GVI SECURITY SOLUTIONS INC - FORM 10-Q

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EX-31.2 - GVI SECURITY SOLUTIONS INC	v165745_ex31-2.htm
EX-32.1 - GVI SECURITY SOLUTIONS INC	v165745_ex32-1.htm
EX-32.2 - GVI SECURITY SOLUTIONS INC	v165745_ex32-2.htm
EX-31.1 - GVI SECURITY SOLUTIONS INC	v165745_ex31-1.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended September 30, 2009

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

For the transition period from __________ to __________

Commission file number: 0-21295

GVI Security Solutions, Inc.

(Exact name of registrant as specified in its charter)

Delaware	77-0436410
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

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

(972) 245-7353

(Registrant’s telephone number, including area code)

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

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

þ Yes ¨ No

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

¨ Yes ¨ No

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

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

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

¨ Yes þ No

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

GVI Security Solutions, Inc.

FORM 10-Q

TABLE OF CONTENTS

PART I. FINANCIAL INFORMATION	3
Item 1. Financial Statements	3
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	17
Item 3. Quantitative and Qualitative Disclosures About Market Risk	24
Item 4T. Controls and Procedures	24

PART II. OTHER INFORMATION	25
Item 1. Legal proceedings	25
Item 1A. Risk Factors	25
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	26
Item 6. Exhibits	26

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements.

GVI Security Solutions, Inc.

Condensed Consolidated Balance Sheets

(In thousands, except share and per share amounts)

	September 30, 2009			December 31, 2008
	(Unaudited)
ASSETS:

Current Assets
Cash and equivalents	$	67		$	46
Accounts receivable, net of allowances for doubtful accounts of $411 and $426, respectively		8,036			7,129
Inventory, net		11,212			15,249
Deferred Tax Assets, Current		738			869
Prepaid and other current assets		1,494			920
Total Current Assets		21,547			24,213

Property and Equipment, net of accumulated depreciation of $1,579 and $1,520 respectively		105			158
Deferred tax assets, non-current		532			178
Deferred loan origination fee, net		37			61
Other assets		72			51
Total Assets	$	22,293		$	24,661

LIABILITIES AND STOCKHOLDERS' EQUITY:
Current Liabilities
Accounts payable to primary supplier	$	5,426		$	7,132
Other trade accounts payable		1,199			1,105
Accrued expenses		2,179			1,799
Capitalized lease obligations, current		-			12
Total Current Liabilities		8,804			10,048

Deferred tax liability, non-current		739			739
Revolving credit facility		8,551			9,862
Total Liabilities		18,094			20,649

Commitments and Contingencies

Stockholders' Equity
Preferred stock, undesignated, $.001 par value, 3,000,000 shares authorized, none issued or outstanding		-			-
Common stock, $.001 par value, 200,000,000 shares authorized, 28,197,106 shares issued at September 30, 2009 and December 31, 2008		28			28
Shares held in treasury, 971,794 at September 30, 2009		(246	)		-
Additional paid-in capital		34,888			34,826
Accumulated deficit		(30,471	)		(30,842	)
Total Stockholders' Equity		4,199			4,012
Total Liabilities and Stockholders' Equity	$	22,293		$	24,661

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

GVI Security Solutions, Inc.

Condensed Consolidated Statements of Operations

(unaudited)

(in thousands, except per share amounts)

	Three Months Ended September 30				Nine Months Ended September 30
	2009		2008		2009		2008

Revenues	$	11,989	$	12,229	$	34,083	$	36,393

Cost of Revenues		8,594		8,559		24,276		25,496

Gross Profit		3,395		3,670		9,807		10,897

Selling, General and Administrative Expenses		3,094		2,989		8,903		8,699

Operating Income		301		681		904		2,198

Interest Expense		115		176		351		559

Income before income taxes		186		505		553		1,639

Income Tax		102		251		182		690

Net Income	$	84	$	254	$	371	$	949

Basic income per common share:
Net income per common share	$	0.00	$	0.01	$	0.01	$	0.03
Weighted average common shares outstanding		27,225,313		28,197,107		27,646,431		28,177,070

Diluted net income per common share:
Net income per common share	$	0.00	$	0.01	$	0.01	$	0.03
Weighted average common shares outstanding		27,965,413		32,265,182		29,559,847		33,238,644

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

GVI Security Solutions, Inc.

Condensed Consolidated Statements of Cash Flows

(unaudited)

(In thousands)

	Nine Months Ending September 30,
	2009			2008
Cash Flows Provided by Operating Activities
Net Income	$	371			949
Adjustments to Reconcile Net Income to Net Cash Used In Operating Activities:
Depreciation and amortization		60			125
Amortization of deferred loan origination fee		24			24
Compensation costs and expenses for stock and options issued		61			210
Changes in Assets and Liabilities:
Accounts receivable, net		(907	)		(1,207	)
Inventory		4,037			(152	)
Prepaid and other current assets		(575	)		450
Other Assets, non-current		(20	)		-
Deferred tax assets and liabilities, net		(224	)		653
Accounts payable		(1,612	)		247
Accrued expenses		381			6
Net cash provided by operating activities		1,596			1,305

Cash Flows Used In Investing Activities
Purchase of property and equipment		(7	)		(145	)

Net Cash Used In Investing Activities		(7	)		(145	)

Cash Flows Used in Financing Activities
Issuance of common stock upon exercise of warrants		-			10
Payments for purchase of treasury stock		(246	)		-
Net payments for revolving credit facility		(1,310	)		(1,406	)
Principal payments of capitalized lease obligations		(12	)		(45	)

Net Cash Used in Financing Activities		(1,568	)		(1,441	)

Net increase (decrease) in cash and equivalents		21			(282	)
Cash and equivalents, beginning of period		46			313
Cash and equivalents, end of period	$	67			31

SUPPLEMENTARY CASH FLOW INFORMATION
Cash paid for interest	$	115			579
Cash paid for income taxes		95			61

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

GVI Security Solutions, Inc.

Notes to Condensed Consolidated Financial Statements (unaudited)

Nine Months Ended September 30, 2009 and 2008

NOTE 1 ~ SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Nature of Business

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

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

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

Basis of Presentation

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

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

Principles of Consolidation

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

Revenue Recognition

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

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

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

Inventory

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

Advertising

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

Income Taxes

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

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

Credit Risk Concentration

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

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

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

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

Use of Estimates

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

Earnings per Share

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

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

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

	Three Months Ended September 30,				Nine Months Ended September 30,
	2009		2008		2009		2008
Numerator
Net income, as reported	$	84	$	254	$	371	$	949

Denominator
Weighted average common shares outstanding, basic		27,225		28,197		27,646		28,177
Effect of dilutive securities:
Warrants		191		1,065		497		1,310
Common stock options		549		3,003		1,416		3,751
Weighted average common shares outstanding, dilutive		27,965		32,265		29,560		33,238

Earnings per share – basic
Net income (loss), as reported	$	0.00	$	0.01	$	0.01	$	0.03

Earnings per share – dilutive
Net income (loss), as reported	$	0.00	$	0.01	$	0.01	$	0.03

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

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

Stock-Based Compensation

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

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

	Nine Months Ended September 30,
	2009			2008

Dividend yield		-			-
Risk-free factors		4.0	%		4.0	%
Volatility factors		63	%		63	%
Option Lives in Years		6.0			6.0

Recent Accounting Pronouncements

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

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

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

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

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

NOTE 2 ~ CREDIT FACILITY

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

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

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

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

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

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

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

NOTE 3 ~ INCOME TAXES

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

	Three Months Ended September 30:						Nine Months Ended September 30:
	2009			2008			2009			2008

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

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

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

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

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

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

NOTE 4 ~ COMMITMENTS & CONTINGENCIES

General

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

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

Lease and Rents

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

Vendor Agreement

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

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

Software Purchase Agreement

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

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

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

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

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

NOTE 5 ~ 2004 STOCK INCENTIVE PLAN

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

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

	Nine Months Ended September 30, 2009
	Shares		Weighted Ave Exercise Price

Outstanding at January 1, 2009:		6,042,218	$	1.06
Granted		-		-
Exercised		-		-
Forfeited		100,000	$	0.80
Outstanding at September 30, 2009:		5,942,218	$	1.07

Options Exercisable at September 30, 2009:		5,459,715	$	1.19

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

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

Outstanding Options				Exercisable Options
Exercise Prices	Shares Outstanding at September 30, 2009		Weighted-average Remaining Contractual Life	Number Outstanding at September 30, 2009
$ 0.20		5,283,590	7.0 years		4,953,366
.46		110,000	3.7 years		73,333
.60		350,000	2.4 years		295,416
.80		50,000	8.2 years		27,416
.95		100,000	8.2 years		61,556
15.93		4,637	3.8 years		4,637
42.50		2,000	5.5 years		2,000
75.00		13,366	5.2 years		13,366
> 130.00		28,625	4.3 years		28,625
		5,942,218	6.7 years		5,459,715

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

NOTE 6 ~ WARRANTS

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

	Nine Months Ended September 30, 2009
	Shares		Weighted Ave Exercise Price

Outstanding at January 1, 2009:		2,709,592	$	4.67
Granted		-		-
Exercised		-		-
Forfeited		-		-
Outstanding at September 30, 2009		2,709,592	$	4.67

Exercisable at September 30, 2009:		2,634,592	$	4.78

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

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

Description	Shares		Approx. Remaining Term (Years)		Exercise Price

Laurus Master Fund		26,800		1.6	$	30.00
Laurus finder’s fee		1,880		1.6	$	175.00
ESI		60,000		2.1	$	75.00
Rapor shareholders		27,079		2.1	$	152.00
Oct. 2004 bridge financing		15,333		0.1	$	75.00
Consultant		3,500		0.1	$	175.00 – $ 250.00
Consulting fee paid to director		1,825,000		3.0	$	0.20
Consultant		100,000		2.5	$	0.60
Consultant		150,000		3.0	$	0.82
Consultant		300,000		1.2	$	1.15
Consultant		50,000		3.8	$	0.60
Consultant		150,000		3.9	$	0.85
		2,709,592

NOTE 7 ~ STOCK REPURCHASE PLAN

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

NOTE 8 ~ SUBSEQUENT EVENTS

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

Proposed Merger

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

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

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

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

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

Stockholder Litigation

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

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

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

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

Summary of Our Business

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

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

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

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

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

Our Products

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

Strategies

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

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

Distribution and Marketing

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

Proposed Merger

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

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

NET REVENUES

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

COST OF GOODS SOLD

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

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

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES

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

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

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

INTEREST EXPENSE

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

INCOME TAX EXPENSE

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

NET INCOME

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

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

NET REVENUES

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

COST OF GOODS SOLD

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

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

SELLING, GENERAL AND ADMINISTRATIVE EXPENSES

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

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

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

INTEREST EXPENSE

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

INCOME TAX EXPENSE

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

NET INCOME

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

LIQUIDITY AND CAPITAL RESOURCES

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

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

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

$15 Million Wells Fargo Revolving Credit Facility

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

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

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

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

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

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

Software Purchase Agreement

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

CRITICAL ACCOUNTING POLICIES AND ESTIMATES

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

Revenue Recognition

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

Inventory

Advertising

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

Long-Lived Assets

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

Income Taxes

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

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

Stock-Based Compensation

Determining the appropriate fair value model and calculating the fair value of stock-based payment awards require the input of highly subjective assumptions, including the expected life of the stock-based payment awards and stock price volatility. We use the Black-Scholes option-pricing model to value compensation expense. The assumptions used in calculating the fair value of stock-based payment awards represent management’s best estimates, but the estimates involve inherent uncertainties and the application of management judgment. As a result, if factors change and we use different assumptions, our stock-based compensation expense could be materially different in the future.

New Accounting Pronouncements

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

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

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

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

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Foreign Currency Exchange Risk

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

Interest Rate Sensitivity

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

Item 4T. Controls and Procedures.

Evaluation of Disclosure Controls and Procedures

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

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

Changes in Internal Control Over Financial Reporting

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

PART II. OTHER INFORMATION

Item 1. Legal proceedings

Item 1A. Risk Factors

In addition to the risk factor set forth below, the “Risk Factors” discussed in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2008, could materially affect our business, financial condition and future results. The risks described in this report and in the Annual Report on Form 10-K are not the only risks we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.

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

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

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

•

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

•

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

•

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

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

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

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

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

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

Item 6. Exhibits.

Number		Description

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

31.2		Certification of Joseph Restivo, Chief Financial Officer of the Registrant, pursuant to Rules 13a-14(a) and 15(d)-14(a) of the Securities Exchange Act of 1934

32.1		Certification of Steven Walin, Chief Executive Officer of the Registrant, pursuant to Rules 13a-14(B) and 15(d)-14(b) of the Securities Exchange Act of 1934

32.2		Certification of Joseph Restivo, Chief Financial Officer of the Registrant, pursuant to Rules 13a-14(B) and 15(d)-14(b) of the Securities Exchange Act of 1934

SIGNATURES

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

	GVI SECURITY SOLUTIONS, INC.

Date: November 13, 2009	By:	/s/ Joseph Restivo
		Name: Joseph Restivo Title: Chief Financial Officer

EXHIBIT INDEX

Number		Description

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

31.2		Certification of Joseph Restivo, Chief Financial Officer of the Registrant, pursuant to Rules 13a-14(a) and 15(d)-14(a) of the Securities Exchange Act of 1934

32.1		Certification of Steven Walin, Chief Executive Officer of the Registrant, pursuant to Rules 13a-14(B) and 15(d)-14(b) of the Securities Exchange Act of 1934

32.2		Certification of Joseph Restivo, Chief Financial Officer of the Registrant, pursuant to Rules 13a-14(B) and 15(d)-14(b) of the Securities Exchange Act of 1934

GVI SECURITY SOLUTIONS INC - FORM 10-Q - November 13, 2009

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