UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


WASHINGTON, D.C.20549








FORM
10-K


ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(d)


OF
THE SECURITIES EXCHANGE ACT OF 1934


FOR
THE FISCAL YEAR ENDED DECEMBER 31, 2008


COMMISSION
FILE NUMBER 000-21295








GVI
Security Solutions, Inc.


(Exact
name of registrant as specified in its charter)





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





2801 Trade Center Drive, Suite 120 Carrollton,
      Texas
              
              75007(Address
      of  principal executive offices)
              
              (Zip
      Code)





Registrant’s telephone number,
including area code (972)
245-7353





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





Indicate
by check mark if the registrant is a well-know seasoned issuer as defined in
Rule 405 of the Securities Act.


 ̈
Yes  þ
No




Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or 15 (d) of the Act.


 ̈
Yes  þ
No





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


þ Yes   ̈
No




Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not 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-K or any amendment to this
Form 10-K.    ̈




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




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




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


 ̈
Yes  þ
No




The
aggregate market value of the voting and non-voting common equity held by
non-affiliates of the registrant as of June 30, 2008 was approximately
$3,160,379.




The
number of shares outstanding of the registrant’s Common Stock as of March 12,
2009 was 28,197,106.





GVI SECURITY SOLUTIONS,
INC.


2008
FORM 10-K ANNUAL REPORT


TABLE
OF CONTENTS




PagePART
      I
                        
                        2Item
      1.  Business
                        2Item
      1A.  Risk Factors
                        6Item
      1B. Unresolved Staff Comments
                        11Item
      2. Properties
                        11Item
      3. Legal Proceedings
                        11Item
      4. Submission of Matters to a Vote of Security Holders
                        11PART
      IIItem
      5. Market for Registrant’s Common Equity, Related Stockholder Matters and
      IssuerPurchases of Equity Securities.
                        11Item
      7. Management's Discussion and Analysis of Financial Conditions and
      Results of Operations
                        12Item
      8. Financial Statements and Supplementary Data.
                        18Item
      9. Changes in and Disagreements With Accountants on Accounting and
      Financial Disclosure.
                        18Item
      9A(T).  Controls and Procedures.
                        18Item
      9B.  Other Information.
                        19PART
      IIIItem
      10 Directors, Executive Officers and Corporate Governance.
                        19Item
      11. Executive Compensation.
                        21Item
      12. Security Ownership of Certain Beneficial Owners and Management and
      Related Stockholder Matters.
                        25Item
      13. Certain Relationships and Related Transactions, and Director
      Independence.
                        27Item
      14. Principal Accountant Fees and Services.
                        27PART
      IVItem
      15. Exhibits, Financial Statement Schedules.
                        28


1


CAUTIONARY
NOTE REGARDING FORWARD-LOOKING STATEMENTS




This
annual report on Form 10-K 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.




Overview




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




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




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




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




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




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.


2


On
October 6, 2006, we completed a $5 million private placement, consisting of 100
Units at a price of $50,000 per unit. Each Unit consisted of 1,250,000 shares of
Common Stock and a 6% Subordinated Secured Convertible Promissory Note in the
principal amount of $45,000, convertible into 11,250,000 shares of Common Stock
at a conversion price equal to $.004. On November 27, 2006, we effected a
50-for-1 reverse stock split of the Common Stock, and all of the Convertible
Notes (including approximately $40,460 of accrued interest) were converted to
Common Stock. After giving effect to the reverse split and the conversion, we
had outstanding 26,392,834 shares of Common Stock, of which 25,202,314 were
issued to the purchasers of the Units (2,500,000 on the closing of the October
2006 private placement and 22,702,314 upon conversion of the Convertible Notes
in November 2006).





On
January 22, 2007, the Company completed a private placement of 1,713,334 shares
of Common Stock at a price of $0.60 per share for aggregate gross consideration
of $1,028,000. The proceeds from the January private placement were used for
working capital and general corporate purposes.




Security
Systems Markets




According to a recent industry report,
the video surveillance market in the Americas totaled approximately $2.7 billion
in 2007, and is estimated to grow to approximately $4.3 billion by the year
2012.According to
this report, the Americas’ security market is expected to continue to grow at an
average annual rate of approximately 10%. We believe that video surveillance
products represent the largest components of a typical integrated security
system. The industry continues to see 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.





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




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




Products
and Services




We are
committed to setting new standards in quality, performance and value by
providing highly functional and competitive 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. We serve the
import, support, marketing, inventory, warranty and distribution needs of our
customers.


3




Products




Our
objective is to provide complete security solutions for our customers by
providing a suite of fully-integrated products. We sell the following products
separately and as part of our fully integrated suite of video surveillance and
integrated security solutions:




·
              a
      full line of video surveillance cameras, which include features like
      motion detection, low light day/night compatibility and high resolution,
      all with systems integration
capabilities




·
              a
      range of vandal proof, water and weather resistant cameras and
      environmental housings




·
              high
      speed PTZ dome cameras




·
              a
      complete range of lenses




·
              a
      full range of LCD, flat screen and CRT
monitors




·
              VCR’s
      and digital video recorders
(DVR’s)




·
              ATM
      and retail POS (point of service) transaction verification
      software




·
              video
      transmission equipment




·
              digital
      processors (quads and multiplexers),
switchers




·
              video
      management systems and recording
software





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 GVITM  label. When assembly of our products is required, it is
done in our Dallas, Texas facility.




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, 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 utilize our products to develop and install a
fully integrated security suite for end users. We also utilize regional sales
executives and independent sales representatives to sell our products to our
customers.





Competition




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, and
others that provide competitive systems or individual elements of a
system.


4





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 product availability, quality, product performance, ease of integration and
customer service, price, and support. There are a number of manufacturers and
distributors of video security products. We believe that we have distinguished
ourselves in this market by providing customers with superior levels of customer
service. Our main competitors are Pelco, Sony, Panasonic, GE, Bosch, and Speco
Technologies, among many others.





In
addition, Samsung Techwin, a company separate from Samsung Electronics but
related through common ownership, manufactures electronic security products that
are competitive with the Samsung Electronics products we sell. Samsung Techwin
distributes its products in the Americas and is competing with us in the systems
integration channel on a limited basis.




Strategic
Vendor Relationship




Historically,
Samsung Electronics has been our primary supplier for the security products that
we distribute. For the years ended December 31, 2008, 2007 and 2006, 73%, 65%
and 67%, respectively, of our revenues (excluding revenues from discontinued
operations), were attributable to products manufactured by Samsung.





Under our
prior agreement with Samsung, we had the exclusive right to sell Samsung
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 previous agreement
with us in January 2006. Samsung was entitled to terminate that agreement
because we did not purchase the minimum amounts required to be purchased
thereunder during the 2005 calendar year. Following the termination of our prior
agreement with Samsung, our Board of Directors approved the discontinuation of
sales to the Retail Channel.




On
October 2, 2006, we entered into a new Distributorship Agreement with Samsung
under which we have the right to distribute Samsung’s complete line of
professional video surveillance and security products in the “Territory”
comprising North, Central and South America through December 31, 2010. Pursuant
to the Distributorship Agreement, Samsung has agreed to a limited non-compete in
the Territory.  In November 2008, the Distribution Agreement was
amended to lower the minimum amounts we are required to purchase from
Samsung.  As amended, the Distributorship Agreement provides for
minimum annual purchase amounts of $25 million, $32.4 million and $42 million
for the years ending December 31, 2008, 2009 and 2010, respectively. Samsung may
terminate the Distributorship Agreement at any time if we do not purchase those
annual amounts, as well as upon a breach of our other obligations thereunder.
For the year ended December 31, 2008, we purchased approximately $26.0 million
under the Distributorship Agreement with Samsung, meeting our minimum purchase
obligations for that year.




We are
also a party to distribution arrangements with other high technology
manufacturers who supply us with other products that complement the Samsung
offering of video security products.




Intellectual
Property




We have
several registered trademarks for “GVI” in connection with the products we
sell.




Employees





As of
December 31, 2008, we had approximately 66 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.


5





Item
1A.  Risk Factors.




RISKS
RELATED TO OUR INDUSTRY AND OUR BUSINESS





A
SUBSTANTIAL PORTION OF OUR BUSINESS IS ATTRIBUTABLE TO A SINGLE
SUPPLIER.





Historically,
Samsung Electronics has been our primary supplier for the security products that
we distribute. For the years ended December 31, 2008, 2007 and 2006, 73%, 65%
and 67%, 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. Under our
Distributorship Agreement with Samsung, we have the right to distribute
Samsung’s complete line of professional video surveillance and security products
in the “territory” comprising North, Central and South America through December
31, 2010, and  Samsung has agreed to a limited non-compete in that
territory. Although we consider our relationship with Samsung to be good, in the
event we fail to purchase the minimum amount of products required under the
Distribution Agreement or breach any other provision of the agreement, Samsung
can terminate its agreement with us and sell products to our competitors.
Further, if Samsung fails to perform its obligations under the Distribution
Agreement or we are unable to renew our agreement with Samsung, our business,
financial condition and results of operations will be materially adversely
affected.For the
year ended December 31, 2008, we were able to meet the minimum amount purchase
requirement only after that amount was reduced by an amendment to the
Distribution Agreement.





A
SUBSTANTIAL PORTION OF OUR BUSINESS IS ATTRIBUTABLE TO TWO KEY
CUSTOMERS.





During
the year ended December 31, 2008, two customers accounted for 20% and 11%
respectively of our sales.  During the year ended December 31, 2007,
these same two customers accounted for 20% and 18% respectively of our
sales.  As a result, our revenues and results of operations could be
materially and adversely affected if any of these clients reduce their purchases
of our products.




CHANGES
IN THE GENERAL ECONOMY, INCLUDING THE GLOBAL FINANCIAL CRISIS THAT ACCELERATED
IN 2008, MAY NEGATIVELY IMPACT OUR BUSINESS.





We sell
our security products to companies and industries that may experience financial
difficulty, particularly in light of conditions in the credit markets and the
overall economy. If our customers experience financial difficulty, we could have
difficulty recovering amounts owed to us from these customers, and demand for
our products from these customers could decline. If our suppliers experience
financial difficulty, we could have difficulty fulfilling our customers’ orders.
Furthermore, continued issues involving liquidity and capital adequacy affecting
lenders could affect our ability to fully access our credit facility or obtain
additional credit. These conditions could adversely affect our financial
position and results of operations.





SAMSUNG
SUBJECTS US TO CREDIT LIMITS, WHICH CAN LIMIT OUR ABILITY TO PURCHASE THEIR
PRODUCTS AND SELL THOSE PRODUCTS TO OUR CUSTOMERS.





Samsung
sets credit limits from time to time with respect to amounts owed by us to
Samsung for products we purchase from them. To the extent the amount we owe
Samsung at a given time exceeds these limits, Samsung will not ship to us
additional products unless we pay for those products in cash or provide Samsung
with a letter of credit. If we exceed Samsung’s credit limits and have
insufficient cash to purchase products from Samsung, we may be unable to meet
the demands of our customers and our business and relationships with our
customers may be materially adversely affected. At December 31, 2008, we
owed Samsung approximately $7.0 million and our credit limit with Samsung was $9
million.





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.


6





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.




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.





Samsung’s
ability to provide security products needed for our market is critical to our
success.   We also have relationships with a number of other
manufacturers for the supply of our GVI branded 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.


7


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 our senior management
team, consisting of Steven Walin, our Chief Executive Officer, and Joseph
Restivo, our Chief Financial Officer and Chief Operating Officer. Mr. Walin and
Mr. Restivo are each a party to an employment agreement with us that expires in
December 2011. 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
HAVE SUBSTANTIAL INDEBTEDNESS TO WELLS FARGO SECURED BY SUBSTANTIALLY ALL OF OUR
ASSETS. IF AN EVENT OF DEFAULT OCCURS UNDER OUR CREDIT AGREEMENT WITH WELLS
FARGO, WELLS FARGO MAY FORECLOSE ON OUR ASSETS.





On
November 20, 2007, we entered into a Credit and Security Agreement with Wells
Fargo Bank, National Association under which we were provided with a $15 million
revolving credit facility. On November 21, 2007, we borrowed approximately $10.3
million under the credit facility, using approximately $8.6 million of the
proceeds to repay in full all of our outstanding indebtedness to our prior
secured lender. The Credit and Security Agreement with Wells Fargo provides for
the following events of default (among others):





·
            failure
      to pay interest and principal when
due;




·
            an
      uncured breach by us of any covenant (including financial covenants), term
      or condition in the Credit and Security Agreement or any of the related
      loan documents;




·
            a
      breach by us, in any material respect, of any representation or warranty
      made in the Credit and Security Agreement or any of the related loan
      documents;




·
            any
      money judgment or similar final process is filed against us for more than
      $50,000;




·
            the
      occurrence of a “Change in Control” as defined in the Credit and Security
      Agreement;




·
            the
      occurrence of a material adverse change in our business or financial
      condition; and




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




8


Upon the
occurrence of an event of default under our agreements with Wells Fargo, Wells
Fargo 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.





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.





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.




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. 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.




9




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.




WE
FACE LABOR, POLITICAL AND CURRENCY RISKS BECAUSE SAMSUNG ELECTRONICS' FACTORIES
ARE LOCATED IN KOREA AND CHINA, 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 Stock
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.


10





SUBSTANTIALLY
ALL OF OUR SHARES OF COMMON STOCK ARE OWNED BY THE INVESTORS IN OUR OCTOBER 2006
PRIVATE PLACEMENT, WHICH LIMITS THE ABILITY OF OUR OTHER STOCKHOLDERS TO
INFLUENCE CORPORATE MATTERS.




The
investors in our October 2006 private placement currently beneficially own
approximately 90% of our outstanding shares of Common Stock. Accordingly, these
stockholders can decide 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
1B.  Unresolved Staff Comments.




Not
Applicable




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.  We expect to enter in an extension of our current
lease or relocate our offices and warehouse to another location in the
Carrollton, Texas area if we are unable to renew our current lease prior to its
expiration.  Our existing properties are in good condition and
suitable for the conduct of our business.




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
2008.




PART
II




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




Our
Common Stock trades in the over-the-counter-market under the symbol “GVSS” and
is 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.  The quotations listed below reflect
inter-dealer prices, without retail mark-ups, mark-downs or commissions and may
not necessarily represent actual transactions.





PriceHigh
                          
                          
                          Low2007First
      quarter
                          
                          $
                          1.17
                          
                          
                          $
                          0.90Second
      quarter
                          
                          $
                          1.01
                          
                          
                          $
                          0.80Third
      quarter
                          
                          $
                          0.83
                          
                          
                          $
                          0.66Fourth
      quarter
                          
                          $
                          1.01
                          
                          
                          $
                          0.562008First
      quarter
                          
                          $
                          1.00
                          
                          
                          $
                          0.77Second
      quarter
                          
                          $
                          0.82
                          
                          
                          $
                          0.51Third
      quarter
                          
                          $
                          0.64
                          
                          
                          $
                          0.38Fourth
      quarter
                          
                          $
                          0.47
                          
                          
                          $
                          0.22




11





The
number of holders of record for our Common Stock as of December 31, 2008 was
approximately 138.  This number excludes individual stockholders
holding stock under nominee security position listings.





Dividends





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.  Nonetheless, the holders of our Common Stock are entitled to
dividends when and if declared by our board of directors from legally available
funds.





Equity
Compensation Plan Information




Plan Category
                        
                        Number of securities to be
                          issued upon exercise of
                          outstanding options, warrants
                          and rights
                        
                        
                        Weighted-average exercise
                          price of outstanding options,
                          warrants and rights
                        
                        
                        Number of securities remaining
                          available for future issuance under
                          equity compensation plans
                          (excluding securities reflected in
                          column (a))(a)
                        
                        
                        (b)
                        
                        
                        (c)Equity compensation plans approved by security
      holders
                        
                        
                        5,900,000
                        
                        
                        $
                        1.06
                        
                        
                        
                        0Equity compensation plans not approved by security
      holders
                        
                        
                        2,717,218
                        (1)
                        
                        
                        0.41
                        
                        
                        
                        857,782
                        (2)Total
                        
                        
                        8,617,218
                        
                        
                        
                        0.86
                        
                        
                        
                        857,782




(1)
            Consists
      of warrants to purchase 2,575,000 shares of common stock issued to
      consultants with a weighted average price of $0.41, the details of which
      are provided in Note 13 of our Financial Statements, and options to
      purchase 142,218 shares of common stock issued outside of our 2004
      Long-Term Stock Plan.  Does not include warrants to purchase
      134,592 shares with exercise prices equal to $30.00 or
    more.




(2)
            Consists
      of shares authorized for issuance under our 2008 Long-Term Stock Plan.




Item
7.  Management’s Discussion and Analysis of Financial Condition and
Results of Operations.




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.





Summary
of Our Business





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




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


12




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




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




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




Our
Products




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




Strategies




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




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




Distribution
and Marketing




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




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.


13


Revenue
Recognition





Our
primary source of revenue is from sales of our products.  We recognize
revenue when the sales process is deemed complete and associated revenue 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 on prior
sales.  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 which are
primarily based on actual historical return rates.  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 2008 and 2007 we experienced losses, or recorded provisions for
potential losses, from customers' inability to make payments, totaling
approximately $25,000 and $163,000, which were equal to 0.05% and 0.4% of
revenues, respectively.  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.





Inventory





Inventory
is stated at the lower of cost (first-in, first-out method) or market and
consists of goods held for resale and parts used for repair work. Reserves are
recorded for slow-moving, obsolete, nonsaleable or unusable items based upon a
product-level review, in order to reflect inventory balances at their net
realizable value. Inventory reserve balances at December 31, 2008 and 2007 were
approximately $2,251,000 and $2,558,000, respectively.





Income
Taxes





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





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


14




Stock-Based
Compensation





We
periodically issue stock options and warrants to employees and non-employees in
non-capital raising transactions for services and for financing costs. We
adopted Statement of Financial Accounting Standards (SFAS) No. 123R effective
January 1, 2006, and is using the modified prospective method in which
compensation cost is recognized beginning with the effective date (a) based on
the requirements of SFAS No. 123R for all share-based payments granted after the
effective date and (b) based on the requirements of SFAS No. 123R for all awards
granted to employees prior to the effective date of SFAS No. 123R that remained
unvested on the effective date. We account for stock option and warrant grants
issued and vesting to non-employees in accordance with EITF No. 96-18:
"Accounting for Equity Instruments that are Issued to Other Than Employees for
Acquiring, or in Conjunction with Selling, Goods or Services” and EITF 00-18
“Accounting Recognition for Certain Transactions involving Equity Instruments
Granted to Other Than Employees” under which the value of the stock compensation
is based upon the measurement date as determined at either a) the date at which
a performance commitment is reached, or b) at the date at which the necessary
performance to earn the equity instruments is complete.





Recent
Accounting Pronouncements





In March
2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments
and Hedging Activities, an amendment of FASB Statement No. 133” (SFAS 161). This
Statement requires enhanced disclosures about an entity’s derivative and hedging
activities, including (a) how and why an entity uses derivative instruments, (b)
how derivative instruments and related hedged items are accounted for under SFAS
No. 133,  “Accounting for Derivative Instruments and Hedging
Activities” (SFAS 133), and its related interpretations, and (c) how derivative
instruments and related hedged items affect an entity’s financial position,
financial performance, and cash flows. SFAS 161 is effective for financial
statements issued for fiscal years and interim periods beginning after November
15, 2008.





In
December 2007, the FASB issued FASB Statement No. 141 (R), “Business
Combinations” (FAS 141(R)), which establishes accounting principles and
disclosure requirements for all transactions in which a company obtains control
over another business.  Statement 141 (R) applies prospectively to
business combinations for which the acquisition date is on or after the
beginning of the first annual reporting period beginning on or after December
15, 2008.  Earlier adoption is prohibited.





In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statements, an amendment of ARB No. 51”.  SFAS
No. 160 establishes accounting and reporting standards that require that the
ownership interests in subsidiaries held by parties other than the parent be
clearly identified, labeled, and presented in the consolidated statement of
financial position within equity, but separate from the parent’s equity; the
amount of consolidated net income attributable to the parent and to the
noncontrolling interest be clearly identified and presented on the face of the
consolidated statement of income; and changes in a parent’s ownership interest
while the parent retains its controlling financial interest in its subsidiary be
accounted for consistently.  SFAS No. 160 also requires that any
retained noncontrolling equity investment in the former subsidiary be initially
measured at fair value when a subsidiary is deconsolidated.  SFAS No.
160 also sets forth the disclosure requirements to identify and distinguish
between the interests of the parent and the interests of the noncontrolling
owners.  SFAS No. 160 applies to all entities that prepare
consolidated financial statements, except not-for-profit organizations, but will
affect only those entities that have an outstanding noncontrolling interest in
one or more subsidiaries or that deconsolidate a subsidiary.  SFAS No.
160 is effective for fiscal years, and interim periods within those fiscal
years, beginning on or after December 15, 2008.  Earlier adoption is
prohibited.  SFAS No. 160 must be applied prospectively as of the
beginning of the fiscal year in which it is initially applied, except for the
presentation and disclosure requirements.  The presentation and
disclosure requirements are applied retrospectively for all periods
presented.


15





RESULTS
OF OPERATIONS





Fiscal
Year Ended December 31, 2008 Compared To Fiscal Year Ended December 31,
2007





Net
Revenues From Continuing Operations





Net
revenues increased approximately $2.3 million, or 5% to approximately $47.3
million during the year ended December 31, 2008 from approximately $45.0 million
during the year ended December 31, 2007.   The increase in
revenues reflects increased sales to distributors, integrators and installers of
a variety of products manufactured by Samsung Electronics as well as other
manufacturers, as we continued to introduce new products to complement our
existing lines.




Cost
Of Goods Sold




Totalcost of goods sold
increased approximately $900,000, or 3% to approximately $33.1 million for the
year ended December 31, 2008, from approximately $32.2 million during the year
ended December 31, 2007. This increase was due to higher sales partially offset
by improved product margins and lower net freight costs.





As a
result of the changes described above in revenues and cost of goods sold, gross
profit for the year ended December 31, 2008 increased to approximately $14.2
million from approximately $12.8 million for the year ended December 31, 2007,
and gross profit as a percentage of revenues increased to 30.0% for the year
ended December 31, 2008 compared with 28.4% for the year ended December 31,
2007.





Selling,
General and Administrative Expenses




Selling,
general, and administrative expenses increased 12% to approximately $11.5
million for the year ended December 31, 2008 from approximately $10.3 million
for the year ended December 31, 2007, as follows:




Sales and Marketing.Sales and
marketing expenses increased approximately 22% to approximately $6.6 million for
the year ended December 31, 2008 from approximately $5.4 million for the year
ended December 31, 2007. The increase was primarily due to (i) an increase
in personnel expense of approximately $504,000, (ii) an increase of
approximately $204,000 in commission expense resulting from increased sales, and
an (iii) increase of approximately $299,000 in international office expenses
associated with increased personnel expenses.




General and Administrative.General and administrative expenses held flat at approximately $4.9
million for both the years ended December 31, 2008 and December 31, 2007.




Interest
Expense




Interest
expense for the year ended December 31, 2008 decreased 32% to approximately
$686,000, from approximately $1.0 million in the year ended December 31, 2007.
This decrease is primarily a result of a reduction in amortized loan fees during
the year ended December 31, 2008 of approximately $180,000, compared with the
year ended December 31, 2007.  The remaining decrease was attributable
to the lower interest rate on the Wells Fargo credit facility in effect for the
year ended December 31, 2008 compared with the interest rate on the Laurus
facility in effect for the majority of the year ended December 31,
2007.  The decrease was partially offset by higher average loan
balances outstanding during the year ended December 31, 2008 compared with the
year ended December 31, 2007.





Income
Tax Expense (Benefit)




We
recorded a current expense for federal, state and local income tax of
approximately $28,000 for the year ended December 31, 2008.  In addition,
we recorded a deferred tax expense of approximately $678,000 related
to the utilization of prior year net operating losses during the year ending
December 31, 2008.  This produced a net income tax expense of
approximately $706,000 for the year ended December 31, 2008, as compared to a
benefit of approximately $941,000 for the comparable period ended December 31,
2007, which resulted from the recognition of prior operating loss
carryovers.


16





Discontinued
Operations




We
recorded no gain or loss from discontinued operations in the year ended December
31, 2008 compared to a gain from discontinued operations, net of tax, of
$233,000 for the year ended December 31, 2007.  The gain for the year
ended December 31, 2007 reflects the offset of a reserve we had taken in
connection with our obligations to service our retail product line, which we
discontinued in 2006.  The obligations related to the discontinued
operations terminated during the year ended December 31, 2007.




Net
Income (Loss)




As a
result of the items discussed above there was net income of approximately $1.3
million for the year ended December 31, 2008 compared with net income of
approximately $2.6 million for the year ended December 31, 2007.




Liquidity
and Capital Resources




At
December 31, 2008, we had cash and equivalents of approximately $46,000, working
capital of approximately $14.2 million, stockholders’ equity of $4.0 million,
and an outstanding balance of $9.9 million under our revolving credit facility
with Wells Fargo. In comparison, at December 31, 2007, we had cash and
equivalents of approximately $313,000, working capital of approximately $11.5
million, and an outstanding balance of $10.3 million under our revolving credit
facility with Wells Fargo. Additionally, we had borrowing availability of
approximately $4.7 million at December 31, 2008 under our credit facility with
Wells Fargo, as compared with $1.9 million of borrowing availability at December
31, 2007.




Cash
decreased from $313,000 at December 31, 2007 to $46,000 at December 31, 2008,
primarily as a result of (i) an increase in inventory of approximately $2.5
million, (ii) an increase in accounts receivable of approximately $434,000,
(iii) an investment in equipment of approximately $145,000, and
(iv)  net repayments on the Wells Fargo credit facility of
approximately $482,000. These factors were partially offset by (i) net income of
$1.3 million, (ii) an increase in accounts payable of approximately $694,000,
and (iii) an decrease in deferred tax assets of approximately
$677,000.




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




$15
Million Wells Fargo Revolving Credit Facility




On
November 20, 2007, through our wholly-owned subsidiary GVI Security, Inc., we
entered into a Credit and Security Agreement with Wells Fargo Bank, National
Association under which we were provided with a $15 million revolving credit
facility. On November 21, 2007, we borrowed approximately $10.3 million under
the credit facility, using approximately $8.6 million of the proceeds to repay
in full all of our outstanding indebtedness to Laurus Master Fund. In addition,
we used $1.7 million of the initial loan proceeds to increase our working
capital. Borrowings under the credit facility are secured by all of our assets.
Upon closing, we paid Wells Fargo an origination fee of $37,500. We also pay
Wells Fargo an annual fee equal to .25% of the average daily unused portion of
the Facility. Outstanding loans under the credit facility will become due on
November 20, 2010.




Pursuant
to the Credit Agreement, among other things:




·
            Subject
      to downward adjustment as provided below, interest accrues on outstanding
      loans under the credit facility, at our option, at a per annum rate equal
      to the prime rate from time to time in effect (3.25% at January 19, 2009)
      plus .75% percent, or a LIBOR rate selected by us, plus
    3.25%.





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




17





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





·
            We
      are required to comply with a number of affirmative, negative and
      financial covenants. Among other things, these covenants restrict our
      ability to pay dividends, require us to achieve minimum quarterly Net
      Income as set forth in the Credit Agreement, and require us to maintain a
      minimum Debt Service Coverage Ratio (as defined in the Credit Agreement)
      as of the last day of each quarter of not less than 1.25 to
      1.0.  As of December 31, 2008, we were in compliance with the
      loan covenants.





In
addition, as a result of our achievement of Net Income (as defined in the Credit
Agreement), in excess of $1 million for the year ending December 31, 2008,
interest rate under the credit facility will be reduced by .50% per annum
commencing within 30 days of Wells Fargo’s receipt of our financial statements
for the year ended December 31, 2008.





Contractual Obligations and
Commitments





A summary
of our contractual obligations as of December 31, 2008 is as
follows:





Payments Due by Period (in
      thousands)2009
                  
                  
                  2010
                  
                  
                  2011
                  
                  
                  2012
                  
                  
                  ThereafterLong-Term
      Debt Obligations
                  
                  $
                  0
                  
                  
                  $
                  0
                  
                  
                  $
                  9,862
                  
                  
                  $
                  0
                  
                  
                  $
                  0Capital
      Lease Obligations
                  
                  
                  12
                  
                  
                  
                  0
                  
                  
                  
                  0
                  
                  
                  
                  0
                  
                  
                  
                  0Operating
      Lease Obligations
                  
                  
                  308
                  
                  
                  
                  46
                  
                  
                  
                  0
                  
                  
                  
                  0
                  
                  
                  
                  0Samsung
      Purchase Commitment
                  
                  
                  32,400
                  
                  
                  
                  42,000
                  
                  
                  
                  0
                  
                  
                  
                  0
                  
                  
                  
                  -Total
                  
                  $
                  32,720
                  
                  
                  $
                  42,046
                  
                  
                  $
                  9,862
                  
                  
                  $
                  0
                  
                  
                  $
                  0




Off-Balance
Sheet Arrangements




We
do not have any off-balance sheet transactions, arrangements or obligations
(including contingent obligations) that would have a material effect on our
financial results.




Item
8.  Financial Statements and Supplementary Data.




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-K.




Item
9.    Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure.




Not
Applicable.




Item
9A(T).  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.


18




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 errors 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.




In 2008,
management conducted tests of our internal controls over financial reporting in
accordance with the standards set forth by the Public Company Accounting
Oversight Board (“PCAOB”). In accordance with these standards, management
assessed and tested, on a sample basis, the Company’s internal control over
financial reporting according to a comprehensive risk analysis using the
Internal Control — Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (“COSO”). It is management’s opinion
that the testing methodology of the internal control framework is appropriate
and provides reasonable assurance as to the integrity and reliability of our
internal controls over financial reporting.




In
management’s opinion, based on the assessment completed as at December 31,
2008, our internal control over financial reporting is operating
effectively.




This
annual report does not include an attestation report of our registered public
accounting firm regarding internal control over financial reporting.
Management’s report was not subject to attestation by our registered public
accounting firm pursuant to temporary rules of the Securities and Exchange
Commission that permit us to provide only management’s report in this annual
report.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
9B.  Other Information.




Not
Applicable.




PART
III




Item
10.  Directors, Executive Officers and Corporate Governance of the
Registrant.




The
following table sets forth our directors and executive officers, their ages and
the positions they hold:




Name
                        
                        Age
                        
                        PositionSteven
      E. Walin
                        
                        53
                        
                        Chairman
      of the Board of Directors and Chief Executive OfficerJoseph
      Restivo
                        
                        55
                        
                        Chief
      Financial Officer, Chief Operating Officer, and
DirectorCraig
      Ellins 1,2,3
                        
                        56
                        
                        DirectorGary
      Freeman  1,2,3
                        
                        41
                        
                        DirectorMoshe
      Zarmi  1,2,3
                        
                        71
                        
                        Director


1Member
of the Audit Committee


2Member
of the Compensation Committee


3Member
of the Governance Committee


19


STEVEN
WALIN has been our Chief Executive Officer since March 6, 2006, and has served
as a director of ours since March 28, 2006.  Mr. Walin was named
Chairman of the Board on January 8, 2008.   Mr. Walin has over 20
years of experience in the security industry.  Most recently, from
April 2003 until his appointment as our Chief Executive Officer, Mr. Walin
served as the President of GE Security Enterprise Solutions, a division of
General Electric Company that provides security solutions, including video
monitoring, intrusion and access control systems.   Prior to his
employment with GE, from July 2001, Mr. Walin served as the Senior Vice
President – North America Security for the Security Systems Division of Siemens
Building Technologies.  Prior to that, Mr. Walin had been the
President and Chief Operating Officer of Securities Technology Group, Inc. until
it was acquired by Siemens in July 2001.  Mr. Walin is currently a
director of Trestle Holdings, Inc.




JOSEPH
RESTIVO has been our Chief Financial Officer since March 2006 and a director
since October 4, 2006.  Mr. Restivo was named Chief Operating Officer
on October 22, 2007.  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 with Casi-Rusco (subsequently acquired by General
Electric), a developer and manufacturer of large-scale access control systems,
including Chief Financial Officer and Chief Operating Officer.




GARY
FREEMAN has served as one of our directors since October 4, 2006.  Mr.
Freeman is currently a Partner in Bandari, Beach, Lim & Cleland’s Audit and
Accounting services division.  In conjunction with various consulting
engagements, Mr. Freeman has assumed interim senior level management roles at
numerous public and private companies during his career, including Co-President
and Chief Financial Officer of Trestle Holdings Inc., Chief Financial Officer of
Silvergraph International and Chief Financial Officer of Galorath
Incorporated.  Mr. Freeman’s previous experience includes ten years
with BDO Seidman, LLP, including two years as an Audit Partner.




CRAIG
ELLINS has served as one of our directors since October 4, 2006.  Mr.
Ellins is the founder, Chairman and Chief Executive Officer of DigitalFX
International, Inc. a digital communication company. Mr. Ellins has more than 20
years of experience in television direct marketing and Internet communications
and has provided strategic planning services to companies such as K-tel
International, Fingerhut Corporation, Guthy-Renker, Simitar Entertainment, and
Stamina Products.




MOSHE
ZARMI has served as one of our directors since October 4, 2006, and previously
served as one of our directors from January 1998 until June 27,
2006.  Mr. Zarmi was also our President and Chief Executive Officer
from January 1998 until February 2004.  Mr. Zarmi has 30 years
experience, primarily in high technology industries.  From February
1993 to January 1997, Mr. Zarmi was the Chief Executive Officer of Geotest, a
leading Automated Test Equipment company based in Southern
California.  His extensive business experience includes a tenure at
Israel Aircraft Industries, where he held various positions in finance and
administration, as well as head of US marketing and sales.




Audit
Committee Financial Expert




The Board
of Directors has determined that Gary Freeman is an “audit committee financial
expert,” as such term is defined in Item 401(h) of Regulation S-K, and is
independent as defined in rule 4200(a)(15) of the listing standards of the
National Association of Securities Dealers.




Section
16(a) Beneficial Ownership Reporting Compliance




The
members of our Board of Directors, our executive officers and persons who hold
more than 10% of our outstanding Common Stock are subject to the reporting
requirements of Section 16(a) of the Exchange Act, which requires them to file
reports with respect to their ownership of our Common Stock and their
transactions in such Common Stock.  Based solely upon a review of
Forms 3 and 4 and amendments furnished to the Company by such persons subject to
the reporting requirements of Section 16(a) of the Exchange Act, we believe that
all reporting requirements under Section 16(a) for the 2008 fiscal year were met
in a timely manner by our directors, executive officers and beneficial owners of
more than 10% of our Common Stock.


20




Code
of Conduct




The
Company maintains a Code of Business Conduct and Ethics that is applicable to
all of our employees, including our Chief Executive Officer and Chief Financial
Officer, and our directors.  The Code of Conduct, which satisfies the
requirements of a “code of ethics” under applicable SEC rules, contains written
standards that are designed to deter wrongdoing and to promote honest and
ethical conduct, including the ethical handling of actual or apparent conflicts
of interest; full, fair, accurate, timely and understandable public disclosures
and communications, including financial reporting; compliance with applicable
laws, rules and regulations; prompt internal reporting of violations of the
code; and accountability for adherence to the code.




Item
11. Executive
Compensation




Summary
Compensation Table





The following table shows for the
fiscal years ended December 31, 2008 and 2007, compensation awarded to or paid
to, or earned by, Steven Walin, our Chief Executive Officer; and Joseph Restivo,
our Chief Financial Officer and Chief Operating Officer (the “Named Executive
Officers”).




Summary
Compensation Table




Name
      and Principal
                  Position
                
                Year
                
                Salary
                  ($)
                
                
                Bonus
                  ($)
                
                
                Option
                  Awards
                  ($)
                
                
                All
      Other
                  Compensation
                  ($)
                
                
                Total
      ($)Steven
      Walin
                
                2008
                
                $
                375,000
                
                
                $
                159,375
                
                
                
                —
                
                
                $
                18,000
                (2)
                
                $
                580,500Chief
      Executive Officer
                
                2007
                
                $
                375,000
                
                
                $
                187,500
                
                
                
                —
                
                
                $
                18,000
                (2)
                
                $
                580,500Joseph
      Restivo,
                
                2008
                
                $
                250,000
                
                
                $
                125,000
                
                
                
                —
                
                
                $
                12,000
                (2)
                
                $
                387,000Chief
      Operating Officer and Chief Financial Officer
                
                2007
                
                $
                212,500
                (1)
                
                $
                106,250
                
                
                
                —
                
                
                $
                133,317
                (2)
                
                $
                452,067




(1)
            Annual
      base salary was increased from $200,000 to $250,000 effective October 1,
      2007.




(2)
            Includes
      a car allowance of $1,500 per month for Mr. Walin and $1,000 per month for
      Mr. Restivo.  Mr Restivo’s 2007 all other compensation also
      includes Mr. Restivo’s costs to relocate from Florida to Carrollton,
      Texas, where we are headquartered, for which we reimbursed Mr.
      Restivo.




Grants
of Plan-Based Awards




We did
not grant any awards under any of our incentive plans to our Named Executive
Officers in 2007 or 2008.




Outstanding
Equity Awards at Fiscal Year –End




The
following table shows for the fiscal year ended December 31, 2008, certain
information regarding outstanding equity awards at fiscal year-end for the Named
Executive Officers.




21


Outstanding
Equity Awards At December 31, 2008




Name
                                                
                                                Number
      of
                                                  Securities
      Underlying
                                                  Unexercised
      Options
                                                  (#)
                                                  Exercisable
                                                
                                                Option
      Awards
                                                  Number
      of Securities
                                                  Underlying
      Unexercised
                                                  Options
                                                  (#)
                                                  Unexercisable
                                                
                                                
                                                Option
                                                  Exercise
                                                  Price
                                                  ($)
                                                
                                                Option
                                                  Expiration DateSteven
      Walin
                                                
                                                1,411,346
                                                
                                                470,449
                                                
                                                $
                                                .20
                                                
                                                October
      4, 2016Joseph
      Restivo
                                                
                                                1,411,346
                                                
                                                470,449
                                                
                                                $
                                                .20
                                                
                                                October
      4,
2016





Employment
Contracts; Termination of Employment and Change-in-Control
Arrangements




Employment
Agreement with Chief Executive Officer




We
entered into an Employment Agreement, dated as of February 9, 2006, with Steven
Walin, our Chief Executive Officer. The Employment Agreement was amended on
January 8, 2008, to extend the term thereof to December 31,
2011.  Pursuant to the Employment Agreement, Mr. Walin receives an
annual base salary of $375,000.




Pursuant
to his Employment Agreement, Mr. Walin is entitled to receive 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, for subsequent
years.




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




·
            payment
      of all accrued but unpaid base salary, his signing bonus (to the extent
      then unpaid), and unpaid annual bonus with respect to any completed fiscal
      year;




·
            payment
      of his base salary and continued medical benefits for 18 months; provided,
      that if such termination occurs after a “Change in Control” Mr. Walin 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 an 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. Walin’s
      employment with us, all of the unvested options will immediately
      vest.




If
Mr. Walin’s employment is terminated as a result of his death or disability, we
will pay him his accrued but unpaid base salary, 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. Walin
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.


22


On
October 4, 2006, we entered into an amendment to our Employment Agreement with
Mr. Walin under which we issued him an option to purchase 1,881,795 shares of
our Common Stock at an exercise price of $.20 per share (such number of shares
and exercise price after giving effect to our subsequent reverse stock split)
vesting over a three-year period.  Pursuant to the amendment, Mr.
Walin forfeited all stock options previously granted to him under his employment
agreement as well as the right to be issued additional stock options upon the
closing of a private placement of our securities.




On
January 8, 2008, we entered into an amendment to our Employment Agreement with
Mr. Walin, under which his term of employment has been extended to December 31,
2011.   The amendment also extends the period following a “Change
in Control,” from 12 months to 18 months, within which Mr. Walin is entitled to
increased severance in the event he is terminated “Without Cause” or resigns for
“Good Reason.”




On March
12, 2009, the Company’s compensation committee approved an annual bonus payment
of $159,375 for Mr. Walin.    This bonus equates to 43% of
Mr. Walin’s 2008 base salary




Employment
Agreement with Chief Financial Officer and Chief Operating Officer




We have
entered into an Employment Agreement, dated as of March 28, 2006, with Joseph
Restivo, our Chief Financial Officer and Chief Operating Officer. The Employment
Agreement was amended on January 8, 2008, to extend the term thereof to December
31, 2011.The Employment Agreement provides Mr. Restivo with an annual base
salary of $250,000, and 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.




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 18 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.




·
            A
      cash payment of $75,000 on an after-tax basis to cover his relocation
      expenses.




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.




On
October 4, 2006, we entered into an amendment to our Employment Agreement with
Mr. Restivo under which we issued him an option to purchase 1,881,795 shares of
our Common Stock at an exercise price of $.20 per share (such number of shares
and exercise price after giving effect to our subsequent reverse stock split)
vesting over a three-year period.  Pursuant to the amendment, Mr.
Restivo forfeited all stock options previously granted to him under his
employment agreement as well as the right to be issued additional stock options
upon the closing of a private placement of our securities.


23




On
January 8, 2008, we entered into an amendment to our Employment Agreement with
Mr. Restivo, under which his term of employment has been extended to December
31, 2011.   The amendment also extends the period following a
“Change in Control,” from 12 months to 18 months, within which Mr. Restivo is
entitled to increased severance in the event he is terminated “Without Cause” or
resigns for “Good Reason.”  The amendment additionally entitles Mr.
Restivo to a cash payment of $75,000 to cover his relocation expenses in the
event he is terminated “Without Cause” or resigns for “Good Reason” (whether
before or after a “Change in Control”).




On March
12, 2009, the Company’s compensation committee approved an annual bonus payment
of $125,000 for Mr. Restivo.    This bonus equates to 50% of
Mr. Restivo’s 2008 base salary




Director
Compensation




Non-employee
Directors




Our non
non-employee directors are entitled to receive a monthly cash payment of
$2,500.  Craig Ellins waived his right to receive these payments
through February of 2008.  In addition,  the chairman of our
audit and compensation committees is entitled to receive $5,000 annually for
each of those committees chaired by him.  Mr. Freeman chaired both the
audit and compensation committee during the year ended December 31,
2008.  Our directors are also reimbursed for actual out-of-pocket
expenses incurred by them in connection with their attendance at meetings of the
Board of Directors.




On July
3, 2008 we granted each of our non-employee directors a ten-year option to
purchase 30,000 shares of Common Stock at an exercise price of $.46 per share.
One quarter of these options vested immediately, with the remaining options
vesting ratably in 12 quarterly installments over a three year period that
commenced September 1, 2008.  In addition, we granted the chairman of
our audit and compensation committees an option to purchase an additional 20,000
shares in the aggregate for his service as chairman of those committees with
similar vesting provisions.




The
following table shows for the fiscal year ended December 31, 2008 certain
information with respect to the compensation of our non-employee
directors.




Director
Compensation for Fiscal 2008




Name
                
                Fees
      Earned or
                  Paid
      in
                  Cash
                  ($)
                
                
                Stock
                  Awards
                  ($)
                
                
                Option
                  Awards
                  ($)
      (1)
                
                
                All
      Other
                  Compensation
                  ($)
                
                
                Total
                  ($)Craig
      Ellins
                
                $
                25,000
                
                
                
                —
                
                
                $
                7,890
                
                
                
                —
                
                
                $
                32,890Gary
      Freeman
                
                $
                35,000
                
                
                
                —
                
                
                $
                13,150
                
                
                
                —
                
                
                $
                53,150Moshe
      Zarmi
                
                $
                30,000
                
                
                
                —
                
                
                $
                7,890
                
                
                
                —
                
                
                $
                37,890







(1)
            The
      value of option awards granted to directors has been estimated pursuant to
      SFAS No. 123(R) based on our expense for the options described in the
      footnotes to our financial statements, except that for purposes of this
      table, we have assumed that none of the options will be
      forfeited.  The directors will not realize the estimated value
      of these awards in cash until these awards are vested and exercised or
      sold. For information regarding our valuation of option awards, see
      “Stock-Based Compensation” in Note 1 of our financial statements for the
      year ended December 31, 2008.




24




The Plan
is administered by the Compensation Committee of the Board of Directors. The
Compensation Committee has the authority to select those employees, officers,
directors and consultants whose performance it determines significantly promotes
the Company’s success to receive discretionary awards under the Plan, grant the
awards, interpret and determine all questions of policy with respect thereto and
adopt rules, regulations, agreements and instruments deemed necessary for its
proper administration.




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




The
following table sets forth as of March 5, 2009, certain information known to us
with respect to the beneficial ownership of Common Stock by (i) each person who
is known by us to own of record or beneficially more than 5% of the outstanding
Common Stock, (ii) each of our directors executive officers, and (iii) all of
our directors and executive officers as a group.  Unless otherwise
indicated, each of the stockholders can be reached at our principal executive
offices located at 2801 Trade Center Drive, Suite 120, Carrollton, Texas
75007.




SHARES
      BENEFICIALLY OWNED1Number
                
                
                Percent
      (%)Beneficial
      Owners of more than 5% of CommonStock
      (other than directors and executiveofficers)Steven
      Kolow2
                  PO
      Box 5360
                  Wayland,
      MA 01778
                
                
                5,345,623
                
                
                
                18.7
                %Europa
      International, Inc.3
                
                
                3,557,303
                
                
                
                12.3
                %Fred
      Knoll 4
                
                
                3,565,445
                
                
                
                12.4
                %HG
      Investments, LLC
                  7030
      Hayvenhurst Ave.
                  Van
      Nuys, CA 91406
                
                
                2,770,342
                
                
                
                9.8
                %Richard
      Kall 5
                  9000
      Players Club Drive
                  Las
      Vegas, NV  89134
                
                
                2,595,342
                
                
                
                9.2
                %David
      Weiner 6
                  3490
      Laurel Canyon Boulevard, Suite 327
                  Studio
      City, California 91604
                
                
                2,818,131
                
                
                
                9.8
                %Strategic
      Turnaround Equity Partners, LP (Cayman)
                  GCM
      Administrative Services LLC
                  Gary
      Herman7
                
                
                1,547,184
                
                
                
                5.5
                %Bruce
      Galloway 8
                  720
      Fifth Avenue, 10th
      Floor
                  New
      York, NY 10019
                
                
                1,589,916
                
                
                
                5.6
                %Directors
      and Executive OfficersCraig
      Ellins 9
                
                
                186,458
                
                
                
                *




25





SHARES
      BENEFICIALLY OWNED1Number
                    
                    
                    Percent
      (%)Moshe
      Zarmi 9
                    
                    
                    147,636
                    
                    
                    
                    *Gary
      Freeman 10
                    
                    
                    111,875
                    
                    
                    
                    *Joseph
      Restivo 11
                    
                    
                    1,821,790
                    
                    
                    
                    6.1
                    %Steven
      Walin11
                    
                    
                    1,839,998
                    
                    
                    
                    6.2
                    %All directors and executive
      officers as a group (five persons) 12
                    
                    
                    4,107,757
                    
                    
                    
                    12.9
                    %








*           Less
than 1%.





1
            Gives
      effect to the shares of Common Stock issuable upon the exercise of all
      options exercisable within 60 days of March 5, 2009 and other rights
      beneficially owned by the indicated stockholders on that
      date.  Beneficial ownership is determined in accordance with the
      rules of the Securities and Exchange Commission and includes voting and
      investment power with respect to shares.  Unless otherwise
      indicated, the persons named in the table have sole voting and sole
      investment control with respect to all shares beneficially
      owned.  Percentage ownership is calculated based on 28,197,107
      shares of the Common Stock outstanding as of March 5, 2009.  All
      information is based upon information furnished by the persons listed,
      contained in filings made by them with the SEC or otherwise available to
      the Company.




2
            Includes
      324,938 shares of Common Stock issuable upon exercise of warrants and
      600,000 shares of Common Stock held by The Kolow Charitable Foundation, as
      to which Mr. Kolow has voting and dispositive powers.  Based on
      a Schedule 13G filed by Mr. Kolow on January 17,
  2008.




3
            Includes
      650,063 shares of Common Stock issuable upon exercise of warrants.
      Europa’s address is P.O. Box 146, Road Town, Tortola, British Virgin
      Islands. Fred Knoll is the principal of Knoll Capital Management, L.P.,
      which manages Europa’s investments.




4
            Includes
      (i) 3,557,303 shares of Common Stock beneficially owned by Europa; (ii)
      1,475 shares of Common Stock beneficially owned by Thinking Technologies,
      L.P., and (iii) warrants to purchase 6,667 shares of Common Stock held by
      Knoll Capital Fund II. Fred Knoll is the principal of Knoll Capital
      Management, L.P., which is the general partner of Thinking Technologies,
      L.P., and the investment manager of Knoll Capital Fund II and Europa. Mr.
      Knoll’s address is c/o Knoll Capital Management, L.P. 666 5th
      Avenue Suite 3702, New York, New York
10102.




5
            Includes
      75,000 shares of Common Stock issuable upon exercise of a
      warrant.




6
            Includes
      (i) 21,000 shares of Common Stock owned by Woodman Management Corporation,
      of which David Weiner is the sole shareholder, (ii) 518,688 shares of
      Common Stock issuable upon exercise of a warrant, and
      (iii)  warrants to purchase 6,667 shares of Common Stock held by
      W-Net, Inc., of which Mr. Weiner is the sole shareholder.  Based
      on a Schedule 13G filed by Mr. Weiner on January 26,
  2009.





7
            These
      shares are held directly by Strategic Turnaround Equity Partners, LP
      (Cayman) (“STEP”), with a principal address of c/o Stuarts Corporate
      Services, Ltd; P.O. Box 2510 GT, 4th
      floor, One Cayman Financial Centre, 36A Dr. Roy’s Drive, Georgetown, Grand
      Cayman, Cayman Island. GCM
      Administrative Services LLC, Gary Herman and Bruce Galloway, which all
      have a principal address of 720 Fifth Avenue, 10th Floor, New York, NY
      10019, share the power to vote and dispose of these
      shares.  Based on a Schedule 13G filed on February 13,
      2009.





26





8
            Includes
      1,547,184 shares of Common Stock held by STEP,15,078 shares of
      Common Stock held by Mr. Galloway’s Individual Retirement Account, 3,700
      shares held in the account of his child which Mr. Galloway has sole power
      to vote and dispose, 20,000 shares held by Rexon Galloway Capital, LLC,
      which Mr. Galloway has sole power to vote and dispose, and 954 shares held
      by Jacombs Investment, Inc. for which Mr. Galloway has sole power to vote
      and dispose. Mr. Galloway is a managing member of Galloway Capital
      Management, LLC, the general partner of STEP. Based on a Schedule 13G
      filed on February 13, 2009.





9
            Includes
      103,125 shares of Common Stock issuable upon exercise of
      options.





10
            These
      shares of Common Stock are all issuable upon exercise of
      options.





11
            Includes
      1,685,773 shares of Common Stock issuable upon exercise of
      options.





12
            Includes
      Messrs. Ellins, Freeman, Zarmi, Walin, and
  Restivo.




Item
13. Certain Relationships and Related Transactions, and Director
Independence.





All members of our Board of Directors,
other than our Chairman of the Board and Chief Executive Officer, Steven Walin,
and our Chief Financial Officer and Chief Operating Officer, Joseph Restivo, are
independent under the standards set forth in Nasdaq Marketplace Rule
4200(a)(15).  In addition, each member of our Compensation and
Governance Committees is independent under Nasdaq Marketplace Rule 4200(a)(15)
and each member of our Audit Committee is independent under the standards set
forth in Nasdaq Marketplace Rules 4350(d)(2)(A)(i) and (ii).




Item
14. Principal Accountant Fees and Services.




The
following table presents fees for professional audit services rendered by
Weinberg & Company for the audit of the Company’s annual financial
statements for the years ended December 31, 2008 and 2007, and fees billed for
other services rendered by Weinberg & Company during those
years.




2008
                    
                    
                    2007Audit
      fees(1)
                    
                    $
                    153,062
                    
                    
                    $
                    176,607Audit
      related fees
                    
                    
                    -
                    
                    
                    
                    -Tax
      fees
                    
                    
                    -
                    
                    
                    $
                    22,039All
      other fees(2)
                    
                    
                    -
                    
                    
                    $
                    24,842Total
      fees
                    
                    $
                    153,062
                    
                    
                    $
                    223,488


_____________________________





(1)
            Includes
      fees paid for professional services rendered in connection with the audit
      of annual financial statements and the review of quarterly financial
      statements.




(2)
            Consisted
      primarily of fees paid in connection with review of the Company’s
      financial statements in the Company’s Registration Statement on Form S-1,
      Current Reports on Form 8-K, and related due
  diligence.




Pre-Approval
Policies and Procedures




The Audit
Committee pre-approves all auditing services and permitted non-audit services
(including the fees and terms thereof) to be performed for us by our independent
auditor, subject to the de minimis exceptions for non-audit services described
in Section 10A(i)(1)(B) of the Securities Exchange Act of 1934, as
amended.  No non-audit services were provided to us by our independent
auditor during the year ended December 31, 2008.


27




PART
IV




Item
15.  Exhibits, Financial Statement Schedules.




The
following documents are filed as part of this report:




Exhibit
                                                Number
                                              
                                              Exhibit Title2.1
                                              
                                              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.
      *3.1
                                              
                                              Certificate
      of Incorporation and Amendments of GVI Security Solutions,
      Inc.**3.2
                                              
                                              Amended
      and Restated By-Laws of GVI Security Solutions, Inc.
***4.1‡
                                              
                                              2004
      Long-Term Stock Incentive Plan (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
      SEC on April 14, 2004)4.2‡
                                              
                                              2008
      Long-Term Stock Incentive Plan10.1
                                              
                                              Distributorship
      Agreement dated as of October 2, 2006 between GVI Security Inc. and
      Samsung Electronics Co., Ltd. ##10.2
                                              
                                              Amendment
      to Samsung Electronics and GVI Security Inc. Distribution Agreement of
      October 2, 2006 (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 26, 2008)10.3
                                              
                                              Commercial
      Industrial Lease Agreement, effective as of April 1, 2004, between, CSHV
      Texas Industrial, L.P., as Landlord, and GVI Security, Inc., as Tenant
      (Incorporated by reference to the similarly described exhibit previously
      filed as an exhibit to Registration Statement on Form SB-2 (Registration
      No. 33-11321)).10.4‡
                                              
                                              Employment
      Agreement, dated as of January 31, 2006, between GVI Security Solutions,
      Inc. and Steven E. Walin  (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 21,
      2006.)10.5‡
                                              
                                              Employment
      Agreement, dated as of March 28, 2006, between GVI Security Solutions,
      Inc. and Joseph Restivo. ***10.6‡
                                              
                                              Amendment
      to Employment Agreement between GVI Security Solutions, Inc. and Steven
      Walin dated as of October 4, 2006#10.7‡
                                              
                                              Amendment
      to Employment Agreement between GVI Security Solutions, Inc. and Joseph
      Restivo dated as of October 4, 2006#10.8‡
                                              
                                              Amendment
      to Employment Agreement between GVI Security Solutions, Inc. and Steven
      Walin dated as of January 8, 2008 (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 11,
      2008)10.9‡
                                              
                                              Amendment
      to Employment Agreement between GVI Security Solutions, Inc. and Joseph
      Restivo dated as of January 8, 2008 (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 11,
      2008)




28





21
                                          
                                          Subsidiaries
      of the Registrant (Incorporated by reference to the similarly described
      exhibit previously filed as an exhibit to Registrant’s Annual Report on
      Form 10-K for the year ended December 31, 2007, filed with the SEC on
      March 25, 2008)23
                                          
                                          Consent
      of Weinberg & Company, P.A.31.1
                                          
                                          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
      193431.2
                                          
                                          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
      193432.1
                                          
                                          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
      193432.2
                                          
                                          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
      1934





*
            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 Registrant’s Annual Report on Form 10-KSB for the year ended
      December 31, 2005, filed with the Securities and Exchange Commission on
      March 31, 2006.





#
            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 5, 2006.





‡
            Indicates
      a management contract or compensatory plan or
  arrangement.


29


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, in the city of Carrolton, State of Texas, on March
13, 2009.




GVI
      SECURITY SOLUTIONS, INC.(Registrant)By:
              /s/  Steven
  WalinSteven
      WalinChief
      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
                        
                        DateChief
      Executive Officer (Principal ExecutiveSteven
      Walin
                        
                        Officer),
      Chairman of the Board, and Director
                        
                        March
      13, 2009Chief
      Financial Officer (Principal AccountingJoseph
      Restivo
                        
                        and
      Financial Officer), Chief Operating Officer
                        
                        March
      13, 2009and
      DirectorDirector
                        
                        March
      13, 2009Craig
      EllinsDirector
                        
                        March
      13, 2009Gary
      FreemanDirector
                        
                        March
      13, 2009Moshe
      Zarmi







GVI
Security Solutions, Inc.





CONSOLIDATED
FINANCIAL STATEMENTS





PageReport
      of Independent Registered Public Accounting Firm
                F-2Consolidated
      Balance Sheets as of December 31, 2008 and 2007
                F-3Consolidated
      Statements of Operations for the yearsended
      December 31, 2008 and 2007
                F-4Consolidated
      Statements of Stockholders’ Equity for the yearsended
      December 31, 2008 and 2007
                F-5Consolidated
      Statements of Cash Flows for the yearsended
      December 31, 2008 and 2007
                F-6Notes
      to Consolidated Financial Statements
                F-7


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 consolidated balance sheets of GVI Security Solutions, Inc. and
Subsidiaries as of December 31, 2008 and 2007, and the related consolidated
statements of operations, stockholders’ equity and cash flows for the years then
ended.  These consolidated financial statements are the responsibility
of the Company's management.  Our responsibility is to express an
opinion on these consolidated financial statements based on our
audits.





We
conducted our audits 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 consolidated financial statements are free of material misstatement. The
Company is not required to have, nor were we engaged to perform, an audit of its
internal control over financial reporting.  Our audit included
consideration of internal control over financial reporting as a basis for
designing audit procedures that are appropriate in the circumstances, but not
for the purpose of expressing an opinion on the effectiveness of the Company’s
internal control over financial reporting.  Accordingly, we express no
such opinion. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the consolidated financial
statements.  An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall consolidated financial statement
presentation.  We believe that our audits provide a reasonable basis
for our opinion.





In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the consolidated financial position of GVI Security
Solutions, Inc. and Subsidiaries as of December 31, 2008 and 2007 and the
results of their operations and their cash flows for the years then ended, in
conformity with accounting principles generally accepted in the United States of
America.





Weinberg
& Company, P.A.


Los
Angeles, California


February
24, 2009


F-2





GVI
Security Solutions, Inc.


Consolidated
Balance Sheets


December
31, 2008 and 2007


(In
thousands, except share and per share amounts)





2008
                      
                      
                      2007ASSETS:Current
      AssetsCash
      and equivalents
                      
                      $
                      46
                      
                      
                      $
                      313Accounts
      receivable, net of allowances for doubtful
                        accounts
      of $426 and $416, respectively
                      
                      
                      7,129
                      
                      
                      
                      6,625Inventory,
      net
                      
                      
                      15,249
                      
                      
                      
                      12,723Deferred
      tax assets, current
                      
                      
                      869
                      
                      
                      
                      907Prepaid
      and other current assets
                      
                      
                      920
                      
                      
                      
                      1,184Total
      Current Assets
                      
                      
                      24,213
                      
                      
                      
                      21,752Property
      and Equipment, net
                      
                      
                      158
                      
                      
                      
                      156Deferred
      tax assets, non-current
                      
                      
                      178
                      
                      
                      
                      1,321Deferred
      loan origination fee, net
                      
                      
                      61
                      
                      
                      
                      93Other
      assets
                      
                      
                      51
                      
                      
                      
                      34Total
      Assets
                      
                      $
                      24,661
                      
                      
                      $
                      23,356LIABILITIES
      AND STOCKHOLDERS' EQUITY:Current
      LiabilitiesAccounts
      payable to primary supplier
                      
                      $
                      7,132
                      
                      
                      $
                      5,710Other
      trade accounts payable
                      
                      
                      1,105
                      
                      
                      
                      1,682Accrued
      expenses
                      
                      
                      1,799
                      
                      
                      
                      1,849Capitalized
      lease obligations, current
                      
                      
                      12
                      
                      
                      
                      51Total
      Current Liabilities
                      
                      
                      10,048
                      
                      
                      
                      9,292Capital
      lease obligations, net of current portion
                      
                      
                      -
                      
                      
                      
                      12Deferred
      tax liability, non-current
                      
                      
                      739
                      
                      
                      
                      1,244Revolving
      credit facility
                      
                      
                      9,862
                      
                      
                      
                      10,344Total
      Liabilities
                      
                      
                      20,649
                      
                      
                      
                      20,892Commitments
      and ContingenciesStockholders'
      EquityPreferred
      stock, undesignated, $.001 par value, 3,000,000 shares authorized, none
      issued or outstanding
                      
                      
                      -
                      
                      
                      
                      -Common
      stock, $.001 par value, 200,000,000 shares authorized, 28,197,106 issued
      and outstanding at December 31, 2008 and 28,147,106 shares issued and
      outstanding at December 31, 2007
                      
                      
                      28
                      
                      
                      
                      28Additional
      paid-in capital
                      
                      
                      34,826
                      
                      
                      
                      34,574Accumulated
      deficit
                      
                      
                      (30,842
                      )
                      
                      
                      (32,138
                      )Total
      Stockholders' Equity
                      
                      
                      4,012
                      
                      
                      
                      2,464Total
      Liabilities and Stockholders' Equity
                      
                      $
                      24,661
                      
                      
                      $
                      23,356





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


F-3


GVI
Security Solutions, Inc.


Consolidated
Statements of Operations


Years
Ended December 31, 2008 and 2007


(In
thousands, except per share amounts)





2008
                              
                              
                              2007Revenues
                              
                              $
                              47,333
                              
                              
                              $
                              45,025Cost
      of Revenues
                              
                              
                              33,152
                              
                              
                              
                              32,238Gross
      Profit
                              
                              
                              14,181
                              
                              
                              
                              12,787Selling,
      General and Administrative Expenses
                              
                              
                              11,554
                              
                              
                              
                              10,312Income
      from operations
                              
                              
                              2,627
                              
                              
                              
                              2,475Other
      Income
                              
                              
                              60
                              
                              
                              
                              -Interest
      Expense
                              
                              
                              (686
                              )
                              
                              
                              (1,012
                              )Income
      from continuing operations before income taxes and  income from
      discontinued operations
                              
                              
                              2,001
                              
                              
                              
                              1,463Income
      Tax (Expense) Benefit
                              
                              
                              (705
                              )
                              
                              
                              942Income
      from continuing operations before income from discontinued
      operations
                              
                              
                              1,296
                              
                              
                              
                              2,405Income
      from discontinued operations, net of taxes
                              
                              
                              -
                              
                              
                              
                              232Net
      income
                              
                              $
                              1,296
                              
                              
                              $
                              2,637Basic
      income per shareContinuing
      operations
                              
                              $
                              0.05
                              
                              
                              $
                              0.08Discontinued
      operations
                              
                              $
                              0.00
                              
                              
                              $
                              0.01Net
      income
                              
                              $
                              0.05
                              
                              
                              $
                              0.09Diluted
      income per shareContinuing
      operations
                              
                              $
                              0.04
                              
                              
                              $
                              0.07Discontinued
      operations
                              
                              $
                              0.00
                              
                              
                              $
                              0.01Net
      income per share
                              
                              $
                              0.04
                              
                              
                              $
                              0.08Shares
      Used in Calculation of Net Income per share - basic
                              
                              
                              28,182,079
                              
                              
                              
                              28,044,465Shares
      Used in Calculation of Net Income per share -
diluted
                              
                              
                              31,453,401
                              
                              
                              
                              33,595,044





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


F-4


GVI
Security Solutions, Inc.


Consolidated
Statements of Stockholders’ Equity


For
the Years Ended December 31, 2008 and 2007





Common StockShares
                        
                        
                        Amount
                        
                        
                        Additional
                          Paid-in-Capital
                        
                        
                        Accumulated
                          Deficit
                        
                        
                        TOTALBalance,
      January 1, 2007
                        
                        
                        26,292,944
                        
                        
                        $
                        26
                        
                        
                        $
                        33,309
                        
                        
                        $
                        (34,775
                        )
                        
                        $
                        (1,440
                        )Private
      placement proceeds, net
                        
                        
                        1,713,333
                        
                        
                        
                        2
                        
                        
                        
                        1,026
                        
                        
                        
                        
                        
                        
                        
                        1,028Conversion
      of severance obligation to common stock
                        
                        
                        100,000
                        
                        
                        
                        -
                        
                        
                        
                        20
                        
                        
                        
                        
                        
                        
                        
                        20Fair
      value of warrants issued for services
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        110
                        
                        
                        
                        
                        
                        
                        
                        110Proceeds
      from exercise of stock options
                        
                        
                        40,829
                        
                        
                        
                        -
                        
                        
                        
                        8
                        
                        
                        
                        
                        
                        
                        
                        8Fair
      value of vested options
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        101
                        
                        
                        
                        
                        
                        
                        
                        101Net
      Income
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        
                        
                        
                        
                        2,637
                        
                        
                        
                        2,637Balance,
      December 31, 2007
                        
                        
                        28,147,106
                        
                        
                        
                        28
                        
                        
                        
                        34,574
                        
                        
                        
                        (32,138
                        )
                        
                        
                        2,464Fair
      value of warrants issued for services
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        149
                        
                        
                        
                        
                        
                        
                        
                        149Proceeds
      from warrant exercise
                        
                        
                        50,000
                        
                        
                        
                        -
                        
                        
                        
                        10
                        
                        
                        
                        
                        
                        
                        
                        10Fair
      value of vested options
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        94
                        
                        
                        
                        
                        
                        
                        
                        94Net
      Income
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        1,296
                        
                        
                        
                        1,295Balance,
      December 31, 2008
                        
                        
                        28,197,106
                        
                        
                        $
                        28
                        
                        
                        $
                        34,826
                        
                        
                        $
                        (30,842
                        )
                        
                        $
                        4,012


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


F-5





GVI
Security Solutions, Inc.


Condensed
Consolidated Statements of Cash Flows


Years
Ended December 31, 2008 and 2007


(In
thousands, except per share amounts)





2008
                                  
                                  
                                  2007Cash
      Flows Provided by Operating ActivitiesNet Income
                                  
                                  $
                                  1,296
                                  
                                  
                                  $
                                  2,637Adjustments
      to reconcile Net Income to net cash provided by (used In)
                                    Operating
      Activities:(Income)
      from discontinued operations, net of tax
                                  
                                  
                                  -
                                  
                                  
                                  
                                  (232
                                  )Depreciation
      and amortization from continuing operations
                                  
                                  
                                  151
                                  
                                  
                                  
                                  229Amortization
      of deferred loan origination fee
                                  
                                  
                                  32
                                  
                                  
                                  
                                  209Compensation costs and
      expenses for stock and options issued
                                  
                                  
                                  242
                                  
                                  
                                  
                                  211Changes in Assets and
      LiabilitiesAccounts receivable,
      net
                                  
                                  
                                  (504
                                  )
                                  
                                  
                                  1,256Inventory
                                  
                                  
                                  (2,526
                                  )
                                  
                                  
                                  (6,307
                                  )Prepaids
      and other current assets
                                  
                                  
                                  368
                                  
                                  
                                  
                                  140Other
      Assets
                                  
                                  
                                  (17
                                  )
                                  
                                  
                                  -Deferred
      Tax Assets and Liabilities, net
                                  
                                  
                                  676
                                  
                                  
                                  
                                  (985
                                  )Accounts
payable
                                  
                                  
                                  741
                                  
                                  
                                  
                                  335Accrued
expenses
                                  
                                  
                                  (50
                                  )
                                  
                                  
                                  (154
                                  )Net
      cash provided by (used in) operating activities from continuing
      operations
                                  
                                  
                                  409
                                  
                                  
                                  
                                  (2,661
                                  )Net
      cash used in operating activitiesof discontinued
      operations
                                  
                                  
                                  -
                                  
                                  
                                  
                                  (168
                                  )Net
      cash provided by (used in) operating activities
                                  
                                  
                                  409
                                  
                                  
                                  
                                  (2,829
                                  )Cash
      Flows Used In Investing ActivitiesPurchase
      of property and equipment
                                  
                                  
                                  (153
                                  )
                                  
                                  
                                  (2
                                  )Net
      cash used in investing activities
                                  
                                  
                                  (153
                                  )
                                  
                                  
                                  (2
                                  )Cash
      Flows Provided By (Used In) Financing ActivitiesIssuance
      of common stock
                                  
                                  
                                  -
                                  
                                  
                                  
                                  1,028Proceeds
      from warrant conversion to common stock
                                  
                                  
                                  10
                                  
                                  
                                  
                                  -Payments
      of Laurus revolving credit facility
                                  
                                  
                                  -
                                  
                                  
                                  
                                  (6,366
                                  )Net
      proceeds from revolving credit facility
                                  
                                  
                                  (482
                                  )
                                  
                                  
                                  10,344Principal payments of Senior
      term note
                                  
                                  
                                  -
                                  
                                  
                                  
                                  (1,925
                                  )Principal payments of
      capitalized lease obligations
                                  
                                  
                                  (51
                                  )
                                  
                                  
                                  (77
                                  )Proceeds
      from exercise of options
                                  
                                  
                                  -
                                  
                                  
                                  
                                  8Loan
      origination costs
                                  
                                  
                                  -
                                  
                                  
                                  
                                  (93
                                  )Net
      Cash (Used In) Provided by Financing Activities
                                  
                                  
                                  (523
                                  )
                                  
                                  
                                  2,919Net
      (Decrease) Increase in Cash
                                  
                                  
                                  (267
                                  )
                                  
                                  
                                  88Cash,
      Beginning of Period
                                  
                                  
                                  313
                                  
                                  
                                  
                                  225Cash,
      End of Period
                                  
                                  $
                                  46
                                  
                                  
                                  $
                                  313SUPPLEMENTARY
      CASH FLOW INFORMATIONCash
      paid for interest
                                  
                                  $
                                  715
                                  
                                  
                                  $
                                  805Cash
      paid for income taxes
                                  
                                  
                                  47
                                  
                                  
                                  
                                  9SUPPLEMENTAL
      SCHEDULE OF NONCASH INVESTING ANDFINANCING ACTIVITIESConversion
      of debt to common stock
                                  
                                  
                                  -
                                  
                                  
                                  
                                  20





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


F-6


GVI
Security Solutions, Inc.


Notes
to Consolidated Financial Statements


For
the years ended December 31, 2008 and 2007





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.





Nature
of Business





The
Company provides video surveillance security solutions that are deployed in the
commercial and homeland security market segments. Products are sold primarily to
distributors and system integrators that specialize in providing security
products and services to these business segments.





Principles
of Consolidation





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





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.





In the
year ended December 31, 2007, the Company paid approximately $168,000 to satisfy
all remaining obligations associated with the Retail Channel business, and
recognized $232,000 as income from discontinued operations, representing the
balance of a $400,000 reserve established in 2006 in connection with Company’s
estimated obligations for this business.





Revenue
Recognition





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





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


F-7





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.




Accounts
Receivable




Trade
receivables are presented on the balance sheet as outstanding amounts adjusted
for any allowance for bad debts. The Company maintains an allowance for doubtful
receivables based primarily on historical 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.




Inventory





Inventory
is stated at the lower of cost (first-in, first-out method) or market and
consists of goods held for resale and parts used for repair work. Reserves are
recorded for slow-moving, obsolete, nonsaleable or unusable items based upon a
product-level review, in order to reflect inventory balances at their net
realizable value. Inventory reserve balances at December 31, 2008 and 2007 were
approximately $2,251,000 and $2,346,000, respectively.





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. 
The Company reviews for impairment annually.  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.  Based upon its
annual review, management determined that there were no indicators of impairment
for its long-lived assets as of December 31, 2008.




Goodwill
and Intangible Assets




The
Company adopted the provisions of FASB Statement No. 142, “Goodwill and Other
Intangible Assets,” (SFAS 142) effective January 1, 2005. SFAS No. 142 requires
that goodwill and intangible assets with indefinite useful lives no longer be
amortized, but instead be tested for impairment using the guidance for measuring
impairment set forth in this statement. The company reviews its goodwill and
intangibles annually for impairment or sooner if indications of impairment are
noted.





Property
and Equipment





Property
and equipment is stated at cost net of depreciation and
amortization.  Depreciation and amortization are provided for on the
straight-line method 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.





Shipping
and Handling Costs





Shipping
and handling costs related to product sales and fulfillment 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.


F-8





Advertising





Advertising
costs are expensed as incurred.  Certain advertising costs, which
included various promotional incentives and trade show participation, for the
years ended December 31, 2008 and 2007 were reimbursed by Samsung in the form of
marketing incentives and partial reimbursement for trade show participation.
Advertising costs during the years ended December 31, 2008 and 2007 were
$630,000 and $477,000, respectively.





Income
Taxes





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





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





Stock-Based
Compensation




The
Company periodically issues stock options and warrants to employees and
non-employees in non-capital raising transactions for services and for financing
costs. The Company adopted Statement of Financial Accounting Standards (SFAS)
No. 123R, “Share-Based Payment,” effective January 1, 2006, and is using the
modified prospective method in which compensation cost is recognized beginning
with the effective date (a) based on the requirements of SFAS No. 123R for all
share-based payments granted after the effective date and (b) based on the
requirements of SFAS No. 123R for all awards granted to employees prior to the
effective date of SFAS No. 123R that remained unvested on the effective date.
The Company accounts for stock option and warrant grants issued and vesting to
non-employees in accordance with EITF No. 96-18: "Accounting for Equity
Instruments that are Issued to Other Than Employees for Acquiring, or in
Conjunction with Selling, Goods or Services” and EITF 00-18 “Accounting
Recognition for Certain Transactions involving Equity Instruments Granted to
Other Than Employees” under which the value of the stock compensation is based
upon the measurement date as determined at either a) the date at which a
performance commitment is reached, or b) at the date at which the necessary
performance to earn the equity instruments is complete.




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:





2008
                                  
                                  
                                  2007Risk
      free rate of return
                                  
                                  
                                  4.0
                                  %
                                  
                                  
                                  4.5
                                  %Option
      lives in years
                                  
                                  
                                  6.0
                                  
                                  
                                  
                                  6.0Annual
      volatility of stock price
                                  
                                  
                                  63
                                  %
                                  
                                  
                                  72
                                  %Dividend
      yield
                                  
                                  
                                  —
                                  %
                                  
                                  
                                  —
                                  %





Net
Income (Loss) Per Share





Statement
of Financial Accounting Standards (SFAS) No. 128 "Earnings Per Share" requires
presentation of basic earnings per share (“Basic EPS”) and diluted earnings per
share (“Diluted EPS”). Basic earnings (loss) per share is computed by dividing
income (loss) available to common stockholders by the weighted average number of
common shares outstanding during the period. Diluted earnings per share gives
effect to all dilutive potential common shares outstanding during the
period.  The income generated by the Company during the year ended
December 31, 2008 led to the Company including an additional 3,271,322
shares of Common Stock as dilutive for Diluted EPS
calculations.  These dilutive shares consisted of outstanding warrants
and stock options that were issued at a price below the average market price of
the stock for the year ended December 31, 2008.  The potentially
dilutive securities consisted of outstanding warrants and stock options to
acquire an aggregate of 8,831,810 shares of Common Stock. The income generated
by the Company during the year ended December 31, 2007 led to the Company
including an additional 5,550,579 shares of Common Stock as dilutive for Diluted
EPS calculations.  These dilutive shares consisted of outstanding
warrants and stock options that were issued at a price below the average market
price of the stock for the year ended December 31, 2007.  The
potentially dilutive securities consisted of outstanding warrants and stock
options to acquire an aggregate of 8,221,810 shares of Common
Stock.


F-9





Credit
Risk Concentration




At
December 31, 2008, two customers accounted for 26% and 13% respectively of the
Company’s receivables balances.  During the year ended December 31,
2008, these same two customers accounted for 20% and 11% respectively of the
Company’s sales.  At December 31, 2007, two customers accounted for
19% and 16% respectively of the Company’s receivables
balances.  During the year ended December 31, 2007, these same two
customers accounted for 20% and 18% respectively of the Company’s
sales.





International
sales accounted for approximately 35% and 30% of the Company's sales during the
years ended December 31, 2008 and 2007 respectively. International sales took
place in Latin America and Canada.  During the year ended December 31,
2008 approximately 13% of the Company’s sales took place in Mexico.





The
Company performs ongoing credit evaluations of its customers and generally
requires no collateral from them.





Fair
Value Measurements





Effective
January 1, 2008, the Company adopted Statement of Financial Accounting Standards
(SFAS) No. 157, Fair Value Measurements. This Statement defines fair value for
certain financial and nonfinancial assets and liabilities that are recorded at
fair value, establishes a framework for measuring fair value, and expands
disclosures about fair value measurements. This guidance applies to other
accounting pronouncements that require or permit fair value measurements. On
February 12, 2008, the FASB finalized FASB Staff Position (FSP) No.157-2,
Effective Date of FASB Statement No. 157. This Staff Position delays the
effective date of SFAS No. 157 for nonfinancial assets and liabilities to fiscal
years beginning after November 15, 2008 and interim periods within those fiscal
years, except for those items that are recognized or disclosed at fair value in
the financial statements on a recurring basis (at least annually). The adoption
of SFAS No. 157 had no effect on the Company’s consolidated financial position
or results of operations.





Use
of Estimates





The
preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosures of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting
period.  Actual results could differ from those
estimates.  Significant estimates include those that relate to the
valuation of inventory, accounts receivable, certain accruals and liabilities
and the useful lives of property and equipment.





Recent
Accounting Pronouncements





In March
2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments
and Hedging Activities, an amendment of FASB Statement No. 133” (SFAS 161). This
Statement requires enhanced disclosures about an entity’s derivative and hedging
activities, including (a) how and why an entity uses derivative instruments, (b)
how derivative instruments and related hedged items are accounted for under SFAS
No. 133,  “Accounting for Derivative Instruments and Hedging
Activities” (SFAS 133), and its related interpretations, and (c) how derivative
instruments and related hedged items affect an entity’s financial position,
financial performance, and cash flows. SFAS 161 is effective for financial
statements issued for fiscal years and interim periods beginning after November
15, 2008.


F-10





In
December 2007, the FASB issued FASB Statement No. 141 (R), “Business
Combinations” (FAS 141(R)), which establishes accounting principles and
disclosure requirements for all transactions in which a company obtains control
over another business.  Statement 141 (R) applies prospectively to
business combinations for which the acquisition date is on or after the
beginning of the first annual reporting period beginning on or after December
15, 2008.  Earlier adoption is prohibited.





In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statements, an amendment of ARB No. 51”.  SFAS
No. 160 establishes accounting and reporting standards that require that the
ownership interests in subsidiaries held by parties other than the parent be
clearly identified, labeled, and presented in the consolidated statement of
financial position within equity, but separate from the parent’s equity; the
amount of consolidated net income attributable to the parent and to the
noncontrolling interest be clearly identified and presented on the face of the
consolidated statement of income; and changes in a parent’s ownership interest
while the parent retains its controlling financial interest in its subsidiary be
accounted for consistently.  SFAS No. 160 also requires that any
retained noncontrolling equity investment in the former subsidiary be initially
measured at fair value when a subsidiary is deconsolidated.  SFAS No.
160 also sets forth the disclosure requirements to identify and distinguish
between the interests of the parent and the interests of the noncontrolling
owners.  SFAS No. 160 applies to all entities that prepare
consolidated financial statements, except not-for-profit organizations, but will
affect only those entities that have an outstanding noncontrolling interest in
one or more subsidiaries or that deconsolidate a subsidiary.  SFAS No.
160 is effective for fiscal years, and interim periods within those fiscal
years, beginning on or after December 15, 2008.  Earlier adoption is
prohibited.  SFAS No. 160 must be applied prospectively as of the
beginning of the fiscal year in which it is initially applied, except for the
presentation and disclosure requirements.  The presentation and
disclosure requirements are applied retrospectively for all periods
presented.





The
Company does not believe that the adoption of the above recent pronouncements
will have a material effect on the Company’s consolidated results of operations,
financial position, or cash flows.





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





NOTE
2 ~ ACCOUNTS RECEIVABLE





Accounts
receivable, net, at December 31, 2008 and 2007 consists of trade receivables
from customers, less allowances for doubtful accounts, estimated future returns
and customer rebates and credits.





The
Company maintains an allowance for doubtful accounts receivables based primarily
on historical 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.





Allowance
for doubtful accounts activity during the years ended December 31, 2008 and 2007
was as follows:





2008
                  
                  
                  2007Beginning
      balance
                  
                  $
                  416
                  
                  
                  $
                  558Bad
      debt provisions
                  
                  
                  26
                  
                  
                  
                  171Account
      write-offs
                  
                  
                  (19
                  )
                  
                  
                  (329
                  )Recoveries
                  
                  
                  3
                  
                  
                  
                  16Ending
      Balance
                  
                  $
                  426
                  
                  
                  $
                  416





NOTE
3 ~ PROPERTY AND EQUIPMENT





Property
and equipment at December 31, 2008 and 2007 consists of the
following:


F-11





Useful Lives
                        in Years
                      
                      
                      2008
                      
                      
                      2007Furniture
      and fixtures
                      
                      
                      5-7
                      
                      
                      $
                      483
                      
                      
                      $
                      483Office
      and warehouse equipment
                      
                      
                      2-7
                      
                      
                      
                      206
                      
                      
                      
                      201Leasehold
      improvements
                      
                      
                      2-7
                      
                      
                      
                      168
                      
                      
                      
                      168Computer
      equipment and software
                      
                      
                      3-5
                      
                      
                      
                      818
                      
                      
                      
                      676Demo
      and sample equipment
                      
                      
                      1-2
                      
                      
                      
                      2
                      
                      
                      
                      21,677
                      
                      
                      
                      1,530Accumulated
      Depreciation
                      
                      
                      
                      
                      
                      
                      (1,519
                      )
                      
                      
                      (1,374
                      )$
                      158
                      
                      
                      $
                      156





NOTE
4 ~ CREDIT FACILITY





On
November 20, 2007, the Company entered into a Credit and Security Agreement with
Wells Fargo Bank, National Association under which the Company was provided with
a $15 million revolving credit facility. Borrowings under the credit facility
are secured by all of the Company’s assets. The Company also pays Wells Fargo an
annual fee equal to .25% of the average daily unused portion of the Facility.
Outstanding loans under the credit facility will become due on November 20,
2010. The Company’s borrowings under its credit facility as of December 31,
2008 and 2007, were approximately $9.9 million and $10.3 million,
respectively.  The Company has classified the note as a long-term
liability based upon management’s current projections of available borrowing
base and utilization.




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




·
            Subject
      to downward adjustment as provided below, interest accrues on
      outstanding loans under the credit facility, at our option, at a per annum
      rate equal to the prime rate from time to time in effect (3.25% at
      December 31, 2008) plus .75% percent, or a LIBOR rate selected by us, plus
      3.25%. In comparison, Laurus borrowings bore interest at a rate per annum
      equal to the prime rate plus two
percent.





·
            Aggregate
      loans (plus the face amount of letters of credit) outstanding under the
      credit facility at any time may not exceed the lesser of $15 million or a
      borrowing base equal to the sum of 85% of “Eligible Accounts” plus the
      lesser of (i) 60% of “Eligible Inventory” (valued at the lower of cost or
      market), (ii) 85% of the “Net Orderly Liquidation Value of Eligible
      Inventory,” and (iii) $8.5 million. In comparison, our Laurus borrowings
      could not exceed $10 million, with inventory based borrowings limited to
      $3.5 million.  As of December 31, 2008, the Company’s borrowing
      base supported approximately $14.6 million of borrowings, under the line
      of credit agreement, of which approximately $9.9 million was
      outstanding.





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





·
            The
      Company is required to comply with a number of affirmative, negative and
      financial covenants. Among other things, these covenants restrict the
      Company’s ability to pay dividends, requires the Company to achieve
      minimum quarterly Net Income as set forth in the Credit Agreement, and
      requires the Company to maintain a minimum Debt Service Coverage Ratio (as
      defined in the Credit Agreement) as of the last day of each quarter of not
      less than 1.25 to 1.0.  As of December 31, 2008, the Company was
      in compliance with all such
covenants.





In
addition, as a result of the Company generating Net Income (as defined in the
Credit Agreement), in excess of $1 million for the year ending December 31,
2008, interest rate under the credit facility will be reduced by .50% per annum
commencing within 30 days of Wells Fargo’s receipt of the Company’s financial
statements for the year ended December 31, 2008.


F-12





NOTE
5 ~LOAN
ORIGINATION FEES





Loan
origination fees consist of the following as of December 31, 2008 and 2007
respectively:





2008
                  
                  
                  2007Fees
                  
                  
                  97
                  
                  
                  $
                  2,192Amortization
                  
                  
                  (37
                  )
                  
                  
                  (2,099
                  )Net
                  
                  $
                  60
                  
                  
                  $
                  93





The
Company incurred and capitalized origination fees associated with the Wells
Fargo credit facility of approximately $97,000 in the year ended December 31,
2007. These fees are amortized into interest expense using the effective
interest method over the initial term of the loan of three years.





In prior
years, the Company incurred and capitalized origination and finders fees
associated with the Laurus credit facility of approximately $1.8 million. These
fees were amortized into interest expense using the effective interest method
over the initial term of the loan of three years. Included in the capitalized
origination fees is compensation of approximately $112,000 relating to the
issuance of warrants to purchase 20,680 shares of the Company’s Common Stock.
These fees were fully amortized in May 2007.





NOTE
6 ~CAPITALIZED LEASES





The
Company has entered into separate capital lease obligations in conjunction with
the acquisition of warehouse racking and office furniture. These assets have
original capitalized values of $519,000, and have payment terms ranging from 48
to 60 months.





Future
minimum lease payments under noncancelable capital lease obligations at December
31, 2008 were as follows:




2009
                      
                      $
                      12Less
      amounts relating to interest
                      
                      
                      -Total
      capital lease obligations
                      
                      
                      12Less
      current portion
                      
                      
                      12Capital
      lease obligations, noncurrent
                      
                      $
                      -





NOTE
7 ~ INCOME TAXES





The
Company’s provision for income tax expense (benefit) consists of the
following:





2008
                  
                  
                  2007FederalCurrentFederal
                  
                  $
                  35
                  
                  
                  $
                  22State
                  
                  
                  (7
                  )
                  
                  
                  20Total
      Current
                  
                  
                  28
                  
                  
                  
                  42DeferredFederal
                  
                  
                  686
                  
                  
                  
                  (832
                  )State
                  
                  
                  (9
                  )
                  
                  
                  (152
                  )Total
      Deferred
                  
                  
                  677
                  
                  
                  
                  (984
                  )Total
                  
                  $
                  705
                  
                  
                  $
                  (942
                  )


F-13





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





2008
                  
                  
                  2007Deferred
      tax assetsAccounts receivable
      allowances
                  
                  $
                  318
                  
                  
                  $
                  435Inventory reserve
                  
                  
                  1,134
                  
                  
                  
                  1,152Uniform capitalization of
      inventory costs
                  
                  
                  151
                  
                  
                  
                  132Other
                  
                  
                  35
                  
                  
                  
                  63Property
      and Equipment
                  
                  
                  716
                  
                  
                  
                  1,211Non
      Cash compensation
                  
                  
                  232
                  
                  
                  
                  138Net operating loss and credit
      carry-forward
                  
                  
                  868
                  
                  
                  
                  1,5083,454
                  
                  
                  
                  4,639Less:
      Deferred tax valuation allowance
                  
                  
                  (2,407
                  )
                  
                  
                  (2,411
                  )Deferred
      Tax Asset, net of valuation
                  
                  
                  1,047
                  
                  
                  
                  2,228Deferred
      tax liabilitiesProperty and
      equipment
                  
                  
                  (739
                  )
                  
                  
                  (1,244
                  )Net
                  
                  $
                  308
                  
                  
                  $
                  984





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





2008
                      
                      
                      2007Income
      tax at statutory rates (34%)
                      
                      $
                      660
                      
                      
                      $
                      577Permanent
      differences
                      
                      
                      59
                      
                      
                      
                      18State
      income tax expense – net of federal benefit
                      
                      
                      (10
                      )
                      
                      
                      (187
                      )Change
      in deferred tax valuation
                      
                      
                      (4
                      )
                      
                      
                      (6,941
                      )Reduction
      in NOL carry-forward due to change in ownership
                      
                      
                      -
                      
                      
                      
                      5,591Income
      tax (benefit) provision
                      
                      
                      705
                      
                      
                      
                      (942
                      )





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





The
Company incurred significant operating losses during the three years prior to
2007, which generated net operating loss carry-forwards which may be available
for future utilization. Internal Revenue Code Section 382 places a limitation on
the utilization of Federal net operating loss and other credit carry-forwards
when an ownership change, as defined by the tax law,
occurs.  Generally, this occurs when a greater than 50 percentage
point change in ownership occurs. In October 2006, as a result of the completion
of the Company’s private placement transaction, the investors in the private
placement as a group became the beneficial owners of approximately 96% of the
Company’s outstanding shares, after consideration of the conversion of
convertible promissory notes issued to those investors in conjunction with the
transaction. Accordingly, the actual utilization of net operating loss
carry-forwards and other deferred tax assets for tax purposes will be limited
annually under Code Section 382 to a percentage of the fair market value of the
Company at the date of this ownership change, and this effect has reduced the
amount of these loss carry-forwards which the Company will be able to utilize to
offset against future taxable income. As a result, at December 31, 2008,
the Company has a federal net operating loss carry-forward of approximately $2.1
million expiring 2026.  Approximately $0.6 million of the federal net
operating loss carry-forward is available for utilization in
2009.  The remaining $1.5 million can be utilized at a rate of
approximately $89,000 annually over the following 17 years ending
2026.  A partial valuation allowance has been provided against the net
deferred tax assets, due to the uncertainty of the Company’s ability to generate
long-term taxable income, particularly as it relates to the current economic
environment.  The company expects to reduce its valuation allowance if
and when it believes that it is more likely than not that it will be
realized.


F-14





Effective
January 1, 2007, the Company adopted Financial Accounting Standards Board
Interpretation No. 48, “Accounting for Uncertainty in Income Taxes (“FIN 48”)
—an interpretation of FASB Statement No. 109, Accounting for Income Taxes.” The
Interpretation addresses the determination of whether tax benefits claimed or
expected to be claimed on a tax return should be recorded in the financial
statements. Under FIN 48, the Company may recognize the tax benefit from an
uncertain tax position only if it is more likely than not that the tax position
will be sustained on examination by the taxing authorities, based on the
technical merits of the position. The tax benefits recognized in the financial
statements from such a position should be measured based on the largest benefit
that has a greater than fifty percent likelihood of being realized upon ultimate
settlement. FIN 48 also provides guidance on derecognition, classification,
interest and penalties on income taxes, accounting in interim periods and
requires increased disclosures. At the date of adoption, and as of December 31,
2008, the Company does not have a liability for unrecognized tax
benefits.





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





The
Company’s policy is to record interest and penalties on uncertain tax provisions
as income tax expense. As of December 31, 2008, the Company has no accrued
interest or penalties related to uncertain tax positions.





NOTE
8 ~ STOCKHOLDERS’ EQUITY





January
2007 Private Placement




On
January 22, 2007, the Company completed a private placement of 1,713,334 shares
of Common Stock at a price of $0.60 per share for aggregate gross consideration
of $1,028,000. The proceeds from the January private placement were used for
working capital and general corporate purposes.




NOTE
9 ~SIGNIFICANT VENDOR AGREEMENT




On
October 2, 2006, the Company entered into a Distribution Agreement (“Agreement”)
with Samsung, under which the Company was granted the right to distribute
Samsung’s complete line of professional video surveillance and security products
in North, Central and South America (“Territory”) through December 31, 2010.
Pursuant to the Agreement, Samsung has agreed to a limited non-compete in the
Territory. In November 2008, the Distribution Agreement was amended to lower the
minimum amounts the Company is  required to purchase from
Samsung.  As amended, the Agreement provides for minimum annual
purchase amounts of $27 million, $25 million, $32.4 million, and $42 million for
the years ending December 31, 2007, 2008, 2009, and 2010, respectively. Samsung
may terminate the Agreement at any time if the Company does not achieve the
annual minimum purchase amounts, as well as upon the Company’s breach of any of
its other obligations thereunder. For the years ended December 31, 2007, and
December 31, 2008, the Company exceeded its minimum purchasing commitment under
the agreement. For the years ended December 31, 2007 and December 31, 2008, the
Company purchased approximately $28 million and $26 million respectively under
the Distributorship Agreement with Samsung.




Samsung
has established a credit limit under which the Company purchases
products.  During the year ended 2007, the limit was approximately
$6.5 million.  In January 2008, the limit was increased to
approximately $10 million.  The Company must pay in advance of
shipment when the credit limit has been met or exceeded.  As of
December 31, 2008 and 2007, $7.1 million and $5.7 million, respectively, was due
to Samsung under this agreement.


F-15




NOTE
10 ~ 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.  For the years ended December 31, 2008 and
2007, no annual discretionary employer contributions were approved and
funded.





NOTE
11 ~ COMMITMENTS & CONTINGENCIES





General





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





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





Lease
and Rents





The
Company leases warehouse and office space under an operating lease agreement
which expires on 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 Company records rent on a
straight-line basis over the life of the lease and records the difference
between amounts paid and expense recorded as a deferred lease
liability.





The
minimum annual rentals under the non-cancelable lease for the periods subsequent
to December 31, 2008 are as follows ($ in thousands):





Years
      Ending December 31:
                        
                        Amount2009
                        
                        
                        250$
                        250





Rent
expense under operating leases was approximately $372,000 and $382,000 during
the years ended December 31, 2008 and 2007 respectively.





NOTE
12 ~ STOCK INCENTIVE PLANS





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





A summary
of the status and activity of the Company’s stock options is presented
below:





Years Ended December 31:2008
                  
                  
                  2007Shares
                  
                  
                  Weighted
                    Ave
                    Exercise
                    Price
                  
                  
                  Shares
                  
                  
                  Weighted
                    Ave
                    Exercise
                    PriceOutstanding
      at January 1:
                  
                  
                  5,962,218
                  
                  
                  $
                  1.04
                  
                  
                  
                  5,498,797
                  
                  
                  $
                  1.37Granted
                  
                  
                  160,000
                  
                  
                  $
                  0.50
                  
                  
                  
                  550,000
                  
                  
                  $
                  0.72Exercised
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (40,830
                  )
                  
                  $
                  0.20Forfeited
                  
                  
                  (80,000
                  )
                  
                  $
                  0.20
                  
                  
                  
                  (45,749
                  )
                  
                  $
                  33.77Outstanding
      at December 31:
                  
                  
                  6,042,218
                  
                  
                  $
                  1.06
                  
                  
                  
                  5,962,218
                  
                  
                  $
                  1.04Options
      Exercisable at December 31:
                  
                  
                  4,417,431
                  
                  
                  $
                  1.34
                  
                  
                  
                  2,867,122
                  
                  
                  $
                  1.88


F-16


The
aggregate intrinsic values of outstanding and exercisable shares at December 31,
2008 were $1,003,882 and $764,312, respectively.





The
weighted average fair value of options issued at date of grant using the fair
value based method during 2008 is estimated at $0.33.





The
following table summarizes information about stock options outstanding as of
December 31, 2008:





Outstanding
      Options
                      
                      Exercisable
      OptionsExercise
                        Prices
                      
                      Shares
                        Outstanding
                        at
      December
                        31,
      2008
                      
                      Weighted-average
                        Remaining
                        Contractual
      Life
                      
                      Number
                        Outstanding
                        at
      December
                        31,
      2008$  0.20
                      
                      
                      5,283,590
                      
                      7.8
      years
                      
                      
                      4,022,6930.46
                      
                      
                      110,000
                      
                      4.5
      years
                      
                      
                      18,3330.60
                      
                      
                      350,000
                      
                      4.1
      years
                      
                      
                      212,4990.80
                      
                      
                      150,000
                      
                      9.0
      years
                      
                      
                      69,1670.95
                      
                      
                      100,
      000
                      
                      9.0
      years
                      
                      
                      46,11115.93
                      
                      
                      4,637
                      
                      4.6
      years
                      
                      
                      4,63742.50
                      
                      
                      2,000
                      
                      6.3
      years
                      
                      
                      2,00075.00
                      
                      
                      13,366
                      
                      6.0
      years
                      
                      
                      13,366130.00
                      
                      
                      28,625
                      
                      5.1
      years
                      
                      
                      28,6256,042,218
                      
                      7.5
      years
                      
                      
                      4,417,431





The
Company recognized compensation expense from the vesting of issued stock options
of approximately $94,000 and $98,000 for the years ended December 31, 2008 and
2007 respectively.  The Company’s future compensation expense from
these stock options was approximately $158,000 on December 31, 2008, which vests
monthly over the next 38 months.





NOTE
13 ~ WARRANTS





A summary
of the status and activity of the Company’s outstanding warrants is presented
below:





Years Ended December 31:2008
                  
                  
                  2007Shares
                  
                  
                  Weighted
                    Ave
                    Exercise
                    Price
                  
                  
                  Shares
                  
                  
                  Weighted
                    Ave
                    Exercise
                    PriceOutstanding
      at January 1:
                  
                  
                  2,259,592
                  
                  
                  $
                  5.38
                  
                  
                  
                  2,009,723
                  
                  
                  $
                  5.98Issued
                  
                  
                  500,000
                  
                  
                  $
                  1.01
                  
                  
                  
                  250,000
                  
                  
                  $
                  0.73Exercised
                  
                  
                  (50,000
                  )
                  
                  $
                  0.20
                  
                  
                  
                  -
                  
                  
                  
                  -Expired
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (131
                  )
                  
                  $
                  390.00Outstanding
      at December 31:
                  
                  
                  2,709,592
                  
                  
                  $
                  4.67
                  
                  
                  
                  2,259,592
                  
                  
                  $
                  5.38


F-17


Summary
of the Company’s outstanding warrants at December 31, 2008 and 2007 are as
follows:





December 31, 2008
              
              
              December
                31, 2007Description
              
              Shares
              
              
              Approx.
                Remaining
                Term
                (Years)
              
              
              Exercise Price
              
              
              SharesLaurus
      Master Fund
              
              
              26,800
              
              
              
              2.5
              
              
              $
              30.00
              
              
              
              26,800Laurus
      finder’s fee
              
              
              1,880
              
              
              
              2.4
              
              
              $
              175.00
              
              
              
              1,880ESI
              
              
              60,000
              
              
              
              2.8
              
              
              $
              75.00
              
              
              
              60,000Rapor
      shareholders
              
              
              27,079
              
              
              
              2.9
              
              
              $
              152.00
              
              
              
              27,079Oct.
      2004 bridge financing
              
              
              15,333
              
              
              
              0.8
              
              
              $
              75.00
              
              
              
              15,333Consultant
              
              
              3,500
              
              
              
              0.8
              
              
              $
              175.00
      – $ 250.00
              
              
              
              3,500Consulting
      fee paid to director
              
              
              1,825,000
              
              
              
              0.8
              
              
              $
              0.20
              
              
              
              1,875,000Consultant
              
              
              100,000
              
              
              
              3.2
              
              
              $
              0.60
              
              
              
              100,000Consultant
              
              
              150,000
              
              
              
              3.8
              
              
              $
              0.82
              
              
              
              150,000Consultant
              
              
              300,000
              
              
              
              2.0
              
              
              $
              1.15
              
              
              
              -Consultant
              
              
              50,000
              
              
              
              4.6
              
              
              $
              0.60
              
              
              
              -Consultant
              
              
              150,000
              
              
              
              4.7
              
              
              $
              0.85
              
              
              
              -2,709,592
              
              
              
              
              
              
              
              
              
              
              
              2,259,592


F-18