UNITED STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C.  20549









FORM 10-Q




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




For
the Quarter Ended March 31, 2010




Commission
File Number 001-33888









American Defense
Systems, Inc.


(Exact
Name of Registrant as Specified in Its Charter)




Delaware
            
            83-0357690(State
      or Other Jurisdiction of Incorporation or
              Organization)
            
            (I.R.S.
      Employer Identification No.)




230
Duffy Avenue


Hicksville,
NY 11801


(516)
390-5300


(Address
including zip code, and telephone number, including area code, of principal
executive


offices)




Indicate
by check mark whether the registrant (1) has filed all reports required to
be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.  Yes  x   No 
o




Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files).  Yes 
o
  No  o




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




Large
      Accelerated Filer   o
            
            Accelerated
      Filer   oNon-Accelerated
      Filer   o
            
            Smaller
      Reporting Company   x




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




As of May
14, 2010, 47,876,318 shares of common stock, par value $0.001 per share, of
the registrant were outstanding.










TABLE OF
CONTENTS




PART I
      — FINANCIAL INFORMATIONItem 1.
                                                                      Condensed Consolidated Financial
      Statements
                                                                      3Condensed Consolidated Balance Sheets as of March
      31, 2010 (Unaudited) and December 31, 2009
                                                                      3Condensed Consolidated Statements
      of Operations for the three months ended March 31, 2010 and
      2009(Unaudited)
                                                                      4Condensed Consolidated Statements
      of Cash Flows for the three months ended March 31, 2010 and
      2009(Unaudited)
                                                                      5Notes to Condensed Consolidated Financial
      Statements
                                                                      6Item 2.
                                                                      Management’s Discussion and Analysis of Financial
      Condition and Results of Operations
                                                                      20Item 3.
                                                                      Quantitative and Qualitative Disclosure About
      Market Risk
                                                                      27Item 4.
                                                                      Controls and Procedures
                                                                      27PART II
      — OTHER INFORMATIONItem 1.
                                                                      Legal ProceedingsItem 1A.
                                                                      Risk Factors
                                                                      29Item 2.
                                                                      Unregistered Sales of Equity Securities and Use of
      Proceeds
                                                                      29Item 3.
                                                                      Defaults Upon Senior
    Securities
                                                                      39Item 4.
                                                                      (Removed and Reserved)
                                                                      39Item 5.
                                                                      Other Information
                                                                      39Item 6.
                                                                      Exhibits
                                                                      40SIGNATURES
                                                                      41










PART
I




Item 1.    Condensed Consolidated
Financial Statements




AMERICAN
DEFENSE SYSTEMS, INC. AND SUBSIDIARIES


CONDENSED
CONSOLIDATED BALANCE SHEETS




ASSETS
                                
                                March
      31,
                                  2010
                                
                                
                                December
      31,
                                  2009
      *(Unaudited)CURRENT
      ASSETSCash
                                
                                $
                                87,971
                                
                                
                                $
                                -Accounts
      receivable, net of allowance for doubtful accounts of $267,448 and
      $222,448 as of March 31, 2010 and December 31, 2009,
      respectively
                                
                                
                                4,284,950
                                
                                
                                
                                2,288,666Accounts
      receivable-factoring
                                
                                
                                346,095
                                
                                
                                
                                199,876Tax
      receivable
                                
                                
                                108,741
                                
                                
                                
                                108,741Costs
      in excess of billings on uncompleted contracts, net
                                
                                
                                6,048,444
                                
                                
                                
                                7,762,836Prepaid
      expenses and other current assets
                                
                                
                                601,730
                                
                                
                                
                                540,381Deferred
      tax assets
                                
                                
                                -
                                
                                
                                
                                521TOTAL
      CURRENT ASSETS
                                
                                
                                11,477,931
                                
                                
                                
                                10,901,021Property
      and equipment, net
                                
                                
                                2,840,600
                                
                                
                                
                                3,078,724Deferred
      financing costs, net
                                
                                
                                1,160,662
                                
                                
                                
                                1,547,551Notes
      receivable, net
                                
                                
                                400,000
                                
                                
                                
                                400,000Intangible
      Assets
                                
                                
                                606,000
                                
                                
                                
                                606,000Goodwill
                                
                                
                                450,000
                                
                                
                                
                                450,000Deposits
                                
                                
                                457,137
                                
                                
                                
                                407,137Other
      Assets
                                
                                
                                -
                                
                                
                                
                                138,001TOTAL
      ASSETS
                                
                                $
                                17,392,330
                                
                                
                                $
                                17,528,434LIABILITIES
      AND SHAREHOLDERS' DEFICIENCYCURRENT
      LIABILITIESAccounts
      payable
                                
                                $
                                5,583,762
                                
                                
                                $
                                6,695,712Cash
      overdraft
                                
                                
                                72,860
                                
                                
                                
                                48,573Accrued
      expenses
                                
                                
                                653,178
                                
                                
                                
                                498,795Warrant
      liability
                                
                                
                                59,842
                                
                                
                                
                                35,413TOTAL
      CURRENT LIABILITIES
                                
                                
                                6,369,642
                                
                                
                                
                                7,278,493LONG
      TERM LIABILITIESMandatory
      redeemable Series A Convertible Preferred Stock (cumulative), 15,000
      shares authorized issued and outstanding
                                
                                
                                13,330,189
                                
                                
                                
                                12,429,832Deferred
      rent
                                
                                
                                204,309
                                
                                
                                
                                -Deferred
      tax liabiity
                                
                                
                                -
                                
                                
                                
                                521TOTAL
      LIABILITIES
                                
                                
                                19,904,140
                                
                                
                                
                                19,708,846SHAREHOLDERS'
      DEFICIENCYCommon
      stock, $0.001 par value, 100,000,000 shares authorized, 47,858,957 and
      46,611,457 shares issued and outstanding as of March 31, 2010 and December
      31, 2009, respectively
                                
                                
                                47,859
                                
                                
                                
                                46,611Additional
      paid-in capital
                                
                                
                                15,204,174
                                
                                
                                
                                14,712,414Accumulated
      Deficit
                                
                                
                                (17,763,843
                                )
                                
                                
                                (16,939,437
                                )TOTAL
      SHAREHOLDERS' DEFICIENCY
                                
                                
                                (2,511,810
                                )
                                
                                
                                (2,180,412
                                )TOTAL
      LIABILITIES AND SHAREHOLDERS' DEFICIENCY
                                
                                $
                                17,392,330
                                
                                
                                $
                                17,528,434




*
Condensed from audited financial statements


The
accompanying notes are an integral part of these condensed consolidated
financial statements.




3





AMERICAN
DEFENSE SYSTEMS, INC. AND SUBSIDIARIES


CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS


(Unaudited)




Three
      Months EndedMarch
      31,2010
                                                                                
                                                                                
                                                                                2009CONTRACT
      REVENUES EARNED
                                                                                
                                                                                $
                                                                                15,445,544
                                                                                
                                                                                
                                                                                $
                                                                                9,489,702COST
      OF REVENUES EARNED (exclusive of depreciationshown
      separately below)
                                                                                
                                                                                
                                                                                9,986,679
                                                                                
                                                                                
                                                                                
                                                                                5,453,109GROSS
      PROFIT
                                                                                
                                                                                
                                                                                5,458,865
                                                                                
                                                                                
                                                                                
                                                                                4,036,593OPERATING
      EXPENSESGeneral
      and administrative expenses
                                                                                
                                                                                
                                                                                1,863,289
                                                                                
                                                                                
                                                                                
                                                                                1,486,529General
      and administrative salaries
                                                                                
                                                                                
                                                                                884,218
                                                                                
                                                                                
                                                                                
                                                                                1,073,037Sales
      and Marketing
                                                                                
                                                                                
                                                                                562,809
                                                                                
                                                                                
                                                                                
                                                                                733,794T2
      expenses
                                                                                
                                                                                
                                                                                218,848
                                                                                
                                                                                
                                                                                
                                                                                113,602Research
      and development
                                                                                
                                                                                
                                                                                121,717
                                                                                
                                                                                
                                                                                
                                                                                186,386Depreciation
                                                                                
                                                                                
                                                                                288,830
                                                                                
                                                                                
                                                                                
                                                                                241,329Professional
      fees
                                                                                
                                                                                
                                                                                573,520
                                                                                
                                                                                
                                                                                
                                                                                587,466TOTAL
      OPERATING EXPENSES
                                                                                
                                                                                
                                                                                4,513,231
                                                                                
                                                                                
                                                                                
                                                                                4,422,143OPERATING
      INCOME (LOSS)
                                                                                
                                                                                
                                                                                945,634
                                                                                
                                                                                
                                                                                
                                                                                (385,550
                                                                                )OTHER
      INCOME (EXPENSE)Unrealized
      loss on adjustment of fair valueSeries
      A convertible preferred stock classifiedas
      a liability
                                                                                
                                                                                
                                                                                (646,100
                                                                                )
                                                                                
                                                                                
                                                                                (694,454
                                                                                )Unrealized
      (loss) gain on warrant liability
                                                                                
                                                                                
                                                                                (24,429
                                                                                )
                                                                                
                                                                                
                                                                                80,672Interest
      expense
                                                                                
                                                                                
                                                                                (644,729
                                                                                )
                                                                                
                                                                                
                                                                                (342,730
                                                                                )Interest
      expense - Mandatorily redeemable preferred stock dividends
                                                                                
                                                                                
                                                                                (375,000
                                                                                )
                                                                                
                                                                                
                                                                                (375,000
                                                                                )Interest
      income
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                8,646Finance
      charge
                                                                                
                                                                                
                                                                                (79,781
                                                                                )
                                                                                
                                                                                
                                                                                -TOTAL
      OTHER INCOME (EXPENSE)
                                                                                
                                                                                
                                                                                (1,770,039
                                                                                )
                                                                                
                                                                                
                                                                                (1,322,866
                                                                                )LOSS
      BEFORE INCOME TAXES
                                                                                
                                                                                
                                                                                (824,405
                                                                                )
                                                                                
                                                                                
                                                                                (1,708,416
                                                                                )INCOME
      TAX PROVISION
                                                                                
                                                                                
                                                                                -
                                                                                
                                                                                
                                                                                
                                                                                -NET
      LOSS
                                                                                
                                                                                $
                                                                                (824,405
                                                                                )
                                                                                
                                                                                $
                                                                                (1,708,416
                                                                                )Weighted
      Average Shares Outstanding (Basic and Diluted)
                                                                                
                                                                                
                                                                                46,798,263
                                                                                
                                                                                
                                                                                
                                                                                39,585,960NET
      LOSS per Share - Basic and Diluted:
                                                                                
                                                                                $
                                                                                (0.02
                                                                                )
                                                                                
                                                                                $
                                                                                (0.04
                                                                                )




The
accompanying notes are an integral part of these condensed consolidated
financial statements.




4










AMERICAN
DEFENSE SYSTEMS, INC. AND SUBSIDIARIES


CONDENSED
CONSOLIDATED STATEMENTS OF CASH
FLOWS


(Unaudited)





For
      the three months ended March 31,2010
                                                              
                                                              
                                                              2009CASH
      FLOWS FROM OPERATING ACTIVITIES:NET
      LOSS
                                                              
                                                              $
                                                              (824,405
                                                              )
                                                              
                                                              $
                                                              (1,708,416
                                                              )Adjustments
      to reconcile net loss to net cash provided by (used in) operating
      activities:Change
      in costs in excess of billings reserve
                                                              
                                                              
                                                              30,000
                                                              
                                                              
                                                              
                                                              -Change
      in fair value associated with preferred stock and Warrants
      Liabilities
                                                              
                                                              
                                                              670,529
                                                              
                                                              
                                                              
                                                              613,778Stock
      based compensation expense
                                                              
                                                              
                                                              118,007
                                                              
                                                              
                                                              
                                                              154,636Amortization
      of deferred financing costs
                                                              
                                                              
                                                              386,889
                                                              
                                                              
                                                              
                                                              147,424Amortization
      of Discount on Series A preferred stock
                                                              
                                                              
                                                              254,257
                                                              
                                                              
                                                              
                                                              142,896Depreciation
      and amortization
                                                              
                                                              
                                                              288,830
                                                              
                                                              
                                                              
                                                              241,329Bad
      debt expense
                                                              
                                                              
                                                              45,000
                                                              
                                                              
                                                              
                                                              -Deferred
      rent
                                                              
                                                              
                                                              204,309
                                                              
                                                              
                                                              
                                                              -Stock
      issued for payment of dividends on preferred stock
                                                              
                                                              
                                                              375,000
                                                              
                                                              
                                                              
                                                              -Changes
      in operating assets and liabilities:Accounts
      receivable
                                                              
                                                              
                                                              (2,041,284
                                                              )
                                                              
                                                              
                                                              (1,453,738
                                                              )Accounts
      receivable-Factoring
                                                              
                                                              
                                                              (146,219
                                                              )
                                                              
                                                              
                                                              -Deposits
      and other assets
                                                              
                                                              
                                                              (50,000
                                                              )
                                                              
                                                              
                                                              -Other
      assets
                                                              
                                                              
                                                              138,001
                                                              
                                                              
                                                              
                                                              -Cost
      in excess of billing on uncompleted contracts
                                                              
                                                              
                                                              1,684,392
                                                              
                                                              
                                                              
                                                              357,095Prepaid
      expenses and other assets
                                                              
                                                              
                                                              (61,349
                                                              )
                                                              
                                                              
                                                              (42,764
                                                              )Accounts
      payable and accrued expenses
                                                              
                                                              
                                                              (957,567
                                                              )
                                                              
                                                              
                                                              741,164Cash
      overdraft
                                                              
                                                              
                                                              24,287
                                                              
                                                              
                                                              
                                                              -NET
      CASH PROVIDED BY (USED IN) OPERATING ACTIVITIES138,677
                                                              
                                                              
                                                              
                                                              (806,596
                                                              )CASH
      FLOWS FROM INVESTING ACTIVITIES:Purchase
      of equipment
                                                              
                                                              
                                                              (50,706
                                                              )
                                                              
                                                              
                                                              (66,625
                                                              )NET
      CASH USED IN INVESTING ACTIVITIES
                                                              
                                                              
                                                              (50,706
                                                              )
                                                              
                                                              
                                                              (66,625
                                                              )CASH
      FLOWS FROM FINANCING ACTIVITIES:Proceeds
      from line of credit
                                                              
                                                              
                                                              -
                                                              
                                                              
                                                              
                                                              582,590-
                                                              
                                                              
                                                              
                                                              582,590NET
      INCREASE (DECREASE) IN CASH
                                                              
                                                              
                                                              87,971
                                                              
                                                              
                                                              
                                                              (290,631
                                                              )CASH
      AT BEGINNING OF YEAR
                                                              
                                                              
                                                              -
                                                              
                                                              
                                                              
                                                              374,457CASH
      AT THE END OF PERIOD
                                                              
                                                              $
                                                              87,971
                                                              
                                                              
                                                              $
                                                              83,826Supplemental
      disclosure of cash flow information:Cash
      paid during the period for interest
                                                              
                                                              $
                                                              -
                                                              
                                                              
                                                              $
                                                              384,730Cash
      paid during the period for taxes
                                                              
                                                              $
                                                              -
                                                              
                                                              
                                                              $
                                                              -Supplemental
      disclosure of non-cash investing and financing activitiesStock
      options issued in lieu of compensation
                                                              
                                                              $
                                                              -
                                                              
                                                              
                                                              $
                                                              29,192Stock
      issued in lieu of cash compensation
                                                              
                                                              $
                                                              -
                                                              
                                                              
                                                              $
                                                              125,443Cumulative
      effect on a change in accounting principle on:Warrants
                                                              
                                                              $
                                                              -
                                                              
                                                              
                                                              $
                                                              165,775Additional
      Paid in Capital
                                                              
                                                              $
                                                              -
                                                              
                                                              
                                                              $
                                                              (837,954
                                                              )Accumulative
      Deficit
                                                              
                                                              $
                                                              -
                                                              
                                                              
                                                              $
                                                              672,179


The
accompanying notes are an integral part of these condensed consolidated
financial statements.





5





AMERICAN
DEFENSE SYSTEMS, INC. AND SUBSIDIARIES
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS







1.
            NATURE
      OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING
  POLICIES





Organization





American
Defense Systems, Inc. (the “Company” or “ADSI”) was incorporated under the laws
of the State of Delaware on December 6, 2002.





On May 1,
2003, the stockholder of A. J. Piscitelli & Associates, Inc. (“AJP”)
exchanged all of his issued and outstanding shares for shares of American
Defense Systems, Inc. The exchange was accounted for as a recapitalization of
the Company, wherein the stockholder retained all the outstanding stock of
American Defense Systems, Inc. At the time of the acquisition American Defense
Systems, Inc. was substantially inactive.





On
November 15, 2007, the Company entered into an Asset Purchase Agreement with
Tactical Applications Group (“TAG”), a North Carolina based sole proprietorship,
and its owner.   TAG has a retail establishment located in
Jacksonville, North Carolina that supplies tactical equipment to military and
security personnel.  As discussed more fully in Note 6, the operations
of TAG were discontinued on January 2, 2009.





In
January 2008, American Physical Security Group, LLC (“APSG”) was established as
a wholly owned subsidiary of the Company for the purposes of acquiring the
assets of American Anti-Ram, Inc., a manufacturer of crash tested vehicle
barricades. This acquisition represents a new product line for the
Company.  APSG is located in North Carolina.





Interim
Review Reporting





The
accompanying interim unaudited condensed consolidated financial statements have
been prepared in accordance with generally accepted accounting principles for
interim financial information and with the instructions to Form 10-Q and Article
8 of Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In our opinion, all adjustments (consisting of normal
recurring accruals) considered necessary for a fair presentation have been
included. Operating results for the three month period ended March 31, 2010 is
not necessarily indicative of the results that may be expected for the year
ending December 31, 2010. For further information, refer to the financial
statements and footnotes thereto included in the Company’s Form 10-K annual
report for the year ended December 31, 2009 filed on April 15,
2010.





Nature
of Business





The
Company designs and supplies transparent and opaque armor solutions for both
military and commercial applications. Its primary customers are United States
government agencies and general contractors who have contracts with governmental
entities. These products, sold under Vista trademarks, are used in transport and
fighting vehicles, construction equipment, sea craft and various fixed
structures which require ballistic and blast attenuation.





The Company also provides engineering and consulting services,
develops and installs detention and security hardware, entry control and
monitoring systems, intrusion detection systems, and security glass. The Company
also supplies vehicle anti-ram barriers.  Its primary customer for
these services and products are the detention and security
industry.





Principles
of Consolidation





The
consolidated financial statements include the accounts of American Defense
Systems, Inc. and its wholly-owned subsidiaries, A.J Piscitelli &
Associates, Inc. and APSG.  All significant intercompany accounts and
transactions have been eliminated in consolidation.





Terms
and Definitions





ADSI
            
            American
      Defense Systems, Inc. (or, the “Company”)AJP
            
            A.J.
      Piscitelli & Associates, Inc., a subsidiaryAPSG
            
            American
      Physical Security Group, LLC, a subsidiaryASC
            
            FASB
      Accounting Standards CodificationFASB
            
            Financial
      Accounting Standards BoardGAAP
            
            Generally
      Accepted Accounting PrinciplesPCAOB
            
            Public
      Companies Accounting Oversight BoardSEC
            
            Securities
      Exchange CommissionSFAS or FAS
            
            Statement
      of Financial Accounting StandardsTAG
            
            Tactical
      Applications Group, a subsidiary




6




AMERICAN
DEFENSE SYSTEMS, INC. AND SUBSIDIARIES
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


Management
Liquidity Plans





As of
March 31, 2010, the Company had working capital of $5,108,289, an accumulated
deficit of $17,763,843, shareholders’ deficiency of $2,511,810 and cash on hand
of $87,971.  The Company had a net loss of $824,405 for the three
months ended March 31, 2010. The Company believes that its current net
accounts receivable and cost in excess of billing together with its expected
cash flows from operations and its ability to sell accounts receivable under its
factoring agreement, will be sufficient to meet its anticipated cash
requirements for working capital at least through March 31, 2011. The Series A
Convertible Preferred Stock (the “Series A Preferred”) had a mandatory
redemption date of December 31, 2010. On April 8, 2010, the Company entered into
a Waiver Agreement with the holders of its Series A Preferred (the “Series A
Holders”) which extended the maturity redemption date from December 31, 2010 to
April 1, 2011. The Company is currently seeking to raise capital or obtain
access to capital sufficient to permit the Company to effect such redemption. If
the Company is unable to timely raise capital or obtain access to a credit
facility or other source of funds sufficient to fund such redemption, its cash
flow could be adversely affected and its business significantly harmed. In
addition, restrictions imposed pursuant to the General Corporation Law of the
State of Delaware (the “DGCL”), its state of incorporation, would prohibit the
Company from satisfying such redemption if the Company lacks sufficient surplus,
as such term is defined under the DGCL.




Use of
Estimates





The
preparation of financial statements and related disclosures in conformity with
accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the amounts reported in
the consolidated financial statements and accompanying notes.  Actual
results could differ from those estimates.





Significant
estimates for all periods presented include cost in excess of billings,
allowance for doubtful accounts, liabilities associated with the Series A
Preferred and warrants and valuation of deferred tax assets.





Subsequent
Events





The
Company has evaluated events that occurred subsequent to March 31, 2010 and
through the date the financial statements were issued.
Management concluded that no additional subsequent events required
disclosure in these financial statements except the following:





On May 7,
2010, the Company issued 17,361 shares of common stock to a consultant as
compensation for services rendered under the Company’s 2007 Incentive
Compensation Plan (the “2007 Plan”).  The fair value on the date of grant
was $5,729 based on the stock price on the date of issuance.





Revenue
and Cost Recognition





The
Company recognizes revenue in accordance with the provisions of Accounting
Standards Codification (“ASC”) 605, “Revenue Recognition”, which states that
revenue is realized and earned when all of the following criteria are
met:


(a)
persuasive evidence of the arrangement exists,


(b)
delivery has occurred or services have been rendered,


(c)
the seller’s price to the buyer is fixed and determinable and


(d)
collectibility is reasonably assured.





The
Company recognizes revenue and reports profits from purchase orders filled under
master contracts when an order is complete. Purchase orders received under
master contracts may extend for periods in excess of one year. Purchase order
costs are accumulated as deferred assets and billings and/or cash received are
charged to a deferred revenue account during the periods of construction.
However, no revenues, costs or profits are recognized in operations until the
period upon completion of the order. An order is considered complete when all
costs, except insignificant items, have been incurred and, the installation or
product is operating according to specification or the shipment has been
accepted by the customer. Provisions for estimated contract losses are made in
the period that such losses are determined. As of March 31, 2010, there were no
such provisions made.




7




AMERICAN
DEFENSE SYSTEMS, INC. AND SUBSIDIARIES


NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS







Contract
Revenue





Cost
in Excess of Billing





All costs
associated with uncompleted customer purchase orders under contract are recorded
on the balance sheet as a current asset called “Costs in Excess of Billings on
Uncompleted Contracts.” Such costs include direct material, direct labor, and
project-related overhead. Upon completion of a purchase order, costs are then
reclassified from the balance sheet to the statement of operations as costs of
revenue. A customer purchase order is considered complete when a satisfactory
inspection has occurred, resulting in customer acceptance and
delivery.





Retail
Revenue




The
Company recognizes revenue from its retail location upon point of sale. Due to
the nature of the merchandise sold, the Company does not accept returns and,
therefore, no provision for returns was recorded as of March 31, 2010 and
December 31, 2009. As a result of the discontinuing of TAG operations, the
Company does not anticipate generating retail revenue in the
future.





Concentrations





The
Company’s bank accounts are maintained in financial institutions. Deposits held
with banks may exceed the amount of insurance provided on such deposits.
Generally, these deposits may be redeemed upon demand and therefore bear minimal
risk.





The
Company received certain of its components from sole suppliers. One of the
Company’s suppliers, in particular,currently provides it with approximately 20% of the Company’s supply
needs. Additionally, the Company relies on a limited number of contract
manufacturers and suppliers to provide manufacturing services for its products.
The inability of any contract manufacturer or supplier to fulfill supply
requirements of the Company could materially impact future operating
results.





For the
three months ended March 31, 2010 and 2009, the Company derived 73% and 90% of
its revenues from various U.S. government entities.





Allowance
For Doubtful Accounts


The
allowance for doubtful accounts reflects management’s best estimate of probable
losses inherent in the account receivable balance. Management determines the
allowance based on known troubled accounts, historical experience, and other
currently available evidence. Management performs on-going credit evaluations of
its customers and adjusts credit limits based upon payment history and the
customer’s current credit worthiness, as determined by the review of their
current credit information. Collections and payments from customers are
continuously monitored. While such bad debt expenses have historically been
within expectations and allowances established, the Company cannot guarantee
that it will continue to experience the same credit loss rates that it has in
the past. At March 31, 2010 and December 31, 2009, the allowance for doubtful
accounts was approximately $267,000 and $222,000, respectively.





Loss per Share





Basic
loss per share is computed using the weighted-average number of common shares
outstanding during the period. Diluted net loss per share is computed using the
weighted-average number of common shares and excludes dilutive potential common
shares outstanding, as their effect is anti-dilutive. Dilutive potential common
shares would primarily consist of employee stock options, warrants and
convertible preferred stock.




8




AMERICAN
DEFENSE SYSTEMS, INC. AND SUBSIDIARIES
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


Securities
that could potentially dilute basic EPS in the future that were not included in
the computation of the diluted EPS because to do so would be anti-dilutive
consist of the following:





March
      31In Thousands
                                  
                                  2010
                                  
                                  
                                  2009Warrants
      to purchase Common Stock
                                  
                                  
                                  1,448,681
                                  
                                  
                                  
                                  5,198,681Options
      to Purchase Common Stock
                                  
                                  
                                  2,330,000
                                  
                                  
                                  
                                  2,095,000Series
      A Convertible Preferred Stock
                                  
                                  
                                  7,500,000
                                  *
                                  
                                  
                                  7,500,000
                                  *Total
      Potential Common Stock
                                  
                                  
                                  11,278,681
                                  
                                  
                                  
                                  14,793,681





* On
April 9, 2010, pursuant to the amendment to the Company’s certificate of
incorporation, the Conversion Price of the Series A Preferred was reduced to
$0.50 and all of the outstanding shares of Series A Preferred are now
convertible into an aggregate of 30,000,000 shares of the Company’s common
stock.





Fair
Value of Financial Instruments





Fair
value of certain of the Company’s financial instruments including cash, accounts
receivable, note receivable, accrued compensation, and other accrued liabilities
approximate cost because of their short maturities. The Company measures and
reports fair value in accordance with ASC 820, “Fair Value Measurements and
Disclosure” which defines fair value, establishes a framework for measuring fair
value in accordance with generally accepted accounting principles and expands
disclosures about fair value investments.




Fair
value, as defined in ASC 820, is the price that would be received to sell an
asset or paid to transfer a liability in an orderly transaction between market
participants at the measurement date. The fair value of an asset should reflect
its highest and best use by market participants, principal (or most
advantageous) markets, and an in-use or an in-exchange valuation premise. The
fair value of a liability should reflect the risk of nonperformance, which
includes, among other things, the Company’s credit risk.




Valuation
techniques are generally classified into three categories: the market approach;
the income approach; and the cost approach. The selection and application of one
or more of the techniques may require significant judgment and are primarily
dependent upon the characteristics of the asset or liability, and the quality
and availability of inputs. Valuation techniques used to measure fair value
under ASC 820 must maximize the use of observable inputs and minimize the use of
unobservable inputs. ASC 820 also provides fair value hierarchy for inputs and
resulting measurement as follows:





Level
1




Quoted
prices (unadjusted) in active markets that are accessible at the measurement
date for identical assets or liabilities;




Level
2




Quoted
prices for similar assets or liabilities in active markets; quoted prices for
identical or similar assets or liabilities in markets that are not active;
inputs other than quoted prices that are observable for the asset or liability;
and inputs that are derived principally from or corroborated by observable
market data for substantially the full term of the assets or liabilities;
and





Level 3




Unobservable
inputs for the asset or liability that are supported by little or no market
activity and that are significant to the fair values.





Fair
value measurements are required to be disclosed by the Level within the fair
value hierarchy in which the fair value measurements in their entirety fall.
Fair value measurements using significant unobservable inputs (in Level 3
measurements) are subject to expanded disclosure requirements including a
reconciliation of the beginning and ending balances, separately presenting
changes during the period attributable to the following: (i) total gains or
losses for the period (realized and unrealized), segregating those gains or
losses included in earnings, and a description of where those gains or losses
included in earning are reported in the statement of operations.




9


The
Company did not have any assets or liabilities categorized as Level 1 or Level 2
as of March 31, 2010.





The
following summarizes the Company’s assets and liabilities measured at fair value
as of March 31, 2010:





Fair Value Measurements at Reporting Date UsingQuoted
                    Pricesin ActiveBalance as of
                  
                  Markets
                    for
                  
                  Significant
                    Other
                  
                  SignificantMarch
                  
                  Identical
                  
                  Observable
                  
                  Unobservable31,
                  
                  Assets
                  
                  Inputs
                  
                  InputsDescription
                  
                  2010
                  
                  (Level 1)
                  
                  (Level 2)
                  
                  (Level 3)LiabilitiesSeries
      A Preferred (1)
                  
                  $
                  13,330,189
                  
                  
                  $
                  —
                  
                  
                  $
                  —
                  
                  
                  $
                  13,330,1892005
      Warrants (1)
                  
                  
                  82
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  822006
      Warrants (1)
                  
                  
                  28
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  28Placement
      Agent Warrants (1)
                  
                  
                  59,732
                  
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  59,732Total
      Liabilities
                  
                  $
                  13,390,031
                  
                  
                  $
                  —
                  
                  
                  $
                  —
                  
                  
                  $
                  13,390,031




(1)
            Methods
      and significant inputs and assumptions are discussed in Note 5
      below





The
following is a reconciliation of the beginning and ending balances for the
Company’s liabilities measured at fair value on a recurring basis using
significant unobservable inputs (Level 3) for the three months ended March 31,
2010:




Series
      A Preferred
                      
                      2005 Warrants
                      
                      2006 Warrants
                      
                      Placement
                        Agent Warrants
                      
                      Investor
      Warrants
                      
                      TotalBalance – January
      1, 2010
                      
                      $
                      12,429,832
                      
                      
                      $
                      4,372
                      
                      
                      $
                      1,494
                      
                      
                      $
                      29,547
                      
                      
                      $
                      --
                      
                      
                      $
                      12,465,245Amortization
      of debt discount
                      
                      
                      254,257
                      
                      
                      
                      --
                      
                      
                      
                      --
                      
                      
                      
                      --
                      
                      
                      
                      --
                      
                      
                      
                      254,257Change
      in fair value
                      
                      
                      646,100
                      
                      
                      
                      (4,290
                      )
                      
                      
                      (1,466
                      )
                      
                      
                      30,185
                      
                      
                      
                      --
                      
                      
                      
                      670,529Balance – March
      31, 2010
                      
                      $
                      13,330,189
                      
                      
                      
                      82
                      
                      
                      $
                      28
                      
                      
                      $
                      59,732
                      
                      
                      $
                      --
                      
                      
                      $
                      13,390,031




The
change in fair value recorded for Level 3 liabilities for the periods above are
reported in other income (expense) on the condensed consolidated statement of
operations.





Reclassification





Certain
prior year amounts have been reclassified to conform to the current year
presentation.




10




AMERICAN
DEFENSE SYSTEMS, INC. AND SUBSIDIARIES
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


Recent
Accounting Pronouncements





In
June 2009, the FASB issued new accounting guidance, under ASC Topic 810,
which modifies how a company determines when an entity that is insufficiently
capitalized or is not controlled through voting (or similar rights) should be
consolidated. This guidance clarified that the determination of whether a
company is required to consolidate an entity is based on, among other things, an
entity’s purpose and design and a company’s ability to direct the activities of
the entity that most significantly impact the entity’s economic performance. An
ongoing reassessment is required of whether a company is the primary beneficiary
of a variable interest entity. Additional disclosures are also required about a
company’s involvement in variable interest entities and any significant changes
in risk exposure due to that involvement. This guidance was effective as of the
beginning of each reporting entity’s first annual reporting period that began
after November 15, 2009, for interim periods within that first annual reporting
period, and for interim and annual reporting periods thereafter. The adoption of
this guidance did not have a material effect on the Company’s consolidated
financial position or results of operations.




The FASB
published FASB Accounting Standards Update 2009-13, Revenue Recognition (Topic 605)-
Multiple Deliverable Revenue Arrangements which addresses the accounting
for multiple-deliverable arrangements to enable vendors to account for products
or services (deliverables) separately rather than as a combined unit.
Specifically, this guidance amends the criteria for Subtopic 605-25, Revenue Recognition-Multiple Element
Arrangements, for separating consideration in multiple-deliverable
arrangements. This guidance establishes a selling price hierarchy for
determining the selling price of a deliverable , which is based on: (a)
vendor-specific objective evidence, (b) third-party evidence: or (c) estimates.
This guidance also eliminates the residual method of allocation and requires
that arrangement consideration be allocated at the inception of the arrangements
to all deliverables using the relative selling price method and also requires
expanded disclosures.  FASB Accounting Standards Update 2009-13 is
effective prospectively for revenue arrangements entered into or materially
modified in fiscal years beginning on or after June 15, 2010. Early adoption is
permitted. The adoption of this standard will have an impact on the Company’s
consolidated financial position and results of operations for all multiple
deliverable arrangements entered into or materially modified in
2010.




In
October 2009, the FASB issued new accounting guidance, under ASC Topic 605
on revenue recognition, which amends revenue recognition policies for
arrangements with multiple deliverables. This guidance eliminates the residual
method of revenue recognition and allows the use of management’s best estimate
of selling price for individual elements of an arrangement when vendor specific
objective evidence (VSOE), vendor objective evidence (VOE) or third-party
evidence (TPE) is unavailable. This guidance is effective for all new or
materially modified arrangements entered into on or after January 1, 2011
with earlier application permitted as of the beginning of a fiscal year. Full
retrospective application of the new guidance is optional.  The Company has
not completed its assessment of this new guidance on its financial condition,
results of operations.





In
October 2009, the FASB issued new accounting guidance, under ASC Topic 985
on software, which amends the scope of existing software revenue recognition
accounting. Tangible products containing software components and non-software
components that function together to deliver the product’s essential
functionality would be scoped out of the accounting guidance on software and
accounted for based on other appropriate revenue recognition guidance. 
This guidance is effective for all new or materially modified arrangements
entered into on or after January 1, 2011 with earlier application permitted
as of the beginning of a fiscal year. Full retrospective application of this new
guidance is optional. This guidance must be adopted in the same period that the
company adopts the amended accounting for arrangements with multiple
deliverables described in the preceding paragraph. The Company has not completed
its assessment of this new guidance on its consolidated financial position or
results of operations.





In
January 2010, the FASB issued authoritative guidance under ASC Topic 820 on Fair
Value Measurements and Disclosures, which requires new disclosures and clarifies
some existing disclosure requirements about fair value measurement. Under the
new guidance, a reporting entity should (a) disclose separately the amounts of
significant transfers in and out of Level 1 and Level 2 fair value measurements
and describe the reasons for the transfers, and (b) present separately
information about purchases, sales, issuances, and settlements in the
reconciliation for fair value measurements using significant unobservable
inputs. This guidance was effective for interim and annual reporting periods
beginning after December 15, 2009, except for the disclosures about purchases,
sales, issuances, and settlements in the roll forward of activity in Level 3
fair value measurements which are effective for fiscal years beginning after
December 15, 2010, and for interim periods within those fiscal years. The
adoption of the guidance effective for interim and annual reporting periods
beginning after December 15, 2009 did not have a material impact upon the
Company’s consolidated financial position or results of operations. The adoption
of the guidance effective for fiscal years beginning after December 15, 2010 is
not expected to have a material effect on the Company’s consolidated financial
position or results of operations.




11




AMERICAN
DEFENSE SYSTEMS, INC. AND SUBSIDIARIES
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS


2.
            COSTS
      IN EXCESS OF BILLINGS (BILLINGS IN EXCESS OF COSTS) ON UNCOMPLETED
      CONTRACTS AND ACCOUNTS RECEIVABLE





Costs in Excess of Billings
and Billing in Excess of Costs


The cost
in excess of billings on uncompleted purchase orders issued pursuant to
contracts reflects the accumulated costs incurred on purchase orders in
production but not completed.  Upon completion, inspection and
acceptance by the customer, the purchase order is invoiced and the accumulated
costs are charged to the statement of operations as costs of revenues
earned.  During the production cycle of the purchase order, should any
progress billings occur or any interim cash payments or advances be received,
such billings and/or receipts on uncompleted contracts are accumulated as
billings in excess of costs. The Company fully expects to collect net costs
incurred in excess of billing within twelve months and periodically
evaluates each purchase order and contract for potential disputes related to
overruns and uncollectable amounts.





Costs in
excess of billing on uncompleted contracts were $6,048,444 and
$7,762,836  as of March 31, 2010 and December 31, 2009,
respectively.





Backlog


The
estimated gross revenue on work to be performed on backlog was $36 million as of
March 31, 2010.





Accounts
Receivable


The
Company records accounts receivable related to its long-term contracts, based on
billings or on amounts due under the contractual terms.  Accounts
receivable consist primarily of receivables from completed purchase orders and
progress billings on uncompleted contracts.  Allowance for doubtful
accounts is based upon a review of outstanding receivables, historical
collection information, and existing economic conditions. Any amounts considered
recoverable under the customer’s surety bonds are treated as contingent gains
and recognized only when received.





Accounts
receivable throughout the year may decrease based on payments received, credits
for change orders, or back charges incurred. At March 31, 2010 and December 31,
2009, the Company had accounts receivable of $4,284,950 and $2,288,666,
respectively and an allowance for doubtful accounts of $267,448 and $222,448,
respectively.  The Company recorded bad debt expense of $45,000 and $0
for the three months ended March 31, 2010 and 2009, respectively.





3.
            COMMITMENTS
      AND CONTINGENCIES





Legal
Proceedings





The
Company is subject to various claims and contingencies in the ordinary course of
its business, including those related to litigation, business transactions,
employee-related matters, and others. When the Company is aware of a claim or
potential claim, it assesses the likelihood of any loss or exposure. If it is
probable that a loss will result and the amount of the loss can be reasonably
estimated, the Company will record a liability for the loss. The liability
recorded includes probable and estimable legal costs associated with the claim
or potential claim. If the loss is not probable or the amount of the loss cannot
be reasonably estimated, the Company discloses the claim if the likelihood of a
potential loss is reasonably possible and the amount involved could be material.
While there can be no assurances, the Company does not expect that any of its
pending legal proceedings will have a material financial impact on the Company’s
results.







On
February 29, 2008, Roy Elfers, a former employee commenced an action against the
Company for breach of contract arising from his termination of employment in the
Supreme Court of the State of New York, Nassau County. The Complaint seeks
damages of approximately $87,000. The Company filed an answer to the complaint.
The parties have completed the discovery and taking depositions.  The
Company believes that meritorious defenses to the claims exist and intends to
vigorously defend this action.  The Company’s attorneys have advised
that it is too early to determine an outcome at this time.





On March
4, 2008, Thomas Cusack, the Company’s former General Counsel, commenced an
action with the United States Department of Labor, Occupational Safety and
Health and Safety Administration, alleging retaliation in contravention of the
Sarbanes-Oxley Act. Mr. Cusack seeks damages in excess of $3,000,000. On April
2, 2008, the Company filed a response to the charges. On March 7, 2008, Mr.
Cusack also commenced a second action against the Company for breach of contract
and related issues arising from his termination of employment in New York State
Supreme Court, Nassau County.  On May 7, 2008, the Company served a
motion to dismiss the complaint, and on or about September 26, 2008, the Court
dismissed several claims (tortious interference with a contract, tortious
interference with economic opportunity, fraudulent inducement to enter into a
contract and breach of good faith and fair dealing). The remaining claims are
Mr. Cusack’s breach of contract claims and claims seeking the lifting of the
transfer restrictions on his stock, as well as one claim for conversion of his
personal property which Mr. Cusack has also asserted against the Company’s chief
executive officer, chief operating officer and chief financial officer. On or
about October 13, 2008, Mr. Cusack filed an amended complaint as to the
remaining claims, and on November 5, 2008, the Company filed an answer to the
complaint and filed counterclaims against Mr. Cusack for fraud. The parties have
completed the discovery and  scheduled depositions. The Company
believes meritorious defenses to both of Mr. Cusack’s claims exist and intends
to vigorously defend this action.  The Company’s attorneys have
advised that it is too early to determine an outcome at this time.





12





4.
            SHAREHOLDERS’
      DEFICIENCY




The
following table summarizes the changes in shareholders' deficiency for
the three months ended March 31, 2010:




Balance
      - January 1, 2010
                  
                  
                  (2,180,412)Stock
      based compensation
                  
                  
                  118,007Shares
      issued for payment of dividends recorded as interest
    expense
                  
                  
                  375,000Net
      Loss
                  
                  
                  (824,405)Balance
      - March 31, 2010
                  
                  $
                  (2,511,810)




Warrants





The
following is a summary of stock warrants outstanding at March 31,
2010:




Warrants
                                
                                
                                Weighted Avenue
                                  Exercise Price
                                
                                
                                Weighted
      Average Remaining Contractual Lives (in years)Balance
      – January 1, 2010
                                
                                
                                1,448,681
                                
                                
                                $
                                1.47
                                
                                
                                
                                1.75Granted
                                
                                
                                -
                                
                                
                                
                                n/a
                                
                                
                                
                                -Exercised
                                
                                
                                -
                                
                                
                                
                                n/a
                                
                                
                                
                                -Cancelled,
      Forfeited or expired
                                
                                
                                -
                                
                                
                                
                                n/a
                                
                                
                                
                                -Balance
      – March 31, 2010
                                
                                
                                1,448,681
                                
                                
                                
                                1.47
                                
                                
                                
                                1.50Exercisable
      – March 31, 2010
                                
                                
                                1,448,681




Stock Option
Plan





The
Company accounts for all stock based compensation as an expense in the financial
statements and associated costs are measured at the fair value of the
award.  The Company also recognizes the excess tax benefit related to
stock option exercises as financing cash inflows instead of operating
inflows.  As a result, the Company’s net loss before taxes for the
three months ended March 31, 2010 and 2009 included approximately $118,007 and
$154,636 of stock based compensation, respectively.    The
stock based compensation expense is included in general and administrative
expense in the condensed consolidated statements of operations.  The
Company has selected a “with-and-without” approach regarding the accounting for
the tax effects of share-based compensation awards.




13





The
following is a summary of stock options outstanding at March 31,
2010:





Stock Options
                        
                        
                        Weighted-
                          Average
                          Exercise Price
                        
                        
                        Aggregate
                          Intrinsic
                          Value
                        
                        Weighted
                          Average
                          Remaining
                          Contractual
                          Life
      (In years)Outstanding,
      January 1, 2010
                        
                        
                        2,230,000
                        
                        
                        
                        1.81
                        
                        
                        
                        -
                        
                        4.76Granted
                        
                        
                        100,000
                        
                        
                        $
                        0.40
                        
                        
                        
                        -
                        
                        n/aExercised
                        
                        
                        -
                        
                        
                        
                        n/a
                        
                        
                        
                        n/a
                        
                        n/aCancelled/forfeited
                        
                        
                        -
                        
                        
                        $
                        n/a
                        
                        
                        
                        n/a
                        
                        n/aOutstanding,
      March 31, 2010
                        
                        
                        2,330,000
                        
                        
                        $
                        1.75
                        
                        
                        
                        -
                        
                        4.69Exercisable,
      March 31, 2010
                        
                        
                        867,000
                        
                        
                        $
                        1.89
                        
                        
                        
                        
                        
                        4.83




As of
March 31, 2010, there was a total of $375,804 of unrecognized compensation
arrangements granted under the 2007 Plan.  The cost is expected to be
recognized through 2014.




On
January 25, 2010, the Company issued an option to purchase 100,000 shares of its
common stock to an officer as compensation under the 2007 Plan pursuant to an
amendment to the officer’s employment agreement. The exercise price for the
option is $0.40 per share and 40% of the option vested on the grant date and 20%
of the option vests annually thereafter with the first 20% vesting upon the
first anniversary of the grant date.





The
Black-Scholes method option pricing model was used to estimate fair value as of
the date of grant using the following assumptions:





Risk-Free
      rate
                          
                          
                          3.12
                          %Expected
      volatility
                          
                          
                          98.76
                          %Forfeiture
      rate
                          
                          
                          0
                          %Expected
      life
                          
                          7
      YearsExpected
      dividends
                          
                          
                          0%





Based on the assumptions noted above, the fair market value of
the option issued during the three months ended March 31, 2010 was valued at
$31,312.





Stock
Grants




On
January 1, 2010, the Company issued 125,000 shares of its common stock to the
Company’s non-employee directors as part of the director compensation under the
2007 Plan. The fair value on the date of grant was $50,000 based on the stock
price on the date of issuance.




On
January 19, 2010, the Company issued 75,000 shares of its common stock to an
employee as compensation under the 2007 Plan.  The fair value on the
date of the grant was $28,500 based on the stock price on the date of
issuance.




On March
2, 2010, the Company issued 12,500 shares of its common stock to a consultant as
compensation for services rendered under the 2007 Plan.  The fair
value on the date of the grant was $4,500 based on the stock price on the date
of issuance.




All of
these awards were fully vested on the date of grant. The Company recorded stock
based compensation of approximately $83,000 for the three months ended March 31,
2010 related to these awards.




On March
31, 2010, the Company issued 1,035,000 shares of its common stock to the Series
A Holders as dividends pursuant to the terms of such Series A Preferred. The
fair value of these shares on the date of issuance was $375,000. The Company
recorded this payment of dividends as interest expense for the three months
ended March 31, 2010.





14








5.
            SERIES
      A CONVERTIBLE PREFERRED STOCK AND WARRANT
  LIABILITIES




Features
of the Series A Preferred and Warrants Liabilities





2005
Warrants





On June
30, 2005, in connection with the closing of its 2005 private placement offering,
the Company issued purchase warrants for up to 555,790 shares of common stock at
the exercise price of $1.10 per share and with the expiration date of June 30,
2010 (the “2005 Warrants”).





On August
16, 2005, the Company issued 50,000 shares of our common stock at an effective
price per share of $1.00 to one of our employees for accepting a job offer. As a
result of this issuance, in accordance with the terms of the 2005 Warrants
agreements, the exercise price was adjusted to $1.00 per share and the number of
shares of common stock that would be acquired was adjusted to
576,587.





2006
Warrants





On
October 24, 2006, in accordance with the terms and conditions of the Company’s
closing of its 2005 private placement offering, the Company issued purchase
warrants for up to 179,175 shares of common stock at the exercise price of $1.10
per share and with the expiration date of June 30, 2010 (the “2006
Warrants”).




On
February 8, 2007, the Company issued an aggregate of 260,000 shares of our
common stock at an effective price per share of $1.00 to certain of our
employees for services rendered. As a result of this issuance, in accordance
with the terms of the 2006 Warrants agreements, the exercise price was adjusted
to $1.00 per share and the number of shares of common stock that would be
acquired was adjusted to 197,093.




Series A Preferred and Investor Warrants and
Placement Agent Warrants





The
Company entered into a Securities Purchase Agreement (“Purchase Agreement”) on
March 7, 2008 to sell shares of its Series A Preferred  and
warrants (“Investor Warrants”) to purchase shares of its common stock, and to
conditionally sell shares of the Company’s common stock, to the Series A
Holders. The Series A Holders purchased an aggregate of 15,000 shares of
Series A Preferred and Investor Warrants to purchase up to 3,750,000 shares
of common stock, and to conditionally purchase 100,000 shares of common stock.
The aggregate purchase price for the Series A Preferred and Investor
Warrants was $15,000,000 and the aggregate purchase price for the common stock
was $500,000.  The Company completed the sale of the Series A
Preferred and Investor Warrants in two rounds, on March 7, 2008 and April
4, 2008, and the Company and the Series A Holders determined not to
complete the conditional sale of the 100,000 shares of common stock. The Series
A Holders are entitled to receive cumulative dividends, due at each subsequent
calendar quarter-end until maturity, at a rate of 9% if settled via cash or at a
rate of 10% if settled via shares (at the option of the Company) of the
Company’s common stock. The dividends rate is subject to increase in the event
of a “Triggering Event” under the Certificate of Designations and in the event
of an “Equity Condition Failure” under the Certificate of Designations,
settlement via shares would not be allowed for the remaining dividend
payments.





The
Series A Holders may convert shares of Series A Preferred, plus the amount of
accrued but unpaid dividends, into shares of the Company’s common stock at a
rate of 2,000 shares of common stock for each share of Series A Preferred, as
amended on April 8, 2010. The Conversion Price is subject to certain adjustments
upon issuance of certain securities, under the Certificate of Designation, with
a lower exercise price and/or with negative dilutive effect. The Series A
Holders may require the Company to redeem, at the amount of 100% if settled in
cash or 110% if settled in cash, all or any portion of the outstanding
shares of Series A Preferred upon a Triggering Event or Equity Condition
Failure.





The
Company may redeem all or any portion of the outstanding shares of Series A
Preferred in cash at the amount of (i) 100% of the “Conversion Amount” at any
time after either the two-year anniversary of the “Public Company Date”, if
certain other conditions are met, or the six-month anniversary of the “Qualified
Public Offering Date”, if certain other conditions are met under
the Certificate of Designations (ii) 110% of the Conversion Amount upon an
Equity Condition Failure or (iii) 115% of the Conversion Amount prior to any
“Fundamental Transaction” under the Certificate of Designations.




Pursuant to the terms of the Series A Preferred, the Company was
required to redeem, in cash, any outstanding shares of the Series A Preferred on
December 31, 2010.  On April 8, 2010, the Company entered into a
Waiver Agreement with the Series A Holders which extended the maturity date for
the mandatory redemption of all outstanding Series A Preferred from December 31,
2010 to April 1, 2011.




15





Settlement
Agreement




In
connection with a Notice of Triggering Event Redemption received by the Company
on April 14, 2009, the Company entered into a Settlement Agreement, Waiver
and Amendment with the Series A Holders on May 22, 2009 (the “ Settlement Agreement
”) pursuant to which, among other things, (i) the Series A Holders
waived any breach by the Company of certain financial covenants or its
obligation to timely pay dividends on the Series A Preferred for any period
through September 30, 2009 and waived any Equity Conditions Failure and any
Triggering Event otherwise arising from such breaches  (ii) the
Investor Warrants were amended to reduce the exercise price thereof from $2.40
per share to $0.01 per share, (iii) the Company issued the Series A Holders
an aggregate of 2,000,000 shares of the Company’s common stock (the “
SettlementShares ”), in full satisfaction of the Company’s obligation to pay
dividends under the Certificate of Designations as of March 31, 2009,
June 30, 2009 and September 30, 2009, and (iv) the Company agreed
to redeem $7,500,000 in stated value of the Series A Preferred by
December 31, 2009 (the “December 2009 Redemption”).  The Company
agreed that, if it fails to so redeem $7,500,000 in stated value of the
Series A Preferred by that date (a “ Redemption Failure
”), then, in lieu of any other remedies or damages available to the
Series A Holders (absent fraud), (i) the redemption price payable by
the Company will increase by an amount equal to 10% of the stated value,
(ii) the Company will use its best efforts to obtain stockholder approval
to reduce the Conversion Price of the Series A Preferred from $2.00 to
$0.50 (which would increase the number of shares of common stock into which
the Series A Preferred is convertible), and (iii) the Company will
expand the size of its board of directors by two, will appoint two persons
designated by the Series A Holders to fill the two newly-created vacancies,
and will use its best efforts to amend the Company’s certificate of
incorporation to grant the Series A Holders the right to elect two persons
to serve on the board.




Pursuant
to the terms of the Settlement Agreement, the Company entered into a
Registration Rights Agreement with the Series A Holders pursuant to which,
among other things, the Company agreed to file with the SEC, by June 1,
2009, a registration statement covering the resale of the Settlement Shares, and
to use its best efforts to have such registration statement declared effective
as soon as practicable thereafter.  The Company further agreed with the
Series A Holders to include in such registration statement the shares of
common stock issued upon the exercise of the Investor Warrants in May and
June 2009.  A registration statement was filed, and subsequently
declared effective on August 10, 2009.





Pursuant to the terms of the Settlement Agreement, each of the
Company’s directors and executive officers has entered into a Lock-Up Agreement,
pursuant to which each such person has agreed that, for so long as any shares of
Series A Preferred remain outstanding, he will not sell any shares of the
Company’s common stock owned by him as of May 22, 2009. Also pursuant to
the terms of the Settlement Agreement, the Company’s Chief Executive Officer,
President and Chairman, entered into an Irrevocable Proxy and Voting Agreement
with the Series A Holders (the “ Voting Agreement ”),
pursuant to which the Company’s CEO agreed, among other things, that if a
Redemption Failure occurs he will vote all shares of the Company’s voting stock
owned by him in favor of (i) reducing the Conversion Price of the
Series A Preferred from $2.00 to $0.50 and (ii) amending the Company’s
certificate of incorporation to grant the Series A Holders the right to
elect two persons to serve on the board of directors (collectively, the “ Company Actions
”).  The Company’s CEO also appointed WCOF as his proxy to vote his shares
of the Company’s voting stock in favor of the Company Actions, and against
approval of any opposing or competing proposal, at any stockholder meeting or
written consent of the Company’s stockholders at which such matters are
considered.





The
Company did not meet the December 2009 Redemption and has increased the size of
its board of directors by two and held a special meeting of shareholders on
April 8, 2010.  At this special meeting, the shareholders approved the
amendments to the Company’s certificate of incorporation to (i) reduce the
Conversion Price of the Series A Preferred from $2.00 to $0.50 and (ii) grant
the Series A holders the right, voting as a separate class, to elect two persons
to serve on the Company’s board of directors.  On April 8, 2010, the
Company entered into a Waiver Agreement with the Series A Holders which extended
the maturity date for the mandatory redemption of all outstanding Series A
Preferred from December 31, 2010 to April 1, 2011.  As a result of the
foregoing extension, the Series A Preferred is classified as a long term
liability in the accompanying condensed consolidated balance sheet as of March
31, 2010.




Investor
Warrants





In
connection with the sale of the Series A Preferred, Investor Warrants to
purchase up to 3,750,000 shares of common stock at $2.40 per share were issued
and with an expiration date of April 11, 2011. The holders of the Investor
Warrants may require the Company to repurchase their warrants upon the
occurrence of certain defined events in the Investor Warrant
agreement.  As such the Company recorded the Investor Warrants as a
derivative at fair value at issuance and subsequent reporting periods in
accordance with ASC 815 “Derivatives and Hedging”. Changes in the fair value
from period to period are reported in the statement of operations.  In
accordance with the Settlement Agreement entered into on May 22, 2009, the
Investor Warrants were amended to reduce the exercise price from $2.40 to
$.01.  The Investor Warrants were fully exercised on May 27, 2009, June 1,
2009, and June 8, 2009.





16





Placement Agent
Warrants





In
connection with the sale of the Series A Preferred and Investor Warrants,
the placement agent for such sale received warrants (the “Placement Agent
Warrants”) to purchase a total of 6% of the number of common stock issued in the
Series A Preferred financing or 675,001 shares at the exercise price of $2.00
per share and with the expiration date of March 7,
2013.





Accounting
for the Series A Preferred and Warrant Liabilities





2005 Warrants, 2006
Warrants, and Placement Agent Warrants





Upon
issuance, the 2005 Warrants, 2006 Warrants, and Placement Agent Warrants met the
requirements for equity classification set forth in EITF Issue 00-19, Accounting for Derivative Financial
Instruments Indexed to, and Potentially Settled in a Company ’ s Own Stock , and SFAS No.
133, as codified in ASC 815. However, effective January 1, 2009 the Company was
required to analyze its then outstanding financial instruments in accordance
with EITF 07-5 as codified in ASC 815-40. Based on the Company’s analysis, its
2005 Warrants, 2006 Warrants, and Placement Agent Warrants, include price
protection provisions whereby the exercise price could be adjusted upon certain
financing transaction at a lower price per share and could no longer be viewed
as indexed to the Company’s common stock. As a result, the 2005 Warrants, 2006
Warrants, and Placement Agent Warrants are accounted for as “derivatives” under
ASC 815 and recorded as liabilities at fair value as of January 1, 2009 with
changes in subsequent period fair value recorded in the statement of operations.




Series A
Preferred





The
Series A Preferred is redeemable on April 1, 2011 and convertible into shares of
common stock at a rate of 2,000 shares of common stock for each share of Series
A Preferred. As a result the Company elected to record the hybrid instrument,
preferred stock and conversion option together, at fair value. Subsequent
reporting period changes in fair value are to be reported in the consolidated
statement of operations.




The
proceeds from the issuance of the Series A Preferred and Investor Warrants,
net of direct costs including the fair value of warrants issued to placement
agent in connection with the transaction, were allocated to the instruments
based upon relative fair value upon issuance as these instruments must be
measured initially at fair value.





Therefore, after the initial
recording of the Series A Preferred based upon net proceeds received, the
carrying value of the Series A Preferred was adjusted to the fair value at
the date of issuance, with the difference recorded as a gain or
loss.





The
Settlement Agreement provides that $7,500,000 in stated value of the
Series A Preferred was to be redeemed at December 31, 2009. The
Company did not effect such redemption. As a result, in lieu of any other
remedies or damages available to Series A Holders, the redemption price payable
by the Company increased by an amount equal to 10% of the stated value, and the
Company amended its certificate of incorporation to (i) reduce the Conversion
Price of the Series A Preferred from $2.00 to $0.50 (which increased the number
of shares of our common stock into which the Series A Preferred is convertible)
and (ii) grant the Series A Holders, voting as a separate class, the right to
elect two persons to serve on its board of directors.





Valuation – Methodology and
Significant Inputs Assumptions





Fair
values for the Company’s derivatives and financial instruments are estimated by
utilizing valuation models that consider current and expected stock prices,
volatility, dividends, market interest rates, forward yield curves and discount
rates.  Such amounts and the recognition of such amounts are subject to
significant estimates which may change in the future. The methods and
significant inputs and assumptions utilized in estimating the fair value of the
2005 Warrants, 2006 Warrants, Placement Agent Warrants, and Series A Preferred
are discussed below. Each of the measurements is considered a Level 3
measurement as a result of at least one unobservable input.





2005 and
2006 Warrants




A
Black-Scholes-Merton option-pricing model was utilized to estimate the fair
value of the 2005 and 2006 Warrants as of March 31, 2010. This model is subject
to the significant assumptions discussed below and requires the following key
inputs with respect to the Company and/or instrument:





17




Input
                      
                      March
      31, 2010Stock
      Price
                      
                      $
                      0.36Exercise
      Price
                      
                      $
                      1.00Time
      to Maturity (in years)
                      
                      
                      0.25Stock
      Volatility
                      
                      
                      71.77
                      %Risk-Free
      Rate
                      
                      
                      1.6
                      %Dividend
      Rate
                      
                      
                      0
                      %




Placement Agent
Warrants




A
Black-Scholes-Merton option-pricing model was utilized to estimate the fair
value of the Placement Agent Warrants as of March 31, 2010. This model is
subject to the significant assumptions discussed below and requires the
following key inputs with respect to the Company and/or instrument:





Input
                      
                      March
      31, 2010Quoted
      Stock Price
                      
                      $
                      0.36Exercise
      Price
                      
                      $
                      2.00Expected
      Life (in years)
                      
                      
                      2.92Stock
      Volatility
                      
                      
                      95.95
                      %Risk-Free
      Rate
                      
                      
                      1.6
                      %Dividend
      Rate
                      
                      
                      0
                      %





Series A
Preferred





A
binomial lattice model was utilized to estimate the fair value of the Series A
Preferred as of March 31, 2010. The binomial model considers the key features of
the Series A Preferred, as noted above, and is subject to the significant
assumptions discussed below. First, a discrete simulation of the Company’s stock
price was conducted at each node and throughout the expected life of the
instrument. Second, an analysis of the higher position of a conversion position,
redemption position, or holding position (i.e. fair value of the respective
future nodes value discounted using the applicable discount rate) was conducted
relative to each node until a final fair value of the instrument is
conducted at the node representing the measurement date. This model requires the
following key inputs with respect to the Company and/or instrument:







Input
                      
                      March
      31, 2010Risk-Free
      Rate
                      
                      
                      0.41
                      %Expected
      volatility
                      
                      
                      70.00
                      %Expected
      remaining term until maturity (in years)
                      
                      1.00Expected
      dividends
                      
                      
                      0.00
                      %Strike
      price
                      
                      $
                      0.58Quoted
      Stock price
                      
                      $
                      0.36Effective
      discount rate
                      
                      
                      33.2
                      %




The
following are significant assumptions utilized in developing the
inputs




·
            Stock
      volatility was estimated by considering (i) the annualized daily
      volatility of the Company’s stock price during the historical period
      preceding the respective valuation dates and measured over a period
      corresponding to the remaining life of the instruments and (ii) the
      annualized daily volatility of comparable companies’ stock price during
      the historical period preceding the respective valuation dates and
      measured over a period corresponding to the remaining life of the
      instrument. Historic prices of the Company and comparable companies’
      common stock were used to estimate volatility as the Company did not have
      traded options as of the valuation
dates;




·
            Based
      on the Company’s historical operations and management’s expectations for
      the near future, the Company’s stock was assumed to be a
      non-dividend-paying stock;




18








·
            Based
      on management’s expectations for the near future, the Company is expected
      to settle the future quarterly dividends due to the Series A Holders via
      shares;





·
            The
      quoted market price of the Company’s stock was utilized in the valuations
      because ASC 820-10 requires the use of quoted market prices, if available,
      without considerations of blockage discounts (if the input is considered
      as a Level 1 input). Because the stock is thinly traded, the quoted market
      price may not reflect the market value of a large block of stock;
      and





·
            The
      quoted market price of the Company’s stock as of measurement dates and
      expected future stock prices were assumed to reflect the effect of
      dilution upon conversion of the instruments to shares of common
      stock.





The changes in fair value estimate between reporting periods
are related to the changes in the price of the Company’s common stock as of
the measurement dates, the expected volatility of the Company’s common stock
during the remaining term of the instrument, changes in the conversion price and
estimated discount rate.




6.
            DISPOSAL
      OF TAG





On
January 2, 2009, the Company entered into an agreement with the prior owners of
TAG to sell the assets and liabilities back to TAG.  TAG was accounted
for as a discontinued operation under GAAP, which requires the income statement
information be reformatted to separate the divested business from the Company’s
continuing operations.





There
were no discontinued operations related to TAG for the three month period ended
March 31, 2010.





In
accordance with the terms of the agreement, the original owners of TAG agreed to
repay $1,000,000 of the original $2,000,000 in consideration as
follows:





2009
                    
                    $
                    100,0002010
                    
                    $
                    100,0002011
                    
                    $
                    200,0002012
                    
                    $
                    300,0002013
                    
                    $
                    300,000Total
                    
                    $
                    1,000,000





The
original owners of TAG have collateralized the note receivable with their
personal residence and the 250,000 shares issued to them on the date of
acquisition.  These shares are being held by the Company in escrow
since January 2009 and will be returned upon final payment toward the note
receivable.




Due to
cash flow constraints, TAG is experiencing difficulty repaying the amounts due
to the Company.




The
Company and the original owners of TAG are currently in the process of
finalizing a re-negotiation of the contract with a new payment schedule starting
in 2011. The Company recorded a reserve on the note receivable of $575,000 as of
March 31, 2010 and December 31, 2009 of which $175,000 was included in current
assets and $400,000 is in long term assets. In addition, the Company recorded a
$575,000 loss from disposal of discontinued division for the year ended December
31, 2009. The Company has included the entire amount as notes receivable on its
balance sheet, of which $400,000 is included within long term
assets.




19




Item 2.    Management’s Discussion and
Analysis of Financial Condition and Results of Operations




The
following discussion and analysis of our financial condition and results of
operations should be read in conjunction with our consolidated financial
statements and related notes that appear elsewhere in this report and in our
annual report on Form 10-K for the year ended December 31,
2009.




Except
for statements of historical fact, certain information described in this report
contains “forward-looking statements” that involve substantial risks and
uncertainties. You can identify these statements by forward-looking words such
as “anticipate,” “believe,” “could,” “estimate,” “expect,” “intend,” “may,”
“should,” “project,” “will,” “would” or similar words. The statements that
contain these or similar words should be read carefully because these statements
discuss our future expectations, contain projections of our future results of
operations or of our financial position, or state other “forward-looking”
information. We believe that it is important to communicate our future
expectations to our investors. However, there may be events in the future that
we are not able accurately to predict or control. Further, we urge you to be
cautious of the forward-looking statements which are contained in this report
because they involve risks, uncertainties and other factors affecting our
operations, market growth, service and products.  You should not place
undue reliance on any forward-looking statement, which speaks only as of the
date made. Our actual results could differ materially from those discussed in
the forward-looking statements. Factors that could cause or contribute to these
differences include those discussed below and elsewhere in this report,
particularly in “Risk Factors” in Item 1A of Part II.




Overview




We
are a defense and security products company engaged in three business areas:
customized transparent and opaque armor solutions for construction equipment and
tactical and non-tactical transport vehicles used by the military; architectural
hardening and perimeter defense, such as bullet and blast resistant transparent
armor, walls and doors, as well as vehicle anti-ram barriers such as bollards,
steel gates and steel wedges that deploy out of the ground; and tactical
training products and services consisting of our live-fire interactive T2
Tactical Training System and our American Institute for Defense and Tactical
Studies.





We
primarily serve the defense market and our sales are highly concentrated within
the U.S. government. Our customers include various branches of the U.S. military
through the U.S. Department of Defense (or DoD) and to a much lesser extent
other U.S. government, law enforcement and correctional agencies as well as
private sector customers.





Our
recent historical revenues have been generated primarily from a limited number
of large contracts and a series of purchase orders from a single customer. To
continue expanding our business, we are seeking to broaden our customer base and
to diversify our product and service offerings. Our strategy to increase our
revenue, grow our company and increase stockholder value involves the following
key elements:





·
                increase
      exposure to military platforms in the U.S. and
      internationally;·
                develop
      strategic alliances and form strategic partnerships with original
      equipment manufacturers (OEMs);·
                capitalize
      on increased homeland security requirements and non-military
      platforms;·
                focus
      on an advanced research and development program to capitalize on increased
      demand for new armor materials; and·
                pursue
      strategic acquisitions.




We are
pursuing each of these growth strategies simultaneously, and expect one or more
of them to result in additional revenue opportunities within the next 12
months.




Sources
of Revenues




We derive
our revenues by fulfilling orders under master contracts awarded by branches of
the United States military, law enforcement and corrections agencies and private
companies involved in the defense market and other customer purchase orders.
Under these contracts and purchase orders, we provide customized transparent and
opaque armor products for transport and construction vehicles used by the
military, group protection kits and spare parts. We also derive revenues from
sales of our architectural hardening and perimeter defense products, which we
sometimes refer to as physical security products. To date, we have generated
nominal revenues from our T2 and other training solutions and we are evaluating
the continued offering of such training products and services and expect to
continue that process over the next several months.




Our
contract backlog as of March 31, 2010 was $36 million. We estimate that all of
the $36 million of contract backlog as of March 31, 2010 will be filled in 2010.
Accordingly, in order to maintain our current revenue levels and to generate
revenue growth, we will need to win more contracts with the U.S. government and
other commercial entities, achieve significant penetration into critical
infrastructure and public safety protection markets, and successfully further
develop our relationships with OEM’s and strategic partners.
 Notwithstanding the possible significant troop reductions in Afghanistan
and Iraq, we expect that demand in those countries for armored military
construction vehicles will continue in order to repair significant war damage
and for nation-building purposes. In addition, we are exploring interest in
armored construction equipment in other countries with mine-infested
regions.




20




We
continue to aggressively bid on projects and are in preliminary talks with a
number of international firms to pursue long-term government and commercial
contracts, including with respect to Homeland Security. While no assurances can
be given that we will obtain a sufficient number of contracts or that any
contracts we do obtain will be of significant value or duration, we are
confident that we will continue to have the opportunity to bid and win contracts
as we have in 2009.




Cost
of Revenues and Operating Expenses




Cost of Revenues.
    Cost of revenues consists of parts, direct labor and
overhead expense incurred for the fulfillment of orders under contract. These
costs are charged to expense upon completion and acceptance of an order. Costs
of revenue also includes the costs of prototyping and engineering, which are
expensed upon completion of an order as well. These costs are included as costs
of revenue because they are incurred to modify products based upon government
specifications and are reimbursable costs within the contract. These costs for
the production of goods under contract are expensed when they are complete. We
allocate overhead expenses such as employee benefits, computer supplies,
depreciation for computer equipment and office supplies based on personnel
assigned to the job. As a result, indirect overhead expenses are included in
cost of revenues and each operating expense category.




Sales and Marketing.
    Expenses related to sales and marketing consist
primarily of compensation for our sales and marketing personnel, sales
commissions and incentives, trade shows and related travel.  Sales and
marketing costs are charged to expense as incurred.





Research and Development.
    Research and development expenses are incurred as we
perform ongoing evaluations of materials and processes for existing products, as
well as the development of new products and processes. Such expenses typically
include compensation and employee benefits of engineering and testing personnel,
materials, travel and costs associated with design and required testing
procedures associated with our product line. We expect that in 2010, research
and development expenses will remain relatively consistent with 2009 in absolute
dollars and as a percentage of revenues. Research and development costs are
charged to expense as incurred.




General and Administrative.
    General and administrative expenses consist of
compensation and related expenses for executive, finance, accounting,
administrative, legal, professional fees, other corporate expenses and allocated
overhead. We expect that in 2010, general and administrative expenses will
decrease as compared to 2009 in absolute dollars and as a percentage of revenue
due to a cost cutting initiative implemented at the end of 2009 and in January
2010.





General and Administrative
Salaries.  General and administrative salaries expenses consist
of compensation for the officers, and IT, design and engineering personnel. We
expect that in 2010, general and administrative salaries expenses will decrease
as compared to 2009 in absolute dollars and as a percentage of revenues due to a
cost cutting measures, which include reduction in labor costs, implemented at
the end of 2009 and in January 2010.





Critical Accounting Policies




Our
condensed consolidated financial statements are prepared in accordance with
accounting principles generally accepted in the United States. The preparation
of these consolidated financial statements requires us to make estimates and
assumptions that affect the reported amounts of assets, liabilities, revenues,
costs and expenses and related disclosures. On an ongoing basis, we evaluate our
estimates and assumptions. Our actual results may differ from these estimates
under different assumptions or conditions.




We
believe that of our significant accounting policies, which are described in
Note 1 to the consolidated financial statements included in our Annual
Report on Form 10-K for the year ended December 31, 2009, involve a greater
degree of judgment and complexity. Accordingly, these are the policies we
believe are the most critical to aid in fully understanding and evaluating our
consolidated financial condition and results of operations.




Revenue and Cost Recognition.
    We recognize revenue in accordance with Accounting
Standards Codification (ASC) 605, “ Revenue Recognition” , which states that
revenue is realized and earned when all of the following criteria are met: (a)
persuasive evidence of the arrangement exists, (b) delivery has occurred or
services have been rendered, (c) the seller’s price to the buyer is fixed and
determinable and (d) collectability is reasonably assured. Under this provision,
revenue is recognized upon delivery and acceptance of the order.




We
recognize revenue and report profits from purchases orders filled under master
contracts when an order is complete, as defined below. Purchase orders received
under master contracts may extend for periods in excess of one year. Purchase
order costs are accumulated as deferred assets and billings and/or cash received
are charged to a deferred revenue account during the periods of construction.
However, no revenues, costs or profits are recognized in operations until the
period upon completion of the order. An order is considered complete when all
costs, except insignificant items, have been incurred and, the installation or
product is operating according to specification or the shipment has been
accepted by the customer. Provisions for estimated contract losses are made in
the period that such losses are determined. As of March 31, 2010 and December
31, 2009, there were no such provisions made.




21




Stock-Based Compensation.
    Stock based compensation consists of stock or options
issued to employees, directors and contractors for services rendered. We
accounted for the stock issued using the estimated current market price per
share at the date of issuance. Such cost was recorded as compensation in our
statement of operations at the date of issuance.




In
December 2007, we adopted our 2007 Incentive Compensation Plan pursuant to
which we have issued and intend to issue stock-based compensation from time to
time, in the form of stock, stock options and other equity based awards. Our
policy for accounting for such compensation in the form of stock options is as
follows:




We
account for stock based compensation in accordance with Accounting Standards
Codification (ASC) 718 “Compensation–Stock Compensation” (ASC 718). In
accordance with ASC 718, we use the Black-Scholes option pricing model to
measure the fair value of our option awards. The Black-Scholes model requires
the input of highly subjective assumptions including volatility, expected term,
risk-free interest rate and dividend yield. In 2005, the SEC issued Staff
Accounting Bulletin (SAB) No. 107, as codified in ASC 718-10-599, which
provides supplemental implementation guidance for ASC 718.




Because
we have only recently become a public entity, we will have a limited trading
history.  The expected term of an award is based on the “simplified” method
allowed by ASC 718-10-599, whereby the expected term is equal to the period of
time between the vesting date and the end of the contractual term of the award.
The risk-free interest rate will be based on the rate on U.S. Treasury zero
coupon issues with maturities consistent with the estimated expected term of the
awards. We have not paid and do not anticipate paying a dividend on our common
stock in the foreseeable future and accordingly, use an expected dividend yield
of zero. Changes in these assumptions can affect the estimated fair value of
options granted and the related compensation expense which may significantly
impact our results of operations in future periods.




Stock-based
compensation expense recognized will be based on the estimated portion of the
awards that are expected to vest. We will apply estimated forfeiture rates based
on analyses of historical data, including termination patterns and other
factors.




We
recognized $118,007 and $154,636 in stock compensation expense for the three
months ended March 31, 2010 and 2009, respectively.




Fair
Value Measurements




We have
adopted the provisions of ASC 820, “Fair Value Measurements and Disclosures”
(ASC 820). ASC 820 defines fair value, establishes a framework for
measuring fair value in accordance with generally accepted accounting principles
and expands disclosures about fair value investments. ASC 820 was
effective for financial assets and liabilities on January 1, 2008. The
statement deferred the implementation of the provisions of ASC 820 relating
to certain non-financial assets and liabilities until January 1,
2009.




Fair
value, as defined in ASC 820, is the price that would be received to sell an
asset or paid to transfer a liability in an orderly transaction between market
participants at the measurement date. The fair value of an asset should reflect
its highest and best use by market participants, whether using an in-use or an
in-exchange valuation premise. The fair value of a liability should reflect the
risk of nonperformance, which includes, among other things, the company’s credit
risk.




Valuation
techniques are generally classified into three categories: the market approach;
the income approach; and the cost approach. The selection and application of one
or more of the techniques requires significant judgment and are primarily
dependent upon the characteristics of the asset or liability, the principal (or
most advantageous) market in which participants would transact for the asset or
liability and the quality and availability of inputs. Inputs to valuation
techniques are classified as either observable or unobservable within the
following hierarchy:




·
                      Level
      1 Inputs:  These inputs come from quoted prices (unadjusted) in
      active markets for identical assets or
  liabilities.·
                      Level 2
      Inputs:  These inputs are other than quoted prices that are
      observable, for an asset or liability. This includes: quoted prices for
      similar assets or liabilities in active markets; quoted prices for
      identical or similar assets or liabilities in markets that are not active;
      inputs other than quoted prices that are observable for the asset or
      liability; and inputs that are derived principally from or corroborated by
      observable market data by correlation or other
  means.·
                      Level 3
      Inputs:  These are unobservable inputs for the asset or liability
      which require the company’s own
  assumptions.


22




Series A Convertible Preferred Stock, Investor Warrants and
Placement Agent Warrants




Series A Convertible Preferred
Stock. The Series A Preferred is redeemable on April 1, 2011
and convertible into shares of common stock at a rate of 2,000 shares of common
stock for each share of Series A Preferred subject to adjustment should we issue
future common stock at a lesser price. As a result we elected to record the
hybrid instrument, preferred stock and conversion option together, at fair
value.  Subsequent reporting period changes in fair value are to be
reported in the statement of operations.




The
proceeds from the issuance of the Series A Preferred and accompanying
common stock warrants, net of direct costs including the fair value of warrants
issued to the Placement Agent in connection with the transaction, must be
allocated to the instruments based upon relative fair value upon issuance as
they must be measured initially at fair value. Therefore, after the initial
recording of the Series A Preferred based upon net proceeds received, the
carrying value of the Series A Preferred must be adjusted to the fair value
at the date of issuance, with the difference recorded as a gain or loss. On
March 7, 2008, the date of initial issuance, we recorded a derivative
liability of $9.8 million. On April 4, 2008, the date of the second
issuance, we recorded a derivative liability of $3.6 million.  These
liabilities were subsequently adjusted to fair value as of March 31, 2010, which
resulted in a loss of $646,100 for the three months ended March 31, 2010. As of
March 31, 2010, the Series A Preferred liability was $13.3
million.




Derivative
Warrants




Investor
Warrants.
    The Investor Warrants met the criteria under ASC
815 “Derivatives and Hedging”. Under ASC 815, the warrants were recorded at
fair value upon the date of issuance, with changes in the value fair value
recognized as a gain or loss as they occur. On March 7, 2008, the date of
initial issuance, we recorded a derivative liability of $1.1 million. On
April 4, 2008, the date of the second issuance, we recorded a derivative
liability of $0.4 million.




On
May 22, 2009 we entered into a Settlement Agreement, Waiver and Amendment
with the Series A Holders (or Settlement Agreement) pursuant to which,
among other things, the Investor Warrants were amended to reduce the exercise
price thereof from $2.40 per share to $0.01 per share.  The warrants were
exercised in full during May and June, 2009 and the Investor Warrant
liability was accordingly reclassified to Additional Paid In
Capital.




For
additional information, see “Liquidity and Capital Resources - Series A
Convertible Preferred Stock” below.





Placement
Agent Warrants.





The
warrants issued to the Placement Agent with respect to the sale of the
Series A Preferred and Investor Warrants (or Placement Agent Warrants) were
accounted for as a transaction cost associated with the issuance of the
Series A Preferred. The Placement Agent Warrants are recorded at fair value
at the date of issuance. Under EITF 00-19 “Accounting for Derivative
Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own
Stock”, as codified in ASC 815, we satisfy the criteria for classification of
the Placement Agent Warrants as equity on the date of issuance. We have recorded
the corresponding amount recorded as a Deferred Financing Cost since the
Series A Preferred and Investor Warrants are classified as liabilities and
are amortized as additional financing costs over the term of the
Series A Preferred using the interest method. At the date of each issuance,
we recorded $1.0 million and $0.4 million in deferred financing costs. Effective
January 1, 2009, we were required to analyze these instruments in accordance
with EITF 07-5 as codified in ASC 815-40. Based on our analysis, the Placement
Agent Warrants include price protection provisions whereby the exercise price
could be adjusted upon certain financing transaction at a lower price per share
and could no longer be viewed as indexed to our common stock. As a result, we
accounted for these warrants as a “derivative” under  ASC 815 and
recorded as liabilities at fair value on January 1, 2009 of $91,743. The fair
value of these warrants was $59,732 as of March 31, 2010 and we recorded a loss
of $30,185 on the change in fair value in the statement of operations for the
three months ended March 31, 2010.




2005 Warrants and 2006
Warrants




Upon
issuance, the 2005 Warrants and 2006 Warrants met the requirements for equity
classification set forth in EITF Issue 00-19, “Accounting for Derivative
Financial Instruments Indexed to, and Potentially Settled in a Company’s Own
Stock”, and SFAS No. 133 as codified in ASC 815. However, effective January 1,
2009, we were required to analyze these instruments in accordance with EITF 07-5
as codified in ASC 815-40. Based on our analysis, the 2005 Warrants and 2006
Warrants include price protection provisions whereby the exercise price could be
adjusted upon certain financing transaction at a lower price per share and could
no longer be viewed as indexed to our common stock. As a result, the 2005
Warrants and 2006 Warrants were accounted for as “derivatives” under ASC
and recorded as liabilities at fair value on January 1, 2009 of $74,032. The
fair value of these warrants was $110 as of March 31, 2010 and we recorded a
gain of $5,756 on the change in fair value in the statement of operations for
the three months ended March 31, 2010.





23





Consolidated
Results of Operations





The
following discussion should be read in conjunction with the information set
forth in the condensed consolidated financial statements and the related notes
thereto appearing elsewhere in this report.




Comparison
of the Three Months Ended March 31, 2010 and 2009




Revenues.   Revenues
from continuing operations for the three months ended March 31, 2010 were $15.4
million, an increase of  $5.9 million, or 62.7%, over revenues of $9.5
million in the comparable period in 2009.  This increase was due
primarily to our increased production under Department of Defense contracts and
increased sales of our physical security products.  For the three
months ended March 31, 2010 the revenues for our physical security product
business was $3.3 million, an increase of  $2.3 million or 230% over
revenues of $1.0 million for the three months ended March 31, 2009.




Cost of Revenues.  Cost
of revenues for the three months ended March 31, 2010 was $10.0 million, an
increase of $4.5 million, or 83.1%, over cost of revenues of $5.5 million in the
comparable period in 2009.  This increase reflects additional costs
with respect to our increased production under the Marine Corps contract No.
M67854-07-D-5023, and increased sales of our physical security products as well
as increased sales of certain of our crew protection kits (or CPKs), which have
lower gross margins than our other CPKs, as compared to the three months ended
March 31, 2009.  The costs of revenue also increased due to additional
costs of sales from our physical security product business during the three
months ended March 31, 2010.




Gross Profit.   The
gross profit margin for the three months ended March 31, 2010 and 2009 were
approximately $5.5 million and $4.0 million, respectively.  The gross
profit margin percentage was 35.3% and 42.5% for the three months ended March
31, 2010 and 2009, respectively.  The decrease in gross profit margin
percentage from 2009 to 2010 resulted primarily from an increase in overall
costs incurred during the three months ended March 31, 2010 that were associated
with a product mix that had a less favorable gross margin for the first quarter
of 2010, as discussed above in “Cost of Revenues.”




Sales and Marketing Expenses.
  Sales and marketing expenses for the three months ended March 31,
2010 and 2009 were $562,809 and $733,794, respectively, representing a decrease
of $170,985, or 23.3%.  The decrease was due primarily to
a decrease in trade show expenses and related expenses from selling and
marketing and the cost cutting initiative we implemented at the end of 2009 and
in January 2010.




T2 Expenses.   T2
expenses for the three months ended March 31, 2010 and 2009 were $218,848 and
$113,602, respectively, representing an increase of $105,246, or
92.6%.  The increase was due primarily to an increase in T2 salary
expense resulting from the increase in the number of T2
employees.




Research and Development
Expenses.   Research and development expenses for the three
months ended March 31, 2010 and 2009 were $121,717and $186,386,
respectively.  The decrease of $64,669 or 34.7% from 2009 to 2010 was
primarily the result of additional testing of our CPKs, and to a lesser extent,
improvements of existing products and continued work on our products in
development during the three months ended March 31, 2009, that did not take
place in the three months ended March 31, 2010, as well as the cost cutting
initiative we implemented at the end of 2009 and in January
2010.




General and Administrative
Expenses.   General and administrative expenses for the three
months ended March 31, 2010 and 2009 were $1.9 million and $1.5 million,
respectively.  The increase of $0.4 million, or 25.3%, was primarily due to
an increase in rent expense and an increase in expenses incurred in connection
with potential future acquisitions.




General and Administrative Salaries
Expense.   General and administrative salaries expense for the
three months ended March 31, 2010 and 2009 was $884,218 and $1,073,037,
respectively. The decrease of $188,819, or 17.6% was a result of the cost
cutting initiative we implemented at the end of 2009 and in January
2010.  As of March 31, 2010, there were 40 employees that were
classified as general and administrative personnel, versus 39 employees as of
March 31, 2009.




Depreciation expense.  
Depreciation expense was $288,830 and $241,329 for the three months ended March
31, 2010 and 2009, respectively.  The increase of $47,501, or 19.7%, was
the result of our higher property and equipment balance as of March 31, 2010
versus March 31, 2009.  This increase was the result of additional property
and equipment purchased in 2009 for our Hicksville facility and physical
security product business, and T2 equipment.  This higher capital balance
as of March 31, 2010 resulted in higher depreciation expense for the three
months then ended.





Professional fees.  
Professional fees were $0.6 million for the three months ended March 31, 2010
and 2009, respectively.




Other (income) and expense.
  Our Series A Preferred and certain warrants, are recorded at fair
value with changes in fair value recorded in the statement of operations.
Changes in the price of our common stock affect these fair values. We
experienced a loss on adjustment of fair value with respect to our Series A
Preferred and Warrants of $670,529 and $613,782 for the three months ended March
31, 2010 and 2009, respectively.  In addition, we incurred interest expense
associated with the amortization of the deferred financing costs and discount on
the Series A Preferred of $641,146 and $290,320 for the three months ended
March 31, 2010 and 2009, respectively.




24





Liquidity
and Capital Resources




The
primary sources of our liquidity during the three months ended March 31, 2010
have come from operations.  As of March 31, 2010, our principal sources of
liquidity were net accounts receivable of $4.3 million, costs in excess of
billings of $6.0 million and the sale of accounts receivable under accounts
receivable purchase agreement with Republic Capital Access (or RCA), of which
RCA has not received payment from our customers for
$346,095.




We
believe that our current net accounts receivable and costs in excess of billings
together with our expected cash flows from operations, ability to sell accounts
receivable to RCA will be sufficient to meet our anticipated cash requirements
for working capital and capital expenditures for at least through the next 12
months, except with respect to mandatory redemption of $15.0 million in stated
value of our Series A Preferred at April 1, 2011, extended from December 31,
2010, pursuant to a waiver agreement which we entered into with the Series A
Holders on April 8, 2010. We are currently seeking to raise capital or obtain
access to capital sufficient to permit us to effect such redemption. If we are
unable to timely raise capital or obtain access to a credit facility or other
source of funds sufficient to fund such redemption, our cash flow could be
adversely affected and our business significantly harmed. Additionally,
restrictions imposed pursuant to the General Corporation Law of the State of
Delaware (the “DGCL”), our state of incorporation, would prohibit us from
satisfying such redemption if we lack sufficient surplus, as such term is
defined under the DGCL.




Cash Flows from Operating
Activities. Net cash provided by operating activities
was approximately $139,000 for the three months ended March 31, 2010
compared to net cash used in operating activities of  approximately
$807,000 for the three months ended March 31, 2009.  Net cash provided by
operating activities during the three months ended March 31, 2010 consisted
primarily of changes in our operating assets and liabilities
of  $1.4 million, including changes in accounts receivable, cost in
excess of billing, prepaid expense, accounts payable and accrued
liabilities.  The changes in accounts receivable and costs in excess of
billing of $2.2 million and $1.7 million, respectively, reflects the increases
in receivables from completed projects and a decrease in costs incurred on
projects in process as of March 31, 2010.  Our prepaid expenses and other
current assets increased $61,349 due to amounts paid in advance in
connection with prepayment of legal expense and insurance.  Net cash used
in operating activities during the three months ended March 31, 2009 consisted
primarily of changes in our operating assets and liabilities including
accounts receivable, cost in excess of billing, prepaid expense, accounts
payable and accrued liabilities.  The changes in accounts receivable and
costs in excess of billing of $1.5 million and $357,095, respectively, reflect
the increases in projects in process as of March 31, 2009.  Our
prepaid expenses and other current assets decreased approximately $43,000 due to
the payment in advance of legal and marketing expenses.




As of December 31, 2009, we had a net operating loss carryforward
of $9.3 million available to reduce future taxable income.  Based on
first quarter operating results and twelve month projections, Management expects
to generate taxable income in 2010.  The taxable income generated
during 2010 will be offset by net operating loss carryforward and result in no
current tax liability.  The Company has a full valuation allowance
against its deferred tax assets as Management concluded that it was more likely
than not that the Company would not realize the benefit of its deferred tax
assets by generating sufficient taxable income in future years.  The
Company expects to continue to provide a full valuation allowance until, or
unless, it can sustain a level of profitability that demonstrates its ability to
utilize these assets.




Net Cash Used In Investing
Activities.   Net
cash used in investing activities for the three months ended March 31, 2010 and
2009 was approximately $51,000 and $67,000, respectively.  Net cash
provided by investing activities for the three months ended March 31, 2010
consisted of amounts paid out for the general and computer equipment and
miscellaneous leasehold improvements.  Net cash used in investing
activities for the three months ended March 31, 2009 consisted primarily of cash
paid for the acquisition of equipment and leasehold improvements and cash paid
out for the acquisition of assets in excess of cash received.




Net Cash Provided by
Financing Activities.   Net
cash provided by financing for the three months ended March 31, 2010
and 2009 was $0 and approximately $583,000, respectively. Net cash
provided by financing activities during the three months ended March 31, 2009
consisted of proceeds from our former revolving credit facility with TD Bank of
$583,000.





Accounts
Receivable Purchase Agreement





In
July 2009, we entered into an accounts receivable purchase agreement with RCA,
which was amended in October 2009. Under the purchase agreement, we can sell
eligible accounts receivables to RCA. Eligible accounts receivable, subject to
the full definition of such term in the purchase agreement, generally are our
receivables under prime government contracts.





Under
the terms of the purchase agreement, we may offer eligible accounts receivable
to RCA and if RCA purchases such receivables, we will receive an initial upfront
payment equal to 90% of the receivable. Following RCA’s receipt of payment from
our customer for such receivable, they will pay to us the remaining 10% of the
receivable less its fees. In addition to a discount factor fee and an initial
enrollment fee, we are required to pay RCA a program access fee equal to a
stated percentage of the sold receivable, a quarterly program access fee if the
average daily amount of the sold receivables is less than $2.25 million and
RCA’s initial expenses in negotiating the purchase agreement and other expenses
in certain specified situations. The purchase agreement also provides that in
the event, but only to the extent, that the conveyance of receivables by us is
characterized by a court or other governmental authority as a loan rather than a
sale, we shall be deemed to have granted RCA effective as of the date of the
first purchase under the Purchase Agreement, a security interest in all of our
right, title and interest in, to and under all of the receivables sold by us to
RCA, whether now or hereafter owned, existing or arising.




25




The
initial term of the purchase agreement was to end on December 31, 2009 and will
renew annually after the initial term, unless earlier terminated by either of
the parties. Pursuant to the October 2009 amendment, the term during which we
may offer and sell eligible accounts receivable to RCA (Availability Period) has
been extended from December 31, 2009 to October 15, 2010, and the discount
factor rate has been reduced from 0.524% to 0.4075%. As of March 31, 2010, RCA
holds $3.1 million of accounts receivable for which RCA has not received payment
from our customers.





Series
A Convertible Preferred Stock





In
March and April 2008, we sold shares of our Series A Preferred and warrants to
purchase our common stock (or the Investor Warrants). We received aggregate
gross proceeds of $15.0 million, before fees and expenses of the placement agent
in the transaction and other expenses.





In
connection with our application to list our common stock on the NYSE Amex, we
entered into a Consent and Agreement (or Consent Agreement) on May 23, 2008 with
the Series A Holders where the Series A Holders agreed to limit the number of
shares of common stock issuable upon conversion of, or as dividends on, the
Series A Preferred and upon the exercise of the Investor Warrants without
approval of our common stockholders (which stockholder approval was received on
December 12, 2008). In return, among other things, we agreed for the fiscal year
ending December 31, 2008 (A) to achieve (i) revenues equal to or exceeding
$50,000,000 and (ii) consolidated EBITDA equal to or exceeding $13,500,000, and
(B) to publicly disclose and disseminate, and to certify to the Series A
Holders, our operating results for such period, no later than February 15, 2009
(we collectively refer to these as the Financial Covenants). Under the Consent
Agreement, the breach of the Financial Covenants were each deemed a ‘‘Triggering
Event’’ under the Certificate of Designations, Preferences and Rights of the
Series A Preferred (or Certificate of Designations), which would purportedly
give the Series A Holders the right to require us to redeem all or a portion of
their Series A Preferred shares at a price per share calculated under the
Certificate of Designations.





We
did not satisfy the terms of the Financial Covenants and in April 2009 we
received a Notice of Triggering Event Redemption from the holder of 94% of our
Series A Preferred. The notice demanded the full redemption of such holder’s
Series A Preferred as a consequence of the breach of the Financial Covenants,
and demanded payment of accrued dividends on the Series A Preferred and legal
fees and expenses incurred in connection with negotiations concerning the breach
of the Financial Covenants.





On
May 22, 2009, we entered into a Settlement Agreement, Waiver and Amendment with
the Series A Holders (or Settlement Agreement) pursuant to which, among other
things, (i) the Series A Holders waived any breach by us of the Financial
Covenants or our obligation to timely pay dividends on the Series A Preferred
for any period through September 30, 2009, and waived any ‘‘Equity Conditions
Failure’’ and any ‘‘Triggering Event’’ under the certificate of designations of
the Series A Preferred otherwise arising from such breaches, (ii) the Investor
Warrants were amended to reduce their exercise price from $2.40 per share to
$0.01 per share, (iii) we issued the Series A Holders an aggregate of 2,000,000
shares of our common stock, in full satisfaction of our obligation to pay
dividends under the Certificate of Designations as of March 31, 2009, June 30,
2009 and September 30, 2009, and (iv) we agreed to redeem $7.5 million in stated
value of the Series A Preferred by December 31, 2009. We agreed that, if we fail
to so redeem $7.5 million in stated value of the Series A Preferred by that date
(a Redemption Failure), then, in lieu of any other remedies or damages available
to the Series A Holders (absent fraud), (i) the redemption price payable by us
will increase by an amount equal to 10% of the stated value, (ii) we will use
our best efforts to obtain stockholder approval to reduce the Conversion Price
of the Series A Preferred from $2.00 to $0.50 (which would increase the number
of shares of common stock into which the Series A Preferred is convertible), and
(iii) we will expand the size of our board of directors by two, will appoint two
persons designated by the Series A Holders to fill the two newly-created
vacancies, and will use our best efforts to amend our certificate of
incorporation to grant the Series A Holders the right to elect two persons to
serve on the board (or Series A Directors).





The
Settlement Agreement provides that if as of December 1, 2009, we do not
reasonably believe that we can fund the required redemption on or before
December 31, 2009, we need to take actions required to seek to obtain the
stockholder approval for an amendment to our certificate of incorporation
necessary for reducing the Conversion Price and granting the Series A Holders
the right to elect two Series A Directors designated by such preferred
stockholder, including, without limitation, (i) calling a meeting of our
stockholders to consider such amendment; (ii) submitting to the SEC a
preliminary proxy statement for such meeting of stockholders; and (iii) upon
receipt of the requisite stockholder approval, filing the amendment to our
certificate of incorporation.




26





We were
unable to effect the redemption of the $7.5 million in stated value of the
Series A Preferred by December 31, 2009 and we have accordingly increased the
number of directors constituting our board of directors by two and held a
special meeting of our stockholders on April 8, 2010. At this special meeting,
the stockholders approved the amendments to our certificate of incorporation to
reduce the Conversion Price of the Series A Preferred from $2.00 to $0.50 and
provide for the ability of the Series A Holders to elect the Series A Directors,
and we amended the certificate of incorporation as of April 9, 2010. Based on
the reduction of the Conversion Price of the Series A Preferred, the number of
our common stock into which the Series A Preferred is convertible into increased
from 7.5 million to 30.0 million. Notwithstanding the Settlement Agreement and
compliance with the remedies described above for the failure to redeem the $7.5
million in stated value of the Series A Preferred by December 31, 2009, the
terms of the Series A Preferred provided that we are to redeem any such
preferred stock outstanding on the Maturity Date, December 31, 2010, as such
term is further defined in the Certificate of Designations (such redemption
provision hereinafter referred to as the Mandatory Redemption
Provision).





On April
8, 2010, we entered into a waiver agreement with the Series A Holders, pursuant
to which the Series A Holders agreed to extend the Maturity Date from December
31, 2010 to April 1, 2011 (the period from December 31, 2010 to April 1, 2011
hereinafter referred to as the extension period). Pursuant to the waiver
agreement, during the extension period, (i) the Series A Holders agreed to waive
any right to the redemption of the Series A Preferred under the Mandatory
Redemption Provision until the last day of the extension period and (ii) our
failure to comply with the Mandatory Redemption Provision prior to the last day
of the extension period shall be deemed not to be a breach of such provision or
the terms and conditions of, or applicable to, the Series A Preferred. We
currently are seeking to raise capital or obtain access to capital sufficient to
permit us to effect the mandatory redemption.  If we fail to redeem
such Series A Preferred, our cash flow could be adversely affected and our
business significantly harmed.




Item 3.    Quantitative and
Qualitative Disclosure About Market Risk




We are a
smaller reporting company as defined by Rule 12b-2 of the Exchange Act and
are not required to provide the information required under this
Item 3.




Item 4.    Controls and
Procedure




Evaluation
of Disclosure Controls and Procedures




Disclosure
controls and procedures, as defined in Rules 13(a)-15(e) and 15(d)-15(e) under
the Securities Exchange Act of 1934 (or Exchange Act), are controls and other
procedures that are designed to ensure that information required to be disclosed
in reports filed or submitted under the Exchange Act is recorded, processed,
summarized, and reported, within the time periods specified by the rules and
forms promulgated by the SEC. Disclosure controls and procedures include,
without limitation, controls and procedures designed to ensure that such
information is accumulated and communicated to management, including our Chief
Executive Officer and Chief Financial Officer, as appropriate, to allow timely
decisions regarding required disclosure. As a result of this evaluation, our
Chief Executive Officer and Chief Financial Officer concluded that our
disclosure controls and procedures were not effective as of March 31, 2010
because of the material weaknesses set forth below.





The
following is a summary of our material weaknesses as of March 31,
2010:





Financial
Reporting





Due to a
lack of adequate systems, processes, and resources with sufficient GAAP
knowledge, experience, and training, we did not maintain effective controls over
the period-end financial close and reporting processes as of March 31, 2010. Due
to the actual and potential effect on financial statement balances and
disclosures, the resulting restatement of our financial statements and the
importance of the financial closing and reporting processes, we concluded that,
in the aggregate, these deficiencies in internal controls over the period-end
financial close and reporting process constituted a material weakness in
internal control over financial reporting. The specific deficiencies
contributing to this material weakness were as follows:




•
            Inadequate policies and
      procedures.  We did not design, establish, and maintain
      effective documented GAAP compliant financial accounting policies and
      procedures, nor a formalized process for determining, documenting,
      communicating, implementing, monitoring, and updating accounting policies
      and procedures, including policies and procedures related to significant,
      complex, and non-routine
transactions.


•
              Inadequate GAAP
      expertise.  We did not have individuals with adequate
      GAAP knowledge in specific complex areas and non-routine transactions such
      as preferred stock, warrants, discontinued operations, costs related to
      registration, acquisitions, and
financing.


•
            Equity
      Compensation.  We did not maintain adequate policies and
      procedures to ensure effective controls over the administration,
      accounting, and disclosure for stock-based compensation sufficient to
      prevent a material misstatement of related compensation expense.
      Specifically, the following deficiencies in our granting, administration,
      and accounting for awards were
identified:




27




o
                Inaccurate accounting and
      disclosure.  We did not maintain adequate procedures or
      effective controls over accounting, communication, and disclosure of
      compensation expense related to awards. Specifically, we lacked a process
      of financial and administrative oversight over the stock-based
      compensation process.
 o
                  Inadequate administration of
      awards.  We did not maintain effective controls as it
      related to the reconciliation of grants to source
    data.
 o
                    Insufficient tracking of
      employee data.  We did not maintain adequate procedures
      or effective controls over tracking awards that ultimately impacted the
      timely accounting for compensation
  expense.
  General
Computing Controls





We did
not maintain adequate general computing control policies and procedures. The
following individual material weaknesses were identified:


•
                Inadequate system access
      controls.  System access controls over our accounting
      information system were not in place to appropriately prohibit or limit
      user access in areas including journal entries, invoice processing,
      master-file maintenance.
  •
                  Inadequate general computing
      controls.  Overall general user and system administration
      were inadequate in the following areas where procedures were in place but
      not formalized or documented;


o
            Backup and recovery of
      financial data





o
            Systems development and change
      management





o
            Incident
      management





o
            Security
      monitoring





Our
efforts to improve our internal controls are ongoing and focused on expanding
our organizational capabilities to improve our control environment and on
implementing process changes to strengthen our internal control and monitoring
activities.





As part
of our ongoing remedial efforts, we are planning, among other things,
to:




•
              expand
      our accounting policy and controls organization by creating and filling a
      new position with permanent and/or temporary resources with GAAP expertise
      around specific topics;


•
                engage
      external subject matter experts to:


o
            advise
      on accounting for and disclosure of stock-based compensation related
      matters, including providing additional ASC 718, training and accounting
      assistance;





o
            develop
      and implement formal remediation
plans;





o
            develop,
      implement and/or enhancing accounting and finance-related policies and
      procedures, including end-user
computing;




•
              initiate
      a project to review our key financial systems security processes and
      responsibilities to appropriately design automated controls that
      adequately segregate job
responsibilities;


•
                communicate
      to all employees the importance of adhering to IT system access
      segregation and change request protocols, to prevent unauthorized changes
      and improper accesses from
recurring;


We
believe that the foregoing actions will improve our internal control over
financial reporting, as well as our disclosure controls and procedures. We
intend to perform such procedures and commit such resources as necessary to
continue to allow us to overcome or mitigate these material weaknesses such that
we can make timely and accurate quarterly and annual financial filings until
such time as those material weaknesses are fully addressed and
remediated.





Changes
in Internal Controls




There
were no changes in our internal controls over financial reporting during the
quarter ended March 31, 2010 that have materially affected, or are reasonably
likely to affect, our internal control over financial reporting.




28





Limitations
on the Effectiveness of Controls




Our
management, including our CEO and CFO, does not expect that our Disclosure
Controls and internal controls 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 control system are met.
Further, the design of a control system must reflect the fact that there are
resource constraints, and the benefits of controls must be considered relative
to their costs. Because of the inherent limitations in all control systems, no
evaluation of controls can provide absolute assurance that all control issues
and instances of fraud, if any, with American Defense Systems have been
detected. These inherent limitations include the realities that judgments in
decision-making can be faulty and that breakdowns can occur because of simple
error or mistake. Additionally, controls can be circumvented by the individual
acts of some persons, by collusion of two or more people or by management
override of the controls.




The
design of any system of controls also is based in part upon certain assumptions
about the likelihood of future events, and there can be no assurance that any
design will succeed in achieving its stated goals under all potential future
conditions; over time, a control may become inadequate because of changes in
conditions or the degree of compliance with the policies or procedures may
deteriorate. Because of the inherent limitations in a cost-effective control
system, misstatements due to error or fraud may occur and may not be
detected.





PART
II







Item
1.    Legal Proceedings





On
February 29, 2008, Roy Elfers, a former employee commenced an action against us
for breach of contract arising from his termination of employment in the Supreme
Court of the State of New York, Nassau County. The Complaint seeks damages of
approximately $87,000. We filed an answer to the complaint and will be
commencing discovery. We believe meritorious defenses to the claims exist and we
intend to vigorously defend this action.





On March
4, 2008, Thomas Cusack, our former General Counsel, commenced an action with the
United States Department of Labor, Occupational Safety and Health and Safety
Administration, alleging retaliation in contravention of the Sarbanes-Oxley Act.
Mr. Cusack seeks damages in excess of $3,000,000. On April 2, 2008, we filed a
response to the charges. We believe the allegations to be without merit and
intend to vigorously defend against the action. On March 7, 2008, Mr. Cusack
also commenced a second action against us for breach of contract and related
issues arising from his termination of employment in New York State Supreme
Court, Nassau County. On May 7, 2008, we served a motion to dismiss the
complaint, and on or about September 26, 2008, the Court dismissed several
claims (tortious interference with a contract, tortious interference with
economic opportunity, fraudulent inducement to enter into a contract and breach
of good faith and fair dealing). The remaining claims are Mr. Cusack’s breach of
contract claims and claims seeking the lifting of the transfer restrictions on
his stock, as well as one claim for conversion of his personal property which
Mr. Cusack has also asserted against our chief executive officer, chief
operating officer and chief financial officer. On October 13, 2008, Mr. Cusack
filed an amended complaint as to the remaining claims, and on November 5, 2008,
we filed an answer to the complaint and filed counterclaims against Mr. Cusack
for fraud. The parties are conducting discovery and have completed scheduled
depositions. We believe meritorious defenses to the claims exist and we intend
to vigorously defend this action.




Item 1A.  Risk Factors




Our
business, industry and common stock are subject to numerous risks and
uncertainties. The discussion below sets forth all of such risks and
uncertainties that we have identified as material, but are not the only risks
and uncertainties facing us.  Any of the following risks, if realized,
could materially and adversely affect our revenues, operating results,
profitability, financial condition, prospects for future growth and overall
business, as well as the value of our common stock.  Our business is
also subject to general risks and uncertainties that affect many other
companies, such as overall U.S. and non-U.S. economic and industry conditions,
including a global economic slowdown, geopolitical events, changes in laws or
accounting rules, fluctuations in interest and exchange rates, terrorism,
international conflicts, major health concerns, natural disasters or other
disruptions of expected economic and business conditions. Additional risks and
uncertainties not currently known to us or that we currently believe are
immaterial also may impair our business operations and liquidity.




Risks
Relating to Our Company




We
depend on the U.S. Government for a substantial amount of our sales and if we do
not continue to experience demand for our products within the U.S. Government,
our business may fail. Moreover, our growth in the last few years has been
attributable in large part to U.S. wartime spending in support of troop
deployments in Iraq and Afghanistan. If such troop levels are reduced, our
business may be harmed.




We
primarily serve the defense market and our sales are highly concentrated within
the U.S. government. Customers for our products include the U.S. Department of
Defense, including the U.S. Marine Corps and U.S. Army Tank Automotive and
Armaments Command (TACOM), and the U.S. Department of Homeland Security.
Government tax revenues and budgetary constraints, which fluctuate from time to
time, can affect budgetary allocations for these customers. Many government
agencies have in the past experienced budget deficits that have led to decreased
spending in defense, law enforcement and other military and security areas. Our
results of operations may be subject to substantial period-to-period
fluctuations because of these and other factors affecting military, law
enforcement and other governmental spending.




29




U.S. defense spending historically has been cyclical. Defense
budgets have received their strongest support when perceived threats to national
security raise the level of concern over the country’s safety, such as in Iraq
and Afghanistan. As these threats subside, spending on the military tends to
decrease. Accordingly, while U.S. Department of Defense funding has grown
rapidly over the past few years, there is no assurance that this trend will
continue. Rising budget deficits, the cost of the war on terror and increasing
costs for domestic programs continue to put pressure on all areas of
discretionary spending, and the new administration has signaled that this
pressure will most likely impact the defense budget. A decrease in U.S.
government defense spending, including as a result of planned significant U.S.
troop level reductions in Iraq or Afghanistan, or changes in spending allocation
could result in our government contracts being reduced, delayed or terminated.
Reductions in our government contracts, unless offset by other military and
commercial opportunities, could adversely affect our ability to sustain and grow
our future sales and earnings.




Our
revenues historically have been concentrated in a small number of contracts
obtained through the U.S. Department of Defense and the loss of, or reduction in
estimated revenue under, any of these contracts, or the inability to contract
further with the U.S. Department of Defense could significantly reduce our
revenues and harm our business.




Our
revenues historically have been generated by a small number of contracts. During
the first quarter of 2010, four contracts with the U.S. Department of Defense
organizations represented approximately 73% of our revenue. During the first
quarter of 2009, we had two contracts with the U.S. Department of Defense
organizations which represented approximately 90% of our revenue. While we
believe we have satisfied and continue to satisfy the terms of these contracts,
there can be no assurance that we will continue to receive orders under such
contracts. Our government customers generally have the right to cancel any
contract, or ongoing or planned orders under any contract, at any time. If any
of our significant contracts were canceled, or our customers reduce their orders
under any of these contracts, or we were unable to contract further with the
U.S. Department of Defense, our revenues could significantly decrease and our
business could be severely harmed.




We
are required to redeem any outstanding Series A Preferred, of which $15.0
million in stated value is outstanding, as of April 1, 2011. If we do not
generate, raise or obtain access to funds sufficient to redeem our Series A
Preferred or if we fail to redeem such Preferred Stock, our cash flow could be
adversely affected and our business significantly harmed.




On May
22, 2009, we entered into a Settlement Agreement, Waiver and Amendment with the
holders of our Series A Preferred, pursuant to which, among other things, we
have agreed to redeem $7,500,000 in stated value of Series A Preferred by
December 31, 2009. We did not effect such redemption. As a result, in lieu of
any other remedies or damages available to the holders of our Series A
Preferred, the redemption price payable by us increased by an amount equal to
10% of the stated value, and we amended our certificate of incorporation to (i)
reduce the conversion price of the Series A Preferred from $2.00 to $0.50 (which
increased the number of shares of our common stock into which the Series A
Preferred is convertible) and (ii) grant the holders of Series A Preferred,
voting as a separate class, the right to elect two persons to serve on our board
of directors.





We
currently have outstanding $15.0 million in stated value of our Series A
Preferred. The terms of such stock provide that we are to redeem any such stock
outstanding as of April 1, 2011, as extended from December 31, 2010 pursuant to
a waiver agreement between us and the holders of our Series A Preferred dated
April 8, 2010. We are seeking to raise capital or obtain access to funds
sufficient to timely redeem our Series A Preferred. If we are not successful and
we do not timely redeem such preferred stock, our cash flow could be adversely
affected and our business significantly harmed. For additional information,
please refer to Part I, Item 2. Management’s Discussion and Analysis of
Financial Condition and Results of Operations — Liquidity and Capital
Resources — Series A Convertible Preferred Stock.




We
are required to comply with complex laws and regulations relating to the
procurement, administration and performance of U.S. government contracts, and
the cost of compliance with these laws and regulations, and penalties and
sanctions for any non-compliance could adversely affect our
business.




We are
required to comply with laws and regulations relating to the administration and
performance of U.S. government contracts, which affect how we do business with
our customers and impose added costs on our business. Among the more significant
laws and regulations affecting our business are the following:




·
              The
      Federal Acquisition Regulations: Along with agency regulations
      supplemental to the Federal Acquisition Regulations, comprehensively
      regulate the formation, administration and performance of federal
      government contracts;
 ·
                  The
      Truth in Negotiations Act: Requires certification and disclosure of all
      cost and pricing data in connection with contract
      negotiations;


30




·
              The
      Cost Accounting Standards and Cost Principles: Imposes accounting
      requirements that govern our right to reimbursement under certain
      cost-based federal government contracts;
  and


·
                  Laws,
      regulations and executive orders restricting the use and dissemination of
      information classified for national security purposes and the export of
      certain products and technical data. We engage in international work
      falling under the jurisdiction of U.S. export control laws. Failure to
      comply with these control regimes can lead to severe penalties, both civil
      and criminal, and can include debarment from contracting with the U.S.
      government.





Our contracting agency customers periodically review our
performance under and compliance with the terms of our federal government
contracts. We also routinely perform internal reviews. As a result of these
reviews, we may learn that we are not in compliance with all of the terms of our
contracts. If a government review or investigation uncovers improper or illegal
activities, we may be subject to civil or criminal penalties or administrative
sanctions, including:




·
      Termination of contracts;




·
      Forfeiture of profits;




·
      Cost associated with triggering of price
reduction clauses;




·
      Suspension of payments;




·
      Fines; and




·
      Suspension or debarment from doing business
with federal government agencies.




If we
fail to comply with these laws and regulations, we may also suffer harm to our
reputation, which could impair our ability to win awards of contracts in the
future or receive renewals of existing contracts. If we are subject to civil and
criminal penalties and administrative sanctions or suffer harm to our
reputation, our current business, future prospects, financial condition, and/or
operating results could be materially harmed. In addition, we are subject to the
industrial security regulations, protocols, and procedures of the U.S.
Government as set forth in the National Industrial Security Program Operating
Manual (NISPOM), which are designed to protect and safeguard classified
information from unauthorized release to individuals and organizations not
possessing a security clearance or the requisite level of clearance necessary to
access that information. Accordingly, any failure to adhere to the requirements
of the NISPOM could expose us to severe legal and administrative consequences,
including, but not limited to, our suspension or debarment from government
contracts, the revocation of our clearance, and the termination of our
government contracts, the occurrence of any of which could substantially harm
our existing business and preclude us from competing for or receiving future
government contracts.




Government
contracts are usually awarded through a competitive bidding process that entails
risks not present in the acquisition of commercial contracts.




A
significant portion of our contracts and task orders with the U.S. government is
awarded through a competitive bidding process. We expect that much of the
business we seek in the foreseeable future will continue to be awarded through
competitive bidding. Budgetary pressures and changes in the procurement process
have caused many government customers to increasingly purchase goods and
services through indefinite delivery/indefinite quantity (IDIQ) contracts,
General Services Administration (GSA) schedule contracts and other
government-wide acquisition contracts (GWACs). These contracts, some of which
are awarded to multiple contractors, have increased competition and pricing
pressure, requiring us to make sustained post- award efforts to realize revenue
under each such contract. Competitive bidding presents a number of risks,
including without limitation:




·
                the
      need to bid on programs in advance of the completion of their design,
      which may result in unforeseen technological difficulties and cost
      overruns;
 ·
                        the
      substantial cost and managerial time and effort that we may spend to
      prepare bids and proposals for contracts that may not be awarded to
      us;
 ·
                                the
      need to estimate accurately the resources and cost structure that will be
      required to service any contract we are awarded;
  and
 ·
                                        the
      expense and delay that may arise if our or our partners’ competitors
      protest or challenge contract awards made to us or our partners pursuant
      to competitive bidding, and the risk that any such protest or challenge
      could result in the resubmission of bids on modified specifications, or in
      the termination, reduction or modification of the awarded
      contract.


31





If we are
unable to consistently win new contract awards over any extended period, our
business and prospects will be adversely affected, and that could cause our
actual results to be adversely affected. In addition, upon the expiration of a
contract, if the customer requires further services of the type provided by the
contract, there is frequently a competitive rebidding process. There can be no
assurance that we will win any particular bid, or that we will be able to
replace business lost upon expiration or completion of a contract, and the
termination or non-renewal of any of our significant contracts would cause our
actual results to be adversely affected.




The
U.S. government may reform its procurement or other practices in a manner
adverse to us.




Because
we derive a significant portion of our revenues from contracts with the U.S.
government or its agencies, we believe that the success and development of our
business will depend on our continued successful participation in federal
contracting programs. The current administration has signed a Memorandum for the
Heads of Executive Departments and Agencies on Government Contracting, which
orders significant changes to government contracting, including the review of
existing federal contracts to eliminate waste and the issuance of
government-wide guidance to implement reforms aimed at cutting wasteful spending
and fraud. The federal procurement reform called for in the Memorandum requires
the heads of several federal agencies to develop and issue guidance on review of
existing government contracts and authorizes that any contracts identified as
wasteful or otherwise inefficient be modified or cancelled. If any of our
contracts were to be modified or cancelled, our actual results could be
adversely affected and we can give no assurance that we would be able to procure
new U.S. Government contracts to offset the revenues lost as a result of any
modification or cancellation of our contracts. In addition, there may be
substantial costs or management time required to respond to government review of
any of our current contracts, which could delay or otherwise adversely affect
our ability to compete for or perform contracts. Further, if the ordered reform
of the U.S. Government’s procurement practices involves the adoption of new
cost-accounting standards or the requirement that competitors submit bids or
perform work through teaming arrangements, that could be costly to satisfy or
could impair our ability to obtain new contracts. The reform may also involve
the adoption of new contracting methods to GSA or other government-wide
contracts, or new standards for contract awards intended to achieve certain
socio-economic or other policy objectives, such as establishing new set-aside
programs for small or minority-owned businesses. In addition, the U.S.
government may face restrictions from other new legislation or regulations, as
well as pressure from government employees and their unions, on the nature and
amount of services the U.S. government may obtain from private contractors.
These changes could impair our ability to obtain new contracts. Any new
contracting methods could be costly or administratively difficult for us to
implement and, as a result, could harm our operating results.




Our
contracts with the U.S. government and its agencies are subject to audits and
cost adjustments. Unfavorable government audits could force us to adjust
previously reported operating results, could affect future operating results and
could subject us to a variety of penalties and sanctions.




U.S.
government agencies, including the Defense Contract Audit Agency (DCAA),
routinely audit and investigate government contracts and government contractors’
incurred costs, administrative processes and systems. Certain of these agencies,
including the DCAA, review our performance on contracts, pricing practices, cost
structure and compliance with applicable laws, regulations and standards. They
also review the adequacy of our internal control systems and policies, including
our purchase, property, estimation, compensation and management information
systems. Any costs found to be improperly allocated to a specific contract will
not be reimbursed, and any such costs already reimbursed must be refunded.
Moreover, if any of the administrative processes and systems are found not to
comply with government requirements, we may be subjected to increased government
scrutiny and approval that could delay or otherwise adversely affect our ability
to compete for or perform contracts. Therefore, an unfavorable outcome of an
audit by the DCAA or another government agency could cause actual results to be
adversely affected and differ materially from those anticipated. If a government
investigation uncovers improper or illegal activities, we may be subject to
civil and criminal penalties and administrative sanctions, including termination
of contracts, forfeitures of profits, suspension of payments, fines and
suspension or debarment from doing business with the U.S. government. In
addition, we could suffer serious reputational harm if allegations of
impropriety were made against us. Each of these events could cause our actual
results to be adversely affected.





A portion of our business depends upon obtaining and maintaining
required security clearances, and our failure to do so could result in
termination of certain of our contracts or cause us to be unable to bid or
re-bid on certain contracts.




Obtaining
and maintaining personal security clearances (PCLs) for employees involves a
lengthy process, and it can be difficult to identify, recruit and retain
employees who already hold security clearances. If our employees are unable to
obtain or retain security clearances, or if such employees who hold security
clearances terminate their employment with us, the customer whose work requires
cleared employees could terminate their contract with us or decide not to
exercise available options, or to not renew it. To the extent we are not able to
engage employees with the required security clearances for a particular
contract, we may not be able to bid on or win new contracts, or effectively
re-bid on expiring contracts, which could adversely affect our
business.




A
facility security clearance (FCL) is an administrative determination by the
Defense Security Service (DSS), a U.S. Department of Defense component, that a
particular contractor facility has the requisite level of security, procedures,
and safeguards to handle classified information requirements for access to
classified information. Our ability to obtain and maintain FCLs has a direct
impact on our ability to compete for and perform U.S. government contracts, the
performance of which requires access to classified information. Our inability to
so obtain or maintain any facility security clearance level could result in the
termination, non-renewal or our inability to obtain certain U.S. government
contracts, which would reduce our revenues and harm our business.




32





We
may not realize the full amount of revenues reflected in our backlog, which
could harm our operations and significantly reduce our future
revenues.




There can
be no assurances that our backlog estimates will result in actual revenues in
any particular fiscal period because our customers may modify or terminate
projects and contracts and may decide not to exercise contract options. We
define backlog as the future revenue we expect to receive from our contracts. We
include potential orders expected to be awarded under IDIQ contracts. Our
revenue estimates for a particular contract are based, to a large extent, on the
amount of revenue we have recently recognized on that contract, our experience
in utilizing capacity on similar types of contracts, and our professional
judgment. Our revenue estimate for a contract included in backlog can be lower
than the revenue that would result from our customers utilizing all remaining
contract capacity. Our backlog includes estimates of revenues the receipt of
which require future government appropriation, option exercise by our clients
and/or is subject to contract modification or termination. At March 31, 2010,
our backlog was approximately $36 million, all of which we estimate will be
realized in 2010. These estimates are based on our experience under such
contracts and similar contracts, and we believe such estimates to be reasonable.
However, we believe that the receipt of revenues reflected in our backlog
estimate for the following twelve months will generally be more certain than our
backlog estimate for periods thereafter. If we do not realize a substantial
amount of our backlog, our operations could be harmed and our future revenues
could be significantly reduced.




U.S.
government contracts often contain provisions that are typically not found in
commercial contracts and that are unfavorable to us, which could adversely
affect our business.




U.S.
government contracts contain provisions and are subject to laws and regulations
that give the U.S. government rights and remedies not typically found in
commercial contracts, including without limitation, allowing the U.S. government
to:




·
            terminate
      existing contracts for convenience, as well as for
  default;




·
            establish
      limitations on future services that can be offered to prospective
      customers based on conflict of interest
  regulations;




·
            reduce
      or modify contracts or
subcontracts;




·
            decline
      to make orders under existing
contracts;




·
            cancel
      multi-year contracts and related orders if funds for contract performance
      for any subsequent year become
unavailable;




·
            decline
      to exercise an option to renew a multi-year contract;
  and




·
            claim
      intellectual property rights in products provided by
  us.





The ownership, control or influence of our company by foreigners
could result in the termination, non-renewal of or our inability to obtain
certain U.S. government contracts, which would reduce our revenues and harm our
business.




We are
subject to industrial security regulations of the U.S. Department of Defense and
other federal agencies that are designed to safeguard against unauthorized
access by foreigners and others to classified and other sensitive information.
If we were to come under foreign ownership, control or influence, our clearances
could be revoked and our U.S. government customers could terminate, or decide
not to renew, our contracts, and such a situation could also impair our ability
to obtain new contracts and subcontracts. Any such actions would reduce our
revenues and harm our business.




We
depend on our suppliers and one, in particular, currently provides us with
approximately 20% of our supply needs. If we cannot obtain certain components
for our products or we lose any of our key suppliers, we would have to develop
alternative designs that could increase our costs or delay our
operations.




We depend
upon a number of suppliers for components of our products. Of these suppliers,
Action Group supplied approximately 20% of the total purchases during the three
months ended March 31, 2010. There is an inherent risk that certain components
of our products will be unavailable for prompt delivery or, in some cases,
discontinued. We have only limited control over any third-party manufacturer as
to quality controls, timeliness of production, deliveries and various other
factors. Should the availability of certain components be compromised through
the loss of, or impairment of the relationship with, any of our three key
suppliers or otherwise, it could force us to develop alternative designs using
other components, which could add to the cost of goods sold and compromise
delivery commitments. If we are unable to obtain components in a timely manner,
at an acceptable cost, or at all, we would need to select new suppliers,
redesign or reconstruct processes we use to build our transparent and opaque
armored products. We may not be able to manufacture one or more of our products
for a period of time, which could materially adversely affect our business,
results from operations and financial condition.




33




If
we fail to keep pace with the ever-changing market of security-related defense
products, our revenues and financial condition will be negatively
affected.




The
security-related defense product market is rapidly changing, with evolving
industry standards. Our future success will depend in part upon our ability to
introduce new products, designs, technologies and features to meet changing
customer requirements and emerging industry standards; however, there can be no
assurance that we will successfully introduce new products or features to our
existing products or develop new products that will achieve market acceptance.
Any delay or failure of these products to achieve market acceptance would
adversely affect our business. In addition, there can be no assurance that
products or technologies developed by others will not render our products or
technologies non-competitive or obsolete. Should we fail to keep pace with the
ever-changing nature of the security-related defense product market, our
revenues and financial condition will be negatively affected.




We
believe that, in order to remain competitive in the future, we will need to
continue to invest financial resources to develop new and adapt or modify our
existing offerings and technologies, including through internal research and
development, acquisitions and joint ventures or other teaming arrangements.
These expenditures could divert our attention and resources from other projects,
and we cannot be sure that these expenditures will ultimately lead to the timely
development of new offerings and technologies. Due to the design complexity of
our products, we may in the future experience delays in completing the
development and introduction of new products. Any delays could result in
increased costs of development or deflect resources from other projects. In
addition, there can be no assurance that the market for our offerings will
develop or continue to expand as we currently anticipate. The failure of our
technology to gain market acceptance could significantly reduce our revenues and
harm our business. Furthermore, we cannot be sure that our competitors will not
develop competing technologies which gain market acceptance in advance of our
products.





We may be subject to personal liability claims for our products
and if our insurance is not sufficient to cover such claims, our expenses may
increase substantially.




Our
products are used in applications where the failure to use our products properly
or their malfunction could result in bodily injury or death, and we may be
subject to personal liability claims. Although we currently maintain general
liability insurance which includes $1 million of product liability coverage, our
insurance may not be adequate to cover such claims. As a result, a significant
lawsuit could adversely affect our business. We may be exposed to liability for
personal injury or property damage claims relating to the use of our products.
Any future claim against us for personal injury or property damage could
materially adversely affect our business, financial condition, and results of
operations and result in negative publicity. We currently maintain insurance for
this type of liability as well as seek Support Antiterrorism by Fostering
Effective Technologies Act of 2002 (also known as the SAFETY Act) certification
for our products where we deem appropriate. However, although we maintain
insurance coverage, we may experience legal claims outside of our insurance
coverage, or in excess of our insurance coverage, or that insurance will not
cover. Even if we are not found liable, the costs of defending a lawsuit can be
high.




We
are subject to substantial competition.




We are
subject to significant competition that could harm our ability to win business
and increase the price pressure on our products. We face strong competition from
a wide variety of firms, including large, multinational, defense and aerospace
firms. Most of our competitors have considerably greater financial, marketing
and technological resources than we do, which may make it difficult to win new
contracts and we may not be able to compete successfully. Certain competitors
operate larger facilities and have longer operating histories and presence in
key markets, greater name recognition and larger customer bases. As a result,
these competitors may be able to adapt more quickly to new or emerging
technologies and changes in customer requirements. They may also be able to
devote greater resources to the promotion and sale of their products. Moreover,
we may not have sufficient resources to undertake the continuing research and
development necessary to remain competitive.




We
must comply with environmental regulations or we may have to pay expensive
penalties or clean up costs.




We are
subject to federal, state, local and foreign laws, and regulations regarding
protection of the environment, including air, water, and soil. Our manufacturing
business involves the use, handling, storage, discharge and disposal of,
hazardous or toxic substances or wastes to manufacture our products. We must
comply with certain requirements for the use, management, handling, and disposal
of these materials. If we are found responsible for any hazardous contamination,
we may have to pay expensive fines or penalties or perform costly clean-up. Even
if we are charged, and later found not responsible, for such contamination or
clean up, the cost of defending the charges could be high. Authorities may also
force us to suspend production, alter our manufacturing processes, or stop
operations if we do not comply with these laws and regulations.




We
may not be able to adequately safeguard our intellectual property rights and
trade secrets from unauthorized use, and we may become subject to claims that we
infringe on others’ intellectual property rights.




34





We rely
on a combination of trade secrets, trademarks, and other intellectual property
laws, nondisclosure agreements and other protective measures to preserve our
proprietary rights to our products and production processes.




We
currently have five utility and one provisional U.S. pending patent
applications. We do not know whether any of our pending patent applications will
result in the issuance of patents or whether the examination process will
require us to narrow our claims. We have not emphasized, and do not presently
intend to emphasize, patents as a source of significant competitive advantage,
however, if we are issued patents we intend to seek to enforce them as
commercially appropriate.




These
measures afford only limited protection and may not preclude competitors from
developing products or processes similar or superior to ours. Moreover, the laws
of certain foreign countries do not protect intellectual property rights to the
same extent as the laws of the United States, and we may face other obstacles to
enforcing our intellectual property rights outside the United States including
the ability to enforce judgments, the possibility of conflicting judgments among
courts and tribunals in different jurisdictions and locating, hiring and
supervising local counsel in such other countries.





Although we implement protective measures and intend to defend
our proprietary rights, these efforts may not be successful. From time to time,
we may litigate within the United States or abroad to enforce our licensed
patents, to protect our trade secrets and know-how or to determine the
enforceability, scope and validity of our proprietary rights and the proprietary
rights of others. Enforcing or defending our proprietary rights could be
expensive, require management’s attention and might not bring us timely or
effective relief.




Furthermore,
third parties may assert that our products or processes infringe their patent or
other intellectual property rights. Our patents, if granted, may be challenged,
invalidated or circumvented. Although there are no pending or threatened
intellectual property lawsuits against us, we may face litigation or
infringement claims in the future. Infringement claims could result in
substantial costs and diversion of our resources even if we ultimately prevail.
A third party claiming infringement may also obtain an injunction or other
equitable relief, which could effectively block the distribution or sale of
allegedly infringing products. Although we may seek licenses from third parties
covering intellectual property that we are allegedly infringing, we may not be
able to obtain any such licenses on acceptable terms, if at all.




We
depend on management and other key personnel and we may not be able to execute
our business plan without their services.




Our
success and our business strategy depend in large part on our ability to attract
and retain key management and operating personnel. Such individuals are in high
demand and are often subject to competing employment offers. We depend to a
large extent on the abilities and continued participation of our executive
officers and other key employees. We presently maintain “key man” insurance on
Anthony Piscitelli, our President and Chief Executive Officer. We believe that,
as our activities increase and change in character, additional experienced
personnel will be required to implement our business plan. Competition for such
personnel is intense and we may not be able to hire them when required, or have
the ability to retain them.




We
may partner with foreign entities, and domestic entities with foreign contacts,
which may affect our business plans by increasing our costs.




We
recognize that there may be opportunities for increased product sales in both
the domestic and global defense markets. We have recently initiated plans to
strategically team with foreign entities as well as domestic entities with
foreign business contacts in order to better compete for both domestic and
foreign military contracts. In order to implement these plans, we may incur
substantial costs which may include additional research and development,
prototyping, hiring personnel with specialized skills, implementing and
maintaining technology control plans, technical data export licenses,
production, product integration, marketing, warehousing, finance charges,
licensing, tariffs, transportation and other costs. In the event that working
with foreign entities and/or domestic entities with foreign business contacts
proves to be unsuccessful, this strategy may ineffectively use our resources
which may affect our profitability and the costs associated with such work may
preclude us from pursuing alternative opportunities.




We
are presently classified as a small business and the loss of our small business
status may adversely affect our ability to compete for government
contracts.




We are
presently classified as a small business as determined by the Small Business
Administration based upon the North American Industry Classification Systems
(NAICS) industry and product specific codes which are regulated in the United
States by the Small Business Administration. While we do not presently derive a
substantial portion of our business from contracts which are set-aside for small
businesses, we are able to bid on small business set-aside contracts as well as
contracts which are open to non-small business entities. It is also possible
that we may become more reliant upon small business set-aside contracts. Our
continuing growth may cause us to lose our designation as a small business, and
additionally, as the NAICS codes are periodically revised, it is possible that
we may lose our status as a small business and may sustain an adverse impact on
our current competitive advantage. The loss of small business status could
adversely impact our ability to compete for government contracts, maintain
eligibility for special small business programs and limit our ability to partner
with other business entities which are seeking to team with small business
entities as may be required under a specific contract.





35





We
intend to pursue international sales opportunities which may require export
licenses and controls and result in the commitment of significant resources and
capital.




In order
to pursue international sales opportunities, we have initiated a program to
obtain product classifications, commodity jurisdictions, licenses, technology
control plans, technical data export licenses and export related programs. Due
to our diverse products, it is possible that some products may be subject to
classification under the United States State Department International Traffic in
Arms Regulations (ITAR). In the event that a product is classified as an
ITAR-controlled item, we will be required to obtain an ITAR export license.
While we believe that we will be able to obtain such licenses, the denial of
required licenses and/or the delay in obtaining such licenses may have a
significant adverse impact on our ability to sell products internationally.
Alternatively, our products may be subject to classification under the United
States Commerce Department’s Export Administration Regulations (EAR). We also
anticipate that we may be required to comply with international regulations,
tariffs and controls and we intend to work closely with experienced freight
forwarders and advisors. We anticipate that an internal compliance program for
international sales will require the commitment of significant resources and
capital.




Increases
in our international sales may expose us to unique and potentially greater risks
than are presented in our domestic business, which could negatively impact our
results of operations and financial condition.




If our
international sales grow, we may be exposed to certain unique and potentially
greater risks than are presented in our domestic business. International
business is sensitive to changes in the budgets and priorities of international
customers, which may be driven by potentially volatile worldwide economic
conditions, regional and local economic and political factors, as well as U.S.
foreign policy. International sales will also expose us to local government
laws, regulations and procurement regimes which may differ from U.S. Government
regulation, including import-export control, exchange control, investment and
repatriation of earnings, as well as to varying currency and other economic
risks. International contracts may also require the use of foreign
representatives and consultants or may require us to commit to financial support
obligations, known as offsets, and provide for penalties if we fail to meet such
requirements. As a result of these and other factors, we could experience award
and funding delays on international projects or could incur losses on such
projects, which could negatively impact our results of operations and financial
condition.




We
have made, and expect to continue to make, strategic acquisitions and
investments, and these activities involve risks and uncertainties.




In
pursuing our business strategies, we continually review, evaluate and consider
potential investments and acquisitions. In evaluating such transactions, we are
required to make difficult judgments regarding the value of business
opportunities, technologies and other assets, and the risks and cost of
potential liabilities. Furthermore, acquisitions and investments involve certain
other risks and uncertainties, including the difficulty in integrating
newly-acquired businesses, the challenges in achieving strategic objectives and
other benefits expected from acquisitions or investments, the diversion of our
attention and resources from our operations and other initiatives, the potential
impairment of acquired assets and the potential loss of key employees of the
acquired businesses.




The
outcome of litigation in which we have been named as a defendant is
unpredictable and an adverse decision in any such matter could have a material
adverse effect on our financial position or results of operations.




We are
defendants in a number of litigation matters. These matters may divert financial
and management resources that would otherwise be used to benefit our operations.
Although we believe that we have meritorious defenses to the claims made in the
litigation matters to which we have been named a party and intend to contest
each lawsuit vigorously, no assurances can be given that the results of these
matters will be favorable to us. An adverse resolution or outcome of any of
these lawsuits, claims, demands or investigations could have a negative impact
on our financial condition, results of operations and liquidity. Please see Part
II, Item 1, Legal Proceedings.







Unanticipated
changes in our tax provisions or exposure to additional income tax liabilities
could affect our profitability.





We are
subject to income taxes in the United States. In the ordinary course of our
business, there are many transactions and calculations where the ultimate tax
determination is uncertain. Furthermore, changes in domestic or foreign income
tax laws and regulations, or their interpretation, could result in higher or
lower income tax rates assessed or changes in the taxability of certain sales or
the deductibility of certain expenses, thereby affecting our income tax expense
and profitability. Although we believe our tax estimates are reasonable, the
final determination of tax audits could be materially different from our
historical income tax provisions and accruals. Additionally, changes in the
geographic mix of our sales could also impact our tax liabilities and affect our
income tax expense and profitability.




Risks
Relating to Our Common Stock




If
we fail to maintain an effective system of internal controls over financial
reporting, we may not be able to report accurately our financial results. This
could have a material adverse effect on our share price.




36





Effective
internal controls are necessary for us to provide accurate financial reports. We
completed documenting and testing our internal control procedures to satisfy the
requirements of Section 404 of the Sarbanes Oxley Act of 2002 and the related
rules of the SEC, which require, among other things, our management to assess
annually the effectiveness of our internal control over financial reporting and
our independent registered public accounting firm to issue a report on that
assessment.




As a
result of the material weaknesses identified during the course of our evaluation
of our controls and procedures, our Chief Executive Officer and Chief Financial
Officer have concluded that our disclosure controls and procedures were not
effective to ensure that the information required to be disclosed by us in the
reports that we file or submit under the Exchange Act was recorded, processed,
summarized and reported within the time periods specified in the SEC’s rules and
forms and that such information required to be disclosed is accumulated and
communicated to management, including our Chief Executive Officer and Chief
Financial Officer, to allow timely decisions regarding required disclosure. We
identified material weaknesses in our period-end financial close processes and
general computing controls. To address these material weaknesses, we intend to
engage outside experts to provide counsel and guidance in areas where we cannot
economically maintain the required expertise internally.





There can
be no assurance that we will maintain adequate controls over our financial
processes and reporting in the future or that those controls will be adequate in
all cases to uncover inaccurate or misleading financial information that could
be reported by members of management. If our controls failed to identify any
misreporting of financial information or our management or independent
registered public accounting firm were to conclude in their reports that our
internal control over financial reporting was not effective, investors could
lose confidence in our reported financial information and the trading price of
our shares could drop significantly. In addition, we could be subject to
sanctions or investigations by the stock exchange upon which our common stock
may be listed, the SEC or other regulatory authorities, which would require
additional financial and management resources.




Volatility
of our stock price could adversely affect stockholders.




The
market price of our common stock could fluctuate significantly as a result
of:




·
            quarterly
      variations in our operating
results;




·
            cyclical
      nature of defense spending;




·
            interest
      rate changes;




·
            changes
      in the market’s expectations about our operating
  results;




·
            our
      operating results failing to meet the expectation of securities analysts
      or investors in a particular
period;




·
            changes
      in financial estimates and recommendations by securities analysts
      concerning our company or the defense industry in
  general;




·
            operating
      and stock price performance of other companies that investors deem
      comparable to us;




·
            news
      reports relating to trends in our
markets;




·
            changes
      in laws and regulations affecting our
business;




·
            material
      announcements by us or our
competitors;




·
            sales
      of substantial amounts of common stock by our directors, executive
      officers or significant stockholders or the perception that such sales
      could occur;





·
            general
      economic and political conditions such as recessions and acts of war or
      terrorism; and




·
            other
      matters discussed in the Risk
Factors.




Fluctuations
in the price of our common stock could contribute to the loss of all or part of
an investor’s investment in our company.




We
currently do not intend to pay dividends on our common stock and consequently
your only opportunity to achieve a return on your investment is if the price of
common stock appreciates.




37





We
currently do not plan to declare dividends on our common stock in the
foreseeable future. Any payment of cash dividends will depend upon our financial
condition, capital requirements, earnings and other factors deemed relevant by
our board of directors. Agreements governing future indebtedness will likely
contain similar restrictions on our ability to pay cash dividends. Consequently,
your only opportunity to achieve a return on your investment in the common stock
of our company will be if the market price of our common stock appreciates and
you sell your common stock at a profit.




In
addition, under the Certificate of Designations for our Series A Preferred, an
affirmative vote at a meeting duly called or the written consent without a
meeting of the holders of such preferred stock representing at least a majority
of then outstanding shares of the Series A Preferred is required for us to pay
dividends or any other distribution on our common stock.




Provisions
in our certificate of incorporation and bylaws or Delaware law might discourage,
delay or prevent a change of control of our company or changes in our management
and, therefore, depress the trading price of our stock.




Our
amended and restated certificate of incorporation and bylaws contain provisions
that could depress the trading price of our common stock by acting to
discourage, delay or prevent a change in control of our company or changes in
our management that the stockholders of our company may deem advantageous. These
provisions:




·
            establish
      a classified board of directors so that not all members of our board of
      directors are elected at one time;




·
            provide
      that directors may only be removed “for cause” and only with the approval
      of 66 2⁄3 percent of our
stockholders;




·
            provide
      that only our board of directors can fill vacancies on the board of
      directors;




·
            require
      super-majority voting to amend our bylaws or specified provisions in our
      certificate of incorporation;




·
            authorize
      the issuance of “blank check” preferred stock that our board of directors
      could issue to increase the number of outstanding shares and to discourage
      a takeover attempt;




·
            limit
      the ability of our stockholders to call special meetings of
      stockholders;




·
            prohibit
      common stockholder action by written consent, which requires all common
      stockholder actions to be taken at a meeting of our
      stockholders;




·
            provide
      that the board of directors is expressly authorized to adopt, amend, or
      repeal our bylaws, subject to the rights of our stockholders to do the
      same by super-majority vote of stockholders;
and




·
            establish
      advance notice requirements for nominations for election to our board of
      directors or for proposing matters that can be acted upon by stockholders
      at stockholder meetings.




In
addition, Section 203 of the Delaware General Corporation Law may discourage,
delay or prevent a change in control of our company.




These and
other provisions contained in our amended and restated certificate of
incorporation and bylaws could delay or discourage transactions involving an
actual or potential change in control of us or our management, including
transactions in which our stockholders might otherwise receive a premium for
their shares over then current prices, and may limit the ability of stockholders
to remove our current management or approve transactions that our stockholders
may deem to be in their best interests and, therefore, could adversely affect
the price of our common stock.




Shares
of stock issuable pursuant to our stock options, warrant and Series A Preferred
may adversely affect the market price of our common stock.




As of May
14, 2010, we had outstanding stock options to purchase an aggregate of 2,330,000
shares of common stock under our 2007 Incentive Compensation Plan of which
867,000 were exercisable and warrants to purchase an aggregate of 1,448,681
shares of common stock. In addition, we have 2,065,139 shares of common stock
reserved for issuance under our 2007 Incentive Compensation Plan and 30,000,000
shares reserved for issuance upon the conversion of our Series A
Preferred.  Our outstanding warrants and Series A Preferred also
contain provisions that increase, subject to limited exceptions, the number of
shares of common stock that may be acquired upon the conversion or exercise of
such securities in the event we issue (or are deemed to have issued) shares of
our common stock at a per share price that is less than their then existing
exercise price, in the case of the warrants, and Conversion Price, in the case
of the Series A Preferred.  The exercise of the stock options and
warrants would further reduce a stockholder’s percentage voting and ownership
interest. Further, the stock options and warrants are likely to be exercised
when our common stock is trading at a price that is higher than the exercise
price of these options and warrants, and we would be able to obtain a higher
price for our common stock than we will receive under such options and warrants.
The exercise, or potential exercise, of these options and warrants or conversion
of our Series A Preferred could adversely affect the market price of our common
stock and adversely affect the terms on which we could obtain additional
financing.




38





Future
sales, or the availability for sale, of our common stock may cause our stock
price to decline.




We have
registered shares of our common stock that are subject to outstanding stock
options, or reserved for issuance under our stock option plan, which shares can
generally be freely sold in the public market upon issuance. Pursuant to a
settlement with the holders of our Series A Preferred in May 2009, we also have
registered the resale of up to 5,695,505 shares of our common
stock  and intend to register an additional 2,115,000 shares of our
common stock held by such preferred stockholders.  Sales, or the
availability for sale, of substantial amounts of our common stock in the public
market could adversely affect the market price of our common stock and could
materially impair our future ability to raise capital through offerings of our
common stock.





The
continued listing of our common stock on the NYSE Amex is subject to compliance
with their continued listing requirements. While we have not received any notice
of an intent to delist our common stock, if such stock were delisted, the
ability of investors in our common stock to make transactions in such stock
would be limited.





Our
common stock is listed on the NYSE Amex, a national securities exchange.
Continued listing of our common stock on the NYSE Amex requires us to meet
continued listing requirements set forth in the NYSE Amex’s Company Guide. These
requirements include both quantitative and qualitative standards. While we have
not received any notice of an intent to delist our common stock, investors
should be aware that if the NYSE Amex were to delist our common stock from
quotation on its exchange, this would limit investors’ ability to make
transactions in our common stock.




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




As of
March 31, 2010, we issued an aggregate of 1,035,000 shares of our common stock
to the holders of our Series A Preferred as dividends for the first quarter of
2010 pursuant to the Certificate of Designations, Preferences and Rights of
Series A Preferred. We relied on the exemption provided by Section 4(2) of the
Securities Act of 1933 and Regulation D promulgated thereunder.





Item
3.         Defaults Upon Senior
Securities





None.




Item
4.         (Removed and
Reserved)







Item
5.           Other
Information




None.




39





Item
6.          
Exhibits




Exhibit
                        Number
                      
                      Exhibit3.1
      (1)
                      
                      Third
      Amended and Restated Certificate of Incorporation.3.2 (2)
                      
                      Amended
      and Restated Bylaws.3.3 (3)
                      
                      First
      Amendment to Third Amended and Restated Certificate of
      Incorporation.3.4 (4)
                      
                      First
      Amendment to Amended and Restated Bylaws.10.1(5)
                      
                      Lease
      between Boon Edams, Inc. and the Registrant, dated February 25,
      201010.2
      (3)
                      
                      Amendment
      to Employment Agreement, effective as of January 1, 2010, between the
      Registrant and Anthony Picitelli.10.3
      (3)
                      
                      Amendment
      to Employment Agreement, effective as of January 1, 2010, between the
      Registrant and Fergal Foley.10.4
      (3)
                      
                      Second
      Amendment to Employment Agreement, effective as of January 1, 2010,
      between the Registrant and Gary Sidorsky.10.5*
                      
                      First
      Amendment to Employment Agreement, effective as of January 25, 2010,
      between the Registrant and Robert Aldrich.10.6*
                      
                      Employment
      Agreement, effective as of January 1, 2009, between the Registrant and
      Russell Scales.31.1*
                      
                      Certification
      of Chairman and Chief Executive Officer pursuant to Rule 13a-14(a) and
      Rule 15d-14(a), promulgated under the Securities Exchange Act of 1934, as
      amended.*31.2*
                      
                      Certification
      of Chief Financial Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a),
      promulgated under the Securities Act of 1934, as
  amended.32.1*
                      
                      Certification
      of Chairman and Chief Executive Officer and Chief Financial Officer
      pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
      the Sarbanes-Oxley Act of
2002.










(1)
 Previously filed as an Exhibit to Amendment No. 3 to the Form 10, filed on
April 22, 2008.


(2)
 Previously filed as an Exhibit to Amendment No.1 to the Form 10, filed on
March 21, 2008.


(3)  Previously
filed as an Exhibit to the Current Report on Form 8-K, filed on April 15,
2010.


(4)  Previously
filed as an Exhibit to the Current Report on Form 8-K, filed on January 28,
2010.


(5)  Previously
filed as an Exhibit to the Annual Report on Form 10-K for the year ended
December 31, 2009, filed on April 15, 2010.


*    
 Filed herewith.




40





SIGNATURES




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




AMERICAN
      DEFENSE SYSTEMS, INC.Date:
      May 14, 2010
              By:
              /s/
      Gary
      SidorskyChief
      Financial Officer





41




Index
to Exhibits




Exhibit
                    Number
                  
                  Exhibit10.5
                  
                  First
      Amendment to Employment Agreement, effective as of January 25, 2010,
      between the Registrant and Robert Aldrich.10.6
                  
                  Employment
      Agreement, effective as of January 1, 2009, between the Registrant and
      Russell Scales.31.1
                  
                  Certification
      of Chairman and Chief Executive Officer pursuant to Rule 13a-14(a) and
      Rule 15d-14(a), promulgated under the Securities Exchange Act of 1934, as
      amended.31.2
                  
                  Certification
      of Chief Financial Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a),
      promulgated under the Securities Act of 1934, as
  amended.32.1
                  
                  Certification
      of Chairman and Chief Executive Officer and Chief Financial Officer
      pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
      the Sarbanes-Oxley Act of
2002.





42