividends on our Common Stock since our inception and do not intend
      to pay any cash dividends to our stockholders in the foreseeable future. In
      addition, we are prohibited from paying dividends on our Common Stock under
      our
      agreements with Laurus.




**Item
      6.** **M** **anagement’s
      Discussion and Analysis of Plan of Operation.**




*This
      report contains forward-looking statements relating to future events and our
      future performance within the meaning of Section 27A of the Securities Act
      of 1933, as amended, and Section 21E of the Securities Exchange Act of
      1934, as amended, including, without limitation, statements regarding our
      expectations, beliefs, intentions or future strategies that are signified by
      the
      words “expects,” “anticipates,” “intends,” “believes” or*  *similar
      language. Actual results could differ materially from those anticipated in
      such
      forward-looking statements. All forward-looking statements included in this
      document are based on information available to us on the date hereof. We caution
      investors that our business and financial performance are subject to substantial
      risks and uncertainties. In evaluating our business, prospective investors
      should carefully consider the information set forth under the caption “Risk
      Factors” in addition to the other information set forth herein and elsewhere in
      our other public filings with the Securities and Exchange
      Commission.*




**Overview**




From
      December 2000 until we acquired GVI Security, Inc. in a merger transaction
      on
      February 20, 2004, we had no active business operations. As a result of the
      merger, GVI Security, Inc. became our wholly-owned subsidiary, and the business
      of GVI Security became our business. Following the merger, on April 12, 2004,
      we
      changed our name from Thinking Tools, Inc. to GVI Security Solutions, Inc.
      Since
      the former stockholders of GVI Security, Inc. acquired a majority of our voting
      interests in the merger, the transaction was treated as a reverse acquisition,
      with GVI Security, Inc. treated as the acquirer for accounting purposes.
      Accordingly, the pre-merger financial statements of GVI Security, Inc. are
      our
      historical financial statements.





Through
      our subsidiaries, we provide 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 .
      We provide
      a
      strong combination of closed
      circuit televisions ( CCTVs),
      digital video recorders (DVRs), access control, Rapid Access
      Portals, software
      systems and networking products that
      enhance life safety for both government agencies and the private sector. Our full
      service Enterprise Solutions Group provides turnkey solutions and integrated
      security systems for various government, homeland security, and Fortune 500
      companies.





**Discontinuance
      of Retail Sales**





**** Historically,
      sales of our products in the Retail Channel have accounted for a substantial
      portion of our revenues. For the years ended December 31, 2005 and 2004, 25%
      and
      46% of our revenues, including revenues from discontinued operations, were
      from
      sales in the Retail Channel. However, over the last three quarters of 2005,
      we
      had minimal sales of our products in the Retail Channel. Among other reasons,
      the recent decline in sales of our retail products resulted from the replacement
      of our products by a major national retailer that accounted for
      substantially all of our Retail Channel sales with products manufactured by
      a
      competitor. In addition, our exclusive agreement to distribute Samsung products
      in the Retail Channel to this retailer expired on December 31, 2005. As a
      result, in the first quarter of 2006 our board of directors approved the
      discontinuance of our sales to the Retail Channel so that we can focus our
      efforts on sales to professionals and sales by our Enterprise Solutions
      Group.




The
      retail 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 year ended December 31, 2005, the Company wrote
      down assets identified with the retail business by approximately $1.4 million,
      net of applicable tax benefit, to net realizable value. The write down to net
      realizable value 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 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.




16


**Critical
      Accounting Policies**




The
      preparation of financial statements in conformity with accounting principles
      generally accepted in the United States requires management to make estimates
      and assumptions that affect the reported amounts of assets and liabilities
      and
      disclosure of contingent assets and liabilities at the date of the financial
      statements and the reported amounts of revenues and expenses during the
      reporting period. Actual results could differ from those estimates. We believe
      the following critical accounting policies have significant effect in the
      preparation of our consolidated financial statements.





*Revenue
      Recognition*





Our
      primary source of revenue is from sales of our products. Sales are recognized
      when revenue is realized and has been earned. Our policy is to recognize revenue
      when risk of loss and title to the product transfers to the customer. Net sales
      is comprised of gross revenue less expected returns, trade discounts and
      customer allowances, which include costs associated with off-invoice mark downs
      and other price reductions, as well as trade promotions. These incentive costs
      are recognized at the later of the date on which we recognize the related
      revenue or the date on which we offer the incentive. For those incentives that
      require the estimate of sales volume or redemption rates, such as for volume
      rebates, we use historical experience and internal and customer data to estimate
      the sales incentives at the time revenue is recognized.





We
      allow
      customers to return defective products when they meet certain established
      criteria as outlined in our trade terms. We regularly review and revise, when
      deemed necessary, our estimates of sales returns based primarily on actual
      returns. We record estimated sales returns as reductions to sales, cost of
      sales, and accounts receivable and an increase to inventory. Returned products
      which are recorded as inventory are valued based upon the amount we expect
      to
      realize upon their subsequent disposition. The physical condition and
      marketability of the returned products are the major factors considered by
      us in
      estimating realizable value. Actual returns, as well as realized values on
      returned products, may differ significantly, either favorably or unfavorably,
      from our estimates if factors such as customer inventory levels or competitive
      conditions differ from our estimates and expectations and, in the case of actual
      returns, if economic conditions differ significantly from our estimates and
      expectations.





*Allowance
      for Doubtful Accounts*





We
      maintain allowances for doubtful accounts for estimated losses from customers'
      inability to make payments. We assess each account that is more than 90 days
      delinquent and other accounts when information known to us indicates amounts
      may
      be uncollectible. In order to estimate the appropriate level of the allowance,
      we consider such factors as historical bad debts, current customer credit
      worthiness, changes in customer payment patterns and any correspondence with
      the
      customer. In 2005, we experienced losses, or recorded provisions for potential
      losses, from customers' inability to make payments, totaling approximately
      $95,000 or less than 1% of revenues. If the financial condition of our customers
      were to deteriorate and impair their ability to make payments, additional
      allowances might be required in future periods.




***Year
      2005*** **compared
      with** **Year 2004**




**Net
      Revenues from Continuing Operations**




Net
      revenues increased approximately $5.3 million, or 14.9% to approximately $41.2
      million for the year 2005 from approximately $35.8 million for the year 2004.
      Sales of professional products increased approximately $4.5 million, or 12.6%,
      and enterprise solutions revenues increased $1.3 million, or 196.5%. 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. Increased revenues of
      our
      enterprise solutions products reflect additional revenues from the Drug
      Enforcement Administration under our contract to supply it with our Rapid Access
      Portals.




17


**Cost
      of Goods Sold from Continuing Operations**




Total **** cost
      of
      good sold increased $3.2 million or 10.6% to approximately $33.5 million from
      approximately $30.3 million in 2004. The increase in costs is the result of
      approximately $3.2 million associated with increased sales of our professional
      and enterprise solutions products. Cost of goods sold for
      2005 include increases in tech support costs and warranty costs of
      approximately $522,000. In addition, during 2004 we benefited from a one time
      reimbursement of $600,000 from a major supplier relating to costs associated
      with a product defect. There was no comparable reimbursement in
      2005.





As
      a
      result of the changes described above in revenues and cost of goods sold, gross
      profit in 2005 increased to approximately $7.7 million from approximately $5.5
      million in 2004, and gross profit as a percentage of revenues (i.e. gross
      margins) in 2005 was 18.6% compared with 15.4% for 2004.





This
      increase was the result of a change in the product mix comprising our sales
      of
      professional products in respective periods. Gross margins on sales of our
      enterprise solutions products increased to 25.9% for 2005 compared to 22.8%
      in
      2004, primarily as a result of higher margins on the sale of our Rapid Access
      Portal to the Drug Enforcement Administration.





**Selling,
      General and Administrative Expenses**





Selling,
      general and administrative expenses increased 15.9% to approximately $16.8
      million in 2005 from approximately $14.5 million in 2004, as follows.





*Sales
      and Marketing.* **** Sales
      and
      marketing expenses increased 41.5% to approximately $9.2 million in 2005 from
      approximately $6.5 million in 2004.  The
      increase was primarily due to; (i) approximately $800,000 in expenses relating
      to a licensing agreement with Cybasec Ltd. entered into January 1, 2005 (which
      has been terminated in accordance with its terms effective January 1, 2006),
      (ii) an increase of approximately $290,000 in sample and demonstration equipment
      costs, (iii) an increase of approximately $309,000 in advertising costs for
      print media, (iv) increased commissions on sales made by our independent sales
      representatives of approximately $442,000, (v) increased tradeshow costs of
      approximately $155,000, and (vi) a decrease of approximately $114,000 in
      contributions from our vendors to offset our marketing costs in 2005, as
      compared to vendor contributions we received in 2004 to cover these costs,





*General
      and Administrative.* **** General
      and administrative expenses decreased 5% to approximately $7.6 million for
      2005
      from approximately $8.0 million in 2004.  Major
      items resulting in the  decreased
      general and administrative expense were (i) decreases of approximately $912,000
      in administrative staff salaries and related benefits, (ii) reductions in bad
      debt provisions and other expenses of approximately $159,000, and (iii) reduced
      bank charges of approximately $129,000. These reductions were offset by (i)
      personnel termination costs during the year of approximately $335,000, (ii)
      an
      approximately $150,000 increase in office rent, (iii) approximately $149,000
      of
      depreciation expense related to assets acquired in the Rapor acquisition in
      December 2004, with no comparable expense in 2004, (iv) an increase of
      approximately $97,000 in legal and accounting fees, and (v) payment of $115,000
      in directors fees.




**Interest
      Expense**





Interest
      expense for 2005 increased 83.2% to approximately $1,266,000 from approximately
      $691,000 in 2004. The increase was due to higher outstanding borrowings and
      a
      higher average interest rate during 2005 as well as the amortization of
      approximately $600,000 of loan origination fees in 2005 compared to amortization
      of approximately $334,000 of loan origination fees in 2004. 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
      receivable facility. As a result of the conversion price under the facility
      exceeding the market price of our Common Stock for periods of 2005, the interest
      rate for those periods was equal to the prime rate plus two percent. If the
      market price of our Common Stock exceeds the conversion price of $2.22, at
      the
      end of a month, the interest rate under the receivable facility will be reduced
      to equal the prime rate minus two percent. The amount of interest expense for
      2005 reflects an offset of approximately $143,000 of interest income earned
      on
      bank balances during the period. Interest income earned in 2004 was
      approximately $2,000.





18


**Discontinued
      Operations**





Net
      revenues from our discontinued Retail Channel operations were approximately
      $13.8 million for the year ended December 31, 2005 compared with approximately
      $30.7 million in 2004. Loss from discontinued operations, net of tax, was
      approximately $2.3 million for the year ended December 31, 2005, compared to
      income from discontinued operations of approximately $2.3 million for the prior
      year ended December 31, 2004. These operating results do not include any
      allocation of corporate overhead. The loss for 2005 included a write down of
      approximately $1.4 million of assets identified with our retail business. Net
      realizable value of these assets reflects management’s best estimates of the
      amounts expected to be realized on the disposition of all related assets and
      liabilities held for sale from the discontinued operations.





**Income
      Tax Expense (Benefit)**





The
      provision for federal, state and local income tax is an expense of approximately
      $83,000 for 2005 compared to a benefit of approximately $413,000 for 2004.
      The
      $83,000 expense relates to state franchise taxes that are not determined based
      on net income. Any provision for federal and state tax benefits due to our
      loss
      for 2005 would be offset by an equal increase in a valuation allowance. **** We
      established this allowance because, in light of our history, including our
      losses following our merger in February 2004, there is uncertainty under
      generally accepted accounting principles as to whether we will have future
      income against which we can offset our losses to reduce our tax expense in
      future periods.





**Net
      Loss**




As
      a
      result of the items discussed above there was a net loss of approximately $13.0
      million in 2005 compared with a net loss of approximately $7.2 million in 2004.





**Year
      2004** **compared
      with** **Year 2003**





**Net
      Revenues From Continuing Operations**





Total
      net
      revenues increased 44.8% to approximately $36.2 million for the year 2004 from
      approximately $25.0 million in 2003. The increase was due to an increase in
      sales of our products consistent with our focus to provide complete solutions
      for our professional customers by providing a suite of fully-integrated
      products. Our fourth quarter of 2004 was negatively effected by reduced sales
      of
      a particular product to the Professional Channel. We were unable to sell this
      product during portions of the fourth quarter of 2004 as a result of a defect
      in
      the product. The manufacturer corrected the defect and we were able to continue
      selling the product at the beginning of the first quarter of 2005.





**Cost
      of Goods Sold From Continuing Operations**





Total
      cost of goods sold increased 57.8% to approximately $30.3 million in 2004 from
      approximately $19.2 million in 2003. Contributing to this increase were the
      following: charges of approximately $.8 million in connection with reserves
      established for slow moving inventory and write-downs of inventory to reflect
      net realizable value, increased revenues, and higher inbound freight costs.
      As a
      result of the changes in sales and costs of goods sold, gross profit for 2004
      decreased to approximately $5.5 million from approximately $5.8 million for
      2003, and gross profit as a percentage of net sales decreased to 15.4% for
      2004,
      compared with 23.1% for 2003.





19


**Selling,
      General and Administrative Expenses**





Selling, **** general
      and administrative expenses **** increased
      85.9% to approximately $14.5 million in 2004 from approximately $7.8 million
      in
      2003, as follows.





*Sales
      and Marketing.* **** Sales
      and
      marketing expenses increased 80.6% to approximately $6.5 million in 2004 from
      approximately $3.6 million in 2003. The increase was primarily due to increased
      commissions, salaries and travel-related expenses. Contributing to the increase
      in salaries and travel-related expenses was approximately $925,000 relating
      to
      the formation of our Enterprise Solutions Group during 2004, which focuses
      on
      providing fully-integrated security products solutions to the Professional
      Channel.





*General
      and Administrative.* **** General
      and administrative expenses increased 95.2% to approximately $8.2 million in
      2004 from approximately $4.2 million in 2003. The increase was primarily due
      to
      increased salaries and wages associated with additional hires; **** increased
      administrative, accounting, finance and legal costs associated with being a
      public company following our merger in February 2004, as well as costs related
      to our Enterprise Solutions Group and expansion into the integrated security
      solutions market. Also included in general and administrative expenses for
      2004
      is approximately $400,000 of costs associated with personnel terminations during
      the year.





**Interest
      Expense**





Interest
      expense for 2004 increased 203% to approximately $691,000 from approximately
      $228,000 in 2003. The increase was primarily related to increased borrowing
      and
      the amortization of increased loan origination fees during 2004 as a result
      of
      our May 2004 debt financing with Laurus Master Fund, described
      below.





**Discontinued
      Operations**





Net
      revenues from our discontinued Retail Channel operations were approximately
      $30.7 million for the year ended December 31, 2004 compared with approximately
      $31.3 million in 2003. Income from discontinued operations of approximately
      $2.3
      million for the year ended December 31, 2004 compares to income from
      discontinued operations of approximately $2.6 million for the prior year ended
      December 31, 2003. These operating results do not include any allocation of
      corporate overhead. Revenues from discontinued operations for the year ended
      December 31, 2004 decreased approximately $600,000, or 1.9%, to $30.7 million,
      compared to $31.3 million for the year ended December 31, 2003. Gross margin
      decreased to 7.3% for the year 2004 compared to 12.6% for 2003. Contributing
      to
      the decrease margins were charges of approximately $1.6 million in connection
      with reserves established for slow moving inventory and write-downs of inventory
      to reflect net realizable value.





**Income
      Tax Expense (Benefit)**




The
      provision for federal, state and local income tax benefit was approximately
      $413,000 for 2004, **** as
      compared to income tax expenses of approximately $536,000 for 2003. The tax
      benefit for 2004 has been reduced by approximately $2.2 million, the amount
      of a
      deferred tax valuation allowance. We established the allowance because, in
      light
      of our history, including our losses following our merger in February 2004,
      there is uncertainty under generally accepted accounting principles as to
      whether we will have future income against which we can offset our losses for
      2004 to reduce our tax expense in future periods. At December 31, 2004, the
      Company had a net operating loss carry-forward of approximately $1.2 million.
      The loss will expire in 2024.




Prior
      to
      May 23, 2003, GVI Security, Inc. was taxed under the provisions of Sub Chapter
      S
      of the Internal Revenue Code. As a Sub Chapter S corporation, GVI Security,
      Inc.
      did not provide for or pay any Federal or certain corporate or state income
      taxes on its taxable income for the period from January 1, 2003 until May 2003.
      In May 2003, GVI Security, Inc. lost its Sub Chapter S corporation status,
      and
      accordingly a provision was made for the payment of income taxes based on the
      prorated taxable income of GVI Security, Inc. for 2003.





**Net
      Loss**





As
      a
      result of the items discussed above, net loss for 2004 was approximately $7.2
      million, compared with net income of approximately $1.3 million for
      2003.






20


**Liquidity
      and Capital Resources**




At
      December 31, 2005, we had cash and cash 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 accounts receivable loans from Laurus of approximately $8.5 million,
      with no additional borrowing availability under such facility. In comparison,
      at
      December 31, 2004, we had cash and cash equivalents of approximately $13.4
      million, working capital of approximately $21.7 million, an outstanding balance
      of $4.7 million under the Laurus Term Loan, and outstanding accounts receivable
      loans from Laurus of approximately $5.5 million, with additional borrowing
      availability under such facility of approximately $3.9 million.




Historically,
      GVI has funded its operations primarily through cash generated from operations,
      the proceeds of borrowings under secured revolving credit facilities and with
      the proceeds of equity offerings.




**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 accounts receivable loan facility. At closing, we borrowed $5 million
      under the term loan and $10 million under the receivable facility, and used
      $10,016,000 of the proceeds to repay in full the indebtedness outstanding under
      our 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 our Common Stock at a price of $3.50
      per
      share. We issued a similar warrant to purchase 94,000 shares of Common Stock
      to
      the finder at a price of $3.50 per share. Borrowings under the Laurus financing
      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. Amortizing payments of principal on the term loan commenced September
      1, 2004. Remaining monthly payments are set forth in the table
      below.


Period
              
              Principal
                  AmountJanuary
                  2006 through May 2006
              
              $150,000
                  per monthJune
                  2006 through April 2007
              
              $190,000
                  per monthMay
                  2007
              
              $435,000




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.




Subject
      to monthly adjustments as set forth below, borrowings under the receivable
      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 receivable facility will be reduced
      to equal the prime rate minus two percent. In addition, the interest rate under
      the receivable facility is subject to downward adjustment at the end of each
      month in the same manner as provided for under the Term Note. The receivable
      facility terminates, and borrowings thereunder become due, on May 27,
      2007.




Amounts
      outstanding under the receivable 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 we repay loans outstanding
      under the receivable facility and/or Laurus converts loans under the receivable
      facility into Common Stock, we may reborrow or make additional borrowings under
      the receivable facility, provided that aggregate loans outstanding under the
      receivable 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.




21


The
      conversion prices under the Term Note and the receivable 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.




The
      loan
      documents with Laurus required our 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 we issued Laurus additional seven-year warrants
      to
      purchase an aggregate of 400,000 shares of our Common Stock at a price of $3.50
      per share.





The
      loan
      documents also required us to have an effective registration statement covering
      the Common Stock underlying the Warrants and $10 million in principal amount
      of
      the Notes, by September 27, 2004. A registration statement covering those shares
      of Common Stock was not declared effective until October 15, 2004. As a result,
      from September 28, 2004 through October 15, 2004, the rate at which interest
      accrued on $10 million in principal amount of those Notes increased by 12%
      per
      annum.




**October
      2004 Bridge Financing**




On
      October 29, 2004, in a private placement exempt from registration under the
      Securities Act, we sold 23 “Units” for an aggregate purchase price of
      $1,150,000, to a group of five purchasers, all of whom are our affiliates.
      Each
      Unit consisted of $50,000 principal amount of 12% Subordinated Secured
      Promissory Notes, and the right to be issued warrants to purchase shares of
      our
      Common Stock.




The
      Notes
      were repaid in full in accordance with their terms in December 2004 upon the
      closing of the private placement described below. As a result of the December
      2004 private placement, and in accordance with the terms of the bridge
      financing, for each $50,000 in principal amount of notes purchased, such
      purchaser was issued a five-year warrant to purchase 33,333 shares of Common
      Stock at an exercise price of $1.50 per share.




**December
      2004 Private Placement**




On
      December 27, 2004, we completed a private placement of approximately 22,620,000
      shares of Common Stock at a price of $1.50 per share, for aggregate gross
      consideration of $33.9 million. C.E. Unterberg, Towbin LLC acted as the
      financial advisor for us in the private placement and was paid a cash fee equal
      to seven percent of the gross proceeds from the private placement, plus its
      legal costs and expenses. Net
      cash
      proceeds were approximately $31.5 million, after compensation to the financial
      advisor and other costs of the placement.





Approximately
      $4.7 million of the proceeds were used to repay borrowings from Laurus Master
      Fund under the receivables facility, and $1.15 million of the proceeds were
      used
      to repay the notes issued in the October 2004 bridge financing. The holders
      of
      $600,000 in principal amount of these notes reinvested such amount in the
      private placement. We used an additional $10 million of the net proceeds to
      repurchase 6,666,667 shares of Common Stock from William A. Teitelbaum, a
      stockholder of the Company, pursuant to a Settlement Agreement between us and
      Mr. Teitelbaum entered into in October 2004. The balance of the net proceeds
      has
      been and will be used primarily for working capital, general corporate purposes
      and acquisitions.





In
      accordance with our obligations under the private placement, in January 2005
      we
      filed a registration statement to register under the Securities Act the resale
      of the shares of Common Stock issued in the private placement. This registration
      statement was declared effective on April 22, 2005.




22


**Going
      Concern Considerations**





As
      a
      result of our losses from operations and limited capital resources, our
      independent auditors have included an explanatory paragraph in their report
      on
      the accompanying financial statements indicating there is substantial doubt
      about our ability to continue as a going concern. The financial statements
      do
      not include any adjustments that might result from the outcome of this
      uncertainty. Our new management has taken steps to both reduce certain costs
      and
      increase sales of our professional products. However, we will have increased
      compensation costs in 2006 associated with the hiring of our new Chief Executive
      Officer and Chief Financial Officer, and we may incur additional costs for
      other
      management personnel. If we are not successful in improving our operating
      results in the near term, we may need to raise additional capital to finance
      our
      operations and sustain our business model. We may not be able to obtain
      additional financing on acceptable terms, or at all. In addition, any financing
      we obtain in the future may result in dilution to our existing stockholders.





**Item
      7.** **Financial
      Statements.**




The
      Financial Statements and Notes thereto can be found beginning on page F-1,
      "Index to Financial Statements," at the end of this Form 10-KSB.





**Item
      8.** **Changes
      in and Disagreements With Accountants on Accounting and Financial
      Disclosure.**




Not
      Applicable.




**Item
      8A. Controls and Procedures** **.**




Our
      management has evaluated, with the participation of our Chief Executive Officer
      and Chief Financial Officer, the effectiveness of our disclosure controls and
      procedures as of the end of the period covered by this report. Based on that
      evaluation, our Chief Executive Officer and Chief Financial Officer have
      concluded that our disclosure controls and procedures were effective as of
      the
      end of the period covered by this report.




Our
      management, including our Chief Executive and Chief Financial Officer, does
      not
      expect that our disclosure controls and procedures or internal control over
      financial reporting will prevent all error and all fraud. A control system,
      no
      matter how well conceived and operated, can provide only reasonable, not
      absolute, assurance that the objectives of the system are met and cannot detect
      all deviations.  Because of the inherent limitations in all control
      systems, no evaluation of control can provide absolute assurance that all
      control issues and instances of fraud or deviations, if any, within the Company
      have been detected. While we believe that our disclosure controls and procedures
      and our internal control over financial reporting have been effective, in light
      of the foregoing, we intend to continue to examine and refine our disclosure
      controls and procedures and our internal control over financial reporting to
      monitor ongoing developments in this area.




There
      were no significant changes in our internal control over financial reporting
      subsequent to our evaluation of our internal control over financial reporting
      that could materially affect or are reasonably likely to materially affect
      our
      internal control over financial reporting.




**Item
      8B. Other Information.**




Appointment
      of Steven Walin as Director and Joseph Restivo as Chief Financial Officer




On
      March
      28, 2006, Steven Walin, our Chief Executive Officer, was appointed to our board
      of directors. In addition, effective March 28, 2006, Joseph Restivo, age 52,
      was
      appointed our Chief Financial Officer, to serve in such capacity pursuant to
      the
      terms of the Employment Agreement described below. Mr. Restivo will replace
      Nazzareno E. Paciotti, who agreed to cease being our Chief Financial Officer
      and
      a director of ours pursuant to the Mutual Separation Agreement described
      below.




23


Prior
      to
      his employment with us, since January 2003, Mr. Restivo was an independent
      business consultant providing services in the areas of financial and business
      planning, turnaround assistance and operational management support. Prior to
      that time, from January 2000 until January 2002, Mr. Restivo served as the
      Vice
      President, North American Services and Business Development, for the Security
      Systems Division of Siemens Building Technologies. In addition, from 1990 until
      1999, Mr. Restivo held numerous positions, including Chief Financial Officer
      and
      Chief Operating Officer, during his employment with Casi-Rusco (subsequently
      acquired by General Electric), a developer and manufacturer of large-scale
      access control systems.




Employment
      Agreement with Joseph Restivo




On
      March
      28, 2006, we entered into an Employment Agreement with Joseph Restivo as our
      Chief Financial Officer. The Employment Agreement is for a three-year term
      and
      provides Mr. Restivo with:




·
            An
                annual base salary of $200,000.




·
            An
                annual bonus of up to 50% of his base salary based on the achievement
                of
                annual performance targets approved of by our board of
                directors.




·
            A
                10-year option to purchase 750,000 shares of our common stock.The
                exercise price per share with respect to the first 250,000 shares
                under
                this option (“Tranche One”) is $.16, the exercise price per share with
                respect to another 250,000 shares under this option (“Tranche Two”) is
                $.50,
                and the exercise price for the final 250,000 shares under this option
                (“Tranche Three”) is $.78.
                Fifty percent of each of the Tranche One, Tranche Two and Tranche
                Three
                option shares are immediately exercisable, and an additional 25%
                of the
                shares under each Tranche will become exercisable on each of the
                first and
                second anniversaries of the commencement of Mr. Restivo’s employment with
                us, provided he is then employed by us.




·
            A
                second 10-year option topurchase
                1.25% of the number of shares of common stock sold by us in the next
                offering of our securities completed within two years of the commencement
                of Mr. Restivo’s employment with us, provided that the number of shares
                subject to this option will not exceed 250,000. The exercise price
                for
                this option will equal the greater of $.16 and the closing price
                of our
                common stock on the day before the date this option is granted. Fifty
                percent of the shares under this option will be immediately exercisable
                and an additional 25% of such shares will become exercisable on each
                of
                the first and second anniversaries of the grant of the option, provided
                Mr. Restivo is then employed by us.




In
      addition, pursuant to the Employment Agreement, in the event that Mr. Restivo’s
      employment is terminated by us without “Cause” or by Mr. Restivo for “Good
      Reason” (as such terms are defined in the Employment Agreement), Mr. Restivo
      will be entitled to:




·
            payment
                of all accrued but unpaid base salary and unpaid annual bonus with
                respect
                to any completed fiscal year;




·
            payment
                of his base salary and continued medical benefits for 12 months;
                provided,
                that if such termination occurs after a “Change in Control” Mr. Restivo
                will instead be entitled to a payment equal to 200% of his base salary
                and
                continued medical benefits for 24
                months;




·
            pro-rated
                bonus for the year in which the termination occurs, payable following
                such
                fiscal year to the extent he would have otherwise been entitled to
                such
                bonus; and




·
            provided
                at least six months has expired since the last vesting of his option
                grant, a pro rata vesting of his option shares which are scheduled
                to vest
                on the next vesting date; provided, that if such termination occurs
                after
                a “Change in Control” or after the first anniversary of Mr. Restivo’s
                employment with us, all of the unvested options will immediately
                vest.






24


If
      Mr.
      Restivo’s employment is terminated as a result of his death or disability, we
      will pay him his accrued but unpaid base salary and unpaid annual bonus with
      respect to any completed fiscal year, and a pro-rated portion of any bonus
      he
      would have otherwise been entitled for the fiscal year in which the termination
      occurs.




Mr.
      Restivo is prohibited under the Employment Agreement from using or disclosing
      any of our proprietary information, competing with us, hiring any of our
      employees or consultants and soliciting any of our customers or suppliers to
      reduce or cease business with us.




Mutual
      Separation Agreement with Nazzareno Paciotti




On
      March
      28, 2006 we also entered into a Mutual Separation Agreement with Nazzareno
      Paciotti, who was our Chief Financial Officer from February 2004 until such
      date, and who was our Chief Executive Officer from February 2004 until March
      6,
      2006. Pursuant to the Mutual Separation Agreement, the parties mutually agreed
      to the termination of Mr. Paciotti’s employment with us and to his resignation
      as a director and officer of GVI Security Solutions, Inc. and its subsidiaries.
      Mr. Paciotti will be entitled to receive severance payments equal to one year
      of
      his annual base salary of $300,000, payable in 12 equal monthly installments.
      In
      addition, Mr. Paciotti will continue to receive medical benefits until January
      24, 2008. We have also agreed that Mr. Paciotti’s options to purchase an
      aggregate of 625,000 shares of our Common Stock vest in full and will be
      exercisable until December 31, 2006. Mr. Paciotti has agreed to release us
      in
      full from any and all claims and to continue to be bound by the confidentiality
      and non-solicitation terms of his employment agreement.




Amendments
      to Bylaws





On
      March
      28, 2006, our board of directors adopted Amended and Restated Bylaws. Except
      as
      otherwise noted below, our Amended and Restated Bylaws are substantially the
      same as our Bylaws prior to such amendment.




General .
      Where
      provisions of our by-laws previously provided that a specified action may be
      taken by our President and/or our Chairman of the Board, we have amended the
      provision so that the relevant action may be taken by either our Chairman of
      the
      Board or our Chief Executive Officer.




Stockholder
      Proposal Procedures .
      We have
      added a new Section 2.1(b) to our Bylaws, which establishes
      advance notice procedures with regard to stockholder proposals eligible to
      be
      brought before an annual meeting of stockholders, including stockholder
      proposals not included in the Company’s proxy statement. In general, notice must
      be received by our Secretary not less than 120 days prior to the anniversary
      date of the immediately preceding annual meeting and must contain specified
      information concerning the matters to be brought before the meeting and the
      stockholder proposing such matters. In the event that the date of the annual
      meeting is advanced by more than sixty days or delayed by more than ninety
      days
      from such anniversary (or if there was no meeting in the prior year), notice
      by
      the stockholder to be timely must be received not earlier than the
      120 th day
      prior to such annual meeting and not later than the close of business on the
      later of (i) the 60 th day
      prior to such annual meeting or (ii) the 10 th day
      following the date on which notice of the date of the annual meeting was mailed
      or public disclosure thereof is made, whichever first occurs.




Stockholder
      Nomination Procedures .
      We have
      also added a new Section 2.1(c) to our Bylaws, which establishes
      similar advance notice procedures with regard to the nomination, other than
      by
      or at the direction of the Board, of candidates for election as directors.
      Only
      persons who are nominated by or at the direction of the Board, or by a
      stockholder who has complied with these procedures, will be eligible for
      election as directors. In general, notice must be received by our Secretary
      within the same time as provided under Section 2.1(b) of our bylaws with respect
      to stockholder proposals. The notice from a stockholder who proposes to nominate
      a person at a meeting for election as a Director must contain certain
      information about the proposed nominee, including age, business and residence
      addresses, principal occupation, the class and number of shares of Common Stock
      or other capital stock beneficially owned, the consent of the person to be
      nominated and such other information as would be required to be included in
      a
      proxy statement soliciting proxies for the election of the proposed nominee.
      The
      notice must also contain certain information about the stockholder making the
      proposed nomination.




Notice
      of Special Meetings of the Board of Directors .
      Section
      3.4 of our bylaws has been amended so that (i) notice of special meetings of
      our
      board of directors given by mail must be provided at least three days in advance
      of the meeting instead of at least five days in advance of such meeting, (ii)
      notice of special meetings of our board of directors given by telex, telecopy,
      telegraph, cable or overnight courier must be provided to our directors at
      least
      24 hours in advance of the meeting instead of at least three days in advance
      of
      the meeting, and (iii) notice of special meetings of our board of directors
      may
      in addition be provided by telephone and electronic mail at least 24 hours
      in
      advance of the meeting.




25


**PART
      III**




**Item
      9.** **Directors
      and Executive Officers of the Registrant.**




The
      information required to be disclosed hereunder will be incorporated by reference
      to our proxy statement, if filed by May 1, 2006 or, if such proxy statement
      is
      not filed by such date, such information will be disclosed by amendment to
      this
      Form 10-KSB prior to May 1, 2006.




**Item
      10.** **Executive
      Compensation.**




The
      information required to be disclosed hereunder will be incorporated by reference
      to our proxy statement, if filed by May 1, 2006 or, if such proxy statement
      is
      not filed by such date, such information will be disclosed by amendment to
      this
      Form 10-KSB prior to May 1, 2006.




**Item
      11.** **Security
      Ownership of Certain Beneficial Owners and Management and Related Stockholder
      Matters.**




The
      information required to be disclosed hereunder will be incorporated by reference
      to our proxy statement, if filed by May 1, 2006 or, if such proxy statement
      is
      not filed by such date, such information will be disclosed by amendment to
      this
      Form 10-KSB prior to May 1, 2006.




**Item
      12.** **Certain
      Relationships and Related Transactions.**




The
      information required to be disclosed hereunder will be incorporated by reference
      to our proxy statement, if filed by May 1, 2006 or, if such proxy statement
      is
      not filed by such date, such information will be disclosed by amendment to
      this
      Form 10-KSB prior to May 1, 2006.




**Item
      13.**




26


**Exhibits.**




(a)  The
      following documents are filed as part of this report:




**Exhibit****Number**
            
            **Exhibit
                Title**2.1
            
            Agreement
                and Plan of Merger, dated as of February 19, 2004, by and among Thinking
                Tools, Inc., GVI Security, Inc., and GVI Security Acquisition Corp.
                *2.2
            
            Agreement
                and Plan of Merger, dated as of June 30, 2004, by and among GVI Security
                Solutions, Inc., Rapor, Inc., and Rapor Acquisition Corp.####3.1
            
            Certificate
                of Incorporation and Amendments of GVI Security Solutions,
                Inc.**3.2
            
            Amended
                and Restated By-Laws of GVI Security Solutions, Inc.3.4
            
            Certificate
                of the Designations, Powers, Preferences and Rights of the Series
                B
                Convertible Preferred Stock of Thinking Tools, Inc.****4.1‡
            
            2004
                Long-Term Stock Incentive Plan #4.2
            
            Securities
                Purchase Agreement, dated May 27, 2004, by and between GVI Security
                Solutions, Inc. and Laurus Master Fund, Ltd. ##4.3
            
            Secured
                Convertible Term Note, dated May 27, 2004, made by GVI Security Solutions,
                Inc. to Laurus Master Fund, Ltd. ##4.4
            
            Common
                Stock Purchase Warrant, dated May 27, 2004, issued to Laurus Master
                Fund,
                Ltd. ##4.5
            
            Security
                Agreement, dated May 27, 2004, by and between GVI Security Solutions,
                Inc.
                and Laurus Master Fund, Ltd. ##4.6
            
            Secured
                Convertible Minimum Borrowing Note, dated May 27, 2004, made by GVI
                Security Solutions, Inc. to Laurus Master Fund, Ltd. ##4.7
            
            Secured
                Revolving Note, dated May 27, 2004, made by GVI Security Solutions,
                Inc.
                to Laurus Master Fund, Ltd. ##4.8
            
            Registration
                Rights Agreement, dated May 27, 2004, by and between GVI Security
                Solutions, Inc. and Laurus Master Fund, Ltd. ##4.9
            
            Master
                Security Agreement, dated May 27, 2004, by GVI Security Solutions,
                Inc.
                and GVI Security, Inc. in favor of Laurus Master Fund, Ltd.
                ##4.10
            
            Subsidiary
                Guarantee, dated May 27, 2004, by GVI Security, Inc. in favor of
                Laurus
                Master Fund, Ltd. ##4.11
            
            Stock
                Pledge Agreement, dated May 27, 2004, by and among GVI Security Solutions,
                Inc. and Laurus Master Fund, Ltd.
                ##






27




4.12
            
            Registration
                Rights Agreement, dated as of February 19, 2004, by and among the
                Registrant and the stockholders of the Registrant party
                thereto.*4.13
            
            Registration
                Rights Agreement, dated as of July, 2004, by and among the GVI Security
                Solutions, Inc. and the former stockholders of Rapor.####4.14
            
            Form
                of Subscription Agreement for Units purchased by investors in October
                2004
                Bridge Financing+4.15
            
            Form
                of Warrant issued to investors in October 2004 Bridge
                Financing+4.16
            
            Security
                Purchase Agreement, dated as of December 21, 2004, by and among GVI
                Security Solutions, Inc. and the Purchasers listed on Schedule A
                thereto.+++10.1
            
            Distributor
                Agreement between Samsung Electronics Co., Ltd. and GVI Security,
                Inc.
                ***10.2‡
            
            Executive
                Employment Agreement, dated as of January 24, 2005, by and between
                the
                Registrant and Nazzareno E. Paciotti ++++10.3‡
            
            Consulting
                Agreement, dated as of February 17, 2004, by and between the Registrant
                and November Group, Ltd. #10.4
            
            Consulting
                Agreement, dated as of February 18, 2004, by and between the Registrant
                and Europa International, Inc. ***10.5
            
            Commercial
                Industrial Lease Agreement,
                effective as of April 1, 2004, between,
                CSHV Texas Industrial, L.P., as Landlord, andGVI
                Security, Inc., as Tenant***10.6
            
            Settlement
                Agreement and General Release, dated as of October 13, 2004, between
                the
                Registrant, GVI Security, Inc., William A. Teitelbaum and Alarmax
                Distributors, Inc. ***10.7
            
            Mutual
                Separation Agreement, dated as of September 30, 2004, by and among
                GVI
                Security, Inc., GVI Security Solutions, Inc. and Thomas Wade.
                ####10.8
            
            Alliance
                Agreement dated May 5, 2005 between GVI Security Solutions, Inc.
                and SSC,
                Inc†10.9‡
            
            GVI
                Security Solutions, Inc. Nonemployee Directors’ Stock Plan ††10.10‡
            
            Employment
                Agreement, dated as of January 31, 2006, between GVI Security Solutions,
                Inc. and Steven E. Walin †††10.11‡
            
            Employment
                Agreement, dated as of March 28, 2006, between GVI Security Solutions,
                Inc. and Joseph Restivo.10.12‡
            
            Mutual
                Separation Agreement, dated as of March 28, 2006, between GVI Security
                Solutions, Inc. and Nazzareno Paciotti.21
            
            Subsidiaries
                of the Registrant ++++31.1
            
            Certification
                of Steven Walin, Chief Executive Officer of the Registrant, pursuant
                to
                Rules 13a-14(a) and 15(d)-14(a) of the Securities Exchange Act of
                193431.2
            
            Certification
                of Joseph Restivo, Chief Financial Officer of the Registrant, pursuant
                to
                Rules 13a-14(a) and 15(d)-14(a) of the Securities Exchange Act of
                193432.1
            
            Certification
                of Steven Walin, Chief Executive Officer of the Registrant, pursuant
                to
                Rules 13a-14(B) and 15(d)-14(b) of the Securities Exchange Act of
                193432.2
            
            Certification
                of Joseph Restivo, Chief Financial Officer of the Registrant, pursuant
                to
                Rules 13a-14(B) and 15(d)-14(b) of the Securities Exchange Act of
                1934






28





*
            Incorporated
                by reference to the similarly described exhibit previously filed
                as an
                exhibit to Registrant’s Current Report on Form 8-K, as filed with the SEC
                on February 27, 2004.**
            Incorporated
                by reference to the similarly described exhibit previously filed
                as an
                exhibit to Registrant’s Quarterly Report on Form 10-QSB for the quarter
                ended March 31, 2004, filed with the Securities and Exchange Commission
                on
                May 24, 2004.***
            Incorporated
                by reference to the similarly described exhibit previously filed
                as an
                exhibit to our Registration Statement on Form SB-2 (Registration
                No.
                33-11321).****
            Incorporated
                by reference to the similarly described exhibit previously filed
                as an
                exhibit to Registrant’s Current Report on Form 8-K, as filed with the SEC
                on March 22, 2000.#
            Incorporated
                by reference to the similarly described exhibit previously filed
                as an
                exhibit to Registrant’s Annual Report on Form 10-KSB for the year ended
                December 31, 2004, filed with the Securities and Exchange Commission
                on
                April 14, 2004.##
            Incorporated
                by reference to the similarly described exhibit previously filed
                as an
                exhibit to Registrant’s Current Report on Form 8-K, as filed with the SEC
                on June 7, 2004.###
            Incorporated
                by reference to the similarly described exhibit previously filed
                as an
                exhibit to Registrant’s Current Report on Form 8-K, as filed with the SEC
                on June 8, 2004.####
            Incorporated
                by reference to the similarly described exhibit previously filed
                as an
                exhibit to Registrant’s Current Report on Form 8-K, as filed with the SEC
                on October 19, 2004.+
            Incorporated
                by reference to the similarly described exhibit previously filed
                as an
                exhibit to Registrant’s Current Report on Form 8-K, as filed with the SEC
                on December 13, 2004.++
            Incorporated
                by reference to the similarly described exhibit previously filed
                as an
                exhibit to Registrant’s Current Report on Form 8-K, as filed with the SEC
                on November 9, 2004.+++
            Incorporated
                by reference to the similarly described exhibit previously filed
                as an
                exhibit to Registrant’s Current Report on Form 8-K, as filed with the SEC
                on December 30, 2004.++++
            Incorporated
                by reference to the similarly described exhibit previously filed
                as an
                exhibit to our Registration Statement on Form SB-2 (Registration
                No.
                33-122314).†
            Incorporated
                by reference to the similarly described exhibit previously filed
                as an
                exhibit to Registrant’s Current Report on Form 8-K, as filed with the SEC
                on June 10, 2005.††
            Incorporated
                by reference to the similarly described exhibit previously filed
                as an
                exhibit to Registrant’s Current Report on Form 8-K, as filed with the SEC
                on October 24, 2005.†††
            Incorporated
                by reference to the similarly described exhibit previously filed
                as an
                exhibit to Registrant’s Current Report on Form 8-K, as filed with the SEC
                on January 21, 2006.‡
            Indicates
                a management contract or compensatory plan or arrangement.




29





**Item
      14.** **Principal
      Accountant Fees and Services.**




The
      information required to be disclosed hereunder will be incorporated by reference
      to our proxy statement, if filed by May 1, 2006 or, if such proxy statement
      is
      not filed by such date, such information will be disclosed by amendment to
      this
      Form 10-KSB prior to May 1, 2006.





30







**SIGNATURES**




In
      accordance with Section 13 or 15(d) of the Exchange Act, GVI Security Solutions,
      Inc. has caused this report to be signed on its behalf by the undersigned,
      thereunto duly authorized, on this 30th day of March, 2006.




GVI
      SECURITY SOLUTIONS, INC.








By: /s/
      Steven Walin


Steven
      Walin


Chief
      Executive Officer





Pursuant
      to the requirements of the Securities Exchange Act of 1934, this report has
      been
      signed below by the following persons on behalf of the registrant and in the
      capacities and on the dates indicated.





**Signature**
            
            **Title**
            
            **Date**/s/
                Steven Walin
            
            Chief
                Executive Officer (Principal Executive Officer) and
                Director
            
            March
                30, 2006Steven
                Walin/s/
                Joseph Restivo
            
            Chief
                Financial Officer (Principal Accounting and Financial
                Officer)
            
            March
                30, 2006Joseph
                Restivo/s/
                Howard Safir
            
            Chairman
                of the Board of Directors
            
            March
                30, 2006Howard
                SafirDirector
            
            March
                30, 2006Richard
              Berman/s/
                Bruce Galloway
            
            Director
            
            March
                30, 2006Bruce
                Galloway/s/John
              Gutfreund
            
            Director
            
            March
                30, 2006John
                Gutfreund/s/
                Asa Hutchinson
            
            Director
            
            March
                30, 2006Asa
                Hutchinson/s/
                Joseph R. Rosetti
            
            Director
            
            March
                30, 2006Joseph
                R. Rosetti/s/
                Moshe Zarmi
            
            Director
            
            March
                30, 2006Moshe
                Zarmi







31


FINANCIAL
                STATEMENTSPageReport
                of Independent Registered Public Accounting Firm
            F-2Balance
                Sheet of GVI Security Solutions, Inc. as of December 31,
                2005
            F-3Statements
                of Operations of GVI Security Solutions, Inc.for the years ended
                December
                31, 2005 and 2004
            F-4Statement
                of Changes in Stockholders' Equity of GVI Security Solutions, Inc.
                for the
                years ended December 31, 2005 and 2004
            F-5Statements
                of Cash Flows of GVI Security Solutions, Inc. for the years ended
                December
                31, 2005 and 2004
            F-6Notes
                to Financial Statements
            F-8





F-1


**Report
      of Independent Registered Public Accounting Firm**





To
      the
      Board of Directors and Stockholders


GVI
      Security Solutions, Inc.


Carrollton,
      Texas





We
      have
      audited the balance sheet of GVI Security Solutions, Inc. and Subsidiaries
      as of
      December 31, 2005, and the related statements of operations, stockholders’
equity and cash flows for each of the two years then ended. These financial
      statements are the responsibility of the Company's management. Our
      responsibility is to express an opinion on these financial statements based
      on
      our audit.





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





In
      our
      opinion, the financial statements referred to above present fairly, in all
      material respects, the financial position of GVI Security Solutions, Inc. and
      Subsidiaries as of December 31, 2005, and the results of their operations and
      their cash flows for each of the two years then ended, in conformity with U.S.
      generally accepted accounting principles.





The
      accompanying financial statements have been prepared assuming that the Company
      will continue as a going concern. As discussed in Note 1 to the financial
      statements, the Company has suffered recurring losses and negative cash flows
      from operating activities, which have resulted in a significant reduction in
      cash. These factors raise substantial doubt about the Company's ability to
      continue as a going concern. Management's plans in regard to these matters
      are
      also described in Note 1. The financial statements do not include any
      adjustments that might result from the outcome of this uncertainty.











/s/
      Mercadien, P.C., Certified Public Accountants


Hamilton,
      New Jersey





March
      30,
      2006







F-2





GVI
      SECURITY SOLUTIONS, INC.


BALANCE
      SHEET


DECEMBER
      31, 2005


($
      in
      thousands, except per share data)







ASSETSCURRENT
                ASSETSCash
                and Equivalents
            
            $
            3,284Accounts
                receivable, net of allowance fordoubtful
                accounts of $246
            
            
            7,688Inventory
            
            
            7,127Other
                receivables
            
            
            491Prepaid
                expenses and other assets
            
            
            426Refundable
                income taxes
            
            
            643Current
                assets of discontinued operations
            
            
            2,850Total
                current assets
            
            
            22,509PROPERTY
                AND EQUIPMENT, net
            
            
            748OTHER
                ASSETSDeferred
                loan origination fee, net ofaccumulated
                amortization
            
            
            809Goodwill
            
            
            544Intangibles,
                net
            
            
            532Investment
            
            
            50Other
            
            
            34TOTAL
                ASSETS
            
            $
            25,226LIABILITIES
                AND STOCKHOLDERS' EQUITYCURRENT
                LIABILITIESAccounts
                payable
            
            $
            7,035Debt
            
            
            2,307Accrued
                expenses
            
            
            1,381Current
                liabilities of discontinued operations
            
            
            70Total
                current liabilities
            
            
            10,793DEBT,
                Non-current portion
            
            
            9,829TOTAL
                LIABILITIES
            
            
            20,622STOCKHOLDERS'
                EQUITYPreferred
                Stock, Undesignated, $.001 Par Value, 3,000,000Shares
                authorized, None Issued Or Outstanding
            
            
            --Common
                stock - $.001 par value; 75,000,000 sharesauthorized;
                50,258,003 shares issued and outstanding
            
            
            50Additional
                paid-in capital
            
            
            22,837Accumulated
                deficit
            
            
            (18,283
            )Total
                stockholders' equity
            
            
            4,604TOTAL
                LIABILITIES AND STOCKHOLDERS' EQUITY
            
            $
            25,226





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





F-3


GVI
      SECURITY SOLUTIONS, INC.


STATEMENTS
      OF OPERATIONS


YEARS
      ENDED DECEMBER 31, 2005 AND 2004





($
      In
      thousands, except income (loss) per share data)





2005
            
            2004INCOMENet
                sales
            
            $
            41,166
            
            $
            36,182COST
                OF GOODS SOLD
            
            
            33,513
            
            
            30,331Gross
                profit
            
            
            7,653
            
            
            5,851SELLING,
                GENERAL AND ADMINISTRATIVEEXPENSES
            
            
            16,841
            
            
            14,526Loss
                from operations
            
            
            (9,188
            )
            
            (8,675
            )INTEREST
                EXPENSE
            
            
            1,266
            
            
            691OTHER
            
            
            200
            
            
            156Loss
                from continuing operations
            
            
            (10,654
            )
            
            (9,522
            )


INCOME
                TAX EXPENSE (BENEFIT)Current
                tax provision
            
            
            83
            
            
            (1,320
            )Deferred
                tax (benefit)
            
            
            --
            
            
            212Total
                income tax expense (benefit)
            
            
            83
            
            
            (1,108
            )


(Loss)
                    or Income from discontinued operations, net of taxes
              
              
              (2,283
              )
              
              1,236


Net
                loss
            
            $
            (13,020
            )
            $
            (7,178
            )Basic
                and diluted income (loss) per share:Continuing
                operations
            
            $
            (0.21
            )
            $
            (0.28
            )Discontinued
                operations
            
            $
            (0.05
            )
            $
            0.04Net
                loss per share (basic and diluted)
            
            $
            (0.26
            )
            $
            (0.24
            )Shares
                Used in Calculation of Net Income (Loss)Per
                shareBasic
                & Diluted
            
            
            50,127
            
            
            30,135








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




F-4




GVI
      SECURITY SOLUTIONS, INC.


STATEMENTS
      OF CHANGES IN STOCKHOLDERS' EQUITY


YEARS
      ENDED DECEMBER 31, 2005 AND 2004


Common
                  Stock
              
              Preferred
                  A
              
              Preferred
                  B
              
              Preferred
                  D
              
              Preferred
                  E
              
              Additional
              
              RetainedPaid-in
              
              EarningsShares
              
              Amount
              
              Shares
              
              Amount
              
              Shares
              
              Amount
              
              Shares
              
              Amount
              
              Shares
              
              Amount
              
              Capital
              
              (Deficit)
              
              TotalBalance,
                  December 31, 2003(Predecessor
                  Business)
              
              
              --
              
              
              --
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              1,000,000
              
              
              1,000
              
              
              574,000
              
              
              1,914,895
              
              
              2,489,895Thinking
                  ToolsCapitalization
              
              
              157,032
              
              
              157
              
              
              1,148,799
              
              
              1,149
              
              
              200
              
              
              --
              
              
              10,000
              
              
              10
              
              
              
              
              
              
              
              
              20,789,166
              
              
              (22,611,032
              )
              
              (1,820,550
              )Eliminate
                  Thinking Toolsto
                  Recapitalize GVI
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (21,094,042
              )
              
              22,611,034
              
              
              1,516,992Conversion
                  to Common
              
              
              44,185
              
              
              44
              
              
              (1,148,799
              )
              
              (1,149
              )
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              1,105Conversion
                  to Common
              
              
              1,187,983
              
              
              1,188
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (10,000
              )
              
              (10
              )
              
              
              
              
              
              
              
              (1,178
              )Conversion
                  to Common
              
              
              28,214,587
              
              
              28,215
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (1,000,000
              )
              
              (1,000
              )
              
              (27,215
              )Warrants
                  issued
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              212,235
              
              
              
              
              
              212,235Shares
                  issued
              
              
              650,000
              
              
              650
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              155,350
              
              
              
              
              
              156,000Acquisition
                  of Rapor
              
              
              2,805,858
              
              
              2,806
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              670,600
              
              
              
              
              
              673,406Private
                  Placement
              
              
              22,619,968
              
              
              22,620
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              31,454,237
              
              
              
              
              
              31,476,857Stock
                  Repurchase
              
              
              (6,666,667
              )
              
              (6,667
              )
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (9,993,333
              )
              
              
              
              
              (10,000,000
              )Net
                  loss
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (7,177,712
              )
              
              (7,177,712
              )Balance,
                  December 31, 2004
              
              
              49,012,946
              
              
              49,013
              
              
              --
              
              $
              --
              
              
              200
              
              $
              --
              
              
              --
              
              $
              --
              
              
              --
              
              $
              --
              
              
              22,740,925
              
              
              (5,262,815
              )
              $
              17,527,123Laurus
                  Principal PaymentConversion
              
              
              35,000
              
              
              35
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              66,815
              
              
              
              
              
              66,850Conversion
                  Series B PreferredTo
                  common
              
              
              3
              
              
              
              
              
              
              
              
              
              
              
              (200
              )Restricted
                  Stock issued toDirectors
              
              
              132,210
              
              
              132
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              29,868
              
              
              
              
              
              30,000Stock
                  options exercise
              
              
              1,975,020
              
              
              1,975
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              627,069
              
              
              
              
              
              629,044Stock
                  exchanged for options
              
              
              (897,176
              )
              
              (897
              )
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (628,147
              )
              
              
              
              
              (629,044
              )Net
                  loss
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (13,019,974
              )
              
              (13,019,974
              )Balance,
                  December 31, 2005
              
              $
              50,258,003
              
              $
              50,258
              
              
              --
              
              $
              --
              
              
              --
              
              $
              --
                  --
              
              
              --
              
              $
              --
              
              
              --
              
              $
              --
              
              $
              22,836,530
              
              $
              (18,282,789
              )
              $
              4,603,999





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




F-5


GVI
      SECURITY SOLUTIONS, INC.


STATEMENTS
      OF CASH FLOWS


YEARS
      ENDED DECEMBER 31, 2005 AND 2004


($
      In
      thousands)






2005
            
            2004CASH
                FLOWS FROM OPERATING ACTIVITIES:Net
                income (loss)
            
            $
            (13,020
            )
            $
            (7,178
            )Adjustments
                to reconcile net income to net cash provided by (used in) operating
                activities:(Income)
                loss from discontinued operations, net of tax
            
            
            2,283
            
            
            (1,236
            )Depreciation
                and amortization fromcontinuing
                operations
            
            
            1,148
            
            
            846Amortization
                of deferred loan originationfees
                & intangibles
            
            
            600
            
            
            312Deferred
                tax liability
            
            
            --
            
            
            213Compensation
                costs for stock and warrantsIssued
            
            
            30
            
            
            189Write
                down of investment
            
            
            200Increase
                (decrease) in cash flows due to changesin
                operating assets and liabilities:Accounts
                receivable
            
            
            734
            
            
            (1,894
            )Inventory
            
            
            2,419
            
            
            (2,215
            )Other
                receivables
            
            
            911
            
            
            38Prepaid
                expenses and other assets
            
            
            (131
            )
            
            161Accounts
                payable
            
            
            (3,712
            )
            
            4,964Accrued
                expenses
            
            
            (512
            )
            
            822Other
            
            
            --
            
            
            (34
            )Refundable
                income taxes/Federal income taxes payable
            
            
            --
            
            
            (1,099
            )Net cash
              used in
              operating activities from continuing operations
            
            
            (9,050
            )
            
            (6,111
            )Net
                cash (used in) provided by operating activities of discontinued
                operations
            
            
            (1,986
            )
            
            155Net
                cash used in operating activities
            
            
            (11,036
            )
            
            (5,956
            )CASH
                FLOWS FROM INVESTING ACTIVITIES:Purchase
                of property and equipment
            
            
            (430
            )
            
            (1,420
            )Purchase
                of Rapor assets
            
            
            --
            
            
            (
              288
            )Purchase
                of investment
            
            
            --
            
            
            (250
            )Net
                cash used in investing activities
            
            
            (430
            )
            
            (1,958
            )CASH
                FLOWS FROM FINANCING ACTIVITIES:Private
                placement proceeds
            
            
            --
            
            
            31,476Proceeds
                from loan/line of credit
            
            
            30,049
            
            
            17,580Repayments
                of loan/line of credit
            
            
            (28,527
            )
            
            (10,905
            )Repayments
                of prior lines of credit
            
            
            --
            
            
            (5,304
            )Repayments
                of capital lease
            
            
            (170
            )
            
            --Restricted
                cash
            
            
            --
            
            
            (10,000
            )Loan
                origination fees
            
            
            --
            
            
            (1,604
            )Net
                cash provided by financing activities
            
            
            1,352
            
            
            21,243Net
                increase (decrease) in cash
            
            
            (10,114
            )
            
            13,329CASH,
                BEGINNING OF YEAR
            
            
            13,398
            
            
            69CASH,
                END OF YEAR
            
            $
            3,284
            
            $
            13,398SUPPLEMENTARY
                INFORMATION TOSTATEMENT
                OF CASH FLOWS:Cash
                paid for interest
            
            $
            429
            
            $
            356Cash
                paid for taxes
            
            $
            110
            
            $
            468






F-6




SUPPLEMENTARY
                    SCHEDULE OF NONCASH INVESTING AND FINANCING
                    ACTIVITIESLiabilities
                    assumed in acquisition andRecapitalization
              
              $
              --
              
              $
              1,821Capital
                  lease equipment acquisitions
              
              
              --
              
              
              501Conversion
                    of related party note and loanand
                    accrued interest
              
              
              --
              
              
              1,517Loan
                    origination fee compensation cost forwarrant
                    issued
              
              
              --
              
              
              112Rapor
                  assets net of liabilities assumed
              
              
              --
              
              
              741Stock
                  Repurchase Obligation
              
              
              --
              
              
              10,000
 The
        Notes to Financial Statements are an
        integral part of these statements.


F-7


**GVI
      SECURITY SOLUTIONS, INC.**





**Notes
      to the Financial Statements**





NOTE
      1 ~
      SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES





Organization





GVI
      Security Solutions, Inc. (the “Company” and/or “GVI”) was incorporated in August
      1996 as Thinking Tools, Inc. and was originally engaged in the software
      development business. From December 18, 2000 until February 20, 2004, Thinking
      Tools, Inc. had no active business. On February 20, 2004, pursuant to an
      Agreement and Plan of Merger, Thinking Tools, Inc. acquired all of the stock
      of
      GVI Security, Inc. in a merger, and the business of GVI Security, Inc. became
      the business of Thinking Tools, Inc. For accounting purposes, because the
      Company had become a shell company, GVI Security, Inc. was treated as the
      acquiror in the merger, which was treated as a recapitalization of GVI Security,
      Inc., and the pre-merger financial statements of GVI Security, Inc. became
      the
      Company’s historical financial statements. The 2003 stockholders’ equity of the
      Company was retroactively restated for the equivalent number of shares of
      Thinking Tools, Inc. received by GVI Security, Inc. in the reverse merger,
      with
      the difference between the par value of Thinking Tools, Inc. preferred stock
      and
      GVI Security, Inc.’s common stock recorded as paid in capital. In the merger
      230,000 shares of GVI Security, Inc.’s Common Stock was converted to 1,000,000
      shares of Thinking Tools, Inc. Series E Preferred Stock. The Series E Preferred
      Stock was initially convertible into 1,833,947,909 shares of Thinking Tools,
      Inc. common stock, and ultimately converted into 28,214,587 shares of common
      stock of the Company as a result of the one-for-65 reverse split effected on
      April 12, 2004, on which date Thinking Tools, Inc. changed its name to GVI
      Security Solutions, Inc. See also Note 14.





GVI
      is a provider
      of video
      surveillance and security solutions incorporating
      a line of video surveillance, access control and detection systems to the
      homeland security, professional and business-to-business market
      segments .
      GVI’s
      business previously included the distribution of security products to the retail
      market. These operations were discontinued during 2005. (See Note 3 below)
      GVI provides
      a combination of closed
      circuit televisions ( CCTVs),
      digital video recorders (DVRs), access control, Rapid Access
      Portals, software
      systems and networking products for both
      government agencies and the private sector .
      During
      the years ended December 31, 2005 and 2004, sales in North America comprised
      81%
      and 86% of total sales, respectively, and international sales comprised 19%
      and
      14% of total sales, respectively.





On
      December 1, 2004, the Company acquired all of the capital stock of Rapor, Inc.
      in a merger in which the Company issued to Rapor’s former stockholders an
      aggregate of 2,707,852 shares of common stock and seven-year warrants to
      purchase an aggregate of 1,353,925 shares of common stock at an exercise price
      of $3.04 per share. In connection with the closing of the merger, the Company
      also paid approximately $184,000 in cash, and issued 98,007 shares of common
      stock, in satisfaction of secured obligations of Rapor. Rapor designs and
      manufactures high security building access portals.





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, the Company experienced, and continues
      to experience, negative cash flow and operating losses. These factors raise
      substantial doubt about the Company’s ability to continue as a going concern.
      Management intends to  monitor the Company’s cash position carefully
      and evaluate its future operating cash requirements with respect to its
      strategy, business objectives and performance.





The
      Company’s operating results in 2006 will be dependent upon its ability to
      continue to provide quality products and services in sufficient volume at
      attractive prices and maintain customer loyalty. Management believes that the
      Company has sufficient cash reserves to meet its funding needs for 2006.
      However, in order to reduce its cash utilization, the Company may implement
      measures to reduce operating costs, including a reduction in sales and marketing
      expenses, support and other general and administrative expenses.




F-8





**GVI
      SECURITY SOLUTIONS, INC.**





**Notes
      to the Financial Statements**





NOTE
      1 ~
      SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, continued





At
      December 31, 2005, the Company had cash and cash 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 accounts
      receivable loans from Laurus of approximately $8.5 million, with no additional
      borrowing availability under such facility.





Depending
      upon the Company’s ability to increase the its revenues, the timeliness of
      collection of accounts receivable and other potential working capital needs,
      as
      well as the timing and rate of revenue growth and management’s ability to
      control costs, the Company may require additional equity or debt financing
      to
      meet future working capital or capital expenditure needs. There can be no
      assurance that such additional financing will be available, or if available,
      that such financing can be obtained on terms satisfactory to the Company. If
      the
      Company is not able to raise additional funds, it may be required to
      significantly curtail its operations which would have an adverse effect on
      its
      financial position, results of operations and cash flow. The financial
      statements do not include any adjustments that might result from the outcome
      of
      this uncertainty.








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. (in 2004 for the period December 1, 2004 through December 31,
      2004). All material inter-company transactions, balances and profits have been
      eliminated.





Fair
      Value of Financial Instruments





The
      following methods and assumptions were used to estimate the fair value of each
      class of financial instruments for which it is practicable to estimate that
      value:




·
            Cash
                and short-term investments - The carrying amount approximates fair
                value
                because of the short maturity of those instruments.****




·
            Long-term
                debt - Based on the borrowing rates currently available to the Corporation
                for bank loans with similar terms and average maturities, the fair
                value
                of long-term debt approximates the carrying value shown on our balance
                sheet.




Cash
      and
      Cash Equivalents




The
      Company considers all highly liquid investments with an original maturity of
      three months or less when purchased to be cash equivalents. The Company held
      no
      cash equivalents as defined at December 31, 2005 or 2004.




Accounts
      Receivable




Trade
      receivables are presented on the balance sheet as outstanding principal adjusted
      for any charge offs. The Company maintains an allowance for doubtful receivables
      based on previous loss experience. Additional amounts are provided through
      charges to income, as management feels necessary, after evaluation of
      receivables and current economic conditions. Amounts which are considered to
      be
      uncollectible are charged off and recoveries of amounts previously charged
      off
      are credited to the allowance upon recovery. The allowance for doubtful accounts
      at December 31, 2005 was approximately $246,000.







F-9




**GVI
      SECURITY SOLUTIONS, INC.**




**Notes
      to the Financial Statements**





NOTE
      1 ~
      SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, continued




Inventory





Inventory
      is stated at the lower of cost (first-in, first-out method) or market and
      consists of goods held for resale and parts used for repair work. Reserves
      are
      recorded for slow-moving, obsolete, nonsellable or


unusable
      items based upon a product-level review.





Long-Lived
      Assets




The
      Company adopted the provisions of FASB Statement No. 144, “Accounting for the
      Impairment or Disposal of Long Lived Assets “ effective January 1, 2005. 
When impairment indicators are present, the Company reviews the carrying value
      of its assets in determining the ultimate recoverability of their unamortized
      values using analyses of future undiscounted cash flows expected to be generated
      by the assets.  If such assets are considered impaired, the impairment
      recognized is measured by the amount by which the carrying amount of the asset
      exceeded its fair value.  Assets to be disposed of are reported at the
      lower of the carrying amount or fair value, less cost to sell.




Goodwill
      and Intangible Assets




The
      Company adopted the provisions of FASB Statement No. 142, “Goodwill and Other
      Intangible Assets,” (SFAS No. 142) effective January 1, 2005.  SFAS No. 142
      required that goodwill and intangible assets with indefinite useful lives no
      longer be amortized, but instead tested for impairment using the guidance for
      measuring impairment set forth in this statement.  As prescribed under SFAS
      142, the Company had an evaluation done of its goodwill and intangible assets,
      which was performed by an independent third party.  The Company tested for
      impairment using the guidance for measuring impairment set forth in SFAS No.
      142
      and it was determined by the Company that there was no impairment at December
      31, 2005.





Property
      and Equipment





Property
      and equipment is stated at cost net of accumulated depreciation and
      amortization. Depreciation and amortization are provided for on straight-line
      and accelerated methods over the estimated useful lives of the respective
      assets. Maintenance and repairs are charged to expense as incurred; major
      renewals and betterments are capitalized. When assets are fully depreciated,
      or
      otherwise disposed of, the related cost and accumulated depreciation are removed
      from the accounts and any gain or loss on disposition is credited or charged
      to
      income.





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 and the
      useful lives of property and equipment.





F-10
 **GVI
        SECURITY SOLUTIONS, INC.**





**Notes
      to the Financial Statements**





NOTE
      1 ~
      SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, Continued





Revenue
      Recognition





Our
      primary source of revenue is from sales of our products. Sales are recognized
      when revenue is realized and has been earned. Our policy is to recognize revenue
      when risk of loss and title to the product transfers


to
      the
      customer. Net sales is comprised of gross revenue less expected returns, trade
      discounts and customer allowances, which include costs associated with
      off-invoice mark downs and other price


reductions,
      as well as trade promotions. These incentive costs are recognized at the later
      of the date on which we recognize the related revenue or the date on which
      we
      offer the incentive. For those incentives that require the estimate of sales
      volume or redemption rates, such as for volume rebates, we use historical
      experience and internal and customer data to estimate the sales incentives
      at
      the time revenue is recognized.





We
      allow
      customers to return defective products when they meet certain established
      criteria as outlined in our trade terms. We regularly review and revise, when
      deemed necessary, our estimates of sales returns based primarily on actual
      returns. We record estimates sales returns as reductions to sales, cost of
      sales, and accounts receivable and an increase to inventory. Returned products
      which are recorded as inventory are valued based upon the amount we expect
      to
      realize upon their subsequent disposition. The physical condition and
      marketability of the returned products are the major factors considered by
      us in
      estimating realizable value. Actual returns, as well as realized values on
      returned products, may differ significantly, either favorably or unfavorably,
      from our estimates if factors such as customer inventory levels or competitive
      conditions differ from our estimates and expectations and, in the case of actual
      returns, if economic conditions differ significantly from our estimates and
      expectations.





At
      the
      time revenue is recognized, the Company also records reductions to revenue
      for
      customer incentive programs in accordance with the provisions of Emerging Issue
      Task Force (EITF) Issue No. 01-09, “Accounting for Consideration Given from a
      Vendor to a Customer (Including a Reseller of the Vendor’s Products).” Such
      incentive programs include cash and volume discounts, price protection,
      promotional, cooperative and other advertising allowances. For those incentives
      that require the estimation of sales volumes or redemption rates, such as for
      volume rebates, the Company uses historical experience and internal and customer
      data to estimate the sales incentive at the time the revenue is recognized.
      In
      the event


that
      the
      actual results of these items differ from the estimates, adjustment to the
      sales
      incentive accruals would be recorded.





Shipping
      and Handling Costs





Shipping
      and handling costs are expensed as incurred and included in cost of goods sold.
      Shipping and handling costs related to purchases are included in the cost of
      inventory, and charged to cost of goods sold when sold to customers.





Gross
      Profit





Calculation
      of gross profit is net sales less cost of goods sold. Cost of goods sold include
      cost of the products sold and excludes cost for selling, general and
      administrative expenses and depreciation and amortization.





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.




F-11





**GVI
      SECURITY SOLUTIONS, INC.**





**Notes
      to the Financial Statements**





NOTE
      1 ~
      SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, Continued





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.




Net
      Income (Loss) Per Share




The
      Company follows Statement of Financial Accounting Standards (SFAS) No. 128
      "Earnings Per Share." Due to the Company's losses from continuing operations
      in
      2005 and 2004, all convertible securities, options and warrants at December
      31,
      2005 and 2004 are anti-dilutive; hence both basic and diluted loss per share
      for
      those years are computed based on the weighted average number of shares of
      common stock outstanding during those periods.





Accrued
      Expenses




Accrued
                expenses at December 31, 2005 ($ in
                thousands):Accrued
                wages, commissions, and related payroll
                taxes
              
              $
              464Inventory
                - received not invoiced
              
              
              200Legal
                and professional fees
              
              
              121Sales
                Tax Payable
              
              
              183Other
                expenses
              
              
              413$
              1,381




Stock
      Based-Compensation





In
      December 2002, the Financial Accounting Standards Board Issued SFAS No. 148,
      "Accounting for Stock-Based Compensation - Transition and Disclosure - an
      amendment of SFAS No. 123." This statement amends SFAS No. 123, "Accounting
      for
      Stock-Based Compensation," to provide alternative methods of transition
      for a voluntary change to the fair value based method of accounting for
      stock-based employee compensation. In addition, this Statement amends the
      disclosure requirements of SFAS No. 123 to require prominent disclosures in
      financial statements about the method of accounting for stock-based employee
      compensation and the effect of the method used on reported results. The Company
      accounts for stock-based employee compensation using Accounting Principles
      Board
      (APB) Option No. 25, "Accounting for Stock Issued to Employees" and has not
      adopted the recognition provisions of SFAS No. 123, as amended by SFAS No.
      148.
      The exercise price of options granted under the stock option plan (Note 10)
      is
      equal to or less than the market price of the underlying stock on the date
      of
      grant. Therefore, no compensation cost was recorded under APB No.
      25.




The
      Company accounts for equity instruments issued to non-employees in accordance
      with the provisions of SFAS No. 123. During 2005 and 2004, the Company recorded
      $30,000 and $189,000, respectively, of such related expenses.




If
      the
      Company had determined compensation cost for stock-based employee
      compensation in accordance with the fair value method prescribed by SFAS No.
      123, proforma net income for the years ended December 31, 2005 and 2004 would
      have been as follows:





F-12





**GVI
      SECURITY SOLUTIONS, INC.**





**Notes
      to the Financial Statements**





NOTE
      1 ~
      SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES, Continued





($
      in
      thousands, except per share amounts)


2005
            
            2004Net
                Income (Loss), as reported
            
            $
            (13,020
            )
            $(7,178)Stock-based
                employee compensation expense, net of related tax effects
            
            
            (188
            )
            (104)Net
                Income (Loss), pro forma
            
            $
            (13,208
            )
            $(7,282)Net
                income (loss) per share:Basic
                as reported
            
            $
            (0.26
            )
            $(0.24)Basic
                pro forma
            
            $
            (0.26
            )
            $(0.24)Diluted
                as reported
            
            $
            (0.26
            )
            $(0.24)Diluted
                pro forma
            
            $
            (0.26
            )
            $(0.24)





The
      weighted average fair value of options granted during both 2005 and 2004 was
      $0.01. The fair value of each option on the date of grant was estimated using
      the Black-Scholes option pricing model with the following weighted average
      assumptions:





2005
            
            2004Risk
                free rate of return
            
            
            3.5
            %
            
            3.5
            %Option
                lives in years
            
            
            3.0
            
            
            3.0Annual
                volatility of stock price
            
            
            74
            %
            
            74
            %Dividend
                yield
            
            
            --
            %
            
            --
            %





Advertising





Advertising
      costs are expensed as incurred. Some advertising costs, which included various
      promotional incentives and trade show participation, for the years ended
      December 31, 2005 and 2004 were reimbursed by Samsung in the form of marketing
      incentives and partial reimbursement for trade show participation.





NOTE
      2 ~
      PROPERTY AND EQUIPMENT





Property
      and equipment at December 31, 2005 ($ in thousands):





UsefulLives
                InYearsFurniture
                and fixtures
            
            
            5-7
            
            $
            517Office
                and warehouse equipment
            
            
            2-7
            
            
            245Leasehold
                improvements
            
            
            2-7
            
            
            163Computer
                equipment and software
            
            
            3-5
            
            
            662Demo
                and sample equipment
            
            
            1-2
            
            
            970Subtotal
              Less:
                accumulated depreciation
            
            
            
            
            
            2,555
              1,809$
            748





NOTE
      3 ~
      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 year ended December 31,
      2005, the Company wrote down assets identified with the retail business by
      approximately $1.4 million, net of applicable tax benefit, to net realizable
      value. The write down to net realizable value 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 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.




F-13


**GVI
      SECURITY SOLUTIONS, INC.**





**Notes
      to the Financial Statements**





NOTE
      3 ~
      DISCONTINUED OPERATIONS, continued





Net
      sales
      for the discontinued Retail Channel business for the year ended December 31,
      2005 were approximately $13.8 million compared to net sales of approximately
      $30.0 million for the year ended December 31, 2004. The results of the
      discontinued operations do not include any allocation of corporate overhead
      from
      the Company during the periods presented.





At
      December 31, 2005, the Net Assets of discontinued operations as presented in
      the
      accompanying Balance Sheet are as follows:








($
                in thousands)Accounts
                receivable, net
            
            $
            1,366Inventory
            
            
            3,397Inventory
                reserve
            
            
            (1,913
            )Net
                assets
            
            $
            2,850Liabilities
            
            
            (70
            )Net
                assets of discontinued operations
            
            $
            2,780




NOTE
      4 ~
      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 accounts receivable loan facility. At closing,
      the
      Company borrowed $5 million under the term loan and $10 million under the
      receivable 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 December 31,
      2005,
      $3.3 million in principal was outstanding under the Term Loan and $8.5 million
      in principal was outstanding under the accounts receivable facility. The Company
      has recorded the fair value of the warrants issued as deferred loan origination
      fees.





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. Amortizing payments of principal on the term loan commenced
      September 1, 2004, with a final payment due on May 27, 2007 as set forth in
      the
      table below.




F-14


**GVI
      SECURITY SOLUTIONS, INC.**




**Notes
      to the Financial Statements**





NOTE
      4 ~
      CREDIT FACILITIES, continued





Period
                Principal AmountJanuary
                2005 through May 2006
            $150,000
                per monthJune
                2006 through April 2007
            $190,000
                per monthMay
                2007
            $435,000




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 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.





Subject
      to monthly adjustments as set forth below, borrowings under the receivable
      facility bear interest at a rate per annum equal to the prime rate plus two
      percent. In addition, the interest rate under the receivable 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
      receivable facility will be reset to equal the prime rate minus two percent.
      The
      receivable facility terminates, and borrowings thereunder become due, on May
      27,
      2007.




Amounts
      outstanding under the receivable 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 receivable facility and/or Laurus converts loans under
      the
      receivable facility into Common Stock, the Company may reborrow or make
      additional borrowings under the receivable facility, provided that aggregate
      loans outstanding under the receivable 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 receivables less foreign receivables and domestic receivables, over
      90
      days from invoice date.  Eligible inventory is substantially all finished
      goods inventory.





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.





Loan
      Origination Fees





The
      loan
      origination and finders fees of $1.8 million for the Laurus loans and line
      of
      credit were capitalized and will be amortized to interest expense over three
      years. Included in loan origination fees is compensation
      of $112,000 relating to the issuance of warrants to purchase 1,034,000 shares
      of
      the company's
      common stock.




F-15


**GVI
      SECURITY SOLUTIONS, INC.**





**Notes
      to the Financial Statements**





NOTE
      4 ~
      CREDIT FACILITIES, continued





Capitalized
      Leases





There
      are
      four capital leases for a trade show booth, warehouse racking, and 2 office
      furniture leases that have a total value of $519,000. These leases will be
      paid
      over terms ranging from 24 to 60 months and will be amortized to interest
      expense over the term of the leases.





Amortization
      Table: ($ in thousands)





2006
            
            2007
            
            2008
            
            2009Capital
                Leases
            
            $
            118
            
            $
            77
            
            $
            51
            
            $
            12




NOTE
      5 ~
      INCOME TAXES





The
      current tax provision consists of the following ($ in thousands):


2005
            
            2004FederalCurrent
            
            $
            
            
            $
            $
                (647
            )Deferred
            
            
            --
            
            
            212State,
                current
            
            
            83
            
            
            22$
            83
            
            $
            (413
            )





Deferred
      taxes are provided for the differences in the tax and accounting basis of assets
      and liabilities as follows ($ in thousands):





2005Current
                deferred taxesAccounts
                receivable allowances
            
            $
            352Other
            
            
            28Inventory
                reserve
            
            
            979Uniform
                capitalization of inventory costs
            
            
            98Net
                operating loss carry-forward
            
            
            5,1696,626Noncurrent
                deferred tax liabilitiesProperty
                and equipment
            
            
            (84
            )Non
                Cash compensation
            
            
            33(51
            )Less:
                Deferred tax valuation allowance
            
            
            6,575Net
            
            $
            --





The
      Company's effective tax rate differs from the expected federal income tax rate
      as follows ($ in thousands):





2005
            
            2004Income
                tax at statutory rates (34%)
            
            $
            (4,397
            )
            $
            (2,581
            )State
                income tax expense - net of federal benefit
            
            
            55
            
            
            15Change
                in deferred tax valuation allowance
            
            
            4,425
            
            
            2,150Other
            
            
            --
            
            
            3Income
                tax (benefit) provision
            
            $
            83
            
            $
            $
                ( 413
            )





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




F-16


**GVI
      SECURITY SOLUTIONS, INC.**




**Notes
      to the Financial Statements**





NOTE
      5 ~
      INCOME TAXES, continued





At December 31,
      200 5, the
      Company has a
      net operating loss carry-forward of approximately $15.2 million expiring
      2025. A full valuation allowance has been provided against the deferred tax
      assets. The valuation allowance reflects management’s assessment of the
      uncertainty of the Company’s ability to utilize the deferred tax benefits in the
      future.





NOTE
      6 ~
      401(K) PLAN





The
      Company has a 401(k) profit-sharing plan covering all of its eligible employees.
      The Plan provides for annual discretionary employer and employee contributions.
      Amounts accrued but not funded for the periods ended December 31, 2005 and
      2004
      were $0 and $90,000, respectively.





NOTE
      7 ~
      COMMITMENTS AND CONTINGENCIES





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; the effects of which have been accrued.





The
      minimum annual rentals under the non-cancelable lease are as follows ($ in
      thousands):





For
                the years ended December 31,2006
            
            $
            3082007
            
            
            3082008
            
            
            3082009
            
            
            258$
            1,182





Rent
      expense amounted to $520,000 and $371,000 for the periods ended December 31,
      2005 and 2004, respectively.





Termination
      Agreement with Nazzareno E. Paciotti





In
      October 2005, the Board of Directors authorized the hiring of Steven Walin
      to
      replace Mr. Paciotti as Chief Executive Officer of the Company.  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 subsidaries. 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 has been accrued for this 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. There is no effect on
      earnings for this acceleration. 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.





F-17


**GVI
      SECURITY SOLUTIONS, INC.**




**Notes
      to the Financial Statements**




NOTE
      7 ~
      COMMITMENTS AND CONTINGENCIES, continued





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





NOTE
      8 ~
      CONCENTRATIONS OF RISK




Samsung
      Electronics Exclusive Product 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
      and 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, and Samsung terminated
      the
      remaining portion of
      its
      agreement with the Company in January 2006 as a result of the Company’s failure
      to achieve minimum purchase requirements required under the distribution
      agreement. However, the Company expects to continue to sell Samsung products
      in
      the professional channel, albeit on a non-exclusive basis. In addition, as
      before, the Company will continue to distribute to the professional channel
      security products manufactured by manufactures other than Samsung. The account
      caption on the Company’s balance sheet "other receivables" is comprised
      primarily of commissions and other amounts due from Samsung under the terminated
      distribution agreement or current operating practice. For the years ended
      December 31, 2005 and 2004, the Company purchased approximately $28 million
      and
      $39 million, respectively, of security products from Samsung. See also Note
      3.




Major
      Customer




The
      Company had one major customer that is a purchasing entity for a major national
      retailer. Approximately 27% and 44% of the Company's sales for the years ended
      December 31, 2005 and 2004, respectively, were from that customer and none
      of
      the Company's accounts receivable at December 31, 2005, were due from the
      customer. Pursuant to a written agreement, this customer purchases products
      from
      the Company at an initial price equal to 108% of the base cost to the Company,
      subject to downward adjustment if the customer’s gross margins fall below
      certain specified levels. The Company is responsible for all warranty
      obligations with respect to these products. In connection with entering this
      agreement, the Company agreed to issue this customer warrants to purchase
      3,000,000 shares of common stock at a price of $1.50 per share, and to issue
      the
      customer up to an additional 3,000,000 shares of common stock upon attaining
      certain goals provided for in the agreement. In January 2006, 712,500 shares
      of
      Common Stock were issued to this customer for attaining certain of those goals.
      Due to the termination of its Samsung distributor agreement and the
      discontinuance of its retail business, the Company does not expect any sales
      to
      this major customer in 2006. See also Note 3.




Cash
      and
      Credit Risk Concentration




The
      Company maintains accounts in a financial institution and at times the balances
      may be in excess of the FDIC insurance limit. Collected balances are invested
      in
      overnight repurchase agreements. The Company periodically evaluates this
      financial institution and does not believe it is exposed to undue risk of loss.
      At December 31, 2005, approximately $2,153,000 and $1,439,000 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. ****






F-18


**GVI
      SECURITY SOLUTIONS, INC.**




**Notes
      to the Financial Statements**




NOTE
      9 ~
      RELATED PARTY TRANSACTIONS




Settlement
      Agreement with William Teitelbaum





In
      October 2004 the Company entered into a Settlement Agreement and General Release
      with William A. Teitelbaum, a founder and principal stockholder of the GVI
      Security, Inc., under which Mr. Teitelbaum was issued 650,000 shares of common
      stock and Mr. Teitelbaum released the Company from claims with respect to a
      warrant he alleged had been issued to him by GVI Security, Inc. The value of
      the
      common stock issued under the agreement is recorded as other non-operating
      expense of $156,000 for the year ended
      December 31, 2004. The Settlement Agreement required the Company to use a
      portion of the proceeds it would receive in a placement of its securities to
      repurchase up to $10 million of shares of common
      stock held by Mr. Teitelbaum at the purchase price of the securities sold in
      the
      placement. On January 4, 2005 the Company completed the purchase of 6,666,667
      shares from William A. Teitelbaum for $10 million.




Termination
      Agreement with Thomas Wade




On
      October 19, 2004, the Company, GVI Security Inc. and Thomas Wade, at that time
      the beneficial holder of approximately 14% of Common Stock and the President
      of
      the Company’s subsidiary, entered into a Mutual Separation Agreement whereby the
      parties mutually agreed to the termination of Mr. Wade’s employment with the
      subsidiary. In accordance with Mr. Wade’s employment agreement, Mr. Wade
      received severance payments equal to one year of his annual base salary of
      $350,000. In addition, under the separation agreement, Mr. Wade was entitled
      to
      continue to receive a car allowance of $800 per month, an unaccounted for
      expense reimbursement of $1,200 per month, and medical benefits, for a period
      of
      one year.
      At
      December 31, 2004, approximately $281,000 for the remaining obligation was
      included in accrued expenses. The Company also agreed that Mr. Wade’s options to
      purchase 1,975,020 shares of our Common Stock would vest in full. There was
      no
      effect on earnings for this acceleration. Mr. Wade agreed to release the Company
      in full from any and all claims and to continue to be bound by all the terms
      of
      his employment agreement.




In
      the
      normal course of business, the Company previously conducted certain transactions
      with a company owned by William Teitelbaum, a principal stockholder. During
      the
      years ended December 31, 2005 and 2004, the Company made sales of $0 and $3,587,
      respectively, to this company. At December 31, 2005, no amounts were due from
      this company. Also see Note 6 concerning settlement agreement with William
      Teitelbaum.




On
      March
      31, 2004, the Company issued three subordinated convertible notes totaling
      $159,000. Each note bore interest at 10% per annum and was convertible into
      common stock at a price of $5.10 per share. The notes were paid in full with
      accumulated interest on June 29, 2004.




On
      October 29, 2004, in a private placement exempt from registration under the
      Securities Act, the Company sold 23 “Units” for an aggregate purchase price of
      $1,150,000, to a group of five purchasers, all of whom were affiliates of the
      Company. Each Unit consisted of $50,000 principal amount of 12% Subordinated
      Secured Promissory Notes, and the right to be issued warrants to purchase shares
      of common stock. The Notes were repaid in full in accordance with their terms
      in
      December 2004 upon the closing of


the
      private placement. Warrants to purchase 766,666 shares of common stock were
      issued to these purchasers in December 2004 in accordance with the terms of
      the
      October 2004 private placement.





Joseph
      Rosetti, one of the Company’s directors, was a director of Rapor prior to the
      merger (See Note 1). Mr. Rosetti was also the direct holder of approximately
      12%
      of Rapor’s outstanding common stock, and a principal partner in a partnership,
      established for the benefit of members of his family, that held approximately
      7.5% of Rapor’s outstanding common stock. In accordance with the terms of the
      merger, as former stockholders of Rapor, Mr. Rosetti was issued 346,060 shares
      of common stock and warrants to ****purchase
      135,787 shares of common stock, and the partnership was issued 208,998 shares
      of
      common stock and warrants to purchase 104,499 shares of common
      stock.


F-19


**GVI
      SECURITY SOLUTIONS, INC.**





**Notes
      to the Financial Statements**





NOTE
      10 ~
      LITIGATION





The
      Company is a party to 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.





NOTE
      11 ~
      STOCK OPTIONS


On
      July
      22, 2003, the predecessor company, GVI Security, Inc., adopted the GVI Security,
      Inc. 2003 Stock Incentive Plan and granted options to purchase 23,000 shares
      of
      common stock of GVI Security, Inc. under that plan. As a result of Merger,
      and
      after giving effect to the 1-for-65 reverse stock split which occurred in April
      2004, the options for 23,000
      shares of GVI Security Inc. stock were converted to options to purchase
      2,821,452 shares of Common Stock of the Company at a price of $.3185 per share.
      In February 2004, the Company adopted its 2004 Long-Term Stock Plan and reserved
      up to 5,939,913 shares of Common Stock (after giving effect to the Reverse
      Stock
      Split) for issuance thereunder.




In
      addition, in February 2004, the Company granted options for common stock
      exercisable under the plan of 2,675,000 at $2.60 per share (post-reverse stock
      split).





In
      January 2005, the Company granted options for common stock exercisable under
      the
      2004 Long-Term Stock Plan of 837,500 at $1.50 per share.





In
      July
      2005, the Company granted to certain employees and consultants options of
      580,000 shares of Common Stock exercisable at $.85 per share. These options
      were
      not granted under a plan.





At
      December 31, 2004 and 2005, the Company had stock-based employee compensation
      plans, which are


described
      more fully above. The Company accounts for those plans under the recognition
      and
      measurement principles of APB Opinion No. 25, Accounting for Stock Issued to
      Employees, and related Interpretations. No stock-based employee compensation
      cost is reflected in net income, as all options granted under those plans had
      an
      exercise price equal to the market value of the underlying common stock on
      the
      date of grant.





A
      summary
      of the status of the Company's stock options as of December 31, 2005 and 2004,
      and the changes during the years ended December 31, 2005 and 2004, are presented
      below:




Number
                of Shares
            
            Range
                ofExercise PricesOutstanding
                at January 1, 2004
            
            
            2,837,189
            
            $
            0.32-65.00Granted
            
            
            2,675,000
            
            $
            2.60-2.60Exercised
            
            
            --
            
            $
            --Forfeited
            
            
            (276,320
            )
            $
            0.32-65.00Outstanding
                at December 31, 2004
            
            
            5,235,869
            
            $
            0.32-65.00Granted
            
            
            1,417,500
            
            $
            0.85-1.50Exercised
            
            
            (1,975,020
            )
            $
            0.32-0.32Forfeited
            
            
            (441,475
            )
            $
            0.32-2.60Outstanding
                at December 31, 2005
            
            
            4,236,874
            
            $
            0.32-65.00







F-20




**GVI
      SECURITY SOLUTIONS, INC.**




**Notes
      to the Financial Statements**







NOTE
      11 ~
      STOCK OPTIONS




Weighted-average fair value of options
              remaining exercisable at December 31, 2005
            $
                0.01




The
      following table summarizes information about stock options outstanding as of
      December 31, 2005:









Outstanding
                Options
            
            Exercisable
                OptionsExercise
                    Prices
            
            Number
                Outstanding At December 31, 2005
            
            Weighted
                average Remaining Contractual Life
            
            Number
                  Outstanding at December 31, 2005$0.32
            
            
            749,522
            
            
            7.6
                years
            
            
            562,1422.60
            
            
            2,062,500
            
            
            8.1
                years
            
            
            1,150,0001.50
            
            
            837,500
            
            
            9.0
                years
            
            
            279,166.85
            
            
            580,000
            
            
            8.4
                years
            
            
            142,500Over
                $32.00
            
            
            15,737
            
            
            3.7
                years
            
            
            15,7374,245,259
            
            
            
            
            
            2,149,545




Statement
      of Financial Accounting Standards No. 123, "Accounting for Stock-Based
      Compensation" ("SFAS 123"), requires the disclosure of pro forma net income
      and
      earnings per share as if the Company adopted the fair value method for stock
      based awards to directors and employees as of the beginning of the fiscal
      period. Under SFAS 123, the fair value of the stock-based awards is calculated
      through the use of option pricing models, even though such models were developed
      to estimate the fair value of freely tradable, fully transferable


options
      without vesting restrictions, which significantly differ from the Company's
      stock option awards. These models also require subjective assumptions, including
      future stock option price volatility and expected time to exercise, which
      greatly affect the calculated values. The Company's calculations were made
      using
      the Black-Scholes option pricing models with the following weighted average
      assumptions: expected life ranging from 3 to 5 years; 74%, stock volatility,
      risk-free interest rates of approximately 3.5%; and no dividends during the
      expected term. The results would have no material effect on the reported
      earnings per share.





NOTE
      12 -
      Warrants





Summary
      of outstanding warrants at December 31, 2005:





Description
            
            Shares
            
            Approx.
              Remaining
                Term
              (Years)
            
            Exercise
                PriceLaurus
                Master Fund
            
            
            1,340,000
            
            
            5.5
            
            $
            3.50Laurus
                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
            
            $
            1.50Other
            
            
            13,743
            
            
            1.0
            
            $
            7.80
                - $69.55






F-21


**GVI
      SECURITY SOLUTIONS, INC.**




**Notes
      to the Financial Statements**





NOTE
      13 ~
      INVESTMENT IN DIGITAL HORIZONS SOLUTIONS, LLC (formerly Bio-AccessID, LLC)





On
      January 20, 2004, pursuant to a Membership Purchase Agreement by and among
      John
      Carter, Ronald DeBerry, GVI Security Solutions, Inc., and Digital Horizons
      Solutions, LLC (formerly Bio-AccessID, LLC)


("Digital
      Horizons"), the Company purchased a 5% membership interest in Bio-Access for
      $250,000. In December 2005 the Company determined the value of this investment
      had been significantly impaired and wrote down the carrying value to $50,000.
      As
      part of the agreement, the Company had the right to acquire up to an additional
      21% of Bio-Access over a three-year period after certain agreed-upon purchase
      goals have been attained for a purchase price of up to an additional $750,030.
       As a result of the amount of the Company’s purchases from Digital
      Horizons, the Company’s option to acquire additional interest has decreased from 21%
      to
      19%.





NOTE
      14 ~
      RECAPITALIZATION





All
      share
      and per share numbers in this Note give retroactive effect to the 1-for-65
      reverse stock split of the Company’s common stock effected in April
      2004.





On
      February 16, 2004, the Board of Directors and Stockholders of the Company
      authorized new Series D and E Convertible Preferred Stock, each for par value
      of
      $.001 per share. On February 20, 2004, pursuant to an Agreement and Plan of
      Merger (the "Merger Agreement") dated as of February 19, 2004, by and among
      the
      Company (then “Thinking Tools, Inc.”), GVI Security, Inc., and GVI Security
      Acquisition Corp., a newly formed wholly-owned subsidiary of the Company, GVI
      Security, Inc. merged (the “Merger”) with GVI Security Acquisition Corp.,
      becoming the Company's wholly-owned subsidiary, and the stockholders of GVI
      became stockholders of the Company as described below. For accounting purposes,
      because Thinking Tools, Inc. had


become
      a
      shell company, the Merger was treated as a recapitalization of GVI Security,
      Inc.





In
      the
      Merger, the Company issued to the former stockholders of GVI an aggregate of
      1,000,000 shares of the Series E Convertible Preferred Stock ("Series E Stock").
      The shares of Series E Stock were convertible into an aggregate of 28,214,587
      shares of the Company's common stock, constituting approximately 95.3% of the
      outstanding shares of the Company's common stock outstanding following the
      Merger, assuming the conversion of all other outstanding shares of the Company's
      preferred stock. The shares of Series E Stock were


automatically
      converted into shares of the Company's common stock when the Company filed
      the
      Charter Amendment (defined below).





The
      two
      largest stockholders of GVI prior to the Merger were William Teitelbaum, who
      owned approximately 47.8% of GVI's common stock, and GVI Acquisition LLC
      ("Acquisition LLC"), which owned approximately 38.3% of GVI's common stock.
      Acquisition LLC is a California limited liability company, whose sole managers,
      Fred Knoll and David Weiner, were directors of the Company until December 31,
      2004 and January


4,
      2005,
      respectively. The sole members of Acquisition LLC are (i) a corporation which
      is
      wholly-owned by David Weiner, and (ii) Europa International, Inc. (“Europa”) an
      equity fund managed by Knoll Capital Management, L.P., of which Mr. Knoll is
      the
      principal.





In
      addition, pursuant to the Merger Agreement, certain employees and directors
      of
      GVI were issued options to purchase an aggregate of approximately 2,821,452
      shares of the Company's common stock under the 2004 Long-Term Incentive Plan
      in
      exchange for the cancellation of options to purchase shares of GVI's common
      stock held by such persons prior to the Merger. All of these options have an
      exercise price of $.32 per share.





Immediately
      prior to the Merger, and as a condition thereto, Europa exchanged a Convertible
      Demand Grid Note issued by the Company in the principal amount of $1,000,000,
      and all other indebtedness of the Company to Europa for 10,000 shares of the
      Series D Convertible Preferred Stock ("Series D Stock") of the Company, which
      shares were convertible into an aggregate of 1,187,983 shares of common stock.
      The shares of Series D Stock automatically converted into shares of the
      Company's common stock when the Company filed the Charter
      Amendment.






F-22




**GVI
      SECURITY SOLUTIONS, INC.**




**Notes
      to the Financial Statements**





NOTE
      14 ~
      RECAPITALIZATION, continued




Pursuant
      to its obligations under the Merger Agreement,
      following the Merger, the Company obtained the approval
      of its stockholders to (i) amend the Company's certificate of incorporation
      increasing the authorized shares of the Company's common stock to 75,000,000
      and
      effecting a one-for-65 reverse stock split of the common stock so that the
      Company would have sufficient shares of unissued common stock to permit the
      conversion of all of the Series D Stock, Series E Stock and all other
      convertible securities of the Company (the "Charter Amendment"), (ii) the
      adoption of the Stock Option Plan, and (iii) the change of the Company’s name to
      GVI Security Solutions, Inc. The Company filed a Certificate of Amendment to
      its
      Certificate of Incorporation with the Secretary of State of the State of
      Delaware giving effect to these amendments in April 2004, whereupon all
      outstanding shares of Series A Preferred Stock, Series D Preferred Stock and
      Series E Preferred Stock automatically converted into shares of the Company's
      common stock.




In
      addition, pursuant to amendments to the terms of the Series A Preferred Stock
      approved in January 2004, upon the filing of the Charter Amendment the
      outstanding shares of Series A Preferred Stock converted into an aggregate
      of
      44,185 shares of the Company’s common stock.





NOTE
      15 ~
      NEW ACCOUNTING PRONOUNCEMENTS





In
      December 2004, the Financial Accounting Standards Board issued Statement 123
      (revised 2004), *Share
      Based Payment* (Statement 123 (R) ).  This Statement requires that the costs of employee
      share based payments be measured at fair value on the awards’ grant date using
      an option-pricing model and recognized in the financial statements over the
      requisite service period.  This Statement does not change the accounting
      for stock ownership plans, which are subject to American Institute of Certified
      Public Accountants SOP 93-6, “Employer’s Accounting for Employee Stock Ownership
      Plans.”  Statement 123 (R) supersedes Opinion 25, *Accounting
      for Stock Issued to Employees* and its
      related interpretations, and eliminates the alternative to use Opinion 25’s
      intrinsic value method of accounting, which the Company is currently
      using.  Statement 123 (R) allows for two alternative transition
      methods.  The first method is the modified prospective application whereby
      compensation cost for the portion of awards for which the requisite service
      has
      not yet been rendered that are outstanding as of the adoption date will be
      recognized over the remaining service period.  The compensation cost for
      that portion of awards will be based on the grant-date fair value of those
      awards as calculated for pro forma disclosures under Statement 123, as
      originally issued.  All new awards and awards that are modified,
      repurchased, or cancelled after the adoption date will be accounted for under
      the provisions of Statement 123 (R).  The second method is the modified
      retrospective application, which requires that the Company restates prior period
      financial statements.  The modified retrospective application may be
      applied either to all prior periods or only to prior interim periods in the
      year
      of adoption of this statement.  The Company has determined that it will
      adopt the modified prospective application whereby compensation cost for the
      portion of awards for which the requisite service has not yet been rendered
      that
      are outstanding as of the adoption date will be recognized over the remaining
      service period.  The compensation cost for that portion of awards will be
      based on the grant-date fair value of those awards as calculated for pro forma
      disclosures under Statement 123, as originally issued.  All new awards and
      awards that are modified, repurchased, or cancelled after the adoption date
      will
      be accounted for under the provisions of Statement 123 (R).





F-23