(Address,
including zip code, and telephone number,
including
area code, of registrant’s principal executive offices)
Securities
registered pursuant to Section 12(b) of the Act: None
Securities
registered pursuant to Section 12(g) of the Act: Common Stock
$0.001
par value
Indicate
by check mark whether 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 Exchange 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 Exchange Act during the past 12 months
(or
for such shorter period that the registrant was required to file such reports),
and (2) has been subject to such filing requirements for the past 90
days.
þ
Yes
¨
No
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. ¨
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated files. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one):
Large
accelerated filer ¨
Accelerated
filer ¨
Non-accelerated
filer þ
Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act.) ¨
Yes
þ
No
The
aggregate market value of the voting and non-voting common equity held by
non-affiliates of the registrant as of June 30, 2006 was approximately
$8,632,050. The number of shares outstanding of the registrant’s Common Stock as
of March 23, 2007 was 28,006,164.
GVI
SECURITY SOLUTIONS, INC.
2006
FORM 10-K ANNUAL REPORT
TABLE
OF CONTENTS
Page
PART
I
2
Item
1. Business
2
Item
1A. Risk Factors
6
Item
1B. Unresolved Staff Comments
12
Item
2. Properties
12
Item
3. Legal Proceedings
12
Item
4. Submission of Matters to a Vote of Security Holders
12
PART
II
Item
5. Market for Registrant’s Common Equity, Related Stockholder Matters and
Issuer Purchases of Equity Securities
13
Item
6. Selected Financial Data
14
Item
7. Management’s Discussion and Analysis of Plan of
Operation
15
Item
7A. Quantitative and Qualitative Disclosures about Market
Risk
26
Item
8. Financial Statements and Supplementary Data
26
Item
9. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure
27
Item
9A. Controls and Procedures
27
Item
9B. Other Information
27
PART
III
Item
10. Directors, Executive Officers and Corporate Governance
27
Item
11. Executive Compensation
29
Item
12. Security Ownership of Certain Beneficial Owners and Management
and
Related Stockholder Matters
38
Item
13. Certain Relationships and Related Transactions, and Director
Independence
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
Through
our subsidiaries, we provide 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.
We
provide
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.
Our
customers include distributors and system integrators that specialize in video
surveillance and security products and services, government agencies and private
sector businesses. Our technology is available to the United States Government
through a General Services Administration (GSA) contract.
Historically,
Samsung Electronics has been the primary supplier of the security products
that
we distribute. We previously sold Samsung’s products under an agreement with
Samsung that gave us the exclusive right to sell its products to the
professional channel and to a major national retailer. Our
exclusive agreement to distribute Samsung products to this retailer expired
on
December 31, 2005, and Samsung terminated our exclusive right to sell to the
professional market in January 2006. As a result of the termination of this
agreement and the decline in sales of our products in the retail channel, we
discontinued sales of security products to the retail channel. We continue
to
sell Samsung security products to the professional market, and 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.
We
operate sales and distribution centers in Dallas, Texas, Mexico City, Mexico,
Sao Paulo, Brazil and Bogotá, Colombia.
Corporate
History
We
were
incorporated in Delaware in August 1996 as Thinking Tools, Inc. and initially
engaged in developing and marketing business simulation software. In April
1999,
we eliminated substantially all of our operations and terminated substantially
all of our personnel. In March 2000, we acquired the business of an Internet
software and service provider. This business did not generate sufficient
revenues to support our operations and was discontinued in December 2000.
From
December 2000 until February 20, 2004, we had no active business. On February20, 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 April12, 2004, we changed our name to GVI Security Solutions, Inc.
On
December 1, 2004, we acquired Rapor, Inc. in a merger for shares of our Common
Stock. Rapor designs and manufactures high security building access portals.
Management has concluded that the Rapor product
2
line
no
longer fits our existing distribution channels and market strategy and,
accordingly, during the third quarter of 2006,
wrote-off goodwill, trademarks and technology associated with this product
line.
We are currently evaluating opportunities to dispose of our Rapor products,
and
have discussed the licensing and/or sale of this business line with several
parties.
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 25,000 shares
of
Common Stock and a 6% Subordinated Secured Convertible Promissory Note in the
principal amount of $45,000, convertible into 225,000 shares of Common Stock
at
a conversion price equal to $.20. 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).
Security
Systems Markets
According
to a recent industry report, the combined market for the world video
surveillance market totaled approximately $4.1 billion in 2003, and is estimated
to grow to approximately $8.6 billion by the year 2010. According to this
report, the global security market is expected to continue to grow at an average
annual rate in excess of 9%, with the primary components of this growth being
electronic integrated security systems. We believe that video surveillance
products represent the largest components of a typical integrated security
system. The industry continues to see significant growth throughout the world
fueled by increased fear of terrorism and crime, heightened expectation of
safety in public places and institutions, and higher expectations of
performance, reliability and architectural appeal.
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 meet the specific needs of the end user. Our goal is to
provide our customers with excellent service and superior technology at
competitive prices. Our customers consist of wholesale distributors as well
as
security system installers and IT integrators.
We
believe that by delivering the highest levels of customer service, we can
strengthen our reputation as a reliable and cost-effective provider in the
electronic security systems industry and develop customer loyalty. We strive
to
anticipate and meet our customers’ needs by increasing the range of products and
services we offer by entering into new business alliances and by pursuing
acquisitions of complementary businesses enabling us to offer new products
and
services. Our goals include further developing our expertise and products in
the
digital video recording sector, as well as developing other products and
services to supplement and complement our existing product line, with a focus
on
increasing sales of our products in the Professional Channel, which typically
generate higher gross margins than Retail Channel sales, which we recently
discontinued. Further, we intend to grow our business by expanding and
diversifying our distribution channels and capitalizing on domestic and
international expansion opportunities.
Our
growth strategy also includes identifying and acquiring businesses engaged
in
similar or complementary industries. However, there can be no assurance that
we
will consummate any additional acquisitions
3
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.
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 black and white and color cameras, which include motion
detection, low light day/night and high resolution, all with systems
integration capabilities
·
a
range of waterproof and weather resistant
cameras
·
high
speed, remote controlled, dome and pinhole cameras and
casings
·
a
complete range of lenses
·
a
range of black and white, color, plasma and flat screen
monitors
·
real
time and time lapse videocassette and digital recorders and hard
disk
recorders
·
video
transmission equipment
·
digital
video processors and recorders, switchers and video management
systems
·
digital
video recording software
·
hardware
and software which enable intelligent video
surveillance.
We
rely
on original equipment manufacturer relationships for a number of our standard
products. In some instances, we purchase products that meet our specifications
from a manufacturer and distribute these products under the 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 Bogotá, 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 who often support
4
sales
across all of our product offerings. We use a combination of our internal sales
force and independent representatives to sell our products to dealers and
systems integrators.
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.
We
believe that the range of our product and service offerings and our distribution
channels enable us to compete favorably in the market for the security products
and services that we offer. However, some of our competitors have greater name
recognition, longer operational histories and greater financial, marketing
and
managerial resources than we do.
The
key
factors which drive competition in the video surveillance and security industry
are price, quality, product performance, ease of integration and customer
service and support. There are a number of distributors of highly sophisticated,
technologically advanced security components. Very few of these distributors,
however, offer fully integrated security suites that can be customized to meet
the specific needs of the end user. We believe that we have distinguished
ourselves in this market by providing our customers with superior levels of
customer service. Our main competitors are Pelco, Sony, Panasonic and Speco
Technologies, among many others.
In
addition, Samsung Techwin, a company distinct 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 United States through Samsung 360, a competitor
of ours.
Strategic
Vendor Relationship
Historically,
Samsung Electronics has been our primary supplier for the security products
that
we distribute. For the years ended December 31, 2006, 2005 and 2004, 67%, 50%
and 68%, respectively, of our revenues (excluding revenues from discontinued
operations), were attributable to products manufactured by Samsung whose
products we sold under an agreement that gave us the exclusive right to sell
its
products in the Professional Channel and the exclusive right to sell its
products in the Retail Channel to a major national retailer. Our exclusive
right
to sell Samsung products to the major national retailer expired on December31,2005, and Samsung terminated the remaining portion of its agreement with us
in
January 2006. Samsung was entitled to terminate the distribution agreement
because we did not purchase the minimum amounts required to be purchased
thereunder during the 2005 calendar year. Following the termination of our
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 been granted 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. The Distributorship Agreement provides for minimum annual
purchase amounts of $21 million and $27 million for the years ending December31, 2006 and 2007, 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 December31, 2006, we purchased approximately $21.3 million under the Distributorship
Agreement with Samsung.
We
are
also a party to distribution arrangements with other high technology
manufacturers who supply us with other products such as digital video recorders,
and internet and networking products.
5
Intellectual
Property
We
have
several registered trademarks for “GVI” in connection with the products we
sell.
Employees
As
of
March 23, 2007, we had approximately 42 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.
Item
1A. Risk Factors.
RISKS
RELATED TO OUR INDUSTRY AND OUR BUSINESS
THE
REPORT OF OUR INDEPENDENT AUDITORS ON OUR FINANCIAL STATEMENTS CONTAINS AN
EXPLANATORY PARAGRAPH ON OUR ABILITY TO CONTINUE AS A GOING
CONCERN.
The
report of our independent auditors contains an explanatory paragraph raising
substantial doubt about our ability to continue as a going concern because
of
our history of operating losses and limited capital resources. Our financial
statements do not include any adjustments that might result from the outcome
of
this uncertainty. We have taken steps to reduce our costs and increase sales
of
our professional products. Although we completed financings in October 2006
and
January 2007 raising approximately $6,028,000 of aggregate gross proceeds,
if we
are not successful in improving our operating results in the near term we may
need to raise additional capital to finance our operations and sustain our
business model. We may not be able to obtain additional financing on acceptable
terms, or at all. In addition, any financing we obtain in the future may result
in dilution to our existing stockholders.
WE
CONTINUE TO EXPERIENCE OPERATING LOSSES AND MAY INCUR ADDITIONAL OPERATING
LOSSES IN THE FUTURE.
We
incurred a net loss of approximately $16.5 million for the year ended December31, 2006, as well as net losses of approximately $13.0 million and $7.2 million
for the years ended December 31, 2005 and 2004, respectively. Our net losses
have primarily resulted from increased administrative, accounting, finance
and
legal costs following our February 2004 merger, write-downs of both retail
and
professional channel inventory, returns of retail products previously sold
by
us, and write downs of goodwill and other assets associated with our Rapor
products. Our 2006 loss included a $4.5 million non-cash charge from a
beneficial conversion feature from a convertible note. We will not be profitable
in the future unless we increase sales of our products and reduce our costs.
Although we are taking steps to reduce our costs and increase sales of our
products and have discontinued sales of retail products to focus on our higher
margin professional products, there can be no assurance that we will be
profitable in the future.
WE
HAVE DISCONTINUED SALES OF OUR PRODUCTS IN THE RETAIL CHANNEL, WHICH PREVIOUSLY
CONSTITUTED A SIGNIFICANT PORTION OF OUR SALES.
Historically,
sales of our products in the Retail Channel have accounted for a large portion
of our revenues. For the years ended December 31, 2005, 2004 and 2003, 25%,
46%
and 56% of our revenues, including revenues from discontinued operations, were
from sales in the Retail Channel. However, over the last three quarters of
2005,
we had nominal sales of our products in the Retail Channel. Among other reasons,
the decline in sales of our retail products resulted from the replacement of
our
products by the major national retailer that accounted for substantially all
of
our Retail Channel sales, with those manufactured by a competitor. In addition,
our exclusive agreement to distribute Samsung products in the Retail Channel
to
this retailer expired on December 31, 2005. As a result, in the first quarter
of
2006 our board of directors approved the discontinuance of our sales to the
Retail Channel so that we can focus our efforts on sales to the Professional
Channel.
6
A
SUBSTANTIAL PORTION OF OUR BUSINESS HAS BEEN 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, 2006, 2005 and 2004, 67%, 50%
and 68%, respectively, of our revenues (excluding revenues from discontinued
operations) were attributable to products manufactured by Samsung, whose
products we sold under an exclusive distribution agreement. Our
exclusive agreement to distribute Samsung products in the Retail Channel to
a
major national retailer expired on December 31, 2005, and Samsung
terminated the remaining portion of its agreement with us in January 2006.
Samsung was entitled to terminate the distribution agreement because we did
not
purchase the minimum amounts required to be purchased thereunder during the
2005
calendar year. Following the termination of our 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 been granted 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. 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 again 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.
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 with respect to amounts owed by us to Samsung for products
purchased by us from Samsung. 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. During
the third quarter of 2006, Samsung suspended shipment of products to us as
a
result of a reduction in our credit limit, causing us to maintain lower levels
of inventory during the remainder of the year, negatively impacting our sales
during the third and fourth quarter of 2006. In
conjunction with our new agreement with Samsung that we entered into on October2, 2006, and our payment of $3 million for past-due amounts, Samsung resumed
shipments to us. However,
in the future, 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.
IF
WE ARE UNABLE TO RESPOND TO THE RAPID TECHNOLOGICAL CHANGES IN OUR INDUSTRY
AND
CHANGES IN OUR CUSTOMERS' REQUIREMENTS AND PREFERENCES, OUR BUSINESS, FINANCIAL
CONDITION AND RESULTS OF OPERATIONS COULD BE MATERIALLY ADVERSELY
AFFECTED.
If
we are
unable, for technological, legal, financial or other reasons, to adapt in a
timely manner to changing market conditions or customer requirements, we could
lose customers and market share. The electronic security systems industry is
characterized by rapid technological change. Sudden changes in customer
requirements and preferences, the frequent introduction of new products and
services embodying new technologies and the emergence of new industry standards
and practices could render our existing products, services and systems obsolete.
The emerging nature of products and services in the electronic security systems
industry and their rapid evolution will require that we continually improve
the
performance, features and reliability of our products and services. Our success
will depend, in part, on our ability:
·
to
enhance our existing products and
services;
·
to
anticipate changing customer requirements by designing, developing,
and
launching new products and services that address the increasingly
sophisticated and varied needs of our current and prospective customers;
and
·
to
respond to technological advances and emerging industry standards
and
practices on a cost-effective and timely
basis.
7
The
development of additional products and services involves significant
technological and business risks and requires substantial expenditures and
lead
time. If we fail to introduce products with new technologies in a timely manner,
or adapt our products to these new technologies, our business, financial
condition and results of operations will be adversely affected. We cannot assure
you that even if we are able to introduce new products or adapt our products
to
new technologies that our products will gain acceptance among our customers.
In
addition, from time to time, we or our competitors may announce new products,
product enhancements or technological innovations that have the potential to
replace or shorten the life cycles of our products and that may cause customers
to defer purchasing our existing products, resulting in inventory
obsolescence.
WE
MAY NOT BE ABLE TO MAINTAIN OR IMPROVE OUR COMPETITIVE POSITION BECAUSE OF
STRONG COMPETITION IN THE ELECTRONIC SECURITY SYSTEMS INDUSTRY, AND WE EXPECT
THIS COMPETITION TO CONTINUE TO INTENSIFY.
The
electronic security systems industry is highly competitive and has become more
so over the last several years as security issues and concerns have become
a
primary consideration at both government and private facilities worldwide.
Competition is intense among a wide range and fragmented group of product and
service providers, including electronic security equipment manufacturers,
distributors, providers of integrated security systems, systems integrators,
consulting firms and engineering and design firms and others that provide
competitive systems or individual elements of a system. Some of our competitors
are larger than us and possess significantly greater name recognition, assets,
personnel, sales and financial resources. These entities may be able to respond
more quickly to changing market conditions by developing new products and
services that meet customer requirements or are otherwise superior to our
products and services and may be able to more effectively market their products
than we can because they have significantly greater financial, technical and
marketing resources than we do. They may also be able to devote greater
resources to the development, promotion and sale of their products than we
can.
Increased competition could require us to reduce our prices, result in our
receiving fewer customers orders, and result in our loss of market share. We
cannot assure you that we will be able to distinguish ourselves in a competitive
market. To the extent that we are unable to successfully compete against
existing and future competitors, our business, operating results and financial
condition would be materially adversely affected.
WE
DEPEND ON OUR MANUFACTURERS, SOME OF WHICH ARE OUR SOLE SOURCE FOR SPECIFIC
PRODUCTS. OUR BUSINESS AND REPUTATION WOULD BE SERIOUSLY HARMED IF THESE
MANUFACTURERS FAIL TO SUPPLY US WITH THE PRODUCTS WE REQUIRE AND ALTERNATIVE
SOURCES ARE NOT AVAILABLE.
We
have
relationships with a number of manufacturers for the supply of our products.
Our
success depends in part on whether our manufacturers are able to fill the orders
we place with them and in a timely manner. If any of our manufacturers fail
to
satisfactorily perform their contractual obligations or fill purchase orders
we
place with them, we may be required to pursue replacement manufacturer
relationships. If we are unable to find replacements on a timely basis, or
at
all, we may be forced to either temporarily or permanently discontinue the
sale
of certain products and associated services, which could expose us to legal
liability, loss of reputation and risk of loss or reduced profit. Although
we
continually evaluate our relationships with our manufacturers and plan for
contingencies if a problem should arise with a manufacturer, finding new
manufacturers that offer a similar type of product would be a complicated and
time consuming process and we cannot assure you that if we ever need to find
a
new manufacturer for certain of our products we would be able to do so on a
completely seamless basis, or at all. Our business, results of operation and
reputation would be adversely impacted if we are unable to provide our products
to our customers in a timely manner.
WE
HAVE SUBSTANTIAL INDEBTEDNESS TO LAURUS MASTER FUND SECURED BY SUBSTANTIALLY
ALL
OF OUR ASSETS. IF AN EVENT OF DEFAULT OCCURS UNDER THE SECURED NOTES ISSUED
TO
LAURUS, LAURUS MAY FORECLOSE ON OUR ASSETS AND WE MAY BE FORCED TO CURTAIL
OUR
OPERATIONS OR SELL SOME OR ALL OF OUR ASSETS TO REPAY THE
NOTES.
On
May27, 2004, we borrowed $15,000,000 from Laurus pursuant to secured promissory
notes and related agreements. Our indebtedness to Laurus as of December 31,2006
was approximately $8.3 million. The notes and agreements provide for the
following events of default (among others):
8
·
failure
to pay interest and principal when
due,
·
an
uncured breach by us of any material covenant, term or condition
in any of
the notes or related agreements,
·
a
breach by us of any material representation or warranty made in any
of the
notes or in any related agreement,
·
any
money judgment or similar final process is filed against us for more
than
$250,000, and
·
any
form of bankruptcy or insolvency proceeding is instituted by or against
us, and
·
our
Common Stock is suspended from our principal trading market for five
consecutive days or five days during any ten consecutive
days.
Upon
the
occurrence of an event of default under our agreements with Laurus, Laurus
may
enforce its rights as a secured party and we may lose all or a portion of our
assets, be forced to materially reduce our business activities or cease
operations. In addition, our obligations to Laurus become due on December 31,2007. We will not be able to repay our obligations to Laurus at maturity unless
we receive replacement financing or extend our current financing. There can
be
no assurance that we will be able to obtain such financing.
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 new management
team, consisting of Steven Walin, our Chief Executive Officer, and Joseph
Restivo, our Chief Financial Officer, both of whom joined us in March 2006.
Mr.
Walin and Mr. Restivo are each a party to an employment agreement with us that
expires in March 2009. There is significant competition in our industry for
qualified managerial, technical and sales personnel and we cannot assure you
that we will be able to retain our key senior managerial, technical and sales
personnel or that we will be able to attract, integrate and retain other such
personnel that we may require in the future.We
also
cannot assure you that our employees will not leave and subsequently compete
against us. If we cannot work together effectively to overcome any operational
challenges that arise during the integration process, if our new management
team
cannot master the details of our business and our market or if we are unable
to
attract and retain key personnel in the future, our business, financial
condition and results of operations could be adversely affected.
WE
RELY ON INDEPENDENT DEALERS AND DISTRIBUTORS TO SELL OUR PRODUCTS. DISRUPTION
TO
THIS DISTRIBUTION CHANNEL WOULD HARM OUR BUSINESS.
Because
we sell a significant portion of our products to independent dealers and
distributors, we are subject to many risks, including risks related to their
inventory levels and support for our products. In particular, if dealers and
distributors do not maintain sufficient levels of inventory to meet customer
demand, our sales could be negatively impacted.
Our
dealers and distributors also sell products offered by our competitors. If
our
competitors offer our dealers and distributors more favorable terms, those
dealers and distributors may de-emphasize or decline to carry our products.
In
the future, we may not be able to retain or attract a sufficient number of
qualified dealers and distributors. If we are unable to maintain successful
relationships with dealers and distributors or to expand our distribution
channels, our business could suffer.
9
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 or other assets associated with
acquisitions;
·
potential
disputes with sellers of acquired businesses, technologies, services
or
products; and
·
dilution
to stockholders if we issue securities in any
acquisition.
Moreover,
performance problems with an acquired business, technology, product or service
could also have a material adverse impact on our reputation as a whole. In
addition, any acquired business, technology, product or service could
significantly under-perform relative to our expectations, and we may not achieve
the benefits we expect from our acquisitions. For all these reasons, our pursuit
of an acquisition and investment strategy or any individual acquisition or
investment, could have a material adverse effect on our business, financial
condition and results of operations.
In
December 2004 we completed the acquisition of Rapor, Inc. During the third
quarter of 2006, we recorded impairment costs of approximately $977,000 related
to Rapor. These
costs resulted from the write-off of goodwill of approximately $544,000, as
well
as the write-off of the remaining net book values of trademark and technology
associated with the Rapor products of approximately $433,000. Management
has concluded that the Rapor product line no longer fits our existing
distribution channels and market strategy and, accordingly
wrote-off goodwill, trademarks and technology associated with this product
line.
We are currently evaluating opportunities to dispose of our Rapor products,
and
have discussed the licensing and/or sale of this business line with several
parties.
10
OUR
PRODUCT OFFERINGS INVOLVE A LENGTHY SALES CYCLE AND WE MAY NOT ANTICIPATE SALES
LEVELS APPROPRIATELY, WHICH COULD IMPAIR OUR
PROFITABILITY.
Some
of
our products and services are designed for medium to large commercial,
industrial and government facilities desiring to protect valuable assets and/or
prevent intrusion into high security facilities in the United States and abroad.
Given the nature of our products and the customers that purchase them, sales
cycles can be lengthy as customers conduct intensive investigations and
deliberate between competing technologies and providers. For these and other
reasons, the sales cycle associated with some of our products and services
is
typically lengthy and subject to a number of significant risks over which we
have little or no control.
If
sales
in any period fall significantly below anticipated levels, our financial
condition and results of operations could suffer. In addition, our operating
expenses are based on anticipated sales levels, and a high percentage of our
expenses are generally fixed in the short term. As a result of these factors,
a
small fluctuation in timing of sales can cause operating results to vary from
period to period.
WE
FACE LABOR, POLITICAL AND CURRENCY RISKS BECAUSE SAMSUNG ELECTRONICS' FACTORIES
ARE LOCATED IN KOREA AND CHINA, AND WE MAY FACE OTHER RISKS IF WE CONTINUE
TO
EXPAND OUR BUSINESS INTERNATIONALLY.
Since
our
primary suppliers are located in Korea and China, 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 THEOTC
BULLETIN BOARD, AND WE MAY BE UNABLE TO OBTAIN LISTING OF OUR COMMON STOCK
ON A
MORE LIQUID MARKET.
Our
Common Stock is quoted on the OTC
Bulletin Board, which
provides significantly less liquidity than a securities exchange (such as the
American or New York Stock Exchange) or an automated quotation system (such
as
the NASDAQ National Market or NASDAQ Capital Market). There is uncertainty
that
we will ever be accepted for a listing on an automated quotation system or
securities exchange.
PENNY
STOCK REGULATIONS MAY AFFECT YOUR ABILITY TO SELL OUR COMMON
STOCK.
To
the
extent the price of our Common Stock remains below $5.00 per share, our Common
Stock will be subject to Rule 15g-9 under the Exchange Act, which imposes
additional sales practice requirements on broker dealers which sell these
securities to persons other than established customers and accredited investors.
Under these rules, broker-dealers who recommend penny stocks to persons other
than established customers and "accredited investors" must make a special
written suitability determination for the purchaser and receive the purchaser's
written agreement to a transaction prior to sale. Unless an exception is
available, the regulations require the delivery, prior to any transaction
involving a penny stock, of a disclosure schedule explaining the penny stock
market and the
11
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.
FUTURE
SALES OF COMMON STOCK COULD RESULT IN A DECLINE IN THE MARKET PRICE OF OUR
STOCK.
The
holders of approximately 1,065,520 shares of Common Stock are able to sell
such
shares without registering them under the Securities Act. In connection with
our
October 2006 and January 2007 private placements, after giving effect to our
recent 50-for-1 reverse stock split and the conversion of the notes sold in
our
October 2006 private placement, we issued an aggregate of 26,915,650 shares
of
Common Stock. In February 2007, an S-1 registration statement providing for
the
resale of 8,150,789 of those shares of Common Stock was declared effective
by
the SEC. Sales of a significant number of shares of our Common Stock in the
public market could result in a decline in the market price of our Common Stock,
particularly in light of the illiquidity and low trading volume in our Common
Stock.
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.
As
a
result of our October 2006 private placement and conversion of the Convertible
Notes issued in that private placement, the investors in the private placement
as a group were the beneficial owners of approximately 96% 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.
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
2006.
12
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.” From
April 14, 2004 until November 28, 2006, our Common Stock was quoted under the
symbol “GVIS.” Prior to April 14, 2004, our Common Stock was quoted under the
symbol “TSIM.” Trades in our Common Stock were reported by the OTC Bulletin
Board from January 1, 2002 until June 9, 2002, and by Pink Sheets LLC from
June9, 2002 until December 13,
2004.
Since December 13, 2004, trades of our Common Stock have been quoted on the
OTC
Bulletin Board. The following table sets forth the quarterly high and low bid
prices of a share of our Common Stock as reported by the OTC Bulletin Board
and
Pink Sheets LLC, respectively. The quotations listed below reflect inter-dealer
prices, without retail mark-ups, mark-downs or commissions and may not
necessarily represent actual transactions. The prices below have not been
adjusted for the one-for-50 reverse split of our Common Stock effected on
November 27, 2006 or the one-for-65 reverse split of our Common Stock effected
April 12, 2004.
Price
High
Low
2004
First
quarter
$
0.51
$
0.02
Second
quarter
$
32.51
$
0.10
Third
quarter
$
6.00
$
1.10
Fourth
quarter
$
8.00
$
1.15
2005
First
quarter
$
5.70
$
1.80
Second
quarter
$
2.45
$
0.70
Third
quarter
$
1.09
$
0.27
Fourth
quarter
$
0.39
$
0.10
2006
First
quarter
$
0.37
$
0.15
Second
quarter
$
0.36
$
0.15
Third
quarter
$
0.17
$
0.03
Fourth
quarter
$
1.25
$
0.02
The
number of holders of record for our Common Stock as of March 23, 2007 was
approximately 153. 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. In
addition, we are prohibited from paying dividends on our Common Stock under
our
agreements with Laurus. Nonetheless, the holders of our Common Stock are
entitled to dividends when and if declared by our board of directors from
legally available funds.
Recent
Sales of Unregistered Securities
Pursuant
to a consulting agreement dated November 8, 2006, we issued 25,000 shares of
Common Stock to Protect-A-Life Inc., in consideration of investor relations
services provided to us by Protect-A-Life Inc. The issuance was exempt from
registration under Section 4(2) of the Securities Act.
13
Item
6. Selected Financial Data
We
present below our selected consolidated financial data. The selected
consolidated statement of operations data for the years ended December 31,2006, 2005 and 2004 and the selected consolidated balance sheet data as of
December 31, 2006 and 2005 have been derived from our audited consolidated
financial statements and related notes. The selected consolidated statement
of
operations data for the year ended December 31, 2003 and 2002, and the
selected consolidated balance sheet data as of December 31, 2004, 2003
(Predecessor Business) and 2002 have been derived from our audited consolidated
financial statements not included in this filing. You should read this
information together with “Management’s Discussion and Analysis of Financial
Condition and Results of Operations” and our audited consolidated financial
statements and related notes. Our historical results are not necessarily
indicative of the results to be expected in any future period.
In
the
first quarter of 2006, our board approved a plan to discontinue our Retail
Channel business. Accordingly, this business is accounted for as discontinued
operations and its operations are segregated in the statement of operations
data
below and in the accompanying financial statements. In connection with the
discontinuance of the Retail Channel business, for the years ended December31,2006 and 2005, we wrote down assets identified with the retail business by
approximately $2.4 million and $2.9 million, respectively, net of applicable
tax
benefit, to net realizable value. The write down to net realizable value was
based on management’s best estimates of the amounts expected to be realized on
the disposition of all related assets and liabilities held for disposition
from
the discontinued operations. At December 31, 2006, we had divested of
substantially all retail inventory and other related assets.
2002
(1)
2003
(1)
2004
2005
2006
(In
thousands, except per share data)
Statement
of operations data:
Net
sales
$
15,707
$
25,019
$
35,761
$
40,782
$
43,973
Gross
Profit
3,514
5,331
4,927
5,968
6,584
Operating
loss
(1,444
)
(1,930
)
(8,831
)
(9,388
)
(7,887
)
Interest
expense
244
230
691
1,266
5,916
Loss
from continuing operations before income (loss) from discontinued
operations
(1,744
)
(1,048
)
(8,414
)
(10,737
)
(13,817
)
Income
(loss) from discontinued operations, net of taxes
2,880
2,305
1,236
(2,283
)
(2,674
)
Net
income (loss)
$
1,136
$
1,257
$
(7,178
)
$
(13,020
)
$
(16,491
)
Basic
and diluted income (loss) per share:
Continuing
operations
$
(0.06
)
$
(0.04
)
$
(13.96
)
$
(10.71
)
$
(3.74
)
Discontinued
operations
$
0.10
$
0.08
$
2.05
$
(2.28
)
$
(0.72
)
Net
income (loss) per share
(basic
and diluted)
$
0.04
$
0.04
$
(11.91
)
$
(12.99
)
$
(4.46
)
Balance
Sheet data:
Working
capital
$
1,209
$
10,985
$
21,689
$
11,715
$
(2,003
)
Total
assets
11,501
23,321
51,605
25,226
16,472
Senior
debt
3,378
8,650
9,057
11,770
8,291
Total
liabilities
10,002
20,831
34.078
20,623
17,912
Total
stockholders’ equity
1,499
2,490
51,605
4,603
(1,440
)
(1)
Results
associated with predecessor
business
14
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” orsimilar
language. Actual results could differ materially from those anticipated in
such
forward-looking statements. All forward-looking statements included in this
document are based on information available to us on the date hereof. We caution
investors that our business and financial performance are subject to substantial
risks and uncertainties. In evaluating our business, prospective investors
should carefully consider the information set forth under the caption “Risk
Factors” in addition to the other information set forth herein and elsewhere in
our other public filings with the Securities and Exchange
Commission.
Overview
From
December 2000 until we acquired GVI Security, Inc. in a merger transaction
on
February 20, 2004, we had no active business operations. As a result of the
merger, GVI Security, Inc. became our wholly-owned subsidiary, and the business
of GVI Security became our business. Following the merger, on April 12, 2004,
we
changed our name from Thinking Tools, Inc. to GVI Security Solutions, Inc.
Since
the former stockholders of GVI Security, Inc. acquired a majority of our voting
interests in the merger, the transaction was treated as a reverse acquisition,
with GVI Security, Inc. treated as the acquirer for accounting purposes.
Accordingly, the pre-merger financial statements of GVI Security, Inc. are
our
historical financial statements.
Through
our subsidiaries, we provide 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.
We
provide
a
strong combination of closed
circuit televisions (CCTVs),
digital video recorders (DVRs), and
networking products
that
enhance life safety for both government agencies and the private sector.
Discontinuance
of Retail Sales
Historically,
sales of our products in the Retail Channel have accounted for a substantial
portion of our revenues. For the years ended December 31, 2005, 2004
and
2003, 25%, 46% and 56% of
our
revenues, including revenues from discontinued operations, were from sales
in
the Retail Channel. Among other reasons, the decline in sales of our retail
products resulted from the replacement of our products by a major national
retailer that accounted for substantially all of our Retail Channel sales with
products manufactured by a competitor. In addition, our exclusive agreement
to
distribute Samsung products in the Retail Channel to this retailer expired
on
December 31, 2005. As a result, in the first quarter of 2006 our board of
directors approved the discontinuance of our sales to the Retail Channel so
that
we can focus our efforts on sales to professionals and wholesale distributors.
The
retail business is accounted for as discontinued operations and, accordingly,
its operations are segregated in the accompanying financial statements. In
connection with the discontinuance of the Retail Channel business for the years
ended December 31, 2006 and 2005, we wrote down assets identified with the
retail business by approximately $2.4 million and $2.9 million, respectively,
to
net realizable value. The write down to net realizable value was based on
management’s best estimates of the amounts expected to be realized on the
disposition of all related assets and liabilities held for disposition from
the
discontinued operations. At December 31, 2006, we had divested of substantially
all retail inventory and other related assets The results of the discontinued
operations do not include any allocation of corporate overhead during the
periods presented.
Reverse
Stock Split
As
discussed below, on October 6, 2006, we completed a $5 million private
placement, and in connection therewith, on November 27, 2006, we effected a
50-for-1 reverse stock split of the Common Stock. After giving effect to the
reverse split, we had outstanding 26,392,834 shares of Common Stock, of which
25,202,314 were
15
issued
to
the purchasers of the Units. Unless otherwise indicated, all
share
and per share amounts in this Annual Report on Form 10-K, including the
accompanying financial statements, give retroactive effect to the 1-for-50
reverse stock split.
CRITICAL
ACCOUNTING POLICIES
The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities
and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates. We believe
the following critical accounting policies have significant effect in the
preparation of our consolidated financial statements.
Revenue
Recognition
Our
primary source of revenue is from sales of our products. 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. 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 2006, 2005 and 2004 we experienced losses, or recorded provisions
for potential losses, from customers' inability to make payments, totaling
approximately $817,000, $166,000 and $254,000, which were equal to 1.8%, 0.4%
and 0.7% 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, 2006 and 2005
were
approximately $2,541,000 and $1,300,000, respectively.
16
Long-Lived
Assets
We
adopted the provisions of FASB Statement No. 144, “Accounting for the Impairment
or Disposal of Long Lived Assets “ effective January 1, 2005. When
impairment indicators are present, we typically review the carrying value of
its
assets in determining the ultimate recoverability of their unamortized values
using analyses of future undiscounted cash flows expected to be generated by
the
assets. If such assets are considered impaired, the impairment recognized
is measured by the amount by which the carrying amount of the asset exceeded
its
fair value. Assets to be disposed of are reported at the lower of the
carrying amount or fair value, less cost to sell.
Goodwill
and Intangible Assets
We
adopted the provisions of FASB Statement No. 142, “Goodwill and Other Intangible
Assets,” 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.
During
the year ended December 31, 2006, we concluded that the Rapor product line
no
longer fit the Company’s existing distribution channels and market strategy and,
accordingly, recorded impairment costs of approximately $977,000 resulting
from
the write-off of goodwill of approximately $544,000, and the write-off of the
remaining net book value of the trademark and technology associated with Rapor
products totaling approximately $433,000, as prescribed under SFAS 142. No such
impairment expense was recorded for the years ending December 31, 2005 and
2004.
Deferred
Tax Asset Valuation Allowance
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
In
December 2004, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards 123R, “Share-Based Payment”. This statement
requires that the cost resulting from all share-based payment transactions
be
recognized in the financial statements. This statement establishes fair value
as
the measurement objective in accounting for share-based payment arrangements
and
requires all entities to apply a fair-value based measurement method in
accounting for share-based payment transactions with employees except for equity
instruments held by employee share ownership plans. Effective January 1,2006, the Company adopted the fair value recognition provisions of SFAS 123R,
using the modified prospective method. Under this method, the provisions of
SFAS
123R apply to all awards granted or modified after the date of adoption and
all
previously granted awards not yet vested as of the date of adoption. Prior
periods have not been restated.
Prior
to
the January 1, 2006 adoption of SFAS 123R, the Company accounted for
stock-based compensation using the intrinsic value method prescribed in
Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to
Employees” and related interpretations. Accordingly, no compensation expense had
been recognized for stock options since all options granted had an exercise
price equal to the market price on the date of grant. As permitted by SFAS
123,
“Accounting for Stock-Based Compensation,” stock-based compensation was included
as a pro forma disclosure in the notes to the consolidated financial statements.
Net
revenues increased approximately $3.2 million, or 8% to approximately $44.0
million during the year ended December 31, 2006 from approximately $40.8 million
during the year ended December 31, 2005. The increase reflects a $5.0 million,
or 13%, increase in sales of professional products, offset by a decrease of
approximately $1.8 million, or 93%, in enterprise solutions revenues, which
have
been discontinued. The increase in revenues of our professional products
reflected increased sales to distributors, integrators and installers of a
variety of products manufactured by Samsung Electronics as well as other
manufacturers. The reduction in enterprise solutions revenues reflects sales
of
the Rapor portal during the year ended December 31, 2005, with no corresponding
sales during the year ended December 31, 2006. As previously noted, during
the third quarter of 2006, management concluded that the Rapor product line
no
longer fit our existing distribution channels and market strategy, and.
accordingly
wrote-off intangibles associated with this product line. We are currently
reviewing opportunities to dispose of our Rapor products, and have discussed
the
licensing and/or sale of this business line with several parties. We continue
to
introduce new products to complement our existing lines, and will continue
to
focus on the professional market through various channels.
Cost
Of Goods Sold From Continuing Operations
Totalcost
of
goods sold increased approximately $2.6 million, or 7% to approximately $37.4
million for the year ended December 31, 2006, from approximately $34.8 million
during the year ended December 31, 2005. This increase was due to the increased
revenue volume from the sale of professional products, partially offset by
improved margins on professional products, which resulted in an overall increase
in cost of sales for professional products of $3.3 million for the year ended
December 31, 2006 as compared to the period ended December 31, 2005. In
addition, cost of sales related to enterprise sales decreased $1.3 million
for
the period ended December 31, 2006 as compared to the comparable period in
2005
as a result of the absence of sales of the Rapor product in 2006. Indirect
costs
included in cost of goods sold, related to salaries and expenses associated
with
our warehouse, assembly and technical support services departments, increased
$600,000 during the year ended December 31, 2006 as compared to the year ended
December 31, 2005. Other charges included in cost of goods sold during the
year
ended December 31, 2006 of approximately $1.6 million related to adjustments
to
reflect slow-moving inventory to their net realizable value, as compared to
similar adjustments of approximately $630,000 during the year ended December31,2005.
As
a
result of the changes described above in revenues and cost of goods sold, gross
profit for the year ended December 31, 2006 increased to approximately $6.6
million from approximately $6.0 million for the year ended December 31, 2005,
and gross profit as a percentage of revenues increased to 15.0% for the year
ended December 31, 2006 compared with 14.6% for the comparable period ended
December 31, 2005. Had we not taken $1.0 million of additional charges to
write-down slow-moving inventory during the year ended December 31, 2006 (as
compared to the prior year), our gross margins would have been 17.2% for the
year ended December 31, 2006.
Selling,
General and Administrative Expenses
Selling,
general, and administrative expenses decreased 12% to approximately $13.5
million for the year ended December 31, 2006 from approximately $15.2 million
for the comparable period ended December 31, 2005, as follows:
Sales
and Marketing. Sales
and
marketing expenses decreased approximately 30% to approximately $6.4 million
for
the year ended December 31, 2006 from approximately $9.1 million for the year
ended December 31, 2005. The decrease was primarily due to (i) the
elimination of approximately $800,000 of expense related to a licensing
agreement entered into January 1, 2005, which was not renewed for 2006, (ii)
decreases of approximately $356,000 in sales and marketing staff salaries and
related benefits, (iii) a decrease of approximately $530,000 in
18
promotional
expenses, (iv) a decrease in commissions of approximately $591,000, and (v)
a
reduction in travel and other various general and administrative expenses of
$330,000.
General
and Administrative. General
and administrative expenses increased 17% to approximately $7.1 million for
the
year ended December 31, 2006 from approximately $6.1 for the comparable period
ended December 31, 2005. Major items resulting in the increased
general and administrative expense were (i) approximately $710,000 in personnel
termination costs, (ii) stock based compensation expense of approximately
$332,000 recorded due to the adoption of SFAS 123R effective January 1, 2006,
with no comparable expense in 2005, and (iii) an increase in bad debt expenses
of approximately $746,000. These increases were partially offset by decreases
in
(i) professional fees of $240,000, (ii) contract and temporary labor of $272,000
and (iii) various other general and administrative expenses of approximately
$250,000.
Impairment
Of Long-Lived Assets
During
the year ended December 31, 2006, the Company recorded impairment costs of
approximately $977,000. These costs resulted from the write-off of goodwill
of
approximately $544,000, and the write-off of the remaining net book value of
the
trademark and technology associated with the Rapor products of approximately
$433,000. No similar impairment expenses were recorded in the year ended
December 31, 2005.
Interest
Expense
Interest
expense for the year ended December 31, 2006 increased 367% to approximately
$5.9 million, from approximately $1.3 million in the year ended December 31,2005. The increase was the result of (i) a charge of $4.5 million to record
beneficial conversion features resulting from the issuance of convertible notes
with exercise terms more favorable than prevailing market conditions, (ii)
a
charge of approximately $47,000 to reflect the fair value of warrants issued
in
conjunction with the October 2006 private placement transaction, and (iii)
interest associated with convertible notes issued in conjunction with the
October 2006 private placement transaction of approximately $40,000.
Income
Tax Expense (Benefit)
We
recorded a provision for federal, state and local income tax of approximately
$14,000 for the year ended December 31, 2006, as compared to an expense of
approximately $83,000 for the comparable period ended December 31, 2005. The
$14,000 expense relates to state franchise taxes due in various states in which
we are licensed and transact business. We believe that any provision for federal
and state tax benefits due to our loss for the year ended December 31, 2006
would be offset by an equal increase in a valuation allowance as a result of
our
history of recurring operating losses.
Discontinued
Operations
Loss
from
discontinued operations, net of tax, was approximately $2.7 million for the
year
ended December 31, 2006, compared to a loss from discontinued operations of
approximately $2.3 million for the year ended December 31, 2005. The loss for
the period ended December 31, 2006 reflects negative revenues and reserves
recorded in connection with returns of retail products sold in prior periods,
and write downs of returned retail inventories. In September 2006 we entered
into an agreement with our former retail distribution agent whereby the parties
terminated the alliance agreement and the respective rights and obligations
of
the parties thereunder. In addition, we transferred to the distribution agent
substantially all of our remaining retail inventory in satisfaction of any
and
all remaining outstanding and future return obligations. In comparison to our
negative revenues for the year ended December 31, 2006, we had net revenues
of
approximately $13.8 million for the comparable period ended December 31, 2005.
Operating results from discontinued operations do not include any allocation
of
corporate overhead.
19
Net
Loss
As
a
result of the items discussed above there was a net loss of approximately $16.5
million for the year ended December 31, 2006 compared with a net loss of
approximately $13.0 million for the year ended December 31, 2005.
Net
revenues increased approximately $5.0 million, or 14.0% to approximately $40.8
million for the year 2005 from approximately $35.8 million for the year 2004.
Sales of professional products increased approximately $3.7 million, or 12.6%,
and enterprise solutions revenues increased $1.3 million, or 196.5%. The
increase in revenues of our professional products reflected increased sales
to
distributors, integrators and installers of a variety of products manufactured
by Samsung Electronics as well as other manufacturers. Increased revenues of
our
enterprise solutions products reflected additional revenues from the Drug
Enforcement Administration under our contract to supply it with our Rapid Access
Portals.
Cost
of Goods Sold from Continuing Operations
Totalcost
of
good sold increased $4.0 million, or 12.9%, to approximately $34.8 million
from
approximately $30.8 million in 2004. The increase in costs is the result of
approximately $3.2 million associated with increased sales of our professional
and enterprise solutions products. Cost of goods sold for 2005 include
increases in tech support costs and warranty costs of approximately $522,000.
In
addition, during 2004 we benefited from a one time reimbursement of $600,000
from a major supplier relating to costs associated with a product defect. There
was no comparable reimbursement in 2005.
As
a
result of the changes described above in revenues and cost of goods sold, gross
profit in 2005 increased to approximately $6.0 million from approximately $4.9
million in 2004, and gross profit as a percentage of revenues (i.e. gross
margins) in 2005 was 14.6% compared with 13.8% for 2004. This increase was
the
result of a change in the product mix comprising our sales of professional
products in respective periods. Gross margins on sales of our enterprise
solutions products increased to 25.9% for 2005 compared to 22.8% in 2004,
primarily as a result of higher margins on the sale of our Rapid Access Portal
to the Drug Enforcement Administration.
Selling,
General and Administrative Expenses
Selling,
general and administrative expenses increased 11.4% to approximately $15.2
million in 2005 from approximately $13.6 million in 2004, as follows.
Sales
and Marketing. Sales
and
marketing expenses increased 41.5% to approximately $9.1 million in 2005 from
approximately $6.5 million in 2004. The
increase was primarily due to (i) approximately $800,000 in expenses relating
to
a licensing agreement with Cybasec Ltd. entered into January 1, 2005 (which
was
terminated in accordance with its terms effective January 1, 2006), (ii) an
increase of approximately $290,000 in sample and demonstration equipment costs,
(iii) an increase of approximately $309,000 in advertising costs for print
media, (iv) increased commissions on sales made by our independent sales
representatives of approximately $442,000, (v) increased tradeshow costs of
approximately $155,000, and (vi) a decrease of approximately $114,000 in
contributions from our vendors to offset our marketing costs in 2005, as
compared to vendor contributions we received in 2004 to cover these costs.
General
and Administrative.General
and administrative expenses decreased 16.3% to approximately $6.1 million for
2005 from approximately $7.1 million in 2004. Major
items resulting in the decreased
general and administrative expense were (i) decreases of approximately
$1,670,000 in administrative staff salaries and related benefits, (ii)
reductions in bad debt provisions and other expenses of approximately $159,000,
and (iii) reduced bank charges of approximately $129,000. These reductions
were
offset by (i) personnel termination costs during the year of approximately
$335,000, (ii) an approximately $150,000 increase in office rent, (iii)
approximately $149,000 of depreciation expense related to assets acquired in
the
Rapor acquisition in December 2004, with no comparable
20
expense
in 2004, (iv) an increase of approximately $97,000 in legal and accounting
fees,
and (v) payment of $115,000 in directors fees.
Interest
Expense
Interest
expense for 2005 increased 83.2% to approximately $1,266,000 from approximately
$691,000 in 2004. The increase was due to higher outstanding borrowings and
a
higher average interest rate during 2005 as well as the amortization of
approximately $600,000 of loan origination fees in 2005 compared to amortization
of approximately $334,000 of loan origination fees in 2004. The higher average
interest rates resulted from a higher prime interest rate during the period
as
well as the interest rate provisions applicable to borrowings under the
receivable facility. As a result of the conversion price under the facility
exceeding the market price of our Common Stock for periods of 2005, the interest
rate for those periods was equal to the prime rate plus two percent. If the
market price of our Common Stock exceeds the conversion price of $2.22, at
the
end of a month, the interest rate under the receivable facility will be reduced
to equal the prime rate minus two percent. The amount of interest expense for
2005 reflects an offset of approximately $143,000 of interest income earned
on
bank balances during the period. Interest income earned in 2004 was
approximately $2,000.
Discontinued
Operations
Net
revenues from our discontinued Retail Channel operations were approximately
$13.8 million for the year ended December 31, 2005, compared with approximately
$30.7 million in 2004. Loss from discontinued operations, net of tax, was
approximately $2.3 million for the year ended December 31, 2005, compared to
income from discontinued operations of approximately $1.2 million for the prior
year ended December 31, 2004. These operating results do not include any
allocation of corporate overhead. The loss for 2005 included a write down of
approximately $1.4 million of assets identified with our retail business. Net
realizable value of these assets reflects management’s best estimates of the
amounts expected to be realized on the disposition of all related assets and
liabilities from the discontinued operations.
Income
Tax Expense (Benefit)
The
provision for federal, state and local income tax is an expense of approximately
$83,000 for 2005 compared to a benefit of approximately $413,000 for 2004
(comprised
of approximately $1.1 million benefit from continuing operations and
approximately $600,000 provision from discontinued operations).
The
$83,000 expense relates to state franchise taxes that are not determined based
on net income. Any provision for federal and state tax benefits due to our
loss
for 2005 would be offset by an equal increase in a valuation allowance.
We
established this allowance because, in light of our history, including our
losses following our merger in February 2004, there is uncertainty as to whether
we will have future income against which we can offset our losses to reduce
our
tax expense in future periods.
Net
Loss
As
a
result of the items discussed above there was a net loss of approximately $13.0
million in 2005 compared with a net loss of approximately $7.2 million in 2004.
Total
net
revenues increased 42.9% to approximately $35.8 million for the year 2004 from
approximately $25.0 million in 2003. The increase was due to an increase in
sales of our products consistent with our focus to provide complete solutions
for our professional customers by providing a suite of fully-integrated
products. Our fourth quarter of 2004 was negatively effected by reduced sales
of
a particular product to the Professional Channel. We were unable to sell this
product during portions of the fourth quarter of 2004 as a result of a defect
in
the product. The manufacturer corrected the defect and we were able to continue
selling the product at the beginning of the first quarter of 2005.
21
Cost
of Goods Sold from
Continuing Operations
Total
cost of goods sold increased 56.6% to approximately $30.8 million in 2004 from
approximately $19.7 million in 2003. Contributing to this increase were (i)
charges of approximately $.8 million in connection with reserves established
for
slow moving inventory and write-downs of inventory to reflect net realizable
value, (ii) increased revenues, and (iii) higher inbound freight costs. As
a
result of the changes in sales and cost of goods sold, gross profit for 2004
of
approximately $4.9 million decreased 7.5% from $5.3 million for 2003, and gross
profit as a percentage of net sales decreased to 13.8% for 2004, compared with
21.3% for 2003.
Selling,
General and Administrative Expenses
Selling,general
and administrative expensesincreased
87.3% to approximately $13.6 million in 2004 from approximately $7.3 million
in
2003, as follows.
Sales
and Marketing.Sales
and
marketing expenses increased 80.6% to approximately $6.5 million in 2004 from
approximately $3.6 million in 2003. The increase was primarily due to increased
commissions, salaries and travel-related expenses. Contributing to the increase
in salaries and travel-related expenses was approximately $925,000 relating
to
the formation of our Enterprise Solutions Group during 2004, which focused
on
providing fully-integrated security products solutions to the Professional
Channel.
General
and Administrative.General
and administrative expenses increased 91.9% to approximately $7.1 million in
2004 from approximately $3.7 million in 2003. The increase was primarily due
to
(i) increased salaries and wages associated with additional hires, (ii)
increased administrative, accounting, finance and legal costs associated with
being a public company following our merger in February 2004, as well as (iii)
costs related to our Enterprise Solutions Group and expansion into the
integrated security solutions market. Also included in general and
administrative expenses for 2004 is approximately $400,000 of costs associated
with personnel terminations during the year.
Interest
Expense
Interest
expense for 2004 increased 203% to approximately $691,000 from approximately
$228,000 in 2003. The increase was primarily related to increased borrowing
and
the amortization of increased loan origination fees during 2004 as a result
of
our May 2004 debt financing with Laurus Master Fund, described
below.
Discontinued
Operations
Net
revenues from our discontinued Retail Channel operations were approximately
$30.7 million for the year ended December 31, 2004 compared with approximately
$31.3 million in 2003. Income from discontinued operations of approximately
$1.2
million (net of $700,000 of income taxes) for the year ended December 31, 2004
compares to income from discontinued operations of approximately $2.3 million
(net of $1.6 million of income taxes) for the prior year ended December 31,2003. These operating results do not include any allocation of corporate
overhead. Revenues from discontinued operations for the year ended December31,2004 decreased approximately $600,000, or 1.9%, to $30.7 million, compared
to
$31.3 million for the year ended December 31, 2003. Gross margin decreased
to
7.3% for the year 2004 compared to 12.6% for 2003. Contributing to the decrease
in margins were charges of approximately $1.6 million in connection with
reserves established for slow moving inventory and write-downs of inventory
to
reflect net realizable value.
Income
Tax Expense (Benefit)
The
provision for federal, state and local income tax benefit was approximately
$413,000 for 2004 (comprised of approximately $1.1 million benefit from
continuing operations and approximately $600,000 provision from discontinued
operations),as
compared to income tax expenses of approximately $536,000 for 2003 (comprised
of
approximately $1.1 million benefit from continuing operations and approximately
$1.6 million provision from discontinued operations). The tax benefit for 2004
has been reduced by approximately $2.2 million, the amount of a deferred tax
valuation allowance. We established the allowance because, in light of our
history, including our losses following our merger in February 2004, there
is
uncertainty under generally accepted accounting principles as to whether we
will
have future income against which we can offset our losses for 2004 to reduce
our
tax expense in future periods.
22
Prior
to
May 23, 2003, GVI Security, Inc. was taxed under the provisions of Sub Chapter
S
of the Internal Revenue Code. As a Sub Chapter S corporation, GVI Security,
Inc.
did not provide for or pay any Federal or certain corporate or state income
taxes on its taxable income for the period from January 1, 2003 until May 2003.
In May 2003, GVI Security, Inc. lost its Sub Chapter S corporation status,
and
accordingly a provision was made for the payment of income taxes based on the
prorated taxable income of GVI Security, Inc. for 2003.
Net
Loss
As
a
result of the items discussed above, net loss for 2004 was approximately $7.2
million, compared with net income of approximately $1.3 million for
2003.
Liquidity
and Capital Resources
At
December 31, 2006, we had cash and equivalents of approximately $225,000,
working capital (excluding senior debt) of approximately $6.9 million,
stockholders’ deficiency of $1.4 million, outstanding balances of $1.9 million
under our term loan with Laurus Master Fund, and outstanding balances of $6.4
million under our revolving credit facility with Laurus. In comparison, at
December 31, 2005, we had cash and equivalents of approximately $3.0 million,
working capital (excluding current portion of senior debt) of approximately
$13.8 million, an outstanding balance of $3.3 million under the Laurus term
loan, and outstanding balances under the Laurus revolving credit facility of
approximately $8.5 million. Additionally, we had borrowing availability of
approximately $2.2 million at December 31, 2006, with no such availability
at
December 31, 2005.
Cash
decreased from $3.0 million at December 31, 2005 to $225,000 at December 31,2006 primarily as a result of (i) cash operating losses of approximately $4.8
million, (ii) term loan principal and interest payments of $1.7 million, and
(iii) net working capital revolver payments of $2.1 million. These factors
were
partially offset by (i) net private placement proceeds received of $4.9 million
in 2006, and (ii) cash generated from discontinued operations of approximately
$506,000, from December 31, 2005 to December 31, 2006.
Our
credit facility with Laurus Master Funds matures December 31, 2007, Accordingly,
at December 31, 2006 we have reflected both the remaining senior term note
balance and working capital revolver as current liabilities. We are currently
in
discussions with Laurus, as well as other potential lenders, with regard to
the
extension and/or replacement of this credit facility. We believe that we will
be
able to obtain additional financing on acceptable or similar terms; however,
there can be no assurance whether we will be able to do so.
In
October 2006 and January 2007, as described below, we raised $6,028,000 in
aggregate gross proceeds from the private placement of common stock and
convertible notes. We may need to raise additional capital in the future to
finance our operations; however, there can be no assurance whether we will
be
able to do so.
October
2006 Private Placement
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 25,000 shares
of
Common Stock and a 6% Subordinated Secured Convertible Promissory Note
(“Convertible Notes”) in the principal amount of $45,000 convertible into
225,000 shares of Common Stock at a conversion price equal to $.20. As a result,
we issued 2,500,000 shares of Common Stock for $500,000 and Convertible Notes
in
the principal amount of $4,500,000 convertible into 22,500,000 shares of the
Company’s Common Stock. 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).
As
part
of the transaction, we agreed to issue warrants to purchase an aggregate of
1,875,000 shares of Common Stock at a price of $.20 per share to a director
and/or his designees as a consulting fee. As a result of this agreement, we
valued the warrant at fair value, resulting in a charge to earnings during
the
year ended December 31,
23
2006
of
$46,875. In addition, in accordance with EITF 98-5 we recognized a debt discount
of $4.5 million associated with the beneficial conversion feature of the
Convertible Notes.
Approximately
$3 million of the proceeds of the private placement were immediately used to
repay past due amounts owed Samsung for security products previously purchased
by us, and approximately $108,000 was paid to a consulting group owned and
controlled by our former Chairman of the Board. The balance of the net proceeds
from the private placement have used primarily for working capital and to pay
expenses incurred in connection with the private placement.
January
2007 Private Placement
On
January 22, 2007, we 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 private placement will be used for working
capital and general corporate purposes. Because the shares were sold directly
by
us to the purchasers in the placement, we did not pay any placement agent fees
or commissions in connection with the private placement.
Laurus
Credit Facility
On
May27, 2004, we closed a $15 million convertible debt financing with Laurus Master
Fund, Ltd. under which we were provided with a $5 million term loan and a $10
million revolving credit facility. At closing, we borrowed $5 million under
the
term loan and $10 million under the revolving credit facility, and used
$10,016,000 of the proceeds to repay in full the indebtedness outstanding under
the prior revolving credit agreement with Comerica Bank. Additional proceeds
of
the financing were used to increase working capital, pay closing fees to Laurus
in the aggregate amount of $617,500, and pay a finder's fee in the amount of
$800,000. As part of the transaction, Laurus was also issued a seven-year
warrant to purchase 18,800 shares of Common Stock at a price of $175.00 per
share. We also issued a similar warrant to purchase 1,880 shares of Common
Stock
to the finder. Borrowings under the Laurus financing are secured by all of
our
assets. At December 31, 2006, $1.9 million in principal was outstanding under
the Term Loan and $6.4 million in principal was outstanding under the revolving
credit facility. The agreements with Laurus prohibit the payment of dividends
on
the Company’s Common Stock, and contain other customary affirmative and negative
covenants.
The
term
loan is evidenced by a Secured Term Note and bears interest at a rate per annum
equal to the prime rate (as reported in the Wall Street Journal), plus two
percent, subject to a floor of six percent. Interest on the term loan is payable
monthly.
Prior
to
the October 2006 amendment described below, the interest rate under the Term
Note was subject to downward adjustment at the end of each month so that if
at
the end of the applicable month we had registered the shares of Common Stock
underlying the Term Note with the SEC, interest payable on the Term Note would
be adjusted downward by 200 basis points (two percent) for each incremental
25
percent increase in the market price of the Common Stock, at the end of the
month, in excess of the conversion price under the Term Note.
Amounts
outstanding under the Term Note were initially convertible into Common Stock
at
Laurus's option. In addition, subject to (i) having an effective registration
statement with respect to the shares of Common Stock underlying the Term Note,
and (ii) limitations based on trading volume of the Common Stock, originally
scheduled principal and interest payments under the Term Note were made in
shares of Common Stock valued at the conversion price. In addition prepayments
under the Term Note were subject to a premium in the amount of 20% of the
principal being prepaid.
Borrowings
under the revolving credit facility bear interest at a rate per annum equal
to
the prime rate plus two percent. In addition, prior to the October 2006
amendment described below, the interest rate under the revolving credit facility
was subject to downward adjustment at the end of each month in the same manner
as provided for under the Term Note. The revolving credit facility terminates,
and borrowings thereunder become due, on December 31, 2007.
24
Amounts
outstanding under the revolving credit facility were also initially convertible
to Common Stock at Laurus's option. To the extent the Company repays loans
outstanding under the revolving credit facility, the Company can reborrow or
make additional borrowings under the revolving credit facility, provided that
aggregate loans outstanding under the revolving credit facility at any time
may
not exceed the lesser of $10 million or a borrowing base equal to the sum of
83.7% of "eligible accounts" plus 60% of "eligible inventory" (with borrowings
based on eligible inventory limited to $3.5 million). Eligible accounts are
generally gross accounts receivable less foreign receivables and domestic
receivables over 90 days from invoice date. Eligible inventory is substantially
all finished goods inventory.
Pursuant
to an amendment, dated as of May 26, 2006, (i) payments of principal due to
Laurus for the months of June 2006 through December 2006 under the Term Note
were reduced from $190,000 per month to $100,000 per month, (ii) the final
payment of principal due to Laurus under the Term Note on May 27, 2007 was
correspondingly increased from $435,000 to $1,065,000, and (iii) the exercise
price of warrants previously issued to Laurus to purchase an aggregate of 26,800
shares of the Company’s Common Stock was reduced from $175.00 to $30.00.
Pursuant to a further Amendment, dated as of June 22, 2006, the conversion
price
of $300,000 of principal under the Term Note was reduced to $7.50 from $95.50,
and Laurus converted such amount of principal into 2,000,000 shares of Common
Stock. The principal so converted was applied to the payments of principal
that
would otherwise have been due under the Term Note for the months of July, August
and September 2006. As a result of the reduction in the exercise price of the
warrants, we recorded an interest charge of approximately $76,000.
On
October 4, 2006, in connection with the private placement referred to above,
we
entered into an Omnibus Amendment and Consent with Laurus, pursuant to which
Laurus consented to the issuance of the Convertible Notes in the private
placement. In addition, Laurus agreed to further amendments to the revolving
credit facility and term loan under which (i) the ability of Laurus to convert
the revolving credit facility and term loan into Common Stock was eliminated;
(ii) the maturity date of both the revolving credit facility and Term Note
was
extended from May 24, 2007 until December 31, 2007; (iii) prepayment penalties
with respect to both the revolving credit facility and Term Note were
eliminated; and (iv) monthly principal payments of $152,000 are due under the
Term Note for the months of January 2007 through December 2007.
We
will
not be able to repay our obligations to Laurus at maturity unless we receive
replacement financing or extend our current financing. There can be no assurance
that we will be able to obtain such financing.
December
2004 Private Placement
On
December 27, 2004, we completed a private placement of approximately 452,400
(post-split) shares of Common Stock for aggregate gross consideration of $33.9
million. C.E. Unterberg, Towbin LLC acted as the financial advisor for us in
the
private placement and was paid a cash fee equal to seven percent of the gross
proceeds from the private placement, plus its legal costs and expenses.
Net
cash
proceeds were approximately $31.5 million, after compensation to the financial
advisor and other costs of the placement.
Approximately
$4.7 million of the proceeds were used to repay borrowings from Laurus Master
Fund under the receivables facility, and $1.15 million of the proceeds were
used
to repay notes issued in an October 2004 bridge financing. The holders of
$600,000 in principal amount of these notes reinvested such amount in the
private placement. We used an additional $10 million of the net proceeds to
repurchase 133,333 (post-split) shares of Common Stock from William A.
Teitelbaum, a stockholder of the Company, pursuant to a Settlement Agreement
between us and Mr. Teitelbaum entered into in October 2004. The balance of
the
net proceeds was used primarily for working capital and general corporate
purposes.
Going
Concern Considerations
As
a
result of our losses from operations and limited capital resources, our
independent auditors have included an explanatory paragraph in their report
on
the accompanying financial statements indicating there is substantial doubt
about our ability to continue as a going concern. The financial statements
do
not include any adjustments that might result from the outcome of this
uncertainty. During
the years ended December 31, 2006, 2005 and 2004, we experienced negative cash
flow and operating losses, as well as losses from discontinued operations,
which
have
resulted in a significant reduction in our cash balances. These factors raise
substantial doubt
25
about
our
ability to continue as a going concern. If we are not successful in improving
our operating results in the near term we may need to raise additional capital
to finance our operations and sustain our business model. We may not be able
to
obtain additional financing on acceptable terms, or at all. In addition, any
financing we obtain in the future may result in dilution to our existing
stockholders.
Contractual
Obligations and Commitments
A
summary
of our contractual obligations as of December 31, 2006 is as follows:
Payments
Due by Period (in thousands)
2007
2008
2009
2010
Thereafter
Long-Term
Debt Obligations
$
8,291
$
0
$
0
$
0
$
0
Capital
Lease Obligations
77
62
0
0
0
Operating
Lease Obligations
308
308
231
0
0
Samsung
Purchase Commitment
27,000
—
—
—
—
Total
$
35,676
$
370
$
231
$
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
7A. Quantitative and Qualitative Disclosures about Market
Risk.
Quantitative
Foreign
Currency Exchange Risk
Our
results of operations and cash flows are not subject in any material
respectto
fluctuations due to changes in foreign currency exchange rates. We do not
currently have any foreign currency hedging contracts in place, nor did we
enter
into any such contracts during the years ended December 31, 2006, 2005 and
2004.
To date, exchange rate fluctuations have had little impact on our operating
results and cash flows.
Interest
Rate Sensitivity
As
disclosed above, our loans with Laurus bear interest at a fluctuating rate
of
interest related to the “prime” rate in effect from time to time. Accordingly,
increases in the prime rate will increase our interest expense under our
agreements with Laurus. We do not use interest rate hedging contracts to manage
our exposure to changes in interest rates.
Item
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.
26
Item
9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure.
Not
Applicable.
Item
9A. Controls and Procedures.
Our
management has evaluated, with the participation of our Chief Executive Officer
and Chief Financial Officer, the effectiveness of our disclosure controls and
procedures as of the end of the period covered by this report. Based on that
evaluation, our Chief Executive Officer and Chief Financial Officer have
concluded that our disclosure controls and procedures were effective as of
the
end of the period covered by this report.
Our
management, including our Chief Executive and Chief Financial Officer, does
not
expect that our disclosure controls and procedures or internal control over
financial reporting will prevent all 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.
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
Position
David
Weiner
50
Chairman
of the Board of Directors
Steven
E. Walin
51
Chief
Executive Officer and Director
Joseph
Restivo
53
Chief
Financial Officer and Director
Craig
Ellins 1,2,3
54
Director
Gary
Freeman 1,2,3
39
Director
Moshe
Zarmi 1,2,3
69
Director
1
Member
of the Audit Committee
2
Member
of the Compensation Committee
3
Member
of the Governance Committee
DAVID
WEINER has served as one of our directors since October 4, 2006, and was
previously a director of ours from February 17, 2004 until January 4, 2005.
Mr.
Weiner is the President of W-Net, Inc., an investment and consulting firm he
founded in 1998. From December 2002 to April 2003 Mr. Weiner was Co-President
for Trestle Holding Inc., a provider of digital imaging and telemedicine
products. In 1993, Mr. Weiner joined K-tel, a music retailer, as Vice President
of Corporate Development. He advanced to the position of President in 1996,
which he held until he left to form W-Net in 1998.
27
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 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.
JOSEPH
RESTIVO has been our Chief Financial Officer since March 2006 and a director
since October 4, 2006. 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
is currently a member of the Board of Directors of Blue Holdings and serves
as
its Audit Committee Chairman. 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.
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, except for a late filing
of a
Form 4 by Europa International, we believe that all reporting requirements
under
Section 16(a) for the 2006 fiscal year
28
were
met
in a timely manner by our directors, executive officers and beneficial owners
of
more than 10% of our Common Stock.
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
Compensation
Discussion and Analysis
General
Our
compensation arrangements with those persons who served as our executive
officers for all or part of 2006 reflect the individual circumstances
surrounding the applicable executive officer’s hiring or appointment, as
reflected in the employment agreements we entered into with those persons,
and
with respect to the person who previously served as our chief executive officer
and chief financial officer, the separation agreement we entered into with
him.
The foregoing information is intended to provide context for the discussion
that
follows regarding our existing compensation arrangements with those persons
who
served as our executive officers for all or part of 2006.
The
compensation committee of the board of directors is responsible for implementing
and administering our benefit and compensation plans and programs. All of the
members of our compensation committee are independent directors who were
appointed to our board in October 2006. Our compensation committee consists
of
Craig Ellins, Gary Freeman and Moshe Zarmi.
Principal
Components of Compensation of Our Executive Officers
The
principal components of the compensation we have historically paid to our
executive officers have consisted of:
·
base
salary;
·
signing
bonuses, paid in cash;
·
operating
bonuses, and
·
equity
compensation, generally in the form of stock options.
Allocation
and Objectives of Compensation
The
compensation committee of our board of directors has not established any
policies or guidelines with respect to the mix of base salary, bonus, cash
incentive compensation and equity awards to be paid or awarded to our executive
officers. In general, the compensation committee implements policies and
negotiates employment agreements designed to attract, retain and motivate
individuals with the skills and experience necessary for us to achieve our
business objectives. Compensation is established based on the scope of the
executive’s responsibilities, taking into account competitive market
compensation paid by other companies for similar positions.
29
Base
Salary
Our
Chief Executive Officer
We
appointed Steven Walin as our chief executive officer in February 2006 following
the negotiation of an employment agreement with him. The terms of Mr. Walin’s
employment agreement were negotiated by our former Chairman of the Board, in
consultation with our directors at that time, based on prevailing market
conditions and available data on the compensation of executives in similar
positions with comparable companies.
Mr. Walin’s
employment agreement with us provides for an initial base salary of $375,000
per
year, with the base salary being subject to an annual increase in the discretion
of our board.
Our
Chief Financial Officer
Following
our hiring of Mr. Walin, in March 2006, we negotiated an employment agreement
with Joseph Restivo to serve as our Chief Financial Officer. Mr. Restivo’s
agreement is similar in form to our agreement with Mr. Walin, and the
negotiations with respect to Mr. Restivo’s agreement were based in part on the
final terms of our agreement with Mr. Walin, as well as prevailing market
conditions and available data on the compensation of executives in similar
positions with comparable companies.
Mr. Restivo’s
employment agreement with us provides for an initial base salary of $200,000
per
year, with the base salary being subject to an annual increase in the discretion
of our board.
Our
former Chief Executive Officer and Chief Financial Officer
Nazzareno
Paciotti was appointed our Chief Executive Officer and Chief Financial Officer
in February 2004 in connection with our reverse merger with GVI Security Inc.
In
connection with such appointment, Mr. Paciotti entered into a one-year
employment agreement with us. In January 2005, we entered into a three-year
employment agreement with Mr. Paciotti, similar in form to the original
agreement we entered into with him, and reflective of negotiations between
Mr.
Paciotti and the persons serving on our compensation committee at that
time.
During
our fiscal year ended December 31, 2006, pursuant to the terms of his employment
agreement with us, Mr. Paciotti was paid a base salary of $300,000 per year
until the time of his departure in March 2006. In connection with his departure,
we negotiated a Mutual Separation Agreement with Mr. Paciotti, the terms of
which are described below under “Separation Agreement with Nazzareno Paciotti.”
Bonus
Compensation
We
have
not historically paid any bonuses to our executive officers. However, during
2006 we paid Mr. Walin a signing bonus of $100,000 and a guaranteed bonus of
$140,625, both as required by the specific terms of Mr. Walin’s employment
agreement with us. Pursuant to their employment agreements, each of Mr. Walin
and Mr. Restivo are eligible to receive an annual cash bonus of up to 50% of
their respective base salaries based on the achievement of annual performance
targets approved by our board. We believe that the establishment of performance
criteria will adequately reflect the quantitative performance of our executive
officers.
Equity
Compensation
Our
board
of directors’ historical practice has been to grant equity-based awards to
attract, retain, motivate and reward our employees, particularly our executive
officers, and to encourage their ownership of an equity interest in us and
align
management’s performance objectives with the interests of our stockholders. Our
Amended and Restated 2004 Long Term Incentive Plan, which is administrated
by
our compensation committee, authorizes us to grant options to purchase shares
to
our employees, directors and consultants. Stock options are generally granted
at
the commencement of employment, and as described below, following other
circumstances to meet retention or performance objectives. Generally, stock
options granted by us have an exercise price equal to the fair market value
on
the grant date, vest over time based on continued employment, and expire ten
years after the grant date.
Pursuant
to their employment agreements with us, upon his appointment as our Chief
Executive Officer, Mr. Walin was granted an option to purchase 60,000 shares
of
common stock at exercise prices ranging from $15.00
30
to
$40.00, and Mr. Restivo was granted an option to purchase 15,000 shares of
common stock at exercise prices ranging from $6.00 to $39.00. The employment
agreements with each of Mr. Walin and Mr. Restivo provided them with the right
to be issued additional options based on the number of shares sold by us on
our
next offering of securities within two-years following the date of their initial
employment.
In
connection with our October 2006 private placement, we negotiated amendments
to
the employment agreements with each of Mr. Walin and Mr. Restivo under which
each of them were granted an option to purchase 1,881,795 shares of common
stock
with an exercise price of $0.20 per share (the price per share paid in
connection with that private placement). The options granted to Mr. Walin and
Mr. Restivo were intended to provide them with beneficial ownership,
collectively, of approximately 10% of our common stock after giving effect
to
the October 2006 private placement. Pursuant to these amendments to their
employment agreements, Mr. Walin and Mr. Restivo forfeited the options
previously granted to them under their employment agreements as well as the
additional options they would have otherwise been entitled to in connection
with
the sale of our securities.
We
do not
have any program, plan or practice that requires us to grant equity-based awards
on specified dates and we have not made grants of such awards that were timed
to
precede or follow the release or withholding of material non-public information.
It is possible that we will establish programs or policies regarding the timing
of equity-based awards in the future. Authority to make equity-based awards
to
executive officers rests with our compensation committee.
Severance
and Change of Control Payments
We
believe that companies should provide reasonable severance benefits to
employees, recognizing that it may be difficult for them to find comparable
employment within a short period of time. We also believe it prudent that we
disentangle ourselves from employees whose employment terminates as soon as
practicable. As provided in greater detail below under “Employment
Agreement with Chief Executive Officer” and “Employment Agreement with Chief
Financial Officer,” the employment agreements with Mr. Walin and Mr. Restivo
contain provisions providing for payments following their termination by us
without cause or for good reason, with increased payments and acceleration
of
option vesting in the event such termination follows a change of control.
In
addition, in connection with his departure, we negotiated a Mutual Separation
Agreement with Mr. Paciotti under which he was entitled to receive severance
payments equal to one year of his annual base salary of $300,000, payable in
12
equal monthly installments. In addition, Mr. Paciotti was to continue to receive
medical benefits until January 24, 2008. In consideration of such payments,
Mr.
Paciotti agreed to release us in full from any and all claims and to continue
to
be bound by the confidentiality and non-solicitation terms of his employment
agreement. In September 2006, in consideration of a cash payment of $85,926,
Mr.
Paciotti agreed to the termination of our remaining obligations under the Mutual
Separation Agreement. Prior to such payment, we had approximately $194,000
of
remaining cash severance obligations to Mr. Paciotti.
Other
Benefits
We
believe that establishing competitive benefit packages for our employees is
an
important factor in attracting and retaining highly qualified personnel.
Executive officers are eligible to participate in all of our employee benefit
plans, such as medical, dental, and our 401(k) plan, in each case on the same
basis as other employees. We do not currently provide a matching contribution
under our 401(k) plan nor do we offer retirement benefits.
Perquisites
Pursuant
to their respective employment agreements, Mr. Walin receives a car allowance
of
$1,500 per month, and Mr. Restivo receives a car allowance of $1,000 per month.
In addition, under the terms of their employment agreements with us, we are
obligated to reimburse Mr. Walin and Mr. Restivo for all reasonable travel,
entertainment and other expenses incurred by them in connection with the
performance of their duties and obligations under their respective
agreements.
31
Summary
Compensation Table
The
following table shows for the fiscal year ended December 31, 2006, compensation
awarded to or paid to, or earned by, Steven Walin, our Chief Executive Officer;
Joseph Restivo, our Chief Financial Officer; and Nazzareno Paciotti, who was
our
Chief Executive Officer and Chief Financial Officer during 2006 and departed
from the Company on March 28, 2006 (the “Named Executive
Officers”).
Summary
Compensation Table for Fiscal 2006
Name
and Principal Position
Year
Salary
($)
Bonus
($)
Option
Awards (2)
($)
All
Other
Compensation
($)
Total
($)
Steven
Walin
Chief
Executive Officer
2006
$315,859
$240,625
(1)
$259,445
(3)
$15,231
(6)
$831,160
Joseph
Restivo Chief Financial Officer
2006
$159,351
—
$50,684
(4)
$9,692
(6)
$219,727
Nazzareno
Paciotti
Former
Chief Executive Officer and Chief Financial Officer
2006
$259,791
(7)
—
$4,000
(5)
—
$263,791
(1)
Consists
of a signing bonus of $100,000 and a guaranteed bonus of $140,625
for the
first year of employment, both as required by the specific terms
of Mr.
Walin’s Employment Agreement.
(2)
The
value of option awards granted to the Named Executive Officers has
been
estimated pursuant to SFAS No. 123(R) based on our expense during
2006 for
the options described in the footnotes below, except that for purposes
of
this table, we have assumed that none of the options will be forfeited.
The Named Executive Officers 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, 2006.
(3)
Represents
2006 expense with respect to options to purchase 60,000 shares of
common
stock granted March 6, 2006, with exercise prices of $15.00 to $40.00
per
share, and options to purchase 1,881,795 shares of common stock granted
October 4, 2006, with an exercise price of $0.20 per share, after
giving
effect to the cancellation of the option granted March 6, 2006, which
was
forfeited in connection with the grant in October 4, 2006.
(4)
Represents
2006 expense with respect to options to purchase 15,000 shares of
common
stock granted March 28, 2006, with exercise prices of $8.00 to $39.00
per
share, and options to purchase 1,881,795 shares of common stock granted
October 4, 2006, with an exercise price of $0.20 per share, after
giving
effect to the cancellation of the option granted March 28, 2006,
which was
forfeited in connection with the grant in October 4, 2006.
(5)
Represents
2006 expense with respect to options to purchase 7,500 share of common
stock granted January 6, 2005, with an exercise price of $75.00 per
share,
and options to purchase 5,000 shares of common stock granted February17,2004, with an exercise price of $130.00 per share.
(6)
Consists
of a car allowance of $1,500 per month for Mr. Walin and $1,000 per
month
for Mr. Restivo.
(7)
Includes
approximately $192,000 of severance
payments.
32
Grants
of Plan-Based Awards
The
following table shows for the fiscal year ended December 31, 2006, certain
information regarding grants of awards under our Amended and Restated 2004
Long
Term Incentive Plan to our Named Executive Officers. All
share
and per share amounts in the table below give effect to the 1-for-50 reverse
stock split effected in November 2006.
Grants
of Plan-Based Awards in Fiscal 2006
Name
Grant
Date
All
Other Option Awards: Number of Securities Underlying Options
(#)
Exercise
or Base
Price
of Option Awards
($/Sh)
Closing
Price of Common Stock on Grant Date (if lower than Exercise
Price)
These
options were granted under our 2004 Long-Term Incentive Plan concurrently
with our October 2006 private placement, and the exercise price of
these
options is equal to the price per share paid by investors in that
private
placement. These options vested immediately as to 25% of the shares
subject to the option grant, and become exercisable as to the remaining
option shares in equal monthly installments over the 36-month period
following the grant date.
(2)
These
options were granted pursuant to the employment agreements of Mr.
Walin
and Mr. Restivo, respectively, and as described above in “Compensation
Discussion and Analysis,” these options were forfeited in connection with
the October 4, 2006 option grants.
Outstanding
Equity Awards at Fiscal Year-End
The
following table shows for the fiscal year ended December 31, 2006, certain
information regarding outstanding equity awards at fiscal year end for the
Named
Executive Officers.
Pursuant
to a Mutual Separation Agreement described below, all options previously
held by Mr. Paciotti expired on December 31,2006.
33
Option
Exercises and Stock Vested
None
of
our Named Executive Officers exercised stock options or vested with respect
to
stock awards during our fiscal year ended December 31, 2006.
Pension
Benefits
None
of
our Named Executive Officers participate in or have account balances in
qualified or non-qualified defined benefit plans sponsored by us.
Nonqualified
Deferred Compensation
None
of
our Named Executive Officers participate in or have account balances in
non-qualified defined contribution plans or other deferred compensation plans
maintained by us.
Employment
Contracts; Termination of Employment and Change-in-Control
Arrangements
Employment
Agreement with Chief Executive Officer
We
have
entered into an Employment Agreement, dated as of February 9, 2006, with Steven
Walin, our Chief Executive Officer. The Employment Agreement is for a three-year
term of employment which commenced March 6, 2006. Pursuant
to the Employment Agreement, Mr. Walin received a $100,000 signing bonus and
receives an annual base salary of $375,000.
Pursuant
to his Employment Agreement, Mr. Walin was also paid a guaranteed bonus equal
to
50% of his base salary ($140,625) for the first nine months of his service
to
us, and 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 12 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 signing bonus, 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.
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.
34
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. In addition, we amended the definition
of
“Cause” for termination purposes to include our incurrence of a net loss, as
defined in the amendment, in the quarter ending June 30, 2007.
Employment
Agreement with Chief Financial Officer
We
have
entered into an Employment Agreement, dated as of March 28, 2006, with Joseph
Restivo, our Chief Financial Officer. The
Employment Agreement is for a three-year term and provides Mr. Restivo with
an
annual base salary of $200,000, 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 12 months;
provided,
that if such termination occurs after a “Change in Control” Mr. Restivo
will instead be entitled to a payment equal to 200% of his base salary
and
continued medical benefits for 24
months;
·
pro-rated
bonus for the year in which the termination occurs, payable following
such
fiscal year to the extent he would have otherwise been entitled to
such
bonus; and
·
provided
at least six months has expired since the last vesting of his option
grant, a pro rata vesting of his option shares which are scheduled
to vest
on the next vesting date; provided, that if such termination occurs
after
a “Change in Control” or after the first anniversary of Mr. Restivo’s
employment with us, all of the unvested options will immediately
vest.
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. In addition, we amended the
definition of “Cause” for termination purposes to include our incurrence of a
net loss, as defined in the amendment, in the quarter ending June 30, 2007.
Separation
Agreement with Nazzareno Paciotti
On
March28, 2006 we entered into a Mutual Separation Agreement with Nazzareno Paciotti,
who was our Chief Financial Officer from February 2004 until such date, and
who
was our Chief Executive Officer from February 2004 until March 6, 2006. Pursuant
to the Mutual Separation Agreement, the parties mutually agreed to
35
the
termination of Mr. Paciotti’s employment with us and to his resignation as a
director and officer of GVI Security Solutions, Inc. and its subsidiaries.
Mr.
Paciotti was entitled to receive severance payments equal to one year of his
annual base salary of $300,000, payable in 12 equal monthly installments. In
addition, Mr. Paciotti will continue to receive medical benefits until January24, 2008. Mr. Paciotti agreed to release us in full from any and all claims
and
to continue to be bound by the confidentiality and non-solicitation terms of
his
employment agreement. In September 2006, in consideration of a cash payment
of
$85,926,
Mr. Paciotti agreed to the termination of our remaining obligations under the
Mutual
Separation Agreement. Prior to such payment, we had approximately $194,000
of
remaining cash severance obligations to Mr. Paciotti.
Director
Compensation
Non-employee
Directors
On
December 6, 2006, our Board of Directors approved compensation arrangements
for
non-employee directors under which, commencing January 2007, each of our
non-employee directors will be entitled to receive a monthly cash payment of
$2,500. David Weiner and Craig Ellins have waived their current rights to
receive these payments. Accordingly, these monthly payments will initially
be
made only to Gary Freeman and Moshe Zarmi. 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.
From
August 2005 through June 2006, our non-employee directors received a monthly
payment of $2,000 in cash. In addition, in October 2005, we adopted a
Non-Employee Directors’ Stock Plan and authorized 400,000 shares of Common Stock
for issuance thereunder. Under the Non-Employee Directors’ Stock Plan, each
non-employee director was awarded shares of our Common Stock with an aggregate
fair market value of $1,000 as of the 15th
day of
each month. The shares authorized for issuance under the Non-Employee Directors’
Stock Plan were exhausted in August 2006.
Former
Chairman Compensation
Howard
Safir was our Chairman of the Board from February 17, 2004 until October 4,2006. Under an agreement dated as of February 17, 2004 with November Group,
Ltd., of which Mr. Safir is a principal, November Group agreed to provide us
with advice, consultation and assistance over a term of three years ending
February 17, 2007 for a fee of $600,000, payable in equal monthly installments
over the term of the agreement. Upon the closing of our October 2006 private
placement, which constituted a change in control under the agreement, we paid
the remaining fee owed to the November Group in the amount of approximately
$108,000.
The
following table shows for the fiscal year ended December 31, 2006 certain
information with respect to the compensation of all non-employee directors
of
the Company.
Director
Compensation for Fiscal 2006
Name
Fees
Earned or
Paid
in
Cash
($)
Stock
Awards
($)
Option
Awards
($)
(1)
All
Other
Compensation
($)
Total
($)
Richard
Berman (2)
$12,000
$7,903
$1,312
(3)
—
$
21,215
Victor
DeMarines (2)
$4,000
$3,903
—
—
$
7,903
36
Name
Fees
Earned or
Paid
in
Cash
($)
Stock
Awards
($)
Option
Awards
($)
(1)
All
Other
Compensation
($)
Total
($)
Craig
Ellins
—
—
$
56 (4)
—
$
56
Gary
Freeman
—
—
$
56 (4)
—
$
56
Bruce
Galloway (2)
$12,000
$6,000
$1,312
(3)
—
$
19,312
John
Gutfreund (2)
$12,000
$7,903
—
—
$
19,903
Asa
Hutchinson (2)
$12,000
$7,903
—
—
$
19,903
Kenneth
Minihan (2)
$4,000
$3,903
—
—
$
7,903
Joseph
Rosetti (2)
$12,000
$7,903
$1,162
(5)
—
$
21,065
Howard
Safir (2)
—
—
$3,883
(6)
$241,673
(8)
$245,556
David
Weiner
—
—
—
—
--
Moshe
Zarmi
$12,000
$6,000
$701
(7)
$
18,701
(1)
The
value of option awards granted to directors has been estimated pursuant
to
SFAS No. 123(R) based on our expense during 2006 for the options
described
in the footnotes below, 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 31,2006.
(2)
Not
currently a director of the
Company.
(3)
Represents
2006 expense with respect to options to purchase 950 shares of common
stock granted January 6, 2005, with an exercise price of $75.00 per
share,
and options to purchase 6,000 shares of common stock granted February17,2004, with an exercise price of $130.00 per share.
(4)
Represents
2006 expense with respect to options to purchase 10,000 shares of
common
stock granted October 20, 2006, with an exercise price of $0.20 per
share.
(5)
Represents
2006 expense with respect to options to purchase 950 shares of common
stock granted January 6, 2005, with an exercise price of $75.00 per
share,
and options to purchase 5,000 shares of common stock granted February17,2004, with an exercise price of $130.00 per share.
(6)
Represents
2006 expense with respect to options to purchase 5,500 shares of
common
stock granted January 6, 2005, with an exercise price of $75.00 per
share,
and options to purchase 10,000 shares of common stock granted February17,2004, with an exercise price of $130.00 per share.
(7)
Represents
2006 expense with respect to options to purchase 10,000 shares of
common
stock granted October 20, 2006, with an exercise price of $0.20 per
share,
options to purchase 450 shares of common stock granted January 6,2005,
with an exercise price of $75.00 per share, and options to purchase
3,000
shares of common stock granted February 17, 2004, with an exercise
price
of $130.00 per share.
(8)
Paid
to November Group, Ltd. pursuant to the agreement dated February17, 2004,
as described above.
Stock
Option Plan
In
March
2004, our stockholders approved our 2004 Long-Term Incentive Plan, reserving
118,798 (after
37
giving
effect to a subsequent one-for-65 reverse split) shares of our Common Stock
for
issuance thereunder. Pursuant to amendments to the Plan approved by our
stockholders, and after giving effect to our recent one-for-50 reverse split,
we
are authorized to issue up to 5,900,000 shares of Common Stock under the Plan.
The Plan provides for the grant of options and other awards to our employees,
officers, directors and consultants. The Plan authorizes the Board of Directors
to issue incentive stock options (“ISOs”) as defined in Section 422(b) of the
Internal Revenue Code of 1986, as amended, stock options that do not conform
to
the requirements of that Code section (“Non-ISOs”), stock appreciation rights
(“SARs”), restricted stock, stock awards and other stock based awards. Directors
who are not employees of the Company may only be granted Non-ISOs.
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.
COMPENSATION
COMMITTEE REPORT
The
Compensation Committee has reviewed and discussed the Compensation Discussion
and Analysis with management. Based upon such review, the related discussions
and such other matters deemed relevant and appropriate by the Compensation
Committee, the Compensation Committee has recommended to the Board of Directors
that the Compensation Discussion and Analysis be included in this Annual Report
on Form 10-K.
Craig
Ellins
Gary
Freeman
Moshe
Zarmi
Compensation
Committee Interlocks and Insider Participation
The
Compensation Committee consists of Messrs. Ellins, Freeman and Zarmi, all
of whom are independent non-management directors. Other than Mr. Zarmi, who
was
our President and Chief Executive Officer from January 1998 until February
2004,
none of the Compensation Committee members has served as an officer or employee
of ours, and none of our executive officers has served as a member of a
compensation committee or board of directors of any other entity, which has
an
executive officer serving as a member of our Board of Directors.
Item
12. Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters.
The
following table sets forth as of March 26, 2007, 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 the Company’s principal executive
offices located at 2801 Trade Center Drive, Suite 120, Carrollton, Texas75007.
38
SHARES
BENEFICIALLY OWNED1
Number
Percent
(%)
Beneficial
Owners of more than 5% of Common Stock (other than directors and
executive
officers)
All
directors and executive officers as a group (six persons)10
4,308,354
14.4
%
*
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 23, 2007 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 28,106,168
shares of the Common Stock outstanding as of March 23, 2007. 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.
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
39
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 York10102.
5
Includes
75,000 shares of Common Stock issuable upon exercise of a
warrant.
6
Includes
(i) 20,020 shares of Common Stock owned by Woodman Management Corporation,
of which David Weiner is the sole shareholder, (ii) 568,688 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.
7
Includes
3,750 shares of Common Stock issuable upon exercise of
options.
8
Consists
of shares of Common Stock issuable upon exercise of options.
9
Includes
666,469 shares of Common Stock issuable upon exercise of options.
10
Includes
Messrs. Weiner, Ellins, Freeman, Zarmi, Walin, and
Restivo.
Item
13. Certain Relationships and Related Transactions,
and Director Independence.
On
October 6, 2006, we completed a $5 million private placement, consisting of
100
Units at a price of $50,000 per unit. Each of Steve Walin, our Chief Executive
Officer, and Joseph Restivo, our Chief Financial Officer, purchased one-half
of
a Unit in the private placement. Each Unit consisted of 25,000 shares of Common
Stock and a 6% Subordinated Secured Convertible Promissory Note in the principal
amount of $45,000, convertible into 225,000 shares of Common Stock at a
conversion price equal to $.20. 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 have
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).
W-Net,
Inc. acted a consultant to us in connection with the private placement
and
in
consideration thereof, we issued to W-Net’s designees warrants to purchase
1,875,000 shares of Common Stock at a price of $.20 per share. David Weiner
is
the principal of W-Net, and is also the managing member of GVI Investment
Company LLC, which was the lead investor in the private placement. In connection
with the private placement, Mr. Weiner was appointed to our Board of
Directors.
The
purchasers in the private placement consisted of a group of accredited investors
led by GVI Investment Company, LLC, a Nevada limited liability company formed
for the purpose of participating in the private placement. GVI Investment
Company, LLC, which purchased $2.5million
of the Units is managed by David Weiner. In January 2007, GVI Investment Company
LLC transferred to its members the 12,601,712 shares of Common Stock it acquired
in connection with its investment in the private placement. Included in such
transfers was the transfer of 2,016,274 shares of Common Stock to Mr. Weiner,
who through GVI Investment Company LLC invested $400,000 in the private
placement.
In
connection with the private placement, and effective immediately following
its
closing, our existing directors at that time, other than Steven Walin our Chief
Executive Officer, resigned, and David Weiner, Craig Ellins, Gary Freeman,
Moshe
Zarmi and Joseph Restivo, our Chief Financial Officer, were appointed to our
Board of Directors.
On
January 22, 2007, we 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 purchasers in the private placement included Craig Ellins,
a
director of ours who purchased 83,333 shares of Common Stock, and Steve Walin,
our Chief Executive Officer, who purchased 16,667 shares of Common
Stock.
40
Director
Independence
All
members of our Board of Directors, other than our Chairman of the Board, David
Weiner, our Chief Executive Officer, Steven Walin, and our Chief Financial
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
Mercadien for the audit of the Company’s annual financial statements for the
years ended December 31, 2006, 2005 and 2004, and fees billed for other services
rendered by Mercadien during those years.
2006
2005
2004
Audit
fees
(1)
$
194,271
$
253,690
$
216,244
Audit
related fees
—
—
—
Tax
fees
11,930
$
15,487
$
3,136
All
other fees(2)
28,429
$
14,291
$
40,220
Total
fees
$
234,630
$
283,470
$
259,600
(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)
Consists
primarily of fees paid in connection with review of the Company’s
financial statements in the Company’s Registration Statement on Form SB-2,
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.
The
Audit Committee approved all such services prior to the auditor’s engagement for
such services during the year ended December 31, 2006.
41
PART
IV
Item
15. Exhibits, Financial Statement Schedules.
The
following documents are filed as part of this report:
Exhibit
Number
Exhibit
Title
2.1
Agreement
and Plan of Merger, dated as of February 19, 2004, by and among Thinking
Tools, Inc., GVI Security, Inc., and GVI Security Acquisition Corp.
*
2.2
Agreement
and Plan of Merger, dated as of June 30, 2004, by and among GVI Security
Solutions, Inc., Rapor, Inc., and Rapor Acquisition
Corp.####
3.1
Certificate
of Incorporation and Amendments of GVI Security Solutions,
Inc.**
3.2
Amended
and Restated By-Laws of GVI Security Solutions, Inc. ****
Registration
Rights Agreement, dated as of July, 2004, by and among the GVI Security
Solutions, Inc. and the former stockholders of
Rapor.####
4.4
Form
of Subscription Agreement for Units purchased by investors in October
2004
Bridge Financing+
4.5
Form
of Warrant issued to investors in October 2004 Bridge
Financing+
4.6
Security
Purchase Agreement, dated as of December 21, 2004, by and among GVI
Security Solutions, Inc. and the Purchasers listed on Schedule A
thereto.+++
4.7
Form
of Subscription Agreement to purchase Units consisting of 6% Subordinated
Secured Convertible Promissory Note and shares of Common Stock, dated
October __, 2006††
4.8
Form
of Warrant to purchase Common Stock issued to designees of W-Net,
Inc.
dated October __, 2006 ††
4.9
Registration
Rights Agreement, dated May 27, 2004, by and between GVI Security
Solutions, Inc. and Laurus Master Fund, Ltd. ##
4.10
Form
of Subscription Agreement to purchase Common Stock in connection
with the
January 2007 Private Placement (Incorporated by reference to the
exhibit
to Registrant’s Current Report on Form 8-K, as filed with the SEC on June23, 2007.)
4.16
Employment
Agreement, dated as of January 31, 2006, between GVI Security Solutions,
Inc. and Steven E. Walin †††
10.1
Distributorship
Agreement dated as of October 2, 2006 between GVI Security Inc. and
Samsung Electronics Co., Ltd.. ††
42
10.2‡
Executive
Employment Agreement, dated as of January 24, 2005, by and between
the
Registrant and Nazzareno E. Paciotti (Incorporated by reference to
the
similarly described exhibit previously filed as an exhibit to Registration
Statement on Form SB-2 (Registration No. 33-122314))
Commercial
Industrial Lease Agreement, effective as of April 1, 2004, between,
CSHV
Texas Industrial, L.P., as Landlord, and GVI Security, Inc., as Tenant
***
10.5
Settlement
Agreement and General Release, dated as of October 13, 2004, between
the
Registrant, GVI Security, Inc., William A. Teitelbaum and Alarmax
Distributors, Inc. ***
10.6
Mutual
Separation Agreement, dated as of September 30, 2004, by and among
GVI
Security, Inc., GVI Security Solutions, Inc. and Thomas Wade.
####
10.7
Alliance
Agreement dated May 5, 2005 between GVI Security Solutions, Inc.
and SSC,
Inc†++
10.8‡
GVI
Security Solutions, Inc. Nonemployee Directors’ Stock Plan
####
10.9‡
Employment
Agreement, dated as of January 31, 2006, between GVI Security Solutions,
Inc. and Steven E. Walin †
10.10‡
Employment
Agreement, dated as of March 28, 2006, between GVI Security Solutions,
Inc. and Joseph Restivo. ****
10.11‡
Mutual
Separation Agreement, dated as of March 28, 2006, between GVI Security
Solutions, Inc. and Nazzareno Paciotti.****
10.12‡
Omnibus
Amendment and Consent between GVI
Security Solutions, Inc., and Laurus
Master Fund Ltd.
dated October 3, 2006††
10.13
Amended
and Restated Securities Purchase Agreement, by and between GVI Security
Solutions, Inc. and Laurus Master Fund, Ltd., dated May 27, 2004,
and
amended and restated as of October 4, 2006††
10.14
Amended
and Restated Secured Term Note, made by GVI Security Solutions, Inc.
to
Laurus Master Fund, Ltd. dated May 27, 2004, and amended and restated
as
of October 4, 2006††
10.15
Common
Stock Purchase Warrant, dated May 27, 2004, issued to Laurus Master
Fund,
Ltd. ##
10.16
Amended
and Restated Security Agreement, by and between GVI Security Solutions,
Inc. and Laurus Master Fund, Ltd., dated May 27, 2004, and amended
and
restated as of October 4, 2006††
10.17
Amended
and Restated Secured Minimum Borrowing Note, made by GVI Security
Solutions, Inc. to Laurus Master Fund, Ltd. dated May 27, 2004, and
amended and restated as of October 4, 2006††
10.18
Amended
and Restated Revolving Note, made by GVI Security Solutions, Inc.
to
Laurus Master Fund, Ltd. dated May 27, 2004, and amended and restated
as
of October 4, 2006††
10.19
Subsidiary
Guarantee, dated May 27, 2004, by GVI Security, Inc. in favor of
Laurus
Master Fund, Ltd. ##
10.20
Stock
Pledge Agreement, dated May 27, 2004, by and among GVI Security Solutions,
Inc. and Laurus Master Fund, Ltd.
##
43
10.21‡
Amendment
to Employment Agreement between GVI Security Solutions, Inc. and
Steven
Walin dated as of October 4, 2006††
10.22‡
Amendment
to Employment Agreement between GVI Security Solutions, Inc. and
Joseph
Restivo dated as of October 4, 2006††
10.23
Amendment,
dated as of June 22, 2006, between GVI Security Solutions, Inc. and
Laurus
Master Fund, Ltd. (Incorporated by reference to the similarly described
exhibit previously filed as an exhibit to Registrant’s Current Report on
Form 8-K, as filed with the SEC on June 22, 2006.)
10.24
Amendment,
dated as of May 26, 2006, between GVI Security Solutions, Inc. and
Laurus
Master Fund, Ltd. (Incorporated by reference to the similarly described
exhibit previously filed as an exhibit to Registrant’s Current Report on
Form 8-K, as filed with the SEC on June 5, 2006.)
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
31.2
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
1934
32.1
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
1934
32.2
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 our Registration Statement on Form SB-2 (Registration
No.
33-11321).
****
Incorporated
by reference to the similarly described exhibit previously filed
as an
exhibit to Registrant’s 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 Annual Report on Form 10-KSB for the year ended
December 31, 2004, filed with the Securities and Exchange Commission
on
April 14, 2004.
##
Incorporated
by reference to the similarly described exhibit previously filed
as an
exhibit to Registrant’s Current Report on Form 8-K, as filed with the SEC
on June 7, 2004.
###
Incorporated
by reference to the similarly described exhibit previously filed
as an
exhibit to Registrant’s Current Report on Form 8-K, as filed with the SEC
on June 8, 2004.
####
Incorporated
by reference to the similarly described exhibit previously filed
as an
exhibit to Registrant’s Current Report on Form 8-K, as filed with the SEC
on October 19, 2004.
44
+
Incorporated
by reference to the similarly described exhibit previously filed
as an
exhibit to Registrant’s Current Report on Form 8-K, as filed with the SEC
on December 13, 2004.
++
Incorporated
by reference to the similarly described exhibit previously filed
as an
exhibit to Registrant’s Current Report on Form 8-K, as filed with the SEC
on June 10, 2005.
+++
Incorporated
by reference to the similarly described exhibit previously filed
as an
exhibit to Registrant’s Current Report on Form 8-K, as filed with the SEC
on December 30, 2004.
++++
Incorporated
by reference to the similarly described exhibit previously filed
as an
exhibit to Registrant’s Current Report on Form 8-K, as filed with the SEC
on October 24, 2005..
†
Incorporated
by reference to the similarly described exhibit previously filed
as an
exhibit to Registrant’s Current Report on Form 8-K, as filed with the SEC
on January 21, 2006.
††
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.
45
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 March29, 2007.
GVI
SECURITY SOLUTIONS, INC.
(Registrant)
By:
/s/
Steven Walin
Steven
Walin
Chief
Executive Officer
Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has
been
signed below by the following persons on behalf of the registrant and in the
capacities and on the dates indicated.
Signature
Title
Date
/s/
Steven Walin
Chief
Executive Officer (Principal Executive Officer) and
Director
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 sheet of GVI Security Solutions, Inc. and
Subsidiaries as of December 31, 2006 and the related consolidated statements
of
operations, stockholders’ equity deficiency and cash flows for the year 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 audit.
We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we
plan
and perform the audit to obtain reasonable assurance about whether the
consolidated financial statements are free of material misstatement. 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 audit provides 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, 2006 and the results of
their operations and their cash flows for the year then ended, in conformity
with U.S. generally accepted accounting principles.
The
accompanying consolidated financial statements have been prepared assuming
that
the Company will continue as a going concern. As discussed in Note 1 to the
financial statements, the Company has suffered recurring losses and negative
cash flows from operating activities, which have resulted in a negative working
capital and a stockholders' equity deficiency. These factors raise substantial
doubt about the Company's ability to continue as a going concern. Management's
plans in regard to these matters are also described in Note 1. The consolidated
financial statements do not include any adjustments that might result from
the
outcome of this uncertainty.
As
discussed in Note 1 to the consolidated financial statements, effective January1, 2006the Company adopted Statement of Financial Accounting Standard ("SFAS"),
"Share-Based Payment" ("SFAS 123(R)") which requires companies to estimate
the
fair value of share-based payment awards on the date of grant using an
option-pricing model.
Report
of Independent Registered Public Accounting Firm
To
the
Board of Directors and Stockholders
GVI
Security Solutions, Inc.
Carrollton,
Texas
We
have
audited the balance sheet of GVI Security Solutions, Inc. and Subsidiaries
as of
December 31, 2005, and the related statements of operations, stockholders’
equity and cash flows for each of the two years then ended. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based
on
our 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 financial
statements are free of material misstatement. An audit includes examining,
on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used
and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In
our
opinion, the financial statements referred to above present fairly, in all
material respects, the financial position of GVI Security Solutions, Inc. and
Subsidiaries as of December 31, 2005, and the results of their operations and
their cash flows for each of the two years then ended, in conformity with U.S.
generally accepted accounting principles.
The
accompanying financial statements have been prepared assuming that the Company
will continue as a going concern. As discussed in Note 1 to the financial
statements, the Company has suffered recurring losses and negative cash flows
from operating activities, which have resulted in a significant reduction in
cash. These factors raise substantial doubt about the Company's ability to
continue as a going concern. Management's plans in regard to these matters
are
also described in Note 1. The financial statements do not include any
adjustments that might result from the outcome of this uncertainty.
(In
thousands, except share and per share
amounts)
2006
2005
ASSETS:
Current
Assets
Cash
and equivalents
$
225
$
2,981
Accounts
receivable, net of allowances for doubtful accounts
of $558 and $317, respectively
7,881
7,688
Inventory,
net
6,416
7,127
Refundable
income tax receivable
-
643
Prepaid
and other current assets
1,324
1,221
Current
assets of discontinued operations
-
2,850
Total
Current Assets
15,846
22,510
Property
and Equipment, net
384
748
Deferred
loan origination fee, net
209
809
Goodwill
-
544
Intangibles,
net
-
532
Other
assets
33
83
Total
Assets
$
16,472
$
25,226
LIABILITIES
AND STOCKHOLDERS' EQUITY (DEFICIENCY):
Current
Liabilities
Accounts
payable
$
7,059
$
7,036
Accrued
expenses
2,023
1,490
Revolving
credit facility, current
6,366
-
Capitalized
lease obligations, current
77
118
Senior
term note, current
1,925
2,080
Liabilities
of discontinued operations
400
70
Total
Current Liabilities
17,850
10,794
Capital
lease obligations, net of current portion
62
139
Revolving
credit facility
-
8,495
Senior
term note, net of current portion
-
1,195
Total
Liabilities
17,912
20,623
Commitments
and Contingencies
Stockholders'
Equity (Deficiency)
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, 26,292,830
issued
and outstanding at December 31, 2006 and 1,005,160 shares issued
and
outstanding at December 31, 2005
26
1
Additional
paid-in capital
33,309
22,886
Accumulated
deficit
(34,775
)
(18,284
)
Total
Stockholders' Equity (Deficiency)
(1,440
)
4,603
Total
Liabilities and Stockholders' Equity (Deficiency)
$
16,472
$
25,226
The
Notes
to Consolidated Financial Statements are an integral part of these
statements
NOTE
1 ~ SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Organization
GVI
Security Solutions, Inc. (the “Company” and/or “GVI”) was incorporated in August
1996 as Thinking Tools, Inc. and was originally engaged in the software
development business. From December 18, 2000 until February 20, 2004, Thinking
Tools, Inc. had no active business. On February 20, 2004, pursuant to an
Agreement and Plan of Merger, Thinking Tools, Inc. acquired all of the stock
of
GVI Security, Inc. in a merger, and the business of GVI Security, Inc. became
the business of Thinking Tools, Inc. For accounting purposes, because the
Company had become a shell company, GVI Security, Inc. was treated as the
acquiror in the merger, which was treated as a recapitalization of GVI Security,
Inc., and the pre-merger financial statements of GVI Security, Inc. became
the
Company’s historical financial statements. The 2003 stockholders’ equity of the
Company was retroactively restated for the equivalent number of shares of
Thinking Tools, Inc. received by GVI Security, Inc. in the reverse merger,
with
the difference between the par value of Thinking Tools, Inc. preferred stock
and
GVI Security, Inc.’s common stock recorded as paid in capital. In the merger,
230,000 shares of GVI Security, Inc.’s Common Stock was converted to 1,000,000
shares of Thinking Tools, Inc. Series E Preferred Stock. The Series E Preferred
Stock was initially convertible into 36,678,958 shares of Thinking Tools, Inc.
common stock, and ultimately converted into 564,292 shares of common stock
of
the Company as a result of the one-for-65 reverse split effected on April 12,2004 (on which date Thinking Tools, Inc. changed its name to GVI Security
Solutions, Inc.) after giving effect to the one-for-50 reverse split effected
on
November 28, 2006 as a result of the Company’s 2006 Private Placement
transaction. See Note 14 for further discussion of the Company’s 2004
Recapitalization, and Note 8 for 2006 Private Placement transaction.
On
December 1, 2004, the Company acquired all of the capital stock of Rapor, Inc.
in a merger in which the Company issued to Rapor’s former stockholders an
aggregate of 54 shares of common stock and seven-year warrants to purchase
an
aggregate of 27,079 shares of common stock at an exercise price of $152 per
share. In connection with the closing of the merger, the Company also paid
approximately $184,000 in cash, and issued 1,960 shares of common stock, in
satisfaction of secured obligations of Rapor. Rapor designs and manufactures
high security building access portals.
All
share
and per share amounts herein have been given retroactive effect to the 1-for-65
reverse stock split of the Company’s common stock effected in April 2004, as
well as to the 1-for-50 reverse stock split effected November 2006. .
See
Note
16 for further discussion of the Company’s 2004 Recapitalization, and Note 8 for
2006 Private Placement transaction.
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 subsidiaries GVI Security, Inc.
and Rapor, Inc. All material intercompany transactions, balances and profits
have been eliminated.
Reclassifications
Certain
reclassifications have been made to the 2005 and 2004 financial statements
for
consistency purposes, including both income statement reclassifications of
certain revenue and expense amounts relating to the years ended December 31,2005 and 2004, as well as balance sheet reclassifications relating to the year
ended December 31, 2005. Income statement reclassifications include (1)
classification of net freight billed to customers as a reduction
of costs of revenue, and (2) classification of certain warehousing, technical
support and assembly expenses as costs of revenue. The balance sheet
reclassification relates to recharacterization of third party controlled cash
lockbox balances as other current assets at December 31, 2006.
F-9
Going
Concern Considerations
The
accompanying financial statements have been presented in accordance with
generally accepted accounting principles , which assumes the continuity of
the
Company as a going concern. During the years ended December 31, 2006, 2005
and
2004, the Company suffered
net losses of $16,5 million, $13.0 million and $7.8 million, respectively.
In
addition the Company utilized net cash from operations of $4,872,000 during
the
year ended December 31, 2006, and had a working capital deficit of $2,004,000
and a stockholders’ deficiency of $1,440,000 as of December 31,2006.
These
factors raise substantial doubt about the Company’s ability to continue as a
going concern.
In
October 2006, the Company raised $5 million in gross proceeds in a private
placement of common stock and convertible notes. The Company may need to raise
additional capital in the future to finance its operations, and management
can
not provide assurance that the Company will be successful in this effort. At
December 31, 2006, the Company had cash and cash equivalents of approximately
$225,000, a working capital deficit of approximately $2.0 million, a
stockholders’ deficiency of $1.4 million, an outstanding balance of $1.9 million
under the Laurus Term Loan, and an outstanding revolving credit loan balance
from Laurus of approximately $6.4 million, with an additional $2.2 million
available for borrowing under such facility.
The
Company’s operating results in 2007 will be dependent upon its ability to
continue to provide quality products and services in sufficient volume at
attractive prices and maintain customer loyalty. The Company will continue
to
implement measures to reduce operating costs, including sales and marketing
expenses, support and other general and administrative expenses. Depending
upon
the Company’s ability to increase its revenues and effectively manage its
working capital requirements, as well as the timing and rate of revenue growth
and management’s ability to control costs, the Company may require additional
equity or debt borrowings to finance its operations, working capital
requirements or capital expenditure needs. There can be no assurance that such
additional financing will be available, or if available, that such financing
can
be obtained on terms satisfactory to the Company. If the Company is not able
to
raise additional funds, it may be required to limit its operations which could
have an adverse effect on its financial position, results of operations and
cash
flow. The financial statements do not include any adjustments that might result
from the outcome of this uncertainty.
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 connection with the discontinuance of the Retail
Channel business for the years ended December 31, 2006 and 2005, the Company
wrote down assets identified with the retail business by approximately $2.3
million and $2.9 million, respectively, to net realizable value. The write
down
to net realizable value was based on management’s best estimates of the amounts
expected to be realized on the disposition of all related assets and liabilities
held for disposition from the discontinued operations. The results of the
discontinued operations do not include any allocation of corporate overhead
during the periods presented.
On
September 13, 2006, the Company entered into an agreement with its former
distributor to the retail channel, whereby the Company transferred to this
distributor substantially all of its remaining retail inventory in exchange
for
the termination of the parties’ respective remaining obligations under its
previous alliance agreement. The Company has written off all remaining net
assets associated with the Retail Channel business, and has accrued a reserve
of
$400,000 for estimated remaining obligations associated with completing the
termination of this business channel.
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.
F-10
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 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 principal adjusted
for any charge offs. 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, 2006 and 2005
were
approximately $2,541,000 and $1,300,000, 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.
When impairment indicators are present, the Company reviews the carrying value
of its assets in determining the ultimate recoverability of their unamortized
values using analyses of future undiscounted cash flows expected to be generated
by the assets. If such assets are considered impaired, the impairment
recognized is measured by the amount by which the carrying amount of the asset
exceeded its fair value. Assets to be disposed of are reported at the
lower of the carrying amount or fair value, less cost to sell.
Goodwill
and Intangible Assets
The
Company adopted the provisions of FASB Statement No. 142, “Goodwill and Other
Intangible Assets,” (SFAS 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.
During
the year ended December 31, 2006, management concluded that the Rapor product
line no longer fit the Company’s existing distribution channels and market
strategy and, accordingly, recorded impairment costs of approximately
$977,000 resulting from the write-off of goodwill of approximately $544,000,
and
the write-off of the remaining net book value of the trademark and technology
associated with Rapor products totaling approximately $433,000, as prescribed
under SFAS 142. No such impairment expense was recorded for the years ending
December 31, 2005 and 2004.
F-11
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.
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, 2006, 2005 and 2004 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, 2006, 2005 and 2004 were
$815,000, $1,495,000 and $893,000, 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.
Income
tax expense for the years ended December 31, 2006 and 2005 primarily relate
to
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
In
December 2004, the Financial Accounting Standards Board (“FASB”) issued
Statement of Financial Accounting Standards 123R, “Share-Based Payment” (“SFAS
123R”). This statement requires that the cost resulting from all share-based
payment transactions be recognized in the financial statements. This statement
establishes fair value as the measurement objective in accounting for
share-based payment arrangements and requires all entities to apply a fair-value
based measurement method in accounting for share-based payment transactions
with
employees except for equity instruments held by employee share ownership plans.
Effective January 1, 2006, the Company adopted the fair value recognition
provisions of SFAS 123R, using the modified prospective method. Under this
method, the provisions of SFAS 123R apply to all awards granted or modified
after the date of adoption and all previously granted awards not yet vested
as
of the date of adoption. Prior periods have not been restated.
F-12
Prior
to
the January 1, 2006 adoption of SFAS 123R, the Company accounted for
stock-based compensation using the intrinsic value method prescribed in
Accounting Principles Board Opinion No. 25 (“APB 25”), “Accounting for
Stock Issued to Employees” and related interpretations. Accordingly, no
compensation expense had been recognized for stock options since all options
granted had an exercise price equal to the market price on the date of grant.
As
permitted by SFAS 123, “Accounting for Stock-Based Compensation,” stock-based
compensation was included as a pro forma disclosure in the notes to the
consolidated financial statements.
The
following table illustrates the effect on operating results and per share
information had the Company accounted for share-based compensation in accordance
with SFAS 123 for the years ended December 31, 2005 and 2004:
($
in thousands, except per share amounts)
2005
2004
Net
Income (Loss), as reported
$
(13,020
)
$
(7,178
)
Stock-based
employee compensation expense,
net
of related tax effects
(188
)
(104
)
Net
Income (Loss), pro forma
$
(13,208
)
$
(7,282
)
Net
income (loss) per share:
Basic
as Reported
$
(12.99
)
$
(11.91
)
Basic
pro forma
$
(13.17
)
$
(12.08
)
Diluted
as reported
$
(12.99
)
$
(11.91
)
Diluted
pro forma
$
(13.17
)
$
(12.08
)
The
weighted average fair value of options granted during 2006, 2005 and 2004 was
$0.09, $1.75 and $2.94, respectively. The fair value of each option on the
date
of grant was estimated using the Black-Scholes option pricing model with the
following weighted average assumptions:
2005
2004
Risk
free rate of return
3.5%
3.5%
Option
lives in years
3.0
3.0
Annual
volatility of stock price
74
%
74
%
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.
These potentially dilutive securities are not included in the calculation of
loss per share for the years ended December 31, 2006, 2005 and 2004 because
the
company incurred a loss during such periods and thus their effect would have
been anti-dilutive. Accordingly, basic and diluted loss per share is the same
for years ended December 31, 2006, 2005 and 2004. At December 31, 2006, 2005
and
2004 potentially dilutive securities consisted of outstanding warrants and
stock
options to acquire an aggregate of 7,508,519, 251,161 and 237,411 shares,
respectively.
Credit
Risk Concentration
At
December 31, 2006, 2005 and 2004, three customers accounted for $17.7 million
(40%), $17.3 million (42%) and $16.8 million (47%), respectively, of the
Company’s continuing sales, and these customers’ receivable balances for the
years ended December 31, 2006, 2005 and 2004 totaled approximately $4,663,000
(50%), $3,982,000 (39%) and $4,861,000 (46%), respectively, of accounts
receivable.
F-13
International
sales accounted for approximately 38%, 33% and 22% of the Company's sales during
the years ended December 31, 2006, 2005 and 2004, respectively. Geographically,
Mexico has become one of our major growth areas. During the year ended December31, 2006, Mexico accounted for 10.4% of our total sales.
The
Company performs ongoing credit evaluations of its customers and generally
requires no collateral from them.
Fair
Value of Financial Instruments
The
following methods and assumptions were used to estimate the fair value of each
class of financial instruments for which it is practicable to estimate that
value:
·
Cash,
accounts receivable, accounts payable and accrued expenses - The
carrying
amount approximates fair value because of the short maturity of those
instruments.
·
Notes
payable and capitalized lease obligations - Based on the borrowing
rates
currently available to the Corporation for bank loans with similar
terms
and average maturities, the fair value of long-term debt approximates
the
carrying value shown on our balance sheet.
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
June
2006, the Financial Accounting Standards Board (“FASB”) issued FIN 48,
"Accounting for Uncertainty in Income Taxes--an interpretation of FASB Statement
No. 109," which seeks to reduce the diversity in practice associated with the
accounting and reporting for uncertainty in income tax positions. This
Interpretation prescribes a comprehensive model for the financial statement
recognition, measurement, presentation and disclosure of uncertain tax positions
taken or expected to be taken in an income tax return. FIN 48 presents a
two-step process for evaluating a tax position. The first step is to determine
whether it is more-likely-than-not that a tax position will be sustained upon
examination, based on the technical merits of the position. The second step
is
to measure the benefit to be recorded from tax positions that meet the
more-likely-than-not recognition threshold, by determining the largest amount
of
tax benefit that is greater than 50 percent likely of being realized upon
ultimate settlement, and recognizing that amount in the financial statements.
FIN 48 is effective for fiscal years beginning after December 15, 2006. The
Company does not believe the adoption of FIN 48 will have a material on its
consolidated results of operations, financial position, or cash
flows.
In
September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements," which
provides enhanced guidance for using fair value to measure assets and
liabilities. SFAS No. 157 provides a common definition of fair value and
establishes a framework to make the measurement of fair value in generally
accepted accounting principles more consistent and comparable. SFAS No. 157
also
requires expanded disclosures to provide information about the extent to which
fair value is used to measure assets and liabilities, the methods and
assumptions used to measure fair value, and the effect of fair value measures
on
earnings. SFAS No. 157 is effective for financial statements issued in fiscal
years beginning after November 15, 2007 and to interim periods within those
fiscal years. The Company does not believe the adoption of SFAS No. 157 will
have a material on its consolidated results of operations, financial position,
or cash flows
In
September 2006, the Securities and Exchange Commission issued Staff Accounting
Bulletin ("SAB") No. 108, "Considering the Effects of Prior Year Misstatements
when Quantifying Misstatements in Current Year Financial Statements". SAB No.
108 was issued in order to eliminate the diversity in practice surrounding
how
public companies quantify financial statement misstatements. SAB No. 108
requires that registrants quantify errors using both
a
balance sheet (iron curtain) approach and an income statement (rollover)
approach then evaluate whether either approach results in a misstated amount
that, when all relevant quantitative and qualitative factors are considered,
is
material. SAB No. 108 is effective for fiscal years ending after November 15,2006. The Company has adopted the bulletin during 2006. The adoption did not
have a material effect on its consolidated results of operations, financial
position, or cash flows.
F-14
NOTE
2 ~ ACCOUNTS RECEIVABLE
Accounts
receivable, net, at December 31, 2006 and 2005 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, 2006 and
2005
was as follows:
On
May27, 2004, the Company closed a $15 million convertible debt financing with
Laurus under which the Company was provided with a $5 million term loan and
a
$10 million revolving credit facility. At closing, the Company borrowed $5
million under the term loan and $10 million under the revolving credit facility,
and used $10,016,000 of the proceeds to repay in full the indebtedness
outstanding under the prior revolving credit agreement with Comerica Bank.
Additional proceeds of the financing were used to increase working capital,
pay
closing fees to Laurus in the aggregate amount of $617,500, and pay a finder's
fee in the amount of $800,000. As part of the transaction, Laurus was also
issued a seven-year warrant to purchase 18,800 shares of Common Stock at a
price
of $175 per share The Company also issued a similar warrant to purchase 1,880
shares of Common Stock to the finder. These warrants were valued at $112,000
using a Black-Scholes pricing model. The assumptions used in the model were
(i)
risk free interest rate of 6%, (ii) expected life of 7 years, (iii) expected
volatility of 70% and (iv) no anticipated
dividends. Borrowings under the Laurus financing are secured by all assets
of
the Company. At December 31, 2006, $1.9 million in principal was outstanding
under the Term Loan and $6.4 million in principal was outstanding under the
revolving credit facility. The agreements with Laurus prohibit the payment
of
dividends on the Company’s Common Stock, and contain other customary affirmative
and negative covenants.
F-15
The
loan
documents with Laurus required the Company’s Common Stock to be quoted on the
NASD Over the Counter Bulletin Board by July 27, 2004, which date was extended
to September 27, 2004 and further extended to December 31, 2004. In
consideration for extending the deadlines, the Company issued Laurus additional
seven-year warrants to purchase an aggregate of 8,000 shares of Common Stock
at
a price of $175 per share. The fair value of these warrants at date of issue
was
determined to be approximately $20,000 using a Black-Scholes pricing model,
and
were charged to expense during the year ended December 31, 2004. The assumptions
used in the model were (i) risk free interest rate of 6%, (ii) expected life
of
7 years, (iii) expected volatility of 70% and (iv) no anticipated dividends.
The
Company’s Common Stock began being quoted on the NASD Over the Counter Bulletin
Board on December 13, 2004.
The
term
loan is evidenced by a Secured Convertible Term Note (“Term Note”) and bears
interest at a rate per annum equal to the prime rate (as reported in the Wall
Street Journal), plus two percent, subject to a floor of six percent. Interest
on the term loan is payable monthly.
Prior
to
the October 2006 amendment described below, the interest rate under the Term
Note was subject to downward adjustment at the end of each month so that if
at
the end of the applicable month the Company had registered the shares of Common
Stock underlying the Term Note with the SEC, interest payable on the Term Note
would be adjusted downward by 200 basis points (two percent) for each
incremental 25 percent increase in the market price of the Common Stock, at
the
end of the month, in excess of the conversion price under the Term Note.
Amounts
outstanding under the Term Note were initially convertible into Common Stock
at
Laurus's option at a conversion price initially equal to $135.00 per share.
As
the market price of the stock at the date of the modification was significantly
below the conversion price, there was no financial statement impact of the
modification of the conversion price. In December 2004 the conversion price
was
reduced to $95.50 under the terms of the anti-dilution feature of the Term
Note.
In addition, subject to (i) having an effective registration statement with
respect to the shares of Common Stock underlying the Term Note, and (ii)
limitations based on trading volume of the Common Stock, originally scheduled
principal and interest payments under the Term Note were made in shares of
Common Stock valued at the conversion price. In addition, prepayments under
the
Term Note were subject to a premium in the amount of 20% of the principal being
prepaid.
Borrowings
under the revolving credit facility bear interest at a rate per annum equal
to
the prime rate plus two percent. In addition, prior to the October 2006
amendment described below, the interest rate under the revolving credit facility
was previously subject to downward adjustment at the end of each month in the
same manner as provided for under the Term Note. The revolving credit facility
terminates, and borrowings thereunder become due, on December 31,2007.
Amounts
outstanding under the revolving credit facility were initially convertible
to
Common Stock at Laurus's option at a conversion price initially equal to $169.00
per share. In December 2004 the conversion price was reduced to $111.00 under
the terms of the anti-dilution feature of the facility. As the market price
of
the stock at the date of the modification was significantly below the conversion
price, there was no financial statement impact of the modification of the
conversion price. To the extent the Company repays loans outstanding under
the
revolving credit facility and/or Laurus converts loans under the revolving
credit facility into Common Stock, the Company could reborrow or make additional
borrowings under the revolving credit facility, provided that aggregate loans
outstanding under the revolving credit facility at any time may not exceed
the
lesser of $10 million or a borrowing base equal to the sum of 83.7% of "eligible
accounts" plus 60% of "eligible inventory" (with borrowings based on eligible
inventory limited to $3.5 million). Eligible accounts are generally gross
accounts receivable less foreign receivables and domestic receivables over
90
days from invoice date. Eligible inventory is substantially all finished goods
inventory.
Pursuant
to an amendment, dated as of May 26, 2006, between the Company and Laurus,
(i)
payments of principal due to Laurus for the months of June 2006 through December
2006 under the Term Note were reduced from $190,000 per month to $100,000 per
month, (ii) the final payment of principal due to Laurus under the Term Note
on
May27, 2007 was correspondingly increased from $435,000 to $1,065,000, and (iii)
the exercise price of warrants previously issued to Laurus to purchase an
aggregate of 26,800 shares of the Company’s Common Stock was reduced from
$175.00 to $30.00. Pursuant to a further Amendment, dated as of June 22, 2006,
the conversion price of $300,000 of principal under the Term Note was reduced
to
$7.50 from $95.50, and Laurus converted such amount of principal into 40,000
shares of the Company’s Common Stock. The principal so converted was applied to
the payments of principal that would otherwise have been due under the Term
Note
for the months of July, August and September 2006. As a result of the reduction
in the exercise price of the warrants, the Company recorded an interest charge
of approximately $76,000 in the second quarter of 2006. In addition, the Company
also recorded a charge of approximately $20,000 from the reduction of the
conversion price of $300,000 of convertible term debt principal in June 2006.
F-16
On
October 4, 2006, in connection with the private placement referred to in Note
8,
the Company entered into an Omnibus Amendment and Consent with Laurus, pursuant
to which Laurus consented to the issuance of the Convertible Notes in the
private placement. In addition, Laurus agreed to further amendments to the
Company’s revolving credit facility and term loan agreements under which (i) the
ability of Laurus to convert the Company’s revolving credit facility and term
loan into Common Stock was eliminated; (ii) the maturity date of both the
revolving credit facility and Term Note was extended from May 24, 2007 until
December 31, 2007; (iii) prepayment penalties with respect to both the revolving
credit facility and Term Note were eliminated; and (iv) monthly principal
payments of $152,000 are due under the Term Note for the months of January
2007
through November 2007, with the final payment in December 2007 of $252,000.
Accordingly,
after giving effect to the amendments above, the remaining amortizing payments
of principal on the Term Note are $152,083 per month January 2007 through
November 2007 and a final payment of $252,083 on December 2007.
NOTE
5 ~
LOAN
ORIGINATION FEES
The
Company incurred and capitalized origination and finders fees associated with
the Laurus credit facility of approximately $1.8 million. These fees are
amortized into interest expense 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
will be fully amortized in May 2007.
As
noted
in Note 8, in conjunction with its private placement transaction in October
2006
the Company recorded loan origination fees of approximately $47,000 to reflect
the fair value of a warrant to purchase 1,875,000 shares of Common Stock issued
to a shareholder for consulting services in connection with the private
placement transaction. These non-cash expenses were initially amortized into
interest expense using the effective interest method over the term of the
underlying subordinated convertible notes of three years. In November 2006,
the
private placement investors exercised the conversion feature of the subordinated
convertible notes, at which time the remaining unamortized balance of the
related loan origination fees were immediately charged to income.
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 December31, 2006 were as follows:
2007
$
83
2008
53
2009
12
Total
payments
148
Less
amounts relating to interest
8
Total
capital lease obligations
140
Less
current portion
77
Capital
lease obligations, noncurrent
$
63
F-17
NOTE
7 ~ INCOME TAXES
The
Company’s provision for income taxes consists of the
following:
2006
2005
2004
Current
Federal
$
-
$
-
$
(647
)
State
14
83
22
14
83
(625
)
Deferred
Federal
-
-
212
State
-
-
-
-
-
212
Total
$
14
$
83
$
(413
)
The
2004
provision includes a benefit of $1.1 million relating to continuing operations,
which is partially offset by $695,000 expense charge relating to discontinued
operations.
Deferred
taxes are provided for the differences in the tax and accounting basis of assets
and liabilities as follows ($ in thousands):
2006
2005
Current
deferred taxes
Accounts
receivable allowances
$
546
$
352
Other
0
28
Inventory
reserve
864
979
Uniform
capitalization of inventory costs
74
98
Net
operating loss carry-forward
7,943
5,169
9,427
6,626
Noncurrent
deferred tax liabilities
Property
and equipment
(121
)
(84
)
Non
Cash compensation
46
33
(75
)
(51
)
Less:
Deferred tax valuation allowance
(9,352
)
6,575
Net
$
-
$
-
The
Company's effective tax rate differs from the expected federal income tax rate
as follows ($ in thousands):
2006
2005
2004
Income
tax at statutory rates (34%)
$
(5,612
)
$
(4,397
)
$
(2,581
)
State
income tax expense - net of federal benefit
14
55
15
Change
in deferred tax valuation allowance
5,612
4,425
2,150
Other
-
-
3
Income
tax (benefit) provision
$
14
$
83
$
(413
)
F-18
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 has incurred significant operating losses over the past several fiscal
years, which has 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 may 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. As a result, at December 31,
2006,
the
Company
has a
net operating loss carry-forward of approximately $27.5 million expiring 2025.
A
full valuation allowance has been provided against the deferred tax assets.
The
valuation allowance reflects management’s assessment of the uncertainty of the
Company’s ability to utilize the deferred tax benefits in the
future.
NOTE
8 ~ STOCKHOLDERS’ EQUITY
October
2006 Private Placement
On
October 6, 2006, the Company completed a $5 million private placement (excluding
closing costs of $100,000), consisting of 100 Units at a price of $50,000 per
unit. Each Unit consisted of 25,000 shares of Common Stock and a 6% Subordinated
Secured Convertible Promissory Note (“Convertible Notes”) in the principal
amount of $45,000, convertible into 225,000 shares of Common Stock at a
conversion price equal to $.20. As a result, the Company issued 2,500,000 shares
of common stock for $400,000 (net of closing costs of $100,000) and Convertible
Notes in the aggregate principle amount of $4,500,000 convertible into
22,500,000 shares of the Company’s common stock. The Company could repay the
Convertible Notes at maturity through the issuance of common stock, so long
as
the market price of the common stock was no less than 150% of the conversion
price at maturity. The Convertible Notes could not be converted into common
stock until the Company could amend its certification of incorporation effecting
a reverse stock split providing for a sufficient number of authorized shares
of
common stock to permit such conversion. On November 27, 2006, the Company
effected a 50-for-1 reverse stock split of the Common Stock, and all of the
Convertible Notes (including $40,463 of accrued interest) were converted to
Common Stock.
The
conversion price of the Convertible Notes was less than the market price of
the
Company’s common stock on the date of the issuance of the Convertible Notes. In
accordance with EITF 98-5 the Company recognized a debt discount of $4.5 million
associated with the beneficial conversion feature of the Convertible Notes.
The
entire debt discount was recognized by the Company on November 27, 2006, the
date on which the Company’s 50-for-1 reverse split was effected and the Notes
became ultimately convertible.
As
part
of the transaction, the Company agreed to issue warrants to purchase an
aggregate of 1,875,000 shares of Common Stock at a price of $.20 per share
to a
consultant that became a director. As a result of this agreement, the Company
recorded deferred loan origination fees equal to the fair value of the warrant
totaling $46,875.
Other
Equity Transactions
During
the year ended December 31, 2006, the Company issued 40,000 shares of common
stock to directors valued at $52,000. The shares were valued at the market
price
at the date of issuance.
During
the year ended December 31, 2006, the Company issued 15,000 shares of common
stock to its former distributor to the retail channel upon achievement of a
contractual sales milestone. The shares were valued at $157,500, the market
price at the date of issuance.
F-19
During
the year ended December 31, 2006, the Company issued 25,000 shares of common
stock for services valued at $23,250. The shares were valued at the market
price
at the date of issuance.
NOTE
9 ~
SIGNIFICANT
VENDOR AGREEMENT
The
Company was party to a product distribution agreement with Samsung Electronics
Co. Ltd. (“Samsung”) that gave the Company the exclusive right to sell Samsung
products in the professional channel, as well as the exclusive right to sell
Samsung products in the retail channel to a major national retailer. The
exclusive right to sell Samsung products to the major national retailer expired
on December 31, 2005. In January 2006 Samsung also terminated the remaining
exclusivity associated with the professional market as a result of the Company’s
failure to achieve minimum purchase requirements in accordance with the
distribution agreement. In the first quarter of 2006, Company management elected
to discontinue its retail business, and no longer sells Samsung retail products.
On
October 2, 2006, the Company entered into a new Product 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. The Agreement also provides for minimum annual
purchase amounts of $21 million and $27 million for the years ending December31, 2006 and 2007, respectively, and allows Samsung to 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 year ended December 31, 2006, the Company exceeded its minimum
purchasing commitment under the agreement. For the year ended December 31,2006,
we purchased approximately $21.3 million under the Distributorship Agreement
with Samsung.
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, 2006, 2005 and 2004, 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 estimates its 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 $25,704 for the
remainder of the sixty-six month lease. The Company records rent on a
straight-line basis over the life of the lease and records the difference
between amounts paid and expense recorded as a deferred lease liability.
The
minimum annual rentals under the non-cancelable lease for the periods subsequent
to December 31, 2006 are as follows ($ in thousands):
Years
Ending December 31:
Amount
2007
$
308
2008
308
2009
231
$
847
F-20
Termination
Agreement with Nazzareno E. Paciotti
On
March28, 2006, the Company and Nazzareno E. Paciotti, entered into a Mutual
Separation Agreement whereby the parties mutually agreed to the termination
of
Mr. Paciotti’s employment with the Company and to his resignation as a director
and officer of the Company and its subsidiaries. Under the terms of the Mutual
Separation Agreement, Mr. Paciotti was entitled to receive severance payments
equal to one year of his annual base salary of $300,000 payable over 12 months.
In addition, under the separation agreement, Mr. Paciotti was entitled to
continue to receive medical benefits through January 24, 2008. The Company
also
agreed that Mr. Paciotti’s options to purchase 12,500 shares of Common Stock
would vest in full and be exercisable in full until December 31, 2006. Mr.
Paciotti agreed to release the Company in full from any and all claims and
to
continue to be bound by the confidentiality and non-solicitation terms of
his
employment agreement.
In
September 2006 the Company entered into an agreement with Mr. Paciotti whereby
the Company paid Mr. Paciotti a one-time payment of $85,925 in satisfaction
of
all remaining obligations under the Mutual Separation Agreement, which resulted
in total payments under the Mutual Separation Agreement to Mr. Paciotti of
$206,112. .
Employment
Agreements
The
Company entered into an Employment Agreement, dated as of February 9, 2006,
with
Steven Walin, the Company’s Chief Executive Officer. The Employment Agreement is
for a three-year term of employment which commenced March 6, 2006. Pursuant
to the Employment Agreement, Mr. Walin received a $100,000 signing bonus and
receives an annual base salary of $375,000.
Pursuant
to his Employment Agreement, Mr. Walin was also paid a guaranteed bonus equal
to
50% of his base salary ($140,625) for the first nine months of his service,
and
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 the Company’s board
of directors, for subsequent years.
In
addition, pursuant to the Employment Agreement, in the event that Mr. Walin’s
employment is terminated 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 12 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, all of the unvested options will immediately
vest.
If
Mr.
Walin’s employment is terminated as a result of his death or disability, the
Company will pay him his accrued but unpaid base salary, unpaid signing bonus,
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.
F-21
Mr.
Walin
is prohibited under the Employment Agreement from using or disclosing any of
the
Company’s proprietary information, competing with the Company, hiring any of the
Company’s employees or consultants and soliciting any of the Company’s customers
or suppliers to reduce or cease business with the Company.
In
addition, the Company also entered into an Employment Agreement, dated as of
March 28, 2006, with Joseph Restivo, the Company’s Chief Financial Officer.
The
Employment Agreement is for a three-year term and provides Mr. Restivo with
an
annual base salary of $200,000, and an annual bonus of up to 50% of his base
salary based on the achievement of annual performance targets approved of by
the
Company’s board of directors.
In
addition, pursuant to the Employment Agreement, in the event that Mr. Restivo’s
employment is terminated without “Cause” or by Mr. Restivo for “Good Reason” (as
such terms are defined in the Employment Agreement), Mr. Restivo will be
entitled to:
·
payment
of all accrued but unpaid base salary and unpaid annual bonus with
respect
to any completed fiscal year;
·
payment
of his base salary and continued medical benefits for 12 months;
provided,
that if such termination occurs after a “Change in Control” Mr. Restivo
will instead be entitled to a payment equal to 200% of his base salary
and
continued medical benefits for 24
months;
·
pro-rated
bonus for the year in which the termination occurs, payable following
such
fiscal year to the extent he would have otherwise been entitled to
such
bonus; and
·
provided
at least six months has expired since the last vesting of his option
grant, a pro rata vesting of his option shares which are scheduled
to vest
on the next vesting date; provided, that if such termination occurs
after
a “Change in Control” or after the first anniversary of Mr. Restivo’s
employment, all of the unvested options will immediately
vest.
If
Mr.
Restivo’s employment is terminated as a result of his death or disability, the
Company 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 the Company’s proprietary information, competing with the Company, hiring
any of the Company’s employees or consultants and soliciting any of our
customers or suppliers to reduce or cease business with the Company.
On
October 4, 2006, in connection with the private placement noted earlier, the
Company entered into amendments to the employment agreements of both the Chief
Executive Officer and Chief Financial Officer, by which the Company agreed
to
issue to each of the two officers an option to purchase 1,881,795 shares of
the
Company’s Common Stock at an exercise price of $.020 per share vesting over a
three-year period, and have amended the definition of “Cause” for termination
purposes under each of the employment agreements to include the Company’s
incurrence of a net loss, as defined in the amendments, in the quarter ending
June 30, 2007. The new options may not be exercised until such time as the
Company has available for issuance a sufficient number of unissued shares of
authorized Common Stock so as to permit such exercise. Pursuant to the
amendments, the two officers agreed to forfeit all stock options previously
granted to them under their employment agreements as well as the right to be
issued additional stock options upon the closing of a private placement of
the
Company’s securities.
NOTE
12 ~ 2004 STOCK INCENTIVE PLAN
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, and in
October 2006 the shares available were increased under this Plan to
5,900,000.
F-22
In
March
2006, the Company granted to the Chief Executive Officer and Chief Financial
Officer options to purchase a total of 75,000 shares of Common Stock exercisable
at $8.00 to $40.00 per share. These options were not granted under a plan.
In
October 2006, the Company entered into amendments to the employment agreements
of both the Chief Executive Officer and Chief Financial Officer, by which the
Company agreed to issue to each of the two officers an option to purchase
1,881,795 shares of the Company’s Common Stock at an exercise price of $.20 per
share vesting over a three-year period. Under the terms of the amendment, the
two officers agreed to forfeit options to purchase an aggregate of 75,000 shares
of common stock previously issued to them. In addition, options to purchase
an
aggregate of 1,640,000 shares of common stock were made available for
distribution to other key management members at an exercise price of $.20 per
share vesting over a three-year period. Additionally, options to purchase an
aggregate of 30,000 shares of common stock were granted to directors. The
director options provided for an exercise price of $.20 per share over a 10
year
life, and vests over a three-year period.
A
summary
of the status and activity of the Company’s stock options is presented below:
Years
Ended December 31:
2006
2005
2004
Shares
Weighted
Ave Exercise Price
Shares
Weighted
Ave Exercise Price
Shares
Weighted
Ave Exercise Price
Outstanding
at January 1:
84,435
$
89.89
110,411
$
80.97
482
$
2,245.54
Granted
5,508,591
$
0.56
28,350
$
61.70
109,929
$
71.48
Exercised
-
-
(39,500
)
$
16.00
-
-
Forfeited
(94,229
)
$
33.42
(14,826
)
$
166.43
-
-
Outstanding
at December 31:
5,498,797
$
1.37
84,435
$
89.89
110,411
$
80.97
Options
Exercisable at December 31:
1,411,795
$
3.80
29,786
$
92.75
41,072
$
76.54
The
aggregate intrinsic values of outstanding and exercisable shares at December31,2006 were $0 and $0, respectively.
In
October 2004 the Company entered into a Settlement Agreement and General Release
with William A. Teitelbaum, a founder and principal stockholder of the GVI
Security, Inc., under which Mr. Teitelbaum was issued 13,000 shares of common
stock and Mr. Teitelbaum released the Company from claims with respect to a
warrant he alleged had been issued to him by GVI Security, Inc. The value of
the
common stock issued under the agreement is recorded as an other operating
expense of $156,000 for the year ended December 31, 2004. The Settlement
Agreement required the Company to use a portion of the proceeds it would receive
in a placement of its securities to repurchase up to $10 million of shares
of
common stock held by Mr. Teitelbaum at the purchase price of the securities
sold
in the placement. On January 4, 2005the Company completed the purchase of
133,333 shares from William A. Teitelbaum for $10 million.
F-24
Termination
Agreement with Thomas Wade
On
October 19, 2004, the Company, GVI Security Inc. and Thomas Wade, at that time
the beneficial holder of approximately 14% of Common Stock and the President
of
the Company’s subsidiary, entered into a Mutual Separation Agreement whereby the
parties mutually agreed to the termination of Mr. Wade’s employment with the
subsidiary. In accordance with Mr. Wade’s employment agreement, Mr. Wade
received severance payments equal to one year of his annual base salary of
$350,000. In addition, under the separation agreement, Mr. Wade was entitled
to
continue to receive a car allowance of $800 per month, an unconditional expense
reimbursement of $1,200 per month, and medical benefits, for a period of one
year. At December 31, 2004, approximately $281,000 for the remaining obligation
was included in accrued expenses. The Company also agreed that Mr. Wade’s
options to purchase 39,500 shares of the Company’s Common Stock would vest in
full. There was no effect on earnings for this acceleration. Mr. Wade agreed
to
release the Company in full from any and all claims and to continue to be bound
by all the terms of his employment agreement.
In
the
normal course of business, the Company previously conducted certain transactions
with a company owned by William Teitelbaum, a principal stockholder. During
the
years ended December 31, 2005 and 2004, the Company made sales of $0 and $3,587,
respectively, to this company. At December 31, 2005, no amounts were due from
this company.
On
March31, 2004, the Company issued three subordinated convertible notes totaling
$159,000. Each note bore interest at 10% per annum and was convertible into
common stock at a price of $255.00 per share. The notes were paid in full with
accumulated interest on June 29, 2004.
On
October 29, 2004, in a private placement exempt from registration under the
Securities Act, the Company sold 23 “Units” for an aggregate purchase price of
$1,150,000, to a group of five purchasers, all of whom were affiliates of the
Company. Each Unit consisted of $50,000 principal amount of 12% Subordinated
Secured Promissory Notes, and the right to be issued warrants to purchase shares
of common stock. The Notes were repaid in full in accordance with their terms
in
December 2004 upon the closing of the private placement. Warrants to purchase
15,333 shares of common stock were issued to these purchasers in December 2004
in accordance with the terms of the October 2004 private placement.
Joseph
Rosetti, one of the Company’s directors, was a director of Rapor prior to the
merger (See Note 1). Mr. Rosetti was also the direct holder of approximately
12%
of Rapor’s outstanding common stock, and a principal partner in a partnership,
established for the benefit of members of his family, that held approximately
7.5% of Rapor’s outstanding common stock. In accordance with the terms of the
merger, as former stockholders of Rapor, Mr. Rosetti was issued 6,921 shares
of
common stock and warrants topurchase
2,716 shares of common stock, and the partnership was issued 4,180 shares of
common stock and warrants to purchase 2,090 shares of common stock.
NOTE
15 ~ INVESTMENT IN DIGITAL HORIZONS SOLUTIONS, LLC (formerly Bio-AccessID,
LLC)
On
January 20, 2004, pursuant to a Membership Purchase Agreement by and among
John
Carter, Ronald DeBerry, GVI Security Solutions, Inc., and Digital Horizons
Solutions, LLC (formerly Bio-AccessID, LLC)
("Digital
Horizons"), the Company purchased a 5% membership interest in Bio-Access for
$250,000. In December 2005 the Company determined the value of this investment
had been significantly impaired and wrote down the carrying value to $50,000,
recording a charge to other operating expenses of $200,000 for the year ended
December 31, 2005. As part of the agreement, the Company had the right to
acquire up to an additional 21% of Bio-Access over a three-year period after
certain agreed-upon purchase goals have been attained for a purchase price
of up
to an additional $750,030. As a result of the amount of the Company’s
purchases from Digital Horizons, the Company’s option to acquire additional
interest has decreased from 21%
to
19%.
In
June
2006, the Company sold its rights and interest in Digital Horizons for
$50,000.
NOTE
16 ~ COMPANY RECAPITALIZATION
On
February 16, 2004, the Board of Directors and Stockholders of the Company
authorized new Series D and E Convertible Preferred Stock, each for par value
of
$.001 per share. On February 20, 2004, pursuant to an Agreement and Plan of
Merger (the "Merger Agreement") dated as of February 19, 2004, by and among
the
Company (then “Thinking Tools, Inc.”), GVI Security, Inc., and GVI Security
Acquisition Corp., a newly formed wholly-owned
subsidiary of the Company, GVI Security, Inc. merged (the “Merger”) with GVI
Security Acquisition Corp., becoming the Company's wholly-owned subsidiary,
and
the stockholders of GVI became stockholders of the Company as described below.
For accounting purposes, because Thinking Tools, Inc. had become a shell
company, the Merger was treated as a recapitalization of GVI Security, Inc.
F-25
In
the
Merger, the Company issued to the former stockholders of GVI an aggregate of
1,000,000 shares of the Series E Convertible Preferred Stock ("Series E Stock").
The shares of Series E Stock were convertible into an aggregate of 564,292
shares of the Company's common stock, constituting approximately 95.3% of the
outstanding shares of the Company's common stock outstanding following the
Merger, assuming the conversion of all other outstanding shares of the Company's
preferred stock. The shares of Series E Stock were automatically converted
into
shares of the Company's common stock when the Company filed the Charter
Amendment (defined below).
The
two
largest stockholders of GVI prior to the Merger were William Teitelbaum, who
owned approximately 47.8% of GVI's common stock, and GVI Acquisition LLC
("Acquisition LLC"), which owned approximately 38.3% of GVI's common stock.
Acquisition LLC is a California limited liability company, whose sole managers,
Fred Knoll and David Weiner, were directors of the Company until December 31,2004 and January 4, 2005, respectively. The sole members of Acquisition LLC
are
(i) a corporation which is wholly-owned by David Weiner, and (ii) Europa
International, Inc. (“Europa”) an equity fund managed by Knoll Capital
Management, L.P., of which Mr. Knoll is the principal.
In
addition, pursuant to the Merger Agreement, certain employees and directors
of
GVI were issued options to purchase an aggregate of approximately 56,429 shares
of the Company's common stock under the 2004 Long-Term Incentive Plan in
exchange for the cancellation of options to purchase shares of GVI's common
stock held by such persons prior to the Merger. All of these options have an
exercise price of $15.93 per share.
Immediately
prior to the Merger, and as a condition thereto, Europa exchanged a Convertible
Demand Grid Note issued by the Company in the principal amount of $1,000,000,
and all other indebtedness of the Company to Europa for 10,000 shares of the
Series D Convertible Preferred Stock ("Series D Stock") of the Company, which
shares were convertible into an aggregate of 23,760 shares of common stock.
The
shares of Series D Stock automatically converted into shares of the Company's
common stock when the Company filed the Charter Amendment. Pursuant to its
obligations under the Merger Agreement, following the Merger, the Company
obtained the approval of its stockholders to (i) amend the Company's certificate
of incorporation increasing the authorized shares of the Company's common stock
to 75,000,000 and effecting a one-for-65 reverse stock split of the common
stock
so that the Company would have sufficient shares of unissued common stock to
permit the conversion of all of the Series D Stock, Series E Stock and all
other
convertible securities of the Company (the "Charter Amendment"), (ii) the
adoption of the Stock Option Plan, and (iii) the change of the Company’s name to
GVI Security Solutions, Inc. The Company filed a Certificate of Amendment to
its
Certificate of Incorporation with the Secretary of State in Delaware giving
effect to these amendments in April 2004, whereupon all outstanding shares
of
Series A Preferred Stock, Series D Preferred Stock and Series E Preferred Stock
automatically converted into shares of the Company's common stock.
In
addition, pursuant to amendments to the terms of the Series A Preferred Stock
approved in January 2004, upon the filing of the Charter Amendment the
outstanding shares of Series A Preferred Stock converted into an aggregate
of
884 shares of the Company’s common stock.
NOTE
17 ~ QUARTERLY
FINANCIAL INFORMATION (UNAUDITED)
The
tables below list the quarterly financial information for the years ended
December 31, 2006 and 2005:
Loss
from continuing operations before income (loss) from discontinued
operations
(670
)
(2,807
)
(2,535
)
(4,725
)
Income
(loss) from discontinued operations, net of taxes
1,180
(43
)
(53
)
(b)
(3,367
)
Net
income (loss)
$
510
$
(2,850
)
$
(2,588
)
$
(8,092
)
Continuing
operations
$
(1.07
)
$
(2.81
)
$
(2.53
)
$
(4.71
)
Discontinued
operations
$
1.59
$
(0.04
)
$
(0.05
)
$
(3.36
)
Net
income (loss) per share
(basic
and diluted)
$
0.52
$
(2.85
)
$
(2.58
)
$
(8.08
)
(a)
The
2006 fourth quarter loss from continuing operations includes a $4.5
million charge to reflect the beneficial conversion feature discount
from
convertible notes issued in October
2006
(b)
The
2005 fourth quarter loss from discontinued operations includes write-off
of retail inventory and other assets of approximately $2.9
million.
NOTE
18 ~ SUBSEQUENT EVENTS
January
2007 Private Placement
On
January 22, 2007, the Company completed an additional 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.
Director
Stock Option Grants
On
February 14, 2007, the Company granted to three directors options to purchase
an
aggregate of 100,000 shares of the Company’s common stock. These options provide
for an exercise price of $.60 per share over a 10 year life. 25% of each
director’s options vest immediately, with the remaining 75,000 options vesting
ratably in 12 installments of 6,250 each on the first day of each fiscal quarter
of the Corporation commencing April 1, 2007.
F-27
Dates Referenced Herein and Documents Incorporated by Reference
