UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

FORM 10-Q/A

(Amendment No. 1)

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

For the Quarter Ended March 31, 2009

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 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  o
Non-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 13, 2009, 39,760,952 shares of common stock, par value $0.001 per share, of the registrant were outstanding.

EXPLANATORY NOTE

This Amendment No. 1 on Form 10-Q/A filed (“Amendment No. 1”) to our Quarterly Report on Form 10-Q for the quarter ended March 31, 2009, initially with the Securities and Exchange Commission on May 15, 2009 (the “Original Filing”), is being filed to restate our consolidated financial statements at, and for the three month period ended, March 31, 2009 and the notes related thereto and the related sections of the Management’s Discussion and Analysis of Financial Condition and Results of Operations.  Management, with the concurrence of the Audit Committee of our Board of Directors, has concluded that the financial statements included in the Original Filing should be restated and no longer be relied upon due to (i) incorrect balance sheet classifications of our Series A Convertible Preferred Stock and warrants to purchase our common stock, and related incorrect recording of the changes in fair value of such reclassified warrants, (ii) the capitalization of certain legal expenditures on our balance sheet that should have been expensed on our statement of operations, (iii) incorrect recording of the dividends on our Series A Convertible Preferred Stock as dividends rather than as interest expense on our statement of operations, (iv) certain costs relating to the registration and exchange listing of our common stock originally included in additional paid in capital on our balance sheet that should have been expensed on our statement of operations, (v) incorrect balance sheet classification of our Assets from Discontinued Operations and Liabilities from Discontinued Operations, (vi) stock-based compensation expense with respect to stock option and common stock grants made to an employee and certain directors that should have been added to our statement of operations, and (vii) incorrect balance sheet classification of an asset from a prior asset acquisition.  See Note 2 in the Notes to Consolidated Financial Statements included in this Amendment No. 1 for a discussion of the corrections and a reconciliation of amounts previously reported to those shown herein.

This Amendment No. 1 also reflects the restatement of our consolidated financial statements at, and for the year ended, December 31, 2008 (the “2008 Financial Statements”).  The restatement of the 2008 Financial Statements was made to correct the accounting for (i) incorrect balance sheet classification of our Series A Convertible Preferred Stock and related investor warrants, (ii) incorrect balance sheet classification of our Assets from Discontinued Operations and Liabilities from Discontinued Operations, (iii) incorrect recording of the dividends on our Series A Convertible Preferred Stock as dividends rather than as interest expense on our statement of operations, (iv) the capitalization of certain legal expenditures on our balance sheet that should have been expensed on our statement of operations, (v) certain costs relating to the registration and exchange listing of our common stock originally included in additional paid in capital on our balance sheet that should have been expensed on our statement of operations, and (vi) incorrect balance sheet classification of an asset from a prior asset acquisition.  The restatement of the 2008 Financial Statements has been made in an amendment to our Annual Report on Form 10-K for the year ended December 31, 2008 filed with the SEC on April 15, 2010 (“Form 10-K/A”).  For more information of the restatement of our 2008 Financial Statements, see Note 2 in the Notes to Consolidated Financial Statements included in this Amendment No. 1 and Note 2 in the Notes to Consolidated Financial Statements included in our Form 10-K/A.

Although this Amendment No. 1 sets forth the Original Filing in its entirety, this Amendment No. 1 only amends and restates Items 1 and 2 of Part I of the Original Filing, in each case, solely as a result of, and to reflect the restatement, and to update our assessment of our internal controls and procedures at March 31, 2009 as set forth in Part I, Item 4 to reflect the effects of the restatement, and Part II, Item 6 to reflect the filing of currently dated certifications of our chief executive officer and chief financial officer.  No other information in the Original Filing is amended hereby.

Except for the foregoing amended and restated information, this Amendment No. 1 continues to describe conditions as of the date of the Original Filing, and we have not updated the disclosures contained herein to reflect events that occurred at a later date.

TABLE OF CONTENTS

PART I – FINANCIAL INFORMATION
Item 1.	Condensed Financial Statements
	Consolidated Balance Sheets as of December 31, 2008 and March 31, 2009 (unaudited)
	Consolidated Statements of Operations for the three months ended March 31, 2008 and 2009 (unaudited)
	Consolidated Statements of Cash Flows for the three months ended March 31, 2008 and 2009 (unaudited)
	Notes to Consolidated Financial Statements
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 4.	Controls and Procedures
PART II – OTHER INFORMATION
Item 1.	Legal Proceedings
Item 1A.	Risk Factors
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds
Item 3.	Defaults Upon Senior Securities
Item 4.	Submission of Matters to a Vote of Security Holders
Item 5.	Other Information
Item 6.	Exhibits
SIGNATURES

PART I

Item 1.    Consolidated Financial Statements

AMERICAN DEFENSE SYSTEMS, INC. and SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

	March 31,			December 31,
	2009			2008
	(Unaudited)			(Audited)
	(Restated)			(Restated)
ASSETS
CURRENT ASSETS
Cash	$	83,826		$	374,457
Accounts receivable, net	6,434,888			4,981,150
Inventory	844,139			621,048
Prepaid expenses and other current assets	1,647,846			2,088,801
Costs in excess of billings on uncompleted contracts	6,562,903			7,143,089
Deposits	437,496			437,496
Assets of discontinued operations	—			736,613
TOTAL CURRENT ASSETS	16,011,098			16,382,654
PROPERTY and EQUIPMENT, net	3,569,232			3,743,936
DEFERRED FINANCING COSTS, net	1,836,820			1,500,533
NOTES RECEIVABLE	925,000			925,000
INTANGIBLE ASSET	606,000			606,000
GOODWILL	450,000			450,000
DEFERRED TAX ASSET	1,167,832			1,167,832
other assets	159,559			159,560
TOTAL ASSETS	$	24,725,541		$	24,935,515
LIABILITIES AND SHAREHOLDERS’ EQUITY
CURRENT LIABILITIES
Accounts payable	$	3,181,123		$	2,480,652
Accrued payroll	409,852			—
Accrued expenses	386,447			755,615
Line of credit	659,422			76,832
Preferred stock, $.001 par value, 5,000,000 shares authorized, 15,000 shares designated as mandatorily redeemable Series A Convertible Preferred Stock (cumulative), 15,000 shares issued and outstanding	11,809,196			10,981,577
Warrant liabilities	214,432			90,409
Liabilities of discontinued operations	—			736,613
TOTAL LIABILITIES	16,660,472			15,121,698
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS’ EQUITY
Common Stock, $.001 par value: 100,000,000 shares authorized, 39,585,960 and 39,585,960 shares issued and outstanding as of March 31, 2009 and December 31, 2008, respectively	39,762			39,586
Additional paid in capital	10,383,344			11,096,031
Accumulated deficit	(2,358,037		)	(1,321,800		)
TOTAL SHAREHOLDERS’ EQUITY	8,065,069			9,813,817
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	24,725,541		$	24,935,515

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

1

AMERICAN DEFENSE SYSTEMS, INC. and SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

	Three Months Ended
	March 31,
	2009			2008
	(Unaudited)			(Unaudited)
	(Restated)			(Restated)
CONTRACT REVENUES EARNED	$	9,489,702		$	8,734,909
COST OF REVENUES EARNED	5,453,109			5,335,036
GROSS PROFIT	4,036,593			3,399,873
OPERATING EXPENSES
General and administrative expenses	2,073,995			1,395,059
General and administrative salaries	1,073,037			1,136,596
Marketing	733,794			632,307
T2 expenses	113,602			—
Research and development	186,386			165,196
Settlement of litigation	—			57,377
Depreciation	241,329			134,769
Professional fees	—			514,714
Total operating expenses	4,422,143			4,036,018
LOSS FROM OPERATIONS	(385,550		)	(636,145		)
OTHER INCOME (EXPENSE)
Unrealized loss on adjustment of fair value Series A convertible preferred stock classified as a liability	(694,454		)	(1,428,665		)
Unrealized gain (loss) on warrant liabilities	80,672			(107,589		)
Other expense	—			(9,046		)
Interest expense	(342,730		)	(55,737		)
Interest expense - mandatory redeemable preferred stock	(375,000		)	—
Interest income	8,646			31,123
Finance charge	—			(4,536		)
Total other income (expense)	(1,322,866		)	(1,574,450		)
LOSS FROM CONTINUING OPERATIONS BEFORE INCOME TAXES	(1,708,416		)	(2,210,595		)
INCOME TAX PROVISION (BENEFIT)	—			—
LOSS FROM CONTINUING OPERATIONS	(1,708,416		)	(2,210,595		)
LOSS FROM DISCONTINUED OPERATIONS, NET OF TAXES
Loss from operations of discontinued division	—			(489		)
Loss from disposal of discontinued division	—			—
	—			(489		)
NET LOSS	(1,708,416		)	(2,211,084		)
NET LOSS ATTRIBUTABLE TO COMMON SHAREHOLDERS	$	(1,708,416	)	$	(2,211,084	)
Weighted Average Shares Outstanding - Basic and Diluted	39,585,960			39,124,616
EARNINGS PER SHARE - Basic and Diluted
Loss from continuing operations	$	(0.04	)	$	(0.06	)
(Loss) from discontinued operations	$	—		$	(0.00	)
Net loss	$	(0.04	)	$	(0.06	)

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

2

AMERICAN DEFENSE SYSTEMS, INC.

AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

For the three months ended March 31, 2009 and 2008

	Three Months Ended
	March 31,
	2009			2008
	(Restated)
Cash flows from operating activities:
Net loss	$	(1,708,416	)	$	(2,211,084	)
Adjustments to reconcile net loss to net cash used in continuing operating activities:
Change in fair value associated with preferred stock and warrants	613,778			1,536,254
Stock based compensation expense	154,636			33,685
Amortization of deferred financing costs	147,424			—
Discount on Series A preferred stock	142,896			—
Depreciation and amortization	241,329			134,769
Changes in operating assets and liabilities:
Accounts receivable	(1,453,738		)	1,953,026
Inventories	(223,091		)	(57,382		)
Deposits and other assets	—			36,794
Cost in excess of billing on uncompleted contracts	580,186			(3,685,895		)
Prepaid expenses and other assets	(42,764		)	(103,681		)
Accounts payable and accrued expenses	741,164			665,436
Due to related party	—			(91,993		)
Net cash used in continuing operating activities	(806,596		)	(1,790,071		)
Net cash used in discontinued operations	—			(235,145		)
Net cash used in operating activities	(806,596		)	(2,025,216		)
Cash flows from continuing investing activities:
Purchase of equipment	(66,625		)	(368,238		)
Advances for future acquisitions	—			(20,000		)
Cash paid for acquisition in excess of cash received	—			(100,000		)
Net cash used in investing activities	(66,625		)	(488,238		)
Cash flows from continuing financing activities:
Proceeds from notes payable	—			69,568
Proceeds from line of credit	582,590			—
Repayments of short term financing	—			(6,342		)
Deferred financing costs	—			(658,500		)
Proceeds from sale of Series A Convertible
Preferred Shares, net of of capitalization costs of $270,000	—			11,303,500
Net cash provided by financing activities	582,590			10,708,226
NET INCREASE (DECREASE) IN CASH	(290,631		)	8,194,772
CASH AT BEGINNING OF YEAR	374,457			1,479,886
CASH AT END OF PERIOD	$	83,826		$	9,674,658
Supplemental disclosure of cash flow information:
Cash paid during the year for interest	$	384,730		$	6,163
Cash paid for taxes	$	—		$	—
Supplemental disclosure of non-cash financing activities
Stock options issued in lieu of cash for compensation	$	29,192		$	33,685
Stock issued in lieu of cash	$	125,443		$	—
Assets and liabilities received in acquisition American Anti-Ram, Inc.
Fixed assets				$	30,000
Inventory				$	120,000
Goodwill				$	280,000
Accounts payable and accrued expense				$	(30,000	)
Notes payable				$	—
Shares issuable in connection with acquisition				$	(200,000	)
Cash paid in connection with acquisition				$	(100,000	)
Amounts due to American Anti-Ram, Inc.				$	(100,000	)

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

3

AMERICAN DEFENSE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO 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 8, 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 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, 2009 are not necessarily indicative of the results that may be expected for the year ending December 31, 2009. For further information, refer to the financial statements and footnotes thereto included in the Company’s Form 10-K/A annual report for the year ended December 31, 2008 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.

4

AMERICAN DEFENSE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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 American Physical Security Group, LLC. The accounts of TAG have been presented as discontinued operations as discussed more fully in Note 8.  All significant intercompany accounts and transactions have been eliminated in consolidation.

Terms and Definitions

ADSI	American Defense Systems, Inc. (the “Company”)
AJP	A.J. Piscitelli & Associates, Inc., a subsidiary
APB	Accounting Principles Board
ARB	Accounting Review Board
APSG	American Physical Security Group, LLC, a subsidiary
EITF	Emerging Issues Task Force
FASB	Financial Accounting Standards Board
FIN	FASB Interpretation Number
FSP	FASB Staff Position
GAAP	Generally Accepted Accounting Principles
PCAOB	Public Companies Accounting Oversight Board
SAB	Staff Accounting Bulletin
SEC	Securities Exchange Commission
SFAS or FAS	Statement of Financial Accounting Standards
TAG	Tactical Applications Group, a subsidiary

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. Estimates are used for revenue recognition, income taxes and accrued liabilities among others. Actual results could differ materially from those estimates.

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

5

AMERICAN DEFENSE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Revenue and Cost Recognition

The Company recognizes revenue in accordance with the provisions of SAB 104, “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.

Under this provision, revenue is recognized upon satisfactory completion of specified inspection, wherein by contract, customer acceptance and delivery occurs and title passes to the customer.

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 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.

Billing in Excess of Cost

All billings associated with uncompleted purchase orders under contract are recorded on the balance sheet as a current liability called “Billings in Excess of Costs on Uncompleted Contracts.”  Upon completion of the purchase order, all such billings are reclassified from the balance sheet to the statement of operations as revenues.  Due to the structure of the Company’s contracts, billing is not done until the purchase order is complete, therefore there are no amounts recorded as liabilities as of March 31, 2009 or 2008.  Contract retentions are included in accounts receivable.

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 has been recorded as of December 31, 2008 or 2007.  As a result of the discontinuing of TAG operations, the Company does not anticipate generating retail revenue in the future. As discussed in Note 7, revenue generated for the three months ended March 31, 2009 and 2008 from TAG retail operations was $0 and $685,211, respectively.

Cash and Cash Equivalents

The Company considers all highly liquid investments with maturities of three months or less at the time of purchase to be cash equivalents.

6

AMERICAN DEFENSE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Concentrations

Cash and cash equivalents 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. 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, 2009 and 2008, the Company derived 90% and 97% of its revenues from various U.S. government entities.

Inventories

Inventories are stated at the lower of cost or market, with cost determined using the first-in, first-out method.

Equipment

Equipment is stated at cost less accumulated depreciation. Depreciation is provided using a straight-line method over an estimated useful life of three to five years. Expenditures for repairs and maintenance are charged to expense as incurred.

Long-Lived Assets

The Company reviews long-lived assets and certain identifiable assets related to those assets for impairment whenever circumstances and situations change, such that there is an indication that the carrying amounts may not be recoverable. If the undiscounted cash flows of the long-lived assets are less than the carrying amount, their carrying amounts are reduced to fair value, and an impairment loss is recognized.

Goodwill and Indefinite-Lived Intangible Assets

In accordance with SFAS 142, “Goodwill and Other Intangible Assets,” goodwill, represents the excess of the purchase price over the fair value of net assets, including the amount assigned to identifiable intangible assets. The Company accounts for business combinations using the purchase method of accounting and accordingly, the assets and liabilities of the acquired entities are recorded at their estimated fair values at the acquisition date. The primary driver that generates goodwill is the value of synergies between the acquired entities and the company, which does not qualify as an identifiable intangible asset.  The Company does not amortize the goodwill balance.

7

AMERICAN DEFENSE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The Company assesses goodwill and indefinite-lived intangible assets for impairment annually during the fourth quarter, or more frequently if events and circumstances indicate impairment may have occurred. If the carrying value of a reporting unit’s goodwill exceeds its implied fair value, the Company records an impairment loss equal to the difference. SFAS 142 also requires that the fair value of indefinite-lived purchased intangible assets be estimated and compared to the carrying value. The Company recognizes an impairment loss when the estimated fair value of the indefinite-lived purchased intangible assets is less than the carrying value.

Advertising Costs

The Company expenses all advertising costs as incurred.

Earnings per Share

Basic earnings (loss) per share is computed using the weighted-average number of common shares outstanding during the period. Diluted net income per share is computed using the weighted-average number of common shares and dilutive potential 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 and restricted common stock.

Fair Value of Financial Instruments

Fair value of certain of the Company’s financial instruments including cash and cash equivalents, accounts receivable, accrued compensation, and other accrued liabilities approximate cost because of their short maturities.

During the current quarter the Company adopted the provisions related to its financial assets and liabilities measured at fair value on a recurring basis.  Current U.S. generally accepted accounting principles establishes a fair value hierarchy that prioritizes the inputs used to measure fair value.  The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurement) and the lowest priority to unobservable inputs (Level 3 measurements)

The three levels of the fair value hierarchy are as follows:

Level 1 – Quoted prices are available in active markets for identical assets or liabilities. Active markets are those in which transactions for the asset or liability occur with sufficient frequency and volume to provide pricing information on an ongoing basis.

Level 2 – Pricing inputs are other than quoted prices in active markets included in Level 1, which are either directly or indirectly observable as of the reporting date. Level 2 includes those financial instruments that are valued using models or other valuation methodologies. These models are primarily industry-standard models that consider various assumptions, including quoted forward prices for commodities, time value, volatility factors, and current

8

AMERICAN DEFENSE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

market and contractual prices for the underlying instruments, as well as other relevant economic measures. Substantially all of these assumptions are observable in the marketplace throughout the full term of the instrument, can be derived from observable data or are supported by observable levels at which transactions are executed in the marketplace.

Level 3 – Pricing inputs include significant inputs that are generally unobservable from objective sources. These inputs may be used with internally developed methodologies that result in management’s best estimate of fair value. Level 3 instruments include those that may be more structured or otherwise tailored to the Company’s needs.

Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement requires judgment, and may affect the valuation of fair value assets and liabilities and their placement within the fair value hierarchy levels.

Income Taxes

The Company accounts for income taxes according to SFAS 109 “Accounting for Income Taxes” which requires an asset and liability approach to financial accounting for income taxes. Deferred income tax assets and liabilities are computed annually for the difference between the financial statement and tax bases of assets and liabilities that will result in taxable or deductible amounts in the future, based on enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. Income tax expense is the tax payable or refundable for the period, plus or minus the change during the period in deferred tax assets and liabilities.

The Corporation adopted the provisions of FIN 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement 109,” effective January 1, 2007. FIN 48 prescribes a recognition threshold and a measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. Benefits from tax positions should be recognized in the financial statements only when it is more likely than not that the tax position will be sustained upon examination by the appropriate taxing authority that would have full knowledge of all relevant information. A tax position that meets the more-likely-than-not recognition threshold is measured at the largest amount of benefit that is greater than fifty percent likely of being realized upon ultimate settlement. Tax positions that previously failed to meet the more-likely-than-not recognition threshold should be recognized in the first subsequent financial reporting period in which that threshold is met. Previously recognized tax positions that no longer meet the more-likely-than-not recognition threshold should be derecognized in the first subsequent financial reporting period in which that threshold is no longer met. FIN 48 also provides guidance on the accounting for and disclosure of unrecognized tax benefits, interest and penalties. Adoption of FIN 48 did not have a significant impact on the Company’s financial statements.

9

AMERICAN DEFENSE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The Company files income tax returns in the U.S. federal jurisdiction and various states. The Company has not been subject to U.S. federal income tax examinations by tax authorities nor state authorities since its inception in 2000.

Recent accounting pronouncements

Business Combinations

In December, 2007, the FASB issued SFAS 141 (revised 2007), “Business Combinations” (hereinafter “SFAS No. 141 (revised 2007)”). This statement establishes principles and requirements for how an acquirer a) recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed and any noncontrolling interest in the acquiree, b) recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase and c) determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. The scope of SFAS 141 (revised 2007) is broader than the scope of SFAS 141, which it replaces. The effective date of SFAS 141 (revised 2007) is for all acquisitions in which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. The adoption of this statement is not expected to have an immediate material effect on the Company’s consolidated financial condition or results of operations.

Noncontrolling Interests in Consolidated Financial Statements — an amendment of ARB 51

In December, 2007, the FASB issued SFAS 160, “Noncontrolling Interests in Consolidated Financial Statements — an amendment of ARB No. 51.” This statement establishes accounting and reporting standards that require a) the ownership interests in subsidiaries held by parties other than the parent be clearly identified, labeled and presented in the consolidated statement of financial position with equity, but separate from the parent’s equity, b) the amount of consolidated net income attributable to the parent and to the noncontrolling interest be clearly identified and presented on the face of the consolidated statement of income, c) changes in a parent’s ownership interest while the parent retains its controlling financial interest in its subsidiary be accounted for consistently, d) when a subsidiary is deconsolidated, any retained noncontrolling  equity investment in the former subsidiary be initially measured at fair value and e) entities provide sufficient disclosures that clearly identify and distinguish between the interests of the parent and the interests of the noncontrolling owners. The effective date of this standard is for fiscal years and interim periods beginning on or after December 15, 2008. Since the Company has no such arrangements as of March 31, 2009, the adoption of this statement did not affect the Company’s consolidated financial condition or results of operations.

Disclosure about Derivative Instruments and Hedging Activities

In March 2008, the FASB issued SFAS 161, “Disclosure about Derivative Instruments and Hedging Activities,” an amendment of FASB Statement No. 133, (SFAS 161). This statement requires that objectives for using derivative instruments be disclosed in terms of underlying risk and accounting designation. The Company is required to adopt SFAS 161 on January 1, 2009. The adoption of SFAS 161 changed the disclosures of derivative instruments held by the Company.

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AMERICAN DEFENSE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Determination of the Useful Life of Intangible Assets

In April 2008, the FASB issued FSP FAS 142-3, “Determination of the Useful Life of Intangible Assets,”, which amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of intangible assets  under FASB 142 “Goodwill and Other Intangible Assets.”  The intent of this FSP is to improve the consistency between the useful life of a recognized intangible asset under SFAS 142 and the period of the expected cash flows used to measure the fair value of the asset under SFAS 141 (revised 2007) “Business Combinations” and other U.S. generally accepted accounting principles.    The Company has considered FSP FAS 142-3 in determining its useful life of intangible assets and has determined that the useful lives are consistent.  As a result, the Company has determined that there was no impact of FSP FAS 142-3 on its consolidated financial statements.

The Hierarchy of Generally Accepted Accounting Principles

In May 2008, the FASB issued SFAS 162, “The Hierarchy of Generally Accepted Accounting Principles.”  SFAS 162 identifies the sources of accounting principles and the framework for selecting the principles used in the preparation of financial statements.  The Company will adopt SFAS 162 as of July 1, 2009.

Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion

(Including Partial Cash Settlement)

In May 2008, the FASB issued FSP APB 14-1, “Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement).” The FSP clarifies the accounting for convertible debt instruments that may be settled in cash (including partial cash settlement) upon conversion.  The FSP requires issuers to account separately for the liability and equity components of certain convertible debt instruments in a manner that reflects the issuer’s nonconvertible debt (unsecured debt) borrowing rate when interest cost is recognized.  The FSP requires bifurcation of a component of the debt, classification of that component in equity and the accretion of the resulting discount on the debt to be recognized as part of interest expense in our consolidated statement of operations.  The FSP requires retrospective application to the terms of instruments as they existed for all periods presented.  The Company has adopted this FSP as of January 1, 2009, however the is currently evaluating the potential impact of FSP APB 14-1 upon its consolidated financial statements since no such debt instruments exist.

Determining Whether an Instrument (or an Embedded Feature) Is Indexed to an entity’s Own Stock

In June 2008, the FASB ratified EITF 07-5, “Determining Whether an Instrument (or an Embedded Feature) Is Indexed to an Entity’s Own Stock” (EITF 07-5)  EITF 07-5 provides that an entity should use a two step approach to evaluate whether an equity-linked financial instrument (or embedded feature) is indexed to its own stock, including evaluating the instrument’s contingent exercise and settlement provisions.  It also clarifies on the impact of foreign currency denominated strike prices and market-based employee stock option valuation instruments on the evaluation.  EITF 07-5 is effective for fiscal years beginning after December 15, 2008.  See Note 2 for the effect of adoption of this pronouncement on the Company’s consolidated financial position and results of operations.

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AMERICAN DEFENSE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities

In June 2008, the FASB issued FSP EITF 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities.” The FSP addresses whether instruments granted in share-based payment transactions are participating securities prior to vesting and, therefore, need to be included in the earnings allocation in computing earnings per share under the two-class method. The FSP affects entities that accrue dividends on share-based payment awards during the awards’ service period when the dividends do not need to be returned if the employees forfeit the award. This FSP is effective for fiscal years beginning after December 15, 2008. The adoption of FSP EITF 03-6-1 did not have a material impact on its consolidated financial position and results of operations.

Determining the Fair Value of a Financial Asset When the Market for That Asset is Not Active

In October 2008, the FASB issued FSP FAS 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset is Not Active.”  This FSP clarifies the application of SFAS 157, “Fair Value Measurements,” in a market that is not active.  The FSP also provides examples for determining the fair value of a financial asset when the market for that financial asset is not active.  FSP FAS 157-3 was effective upon issuance, including prior periods for which financial statements have not been issued.  The impact of adoption was not material to the Company’s consolidated financial condition or results of operations.

Equity Method Investment Accounting Considerations

In November 2008, the FASB issued EITF 08-6, “Equity Method Investment Accounting Considerations.”  EITF 08-6 clarifies accounting for certain transactions and impairment considerations involving the equity method.  Transactions and impairment dealt with are initial measurement, decrease in investment value, and change in level of ownership or degree of influence.  EITF 08-6 is effective on a prospective basis for fiscal years beginning on or after December 15, 2008.  The adoption of EITF 08-6 did not have a material impact on its consolidated financial position and results of operations.

Accounting for Defensive Intangible Assets

In November 2008, the FASB issued EITF 08-7, “Accounting for Defensive Intangible Assets.”  EITF 08-7 clarifies how to account for defensive intangible assets subsequent to initial measurement.  EITF 08-7 applies to all defensive intangible assets except for intangible assets that are used in research and development activities.  EITF 08-7 is effective for intangible assets acquired on or after the beginning of the first annual reporting period beginning on or after December 15, 2008.  The adoption of EITF 08-7 did not have a material impact on its consolidated financial position and results of operations.

Accounting for an Instrument (or an Embedded Feature) with a Settlement Amount That is Based on the Stock of an Entity’s Consolidated Subsidiary

In November 2008, the FASB issued EITF 08-8, “Accounting for an Instrument (or an Embedded Feature) with a Settlement Amount That is Based on the Stock of an Entity’s Consolidated Subsidiary.”  EITF 08-8 clarifies whether a financial instrument for which the payoff to the counterparty is based, in whole or in part, on the stock of an entity’s consolidated subsidiary is indexed to the reporting entity’s own stock.  EITF 08-8 also clarifies whether or not

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AMERICAN DEFENSE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

stock should be precluded from qualifying for the scope exception of SFAS 133, “Accounting for Derivative Instruments and Hedging Activities,” or from being within the scope of EITF 00-19, “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock.”  EITF 08-8 is effective for fiscal years beginning on or after December 15, 2008, and interim periods within those fiscal years.  The adoption of EITF 08-8 did not have a material impact on its consolidated financial position and results of operations.

Disclosures by Public Entities (Enterprises) about Transfers of Financial Assets and Interests in Variable Interest Entities

In December 2008, the FASB issued FSP FAS 140-4 and FIN 46(R)-8, “Disclosures by Public Entities (Enterprises) about Transfers of Financial Assets and Interests in Variable Interest Entities.”  This FSP amends SFAS 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities,” to require public entities to provide additional disclosures about transfers of financials assets.  FSP FAS 140-4 also amends FIN 46(R)-8, “Consolidation of Variable Interest Entities,” to require public enterprises, including sponsors that have a variable interest entity, to provide additional disclosures about their involvement with a variable interest entity.  FSP FAS 140-4 also requires certain additional disclosures, in regards to variable interest entities, to provide greater transparency to financial statement users.  FSP FAS 140-4 is effective for the first reporting period (interim or annual) ending after December 15, 2008, with early application encouraged.  The adoption of FSP FAS 140-4 did not have a material impact on its consolidated financial position and results of operations.

Effective Date of FASB Interpretation No. 48 for Certain Nonpublic Enterprises

In December 2008, the FASB issued FSP FIN 48-3, “Effective Date of FASB Interpretation No. 48 for Certain Nonpublic Enterprises.”  FSP FIN 48-3 defers the effective date of FIN 48, “Accounting for Uncertainty in Income Taxes,” for certain nonpublic enterprises as defined in SFAS 109, “Accounting for Income Taxes.”  However, nonpublic consolidated entities of public enterprises that apply U.S. generally accepted accounting principles (GAAP) are not eligible for the deferral.  FSP FIN 48-3 was effective upon issuance.  The impact of adoption was not material to the Company’s consolidated financial condition or results of operations.

Employers’ Disclosures about Postretirement Benefit Plan Assets

In December 2008, the FASB issued FSP FAS 132(R)-1, “Employers’ Disclosures about Postretirement Benefit Plan Assets.”  This FSP amends SFAS 132(R), “Employers’ Disclosures about Pensions and Other Postretirement Benefits,” to provide guidance on an employer’s disclosures about plan assets of a defined benefit pension or other postretirement plan.  FSP FAS No. 132(R)-1 also includes a technical amendment to SFAS 132(R) that requires a nonpublic entity to disclose net periodic benefit cost for each annual period for which a statement of income is presented.  The required disclosures about plan assets are effective for fiscal years ending after December 15, 2009.  The technical amendment was effective upon issuance of FSP FAS 132(R)-1.  The Company is currently assessing the impact of FSP FAS 132(R)-1 on its consolidated financial position and results of operations.

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AMERICAN DEFENSE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

2.      Restatements

On November 20, 2009, the Company’s management and the Audit Committee of its Board of Directors concluded that the Company’s consolidated financial statements as of and for the year ended December 31, 2008, as of and for the three months ended March 31, 2009 and as of and for the three and six months ended June 30, 2010, should be restated and should no longer be relied upon as a result of certain errors discovered as described below.

Series A Convertible Preferred Stock:

On April 14, 2009, the Company received a Notice of Triggering Event Redemption from the holder of 94% of the Series A Convertible Preferred Stock. The notice demanded the full redemption of the holders’ shares of Series A Convertible Preferred Stock pursuant to a right to require the Company to redeem shares of Series A Convertible Preferred Stock provided under the Certificate of Designation, Preferences and Rights of the Series A Convertible Preferred Stock.  The redemption right purportedly was triggered by the Company’s breach of certain covenants as of December 31, 2008 under a Consent and Agreement, dated May 23, 2008, between the Company and holders of the Series A Convertible Preferred Stock, which agreement and covenants are discussed in Note 11.  Although such redemption notice had been received, the Series A Convertible Preferred Stock continued to be reflected as a long term liability as of December 31, 2008 due to restrictions that precluded the Company from satisfying such demand.  These restrictions were imposed pursuant to the General Corporation Law of the State of Delaware (the “DGCL”), the Company’s state of incorporation, which would prohibit the Company from satisfying such redemption demand due to its lack of sufficient surplus, as such term is defined under the DGCL.  In addition, the Company was restricted, under its revolving line of credit with TD Bank, from effecting such a redemption.  Based on these external restrictions, management determined that the Company could not have satisfied the redemption demand without violating Delaware law and its contractual obligations under its credit facility with TD Bank.

Management has reconsidered the classification of the Series A Convertible Preferred Stock and determined that, notwithstanding the legal and contractual restrictions to satisfying the demanded redemption, the obligation to redeem such preferred stock purportedly remained outstanding.  Accordingly, management concluded that the Series A Convertible Preferred Stock should be classified as a current liability as of December 31, 2008 and March 31, 2009, rather than a long term liability, in accordance with paragraph 5 of Statement of Financial Accounting Standard 78, which indicates that liabilities due within one year should be presented within the financial statements as current liabilities.

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AMERICAN DEFENSE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Investor Warrants:

The company has restated its financial statements as of December 31, 2008 and March 31, 2009 to reclassify its derivative warrant liability associated with its detachable warrants issued to the investors in the Series A Preferred Stock (see Note 8).  The warrant contains features that allow the holder to request that the Company repurchase the warrant upon the occurrence of certain events as defined in the agreement. The Company re-evaluated the classification of this liability and determined that the warrant holder’s right to “put” the warrant to the Company represented the ability to request cash on demand and as such should be classified as a current liability. The Company previously recorded the warrant liability as a long term liability.

Assets from Discontinued Operations and Liabilities from Discontinued Operations:

In order to reflect the nature of the assets and liabilities associated with the Company’s discontinued operations Management and its Audit Committee have reclassified its balance sheet presentation from long term to short term at December 31, 2008.  This change was made to reflect that such assets and liabilities would be realized within a period of less than one year.

Adoption of EITF 07-5

Effective January 1, 2009, the Company was required to analyze its outstanding financial instruments following the guidance of EITF 07-5: and that pronouncements effect in interpreting Statement of Financial Accounting Standards (“SFAS”) Statement No. 133 “Accounting for Derivative Instruments and Hedging Activities” (“SFAS 133”). The Company determined that certain warrants issued in 2005, 2006 and 2008 contained provisions whereby the exercise price could be adjusted upon certain financing transactions at a lower price per share could no longer be viewed as indexed to the Company’s common stock. As such, the Company should have changed the accounting for these warrants to a “derivative” at fair value under SFAS 133. As a result the Company recorded the warrant liability at the fair value of the warrant of $166,775 as of January 1, 2009 and reclassified its issuance date fair value from additional paid-in-capital. The cumulative effect on adoption of EITF 07-5 as of January 1, 2009 is as follows:

	Additional Paid in Capital			Retained Earnings
Balance December 31, 2008	$	11,096,031		$	(1,321,800	)
Cumulative effect of a change in accounting principle	(837,954		)	672,179
Balance – January 1, 2009	$	10,258,077		$	(649,621	)

The derivative warrant liability is recorded at fair value in each subsequent reporting period with changes in fair value recorded in the statement of operations.

Registration Costs:

The Company has restated its financial statements as of December 31, 2008 to reclass approximately $1,561,000 of costs related to the registration of the Company’s common stock with the SEC and listing on the American Stock Exchange.  The $1,561,000 costs were originally recorded against additional paid in capital reflected accordingly in the Company’s 2008 financial statements.  Based on additional analyses and research of the $1,561,000 costs, the Company has concluded that a more appropriate and conservative accounting treatment would have been to expense such costs when incurred rather than charged directly to additional paid in capital.  Consequently, the Company has determined it should restate its financial statements and expense the $1,561,000 costs when incurred for the year ended December 31, 2008.  Management also notes there is no affect on total stockholders’ equity as a result of the restatement.  However, the restatement will increase the net loss for the year ended December 31, 2008 and more accurately reflect retained earnings (accumulated deficit) and additional paid in capital and will result in retained earnings being an accumulated deficit at December 31, 2008.

Certain legal expenses:

The Company has restated its financial statements as of December 31, 2008 and for the year then ended and as of March 31, 2009 and the three months then ended to reclassify and expense certain legal fees that were originally capitalized in prepaid expenses and other current assets.  The legal expenses pertained to fees incurred related to a lawsuit.  The litigation fees of approximately $227,000 and $352,000 should have been expensed as incurred for the year ended December 31, 2008 and the three months ended March 31, 2009, respectively.  In addition $222,700 of fees associated with the Series A Preferred Stock should have been recorded as deferred financing costs rather than a current asset.  As of December 31, 2008, the amortization of these costs should also be recorded as interest expense.

Dividends Paid:

The company has restated its financial statements as of March 31, 2009 and for the three months then ended to reclassify on its Statement of Operations its presentation of dividends accrued on its Series A Preferred Stock.  Under SFAS 150 “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity”, the Company is required to present dividends paid to its Preferred Stockholders as interest expense due to the mandatory redemption feature on its Series A Preferred Stock.  The Company re-evaluated its presentation of Preferred Stock Dividends Accrued on its Statement of Operations and reclassified $375,000 in dividends accrued to interest expense.

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AMERICAN DEFENSE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Capitalization of certain legal expenditures and the reclassification of the dividends accrued for the Series A Preferred Stock Shareholders from “Preferred Stock dividends accrued” to “Interest Expense” on the Statement of Operations discussed above were material under Staff Accounting Bulletin No. 99, “Materiality” and Staff Accounting Bulletin No. 108, “Considering Effects of Prior Misstatements When Quantifying Misstatements in Current Year Financial Statements” for the 2008 period.  Management determined that the above errors were material for the year ended December 31, 2008 and the three months ended March 31, 2009.  Accordingly, management recommended to the Audit Committee that a restatement was required.

Intangible Asset:

The Company has restated its financial statements as of December 31, 2008 and March 31, 2009 to reclassify an indefinite lived intangible asset of $606,000 from its acquisition of the assets of American Anti-Ram to a long term asset. Previously this intangible asset was recorded as a current asset included in prepaid expenses and other current assets.

Stock based Compensation

The Company, in reviewing its stock based compensation expense, determined that it had not recorded certain expenses totaling $125,442 for the three months ended March 31, 2009 related to the grant of common stock and stock options to an employee and certain directors.

Management has conducted an additional review of whether the matters above were material under SAB 99, and SAB 108, for the 2008 period. Management determined that the above errors were material for the year ended December 31, 2008 and three months ended March 31, 2009. Accordingly, management recommended to the Audit Committee that a restatement was required.

The effect of the restatements on specific amounts provided in the condensed consolidated financial statements is as follows:

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AMERICAN DEFENSE SYSTEMS, INC. and SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

	As of March 31, 2009						As of December 31, 2008
	As Previously Recorded			As Restated			As Previously Recorded		As Restated
ASSETS
CURRENT ASSETS
Prepaid expenses and other current assets	$	3,539,842		$	1,647,846		$	3,144,601	$	2,088,801
Assets of discontinued operations	—			—			—		736,613
TOTAL CURRENT ASSETS	17,819,268			16,011,098			16,701,841		16,382,654
DEFERRED FINANCING COSTS, net	1,130,409			1,836,820			1,277,833		1,500,533
INTANGIBLE ASSETS	—			606,000			—		606,000
ASSETS OF DISCONTINUED OPERATIONS	—			—			736,613		—
TOTAL ASSETS	$	25,221,300		$	24,725,541		$	25,162,615	$	24,935,515
LIABILITIES AND SHAREHOLDERS’ EQUITY
CURRENT LIABILITIES
Preferred stock, $.001 par value, 5,000,000 shares authorized, 15,000 shares designated as mandatorily redeemable Series A Convertible Preferred Stock (cumulative), 15,000 shares issued and outstanding	$	—		$	11,809,196		$	—	$	10,981,577
Warrant liabilities	—			214,432			—		90,409
Liabilities of discontinued operations	—			—			—		736,613
TOTAL CURRENT LIABILITIES	4,553,018			16,660,472			3,313,099		15,121,698
LONG TERM LIABILITIES
Preferred stock, $.001 par value, 5,000,000 shares authorized, 15,000 shares designated as mandatorily redeemable Series A Convertible Preferred Stock (cumulative), 15,000 shares issued and outstanding	11,809,196			—			10,981,577		—
Warrant liabilities	115,275			—			90,409		—
Liabilities of discontinued operations	—			—			736,613		—
TOTAL LIABILITIES	16,477,489			16,660,472			15,121,698		15,121,698
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS’ EQUITY
Common Stock	39,587			39,762			—		—
Additional paid in capital	9,534,616			10,383,344			9,534,616		11,096,031
Retained earnings (accumulated deficit)	(830,392		)	(2,358,037		)	466,715		(1,321,800		)
TOTAL SHAREHOLDERS’ EQUITY	8,743,811			8,065,069			10,040,917		9,813,817
TOTAL LIABILITIES AND SHAREHOLDERS’ EQUITY	$	25,221,300		$	24,725,541		$	25,162,615	$	24,935,515

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AMERICAN DEFENSE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

AMERICAN DEFENSE SYSTEMS, INC. and SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

	Three Months Ended March 31, 2009
	As Previously Recorded			As Restated
OPERATING EXPENSES
General and administrative expenses	$	1,648,478		$	2,073,995
Total operating expenses	3,996,626			4,422,143
INCOME (LOSS) FROM OPERATIONS	39,967			(385,550		)
OTHER INCOME (EXPENSE)
Unrealized gain (loss) on warrant liabilities	14,054			80,672
Interest expense	(290,320		)	(342,730		)
Interest expense - mandatory redeemable preferred stock	—			(375,000		)
Total other income (expense)	(962,074		)	(1,322,866		)
LOSS FROM CONTINUING OPERATIONS	(922,107		)	(1,708,416		)
NET LOSS ATTRIBUTABLE TO COMMON SHAREHOLDERS	$	(1,297,107	)	$	(1,708,416	)
Weighted Average Shares Outstanding - Basic and Diluted	39,585,960			39,585,960
EARNINGS PER SHARE - Basic and Diluted
Income from continuing operations	$	(0.02	)	$	(0.04	)
(Loss) from discontinued operations	$	—		$	—
Net income (loss)	$	(0.03	)	$	(0.04	)

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AMERICAN DEFENSE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

3.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 contracts reflects the accumulated costs incurred on contracts in production but not completed.  Upon completion, inspection and acceptance by the customer, the contract is invoiced and the accumulated costs are charged to statement of operations as costs of revenues.  During the production cycle of the contract, 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 and periodically evaluates each contract for potential disputes related to contract overruns and uncollectable amounts.  There was no bad debt expense recorded for the three months ended March 31, 2009 and 2008.

Net costs incurred in excess of billing consisted of the following as of March 31, 2009 and December 31, 2008

	2009		2008
Cost in excess of billings on uncompleted contracts	$	6,562,903	$	7,143,089
Billings and/or receipts on uncompleted contracts	—		—
Net costs incurred in excess of billing on uncompleted contracts	$	6,562,903	$	7,143,089

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 contracts 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, 2009 and December 31, 2008, the Company had $6,434,888 and $4,981,150, respectively, of accounts receivable, of which the Company considers all to be fully collectible.  There was no bad debt expense recorded for the years ended March 31, 2009 and December 31, 2008.

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AMERICAN DEFENSE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

4.      PROPERTY AND EQUIPMENT

Property and equipment at March 31, 2009 and December 31, 2008 consisted of the following:

	2009		2008
Leasehold improvements	$	1,749,367	$	1,749,367
General equipment	732,745		666,120
Light vehicles and trailers	221,247		221,247
T2 Demonstration range and firearms	744,454		744,454
Office equipment	855,294		855,294
Furniture and fixtures	163,658		163,658
Aircraft	868,750		868,750
	5,335,515		5,268,890
Less: accumulated depreciation and amortization	1,766,283		1,524,954
	$	3,569,232	$	3,743,936

For the three months ended March 31, 2009 and 2008, the Company recorded $241,329 and $134,769 in depreciation and amortization expense, respectively.

The Company maintains its firearms under the custodianship of an individual in accordance with New York State law. The firearms are used for testing and demonstrating the effectiveness of the Company’s bullet resistant and blast mitigation products.

5.    FAIR VALUE

As required by SFAS 157, financial assets and liabilities are classified based on the lowest level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement requires judgment, and may affect the valuation of the fair value of assets and liabilities and their placement within the fair value hierarchy levels.

The Company’s financial liabilities carried at fair value as of March 31, 2009 are the Series A Preferred and derivative warrants.  Since the Series A Preferred valuation utilizes certain unobservable inputs that are based upon estimate, including estimates on the initial stock prices, volatility based upon comparable companies and estimation of equity and debt positions, the Company considers this to be a Level III input.  The Company’s Derivative Warrants were also carried at fair value and were considered valued using a Level III input, through the date of settlement.

The following table discloses by level within the fair value hierarchy the Company’s assets and liabilities measured and reported on the Consolidated Balance Sheet:

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AMERICAN DEFENSE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

			Fair Value Measurements at March 31, 2009
	Total		Level 1		Level 2		Level 3
Liabilitites:
Series A Preferred Shares	$	11,809,196			$	—	$	11,809,196
Warrant Derivatives	$	214,432	$	—	$	—	$	214,432
Total Liabilities:	$	12,023,628	$	—	$	—	$	12,023,628

			Fair Value Measurements at December 31, 2008
	Total		Level 1		Level 2		Level 3
Liabilitites:
Series A Preferred Shares	$	10,981,577			$	—	$	10,981,577
Warrant Derivatives	$	90,409	$	—	$	—	$	90,409
Total Liabilities:	$	11,071,986	$	—	$	—	$	11,071,986

The following is a reconciliation of the beginning and ending balances for the Company’s assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3):

Fair Value Measurements Using Significant Unobservable Inputs (Level 3):

Description	(Level 3)
Liabilities
Balance at January 1, 2009	$	11,071,986
Cumulative effect of the change in accounting principal, January 1, 2009	165,775
Change in fair value included in operations	785,867
Balance , March 31, 2009	$	12,023,628

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AMERICAN DEFENSE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

6.      COMMITMENTS AND CONTINGENCIES

Legal Proceedings

Southern California Gold Products d/b/a Gypsy Rack

On July 10, 2007, the Company filed a lawsuit against a former subcontractor, Southern California Gold Products d/b/a Gypsy Rack, the subcontractor’s President and owner, Glenn Harris, and a designer, James McAvoy in the United States District Court, Eastern District of New York. Defendants moved to change venue to the Central District of California based upon insufficient contacts to the State of New York and on October 12, 2007 the matter was transferred to the United States District Court for the Central District of California, Case Number 07-CV-02779. On February 21, 2008, pursuant to the court’s order, the Company filed an amended complaint. The amended complaint names only Southern California Gold Products and James McAvoy as defendants and asserts six counts as follows: misappropriation of trade secrets and confidential information; breach of contract; unfair competition; conversion; violation of the Lanham Act; and interference with prospective economic advantage. The amended complaint seeks to enjoin the defendants from misappropriating, disclosing, or using our confidential information and trade secrets, and recall and surrender all products and trade secrets wrongfully misappropriated or converted by the defendants. It also seeks compensatory damages in an amount to be established at trial together with prejudgment and post judgment interest, exemplary damages, disgorgement, restitution with interest, attorney’s fees and the costs of suit.  Defendants filed an answer to the amended complaint on April 16, 2008.  Shortly after the filing of the amended answer, defendants made a motion for summary judgment on, among others, the grounds of collateral estoppel and res juditca.  We filed opposition to the motion.  The defendants motion and a subsequent application for an immediate interlocutory appeal were denied.  A mediation settlement conference was held on October 31, 2008, which was unsuccessful.  The discovery process is continuing and trial is currently set for August 25, 2009.

Breach of Contract

On February 29, 2008, 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 and will be commencing discovery.  Meritorious defenses to the claims exist and the Company intends to vigorously defend this action.

Breach of Contract

On March 4, 2008, 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. The Complaint seeks damages in excess of $3,000,000. The Company believes the allegations to be without merit and intend to vigorously defend against the action. On March 7, 2008, a second action was commenced 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, which is fully submitted to the Court. No amounts have been accrued for damages as the Company believes meritorious defenses to the claims

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AMERICAN DEFENSE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

exist.  The Company intends to vigorously defend this action. No further, significant actions have occurred and the matter is still pending resolution at March 31, 2009.

Financing

As of March 31, 2009 and 2008, the Company had access to $12 million dollars of financing, respectively, with TD Bank, f/k/a Commerce Bank as follows:

$12 Million Line of Credit — This line of credit allows the Company to borrow up to $12 Million dollars, limited to 80 — 85% of the total accounts receivable.  Under the line of credit, the Company is charged interest at 1.75% over the libor rate.  The line of credit repayment terms are due upon demand.  The balances as of March 31, 2009 and 2008 were $659,422 and $76,832, respectively.

7.      STOCKHOLDERS’ EQUITY

Warrants

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 Warrant”). Subsequent to the issuance of the 2005 Warrant, the Company issued common stock at an effective price per share of $1.00 and, in accordance with the terms of the 2005 Warrants agreement, the exercise price was adjusted to $1.00 per share and resulted in 611,369 warrants. The following is a summary of the 2005 Warrants outstanding as of March 31, 2009:

	2005Warrants	ExercisePrice
Beginning balance, January 1, 2009	576,587	$	1.00
Add: Grants	—	n/a
Less: Exercised	—	n/a
Ending balance, March 31, 2009	576,587	$	1.00

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 Warrant”). Subsequent to the issuance of the 2006 Warrant, the Company issued common stock at an effective price per share of $1.00 and, in accordance with the terms of the 2006 Warrants agreement, the exercise price was adjusted to $1.00 per share and resulted in 17,918 warrants. The following is a summary of the 2006 Warrants outstanding as of March 31, 2009:

	2006Warrants	ExercisePrice
Beginning balance, January 1, 2009	197,093	$	1.00
Add: Grants	—	—
Less: Exercised	—	n/a
Ending balance, March 31, 2009	197,093	$	1.00

Stock Option Plan

The following is a summary of stock options outstanding at March 31, 2009.

Beginning balance – December 31, 2008	1,995,000
Options issued	200,000
Exercised	—
Forfeited or expired	—
Ending balance – December 31, 2008	2,195,000

On January 12, 2009, we issued options to purchase an aggregate of 100,000 shares of our common stock to out consultants for services rendered.  The exercise price for each option is $2.00 per share and each option vested immediately upon the issuance.

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AMERICAN DEFENSE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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	2.99	%
Expected volatility	45.00	%
Forfeiture rate	10.00	%
Expected life	5 Years
Expected dividends	—

Based on the assumptions noted above, the fair market value of the options issued was valued at $13,183 as of March 31, 2009.

8.      SERIES A CONVERTIBLE PREFERRED STOCK, INVESTOR WARRANTS AND PLACEMENT WARRANTS

The Company entered into a Securities Purchase Agreement (“Purchase Agreement”) on March 7, 2008 to sell shares of its Series A Convertible Preferred Stock (“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 three investors. The investors have agreed to purchase 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 is $15,000,000 and the aggregate purchase price for the common stock is $500,000.

Series A Preferred Stock

The Series A Preferred Stock is redeemable on December 31, 2010 and convertible into shares of common stock at $2.00 subject to adjustment should the Company issue future common stock at a lesser price.  As a result, the Company elected to record their hybrid instrument, preferred stock and conversion option together, at fair value in accordance with SFAS 133.  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 placement agent in connection with the transaction, must be allocated to the instruments based upon relative fair value upon issuance and must be measured initially at fair value.”  Therefore, after the initial recording of the Series A Stock 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 loss.

The valuation of the Series A Preferred at March 31, 2009 is as follows:

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AMERICAN DEFENSE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Security	Face Value		Fair Value		Allocation of proceeds		Proceeds in excess of fair value
Series A Preferred	$	15,000,000	$	11,809,196	$	13,459,474	1,650,278
Warrants	—		115,275		1,540,526		1,425,251
	$	15,000,000	$	11,924,471	$	15,000,000	$	3,075,529

On April 14, 2009, the Company received a Notice of Triggering Event Redemption purportedly pursuant to a redemption option provided under the Certificate of Designation, as more fully discussed in Note 10.  As such the Company  has reflected the Series A Preferred Stock  liability as  a current liability.  The Company is precluded from satisfying such a demand, due to its lack of sufficient surplus as such term is defined under Delaware law to effect the redemption demand, and restrictions under our revolving line of credit would nevertheless prohibit any such redemption.

For the three months ended March 31, 2009 and 2008, the Company has recorded a net loss on adjustment of fair value of their Series A Preferred of $694,454 and $1,428,665, respectively.

Investor Warrants

In connection with the closings under the Purchase Agreement, Investor Warrants to purchase up to 3,750,000 shares of Common Stock at $2.40 per share were issued in addition to the 15,000 shares of Series A Preferred.  The warrant holder has a right based on certain events to “put” the warrant back to the Company and receive cash.  As such the Company has recorded the warrant as a derivative liability at fair value with changes in fair value reported in the statement of operations in accordance with SFAS 133.

Placement Agent Warrants

In connection with the sale of the Series A Preferred and Investor Warrants, the placement agent was entitled to receive warrants (Placement Agent Warrants) to purchase a total of 6% of the number of common stock issued in the financing or 675,000 shares.  The Placement Agent Warrants were accounted for as a transaction cost associated with the issuance of the Series A Preferred.  The Placement Agent Warrants 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”, the Company satisfies the criteria for classification of the Placement Agent Warrants as equity.  The fair value associated with the 675,000 Placement Agent Warrants was $511,742.

Deferred Financing Costs

Deferred financing costs include the corresponding amount associated with the Placement Agent Warrants as indicated above, along with all other costs associated with obtaining the Series A

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AMERICAN DEFENSE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Preferred financing.  Since the Series A Preferred and Investor Warrants are classified as liabilities, the carrying value of the Placement Agent Warrants has been recorded as Other Assets on the balance sheet and is amortized as additional financing costs over the term of the Series A Preferred using the interest method.

Deferred financing costs included the following:

Placement agent costs	$	900,000
Investor expenses	60,000
Legal and other related costs	941,769
Fair market value of placement agent warrants	511,742
Less: amortization	(576,691		)
Deferred financing costs, net	$	1,836,820

9.      DISCONTINUED OPERATIONS

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 and cash flow information be reformatted to separate the divested business from the Company’s continuing operations.

The following amounts represent TAG’s operations and have been segregated from continuing operations and reported as discontinued operations as of March 31, 2009 and March 31, 2008.

	2008
Contract Revenues Earned	$	685,210
Cost of Revenues Earned	131,642
Gross Profit	553,568
Operating Expenses	(554,057		)
Other Expenses	—
Net Loss	$	(489	)

The following is a summary of assets and liabilities of TAG discontinued operations as of March 31, 2009 and December 31, 2008.

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AMERICAN DEFENSE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

	2008
Assets
Cash	$	75,103
Inventory	591,688
Prepaid Expenses	174
Property and Equipment, net	69,648
Deferred Financing Costs
Total Assets	$	736,613
Liabilities
Accounts Payable	$	700,287
Short Term Notes	36,326
Total Liabilities	$	736,613

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	$	75,000
2010	$	100,000
2011	$	175,000
2012	$	275,000
2013	$	375,000
Total	$	1,000,000

The Company has included the entire amount as notes receivable on its balance sheet, of which $75,000 is included within other current assets and $925,000 is recorded as a long term notes receivable.  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.

10.    SUBSEQUENT EVENT

Series A Preferred Stock

The Company, West Coast Opportunity Fund, LLC (“WCOF”), Centaur Value Partners, LP (“Centaur Value”) and United Centaur Master Fund (“United Centaur”, and together with Centaur Value, “Centaur”) entered into a Securities Purchase Agreement, dated March 7, 2008 (the “Purchase Agreement”), pursuant to which WCOF and Centaur purchased  an aggregate of 15,000 shares of the Company’s Series A Convertible Preferred Stock (the “Series A Preferred”) and warrants to acquire an aggregate of 3,750,000 shares of the Company’s common stock (the “Warrants”) for an aggregate purchase price of $15,000,000.

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AMERICAN DEFENSE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The Company, WCOF and Centaur entered into a Consent and Agreement of Series A Convertible Preferred Stockholders, dated May 23, 2008 (the “Consent Agreement”), in which the parties agreed that the Company would not be permitted to issue shares of common stock as dividends on, or upon conversion of, the Series A Preferred or upon the exercise of the Warrants in excess of a specified number of shares without the approval of the Company’s stockholders.  In the Consent Agreement, the Company covenanted, for the fiscal year ending December 31, 2008  (A) to achieve (i) Revenues (as that term is defined in the Consent Agreement) equal to or exceeding $50,000,000 and (ii) Consolidated EBITDA (as that term is defined in the Consent Agreement) equal to or exceeding $13,500,000, and (B) to publicly disclose and disseminate, and to certify to WCOF and Centaur, its operating results for such period, no later than February 15, 2009 (collectively, the “Financial Covenants”).

The Company did not meet the Revenue and Consolidated EBITDA targets set forth in the Consent Agreement and was not in a position to disclose or certify its operating results by February 15, 2009.

Under the Consent Agreement, the breach of the Financial Covenants are each deemed a “Triggering Event” under Section 3(a)(vii) of the Company’s Certificate of Designations, Preferences and Rights of the Series A Convertible Preferred Stock (the “Certificate of Designations”), giving the holders of the Series A Preferred the right to require the Company to redeem all or a portion of such holder’s Series A Preferred shares at a price per share as calculated pursuant to Section 3(b)(i) of the Certificate of Designations.  The Company had negotiated the key terms of a resolution to the foregoing with WCOF and Centaur, and, to that end entered into a Term Sheet with each of WCOF and Centaur dated February 13, 2009 (the “WCOF Term Sheet” and the “Centaur Term Sheet”, respectively, and, collectively, the “Term Sheets”).

In order to allow the parties to negotiate definitive agreements relating to the foregoing and to consummate the same, WCOF and Centaur had agreed, subject to the terms and conditions set forth in the letters of forbearance entered into by the Company and each of WCOF and Centaur on February 13, 2009 to forbear from exercising their rights and remedies, including without limitation the right to cause the redemption of the Series A Preferred shares as a result of breaches of the Consent Agreement described above, until the earlier of (a) the date on which any Triggering Event (as defined in the Certificate of Designations), other than a breach of the Financial Covenants, shall occur or exist and (b) February 27, 2009.

The Forbearance Period expired effective February 27, 2009.  The Company received a notice of Triggering Event redemption purportedly pursuant to a redemption option provided under the Certificate of Designation (or Notice of Triggering Event Redemption) on April 14, 2009 from a Series A Preferred Stockholder that holds approximately 94% of such preferred stock.  The Series A Preferred Stockholder has demanded that the Company immediately redeem 14,025 shares of the Series A Preferred, which constitutes all of the shares of Series A Preferred held by such Series A Preferred Stockholder, at an aggregate price of $15,427,500.  The Series A Preferred Stockholder has also demanded payment of $470,317 as dividends they assert have accrued from January 1, 2009 through April 13, 2009, on their Series A Preferred at the cash

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AMERICAN DEFENSE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

dividend rate of 12%, as well as $70,000.00 in legal fees and expenses incurred in connection with the negotiations relating to the breach of the Financial Covenants pursuant to the forbearance letter dated February 13, 2009.  Due to restrictions on the payment of dividends under our revolving line of credit with TD Bank, the Company has not paid dividends on the Series A Preferred for 2009.

The Company currently does not have sufficient surplus as such term is defined under Delaware law to effect the redemption sought by the Series A Preferred Stockholder, and restrictions under the Company’s revolving line of credit would nevertheless prohibit any such redemption.  The Company continues to value the Series A Preferred Stock and Investor Warrants at its fair value as of March 31, 2009 of 11,924,471.

TD Bank

On April 1, 2009, the Company received a Notice of Default from TD Bank (Lender), resulting from the violation of financial covenants.  The Lender has stated that they are not presently taking action to enforce its rights and remedies under the Loan documents, however they are not waiving their rights under any existing or future defaults or events of default.  The Lender will continue to make advances under the Revolving Credit, but it has no obligation to do so and may refuse an advance request in its sole discretion without notice.

The Lender has demanded that the Company provide unaudited consolidated financial statements and a cash flow forecast within 20 days after each month end.  In addition, the Lender further demands that, in accordance with the terms of the loan agreement, the Company shall not make Restricted Payments, including dividends payable on preferred stock.

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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 (SEC No. 001-33888) filed with the Securities and Exchange Commission (or SEC) on April 15, 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,” “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. The factors listed in the section captioned “Risk Factors” within Item 1A, “Description of Business,” in our annual report on Form 10-K filed with the SEC on April 15, 2009, as well as other cautionary language in such Form 10-K, describe such risks, uncertainties and events that may cause our actual results and achievements, whether expressed or implied, to differ materially from the expectations we describe in our forward-looking statements. The occurrence of any of the events described as risk factors could have a material adverse effect on our business, results of operations and financial position.

Overview

        We are a provider of customized transparent and opaque armor solutions for tactical and non-tactical transport vehicles and construction equipment used by the military.

        We also provide physical security products for 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.

        In 2008, we launched our new live-fire interactive T2 Tactical Training System and have begun active marketing of the system. T2 provides law enforcement officers, SWAT team members, tactical specialists and military operators with the opportunity to hone their firearms and combat skills, with their own weapons and ammunition, in conjunction with realistic video scenarios broadcast on a large screen, incorporating environmental factors such as heat, cold,

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sound and light effects. In addition to installation fees for T2 systems, we anticipate additional revenue opportunities for service and support of T2 facilities once installed, and expect to offer training in the T2 as part of our American Institute for Defense and Tactical Studies.

        Also in 2008, in conjunction with the T2, we began offering courses and seminars through our tactical training institute, the American Institute for Defense and Tactical Studies. Course offerings include training in the fields of Counterterrorism, Fundamentalist Islam and Middle Eastern Mindset, Dignitary Protection, IED Terrorist Tradecraft, Emergency Tactical Medicine, Post Suicide-Bombing Command and Incident Response, Forensics and Hand-to-Hand Combat.

        We focus primarily on research and development, design and engineering, fabrication and providing component integration. Our armor solutions are used in retrofit applications for equipment already in service, and we work with original equipment manufacturers to provide armor solutions for new equipment purchased by the military. Similarly, our architectural hardening and other physical security products are incorporated in new construction, but are more often deployed in existing structures and facilities ranging from secure commercial buildings to military bases and other facilities.

        Our technical expertise is in the development of lightweight composite ballistic, blast and bullet mitigating materials used to fortify and enhance capabilities of existing and in-service equipment and structures. We serve primarily 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 two 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;

·form strategic partnerships with original equipment manufacturers (OEMs);

·develop strategic alliances;

·capitalize on increased homeland security requirements and non-military platforms;

·increase marketing efforts relating to our new tactical training products and services; and

·focus on an advanced research and development program to capitalize on increased demand for new armor materials.

        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.

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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 physical security products.

Our contract backlog as of March 31, 2009 and March 31, 2008 was $60.0 million and $35 million, respectively, and of our $60 million of contract backlog as of March 31, 2009, we estimate that $45.0 million will be filled in 2009. 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.

        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 2007 and 2008.

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 protyping 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.

        As our revenues increase, we plan to continue to invest heavily in sales and marketing by increasing the number of direct sales personnel in order to add new customers and increase sales to our existing customers. We also plan to expand our marketing activities in order to build brand

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awareness and generate additional leads for our growing sales personnel. We expect that in 2009, sales and marketing expenses will remain at the same or a slightly higher level in absolute dollars but will decrease as a percentage of revenues.

        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 2009, research and development expenses will increase in absolute dollars as we upgrade and extend our service offerings and develop new protections products, but will remain relatively consistent or decrease slightly 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 2009, general and administrative expenses will remain at the same or a slightly higher level in absolute dollars but decrease as a percentage of revenues.

Critical Accounting Policies

        Our 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, the following accounting policies 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 the provisions of the Securities and Exchange Commission (SEC) Staff Accounting Board (SAB) No. 104, “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 under the completed contract method. Purchase orders received under master contracts may extend for periods in excess of one year. Contract costs are accumulated as deferred assets and

33

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, 2009, there were no such provisions made.

        All costs associated with uncompleted purchase orders under contract are recorded on the balance sheet as a deferred asset called “Costs in Excess of Billings on Uncompleted Contracts.” Upon completion of a purchase order, such associated costs are then reclassified from the balance sheet to the statement of operations as costs of revenue.

        All billings associated with uncompleted purchase orders under contract are recorded on the balance sheet as a deferred liability called “Billings in Excess of Costs on Uncompleted Contracts”. Upon completion of a purchase order, all such associated billings would be reclassified from the balance sheet to the statement of operations as revenues. Due to the structure of our contracts, billing is not done until the purchase order is complete, therefore there are no amounts recorded as deferred liabilities as of March 31, 2009.

        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 have adopted the provisions of Statement of Financial Accounting Standard No. 123(R), Share-Based Payment (SFAS No. 123R). In accordance with SFAS No. 123R, we will use the Black-Scholes option pricing model to measure the fair value of our option awards granted after June 15, 2005. 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 (SAB No. 107) which provides supplemental implementation guidance for SFAS No. 123R.

        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 SAB No. 107, whereby the expected term is equal to the midpoint 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

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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 $154,636 and $33,685 in stock compensation expense as of March 31, 2009 and March 31, 2008, respectively.

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

Series A Convertible Preferred Stock

The Series A Convertible Preferred Stock (or Series A Preferred) is redeemable on December 31, 2010 and convertible into shares of common stock at $2.00 subject to adjustment should we issue future common stock at a lesser price.  As a result, we have elected to record its hybrid instrument, preferred stock and conversion option together, at fair value in accordance with SFAS 133.  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 placement agent in connection with the transaction, must be allocated to the instruments based upon relative fair value upon issuance and must be measured initially at fair value.  Therefore, after the initial recording of the Series A Stock 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 loss.  On March 7, 2008, the date of initial issuance, we recorded a derivative liability of $9,832,497. On April 4, 2008, the date of the second issuance, we recorded a derivative liability of $3,626,977.  These liabilities were subsequently adjusted to fair value as of March 31, 2009, which resulted in a net loss of $694,454. As of March 31, 2009, the Series A Preferred liability was $11,809,196.

        Investor Warrants.    The warrants issued with the Series A Preferred (or Investor Warrants) meet the criteria under SFAS 133 “Accounting for Derivative Instruments and Hedging Activities”. Under SFAS 133, the warrants are 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, 2007, the date of initial issuance, we recorded a derivative liability of $1,142,503. On April 4, 2008, the date of the second issuance, we recorded a derivative liability of $398,023.  As of December 31, 2008, the Investor Warrant liability was $115,275.  These liabilities were subsequently adjusted to fair value as of March 31, 2009, which resulted in a net gain of $14,054.  The Investor Warrants meet the criteria under EITF 01-6 “The Meaning of Indexed to a Company’s Own Stock”, which provides guidance as to whether a contract is indexed to a company’s own stock. However, since the warrants do not meet the criteria for reporting as an  

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equity instruments under EITF 00-19 “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock”, the fair value of the Investor Warrants is included as a current liability.

        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”, we satisfy the criteria for classification of the Placement Agent Warrants as equity. We have recorded the corresponding amount recorded as a Deferred Financing Cost. Since the Series A Preferred and Investor Warrants are classified as liabilities, the carrying value of the Placement Agent Warrants has been recorded as an other asset and is 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 $1,033,433 and $868,336 in deferred financing costs and amortized $147,424 as interest expense as of March 31, 2009.

Comparison of the Three Months Ended March 31, 2009 and 2008

Revenues.  Revenues from continuing operations for the three months ended March 31, 2009 was approximately $9.4 million, an increase of approximately $700,000, or 8%, over revenues of approximately $8.7 million in the comparable period in 2008.  This increase was due primarily to increased order fulfillment under our Marine Corp Contract No. M67854-07-D-5023 during the first quarter of 2009 versus the same quarter in 2008, including orders that had been expected in the fourth quarter of 2008 that were delayed into the first quarter of 2009.  The revenue increase also was due to additional sales generated from our physical security product business for the three months ended March 31, 2009 of approximately $963,000, an increase of approximately $800,000 or 490% over revenues of approximately $163,000 for the three months ended March 31, 2008.

Revenues from discontinued operations from the tactical application retail outlet for the three months ended March 31, 2008 was approximately $685,000.  There were no revenues generated from discontinued operations during the three months ended March 31, 2009.

Cost of Revenues.  Cost of revenues for the three months ended March 31, 2009 was approximately $5.4 million, an increase of approximately $100,000, or 2%, over cost of revenue of $5.3 million in the comparable period in 2008.  This increase was related to our increased production costs under the Marine Corp. sales contract mentioned above.  The costs of revenue also increased due to additional costs of sales from our physical security product business, which had just commenced during the first quarter of March 31, 2008.

Cost of revenues from discontinued operations from the tactical application retail outlet for the three months ended March 31, 2008 was approximately $131,000.  There were no costs of revenues generated from discontinued operations for the three months ended March 31, 2009.

Gross profit margin.   The gross profit margin for the three months ended March 31, 2009 and March 31, 2008 were approximately $4 million and $3.4 million, respectively.  The

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gross profit margin percentage was 42.5% and 39% for the three months ended March 31, 2009 and March 31, 2008, respectively. The increase in gross profit margin percentage from continuing operations from 2008 to 2009 resulted primarily from a reduction in overall costs incurred during the three months ended March 31, 2009 that were associated with production on the Marine Corp. sales contract.

Sales and Marketing Expenses.  Sales and marketing expenses for the three months ended March 31, 2009 and March 31, 2008 were approximately $733,000 and $632,000, respectively, representing an increase of $101,000, or 16%.  The increase was due primarily to an increase in trade show expenses and related expenses from marketing T2, along with our current product line for the three months ended March 31, 2009.  We did not offer the T2 during the three months ended March 31, 2008 and, therefore, incurred no marketing expense for its promotion.  There were no sales or marketing expenses for discontinued operations.

Research and Development Expenses.  Research and development expenses for the three months ended March 31, 2009 and March 31, 2008 were approximately $186,000 and $165,000, respectively.  The increase of $21,000 or 12% from 2008 to 2009 was the result of additional testing and improvements of existing products and continued work on our products in development.  There were no research and development expenses for discontinued operations.

General and Administrative Expenses.  General and administrative expenses from continuing operations for the three months ended March 31, 2009 and March 31, 2008 were approximately $2.1 million and $1.4 million, respectively.  The increase of approximately $700,000, or 50%, was primarily due to general increases in expenses, such as general and liability insurance, rent and general supplies, which approximated $190,000.  We also incurred additional general and administrative expenses associated with the facilities for our physical security product business of approximately $60,000.  We also incurred approximately $350,000 in legal expenses associated with ongoing litigation.

General and administrative expenses associated with discontinued operations was approximately $554,000 for the three months ended March 31, 2008.  There were no such expenses incurred during the three months ended March 31, 2009.

General and Administrative Salaries Expense.  General and administrative salaries expense for the three months ended March 31, 2009 and March 31, 2008 were approximately $1.07 million and $1.13 million, respectively.  The net decrease of $60,000, or 5% was due to the decrease in salary expense at the Hicksville facility and the reduction of salary expense associated with the tactical application retail outlet that was discontinued in 2008.  As of March 31, 2009, there were 39 employees that were classified as general and administrative personnel, versus 41 employees as of March 31, 2008.

Depreciation expense.  Depreciation expense was approximately $241,000 and $135,000 for the three months ended March 31, 2009 and March 31, 2008, respectively.  The increase of

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$106,000, or 79%, was the result of our higher property and equipment balance as of March 31, 2009 versus March 31, 2008.  This increase was the result of additional leasehold improvements and equipment associated with the expansion of our facility during 2008, property and equipment purchased 2008 for our physical security product business, and T2 equipment.  This higher capital balance as of March 31, 2009 resulted in higher depreciation expense.

Other (income) and expense.  As a result of our agreement to sell our Series A Convertible Preferred Stock and warrants to purchase common stock, we incurred losses which occurred upon the valuation of the stock.  Such valuation took into account the features, rights and obligations of the convertible preferred stock, which ultimately resulted in a higher fair value than the proceeds received.  Since the Series A Convertible Preferred Stock and related Investor Warrants are required to be recorded at fair value, we recorded a loss on such securities.  We experienced a loss on adjustment of fair value with respect to our Series A Convertible Preferred Stock of $694,000 and $1.4 million for the three months ended March 31, 2009 and 2008, respectively.  We also recognized a gain of approximately $81,000 and a loss on the related investor warrants of $107,000 as of March 31, 2009 and 2008, respectively.  In addition, we incurred interest expense associated with the amortization of the deferred financing costs and discount on the Series A Convertible Preferred Stock of $290,320 and $54,752 for the three months ended March 31, 2009 and 2008.  We also incurred interest expense of $375,000 for the three months ended March 31, 2009 associated with dividends accrued on our Series A Convertible Preferred Stock.

Liquidity and Capital Resources

The primary sources of our liquidity during the quarter ended March 31, 2009 have come from operations and to a lesser extent under our bank credit facility.  As of March 31, 2009, our principal sources of liquidity were net accounts receivable of approximately $6.4 million and costs in excess of billings of approximately $6.6 million and borrowings under our revolving credit facility with TD Bank of approximately $591,000.

As of March 31, 2008, our principal sources of liquidity were cash and cash equivalents totaling approximately $9.8 million, net accounts receivable of approximately $4.8 million and costs in excess of billings of approximately $8.7 million.  The primary sources of our liquidity during the three months ended March 31, 2008 came from operations and the proceeds from the sale of our Series A Convertible Preferred Stock.

On March 7, 2008, we entered into an agreement to sell shares of our Series A Convertible Preferred Stock and warrants to purchase our common stock, and to conditionally sell shares of our common stock, to three investors. The aggregate purchase price of the preferred stock and warrants is $15.0 million and the aggregate purchase price of the common stock is $0.5 million.  An initial closing on the sale of the preferred stock and warrants was held on March 7, 2008 in which we received gross proceeds of $10,975,000. A subsequent closing took place on April 4, 2008 in which we received gross proceeds of $4,025,000.

On April 14, 2009, we received a Notice of Triggering Event Redemption purportedly pursuant to a redemption option provided under the Series A Convertible Preferred Stock Certificate of Designations from the holder of approximately 94% of our Series A Convertible Preferred Stock, resulting from the breach of certain financial covenants and the purported

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occurrence of a Triggering Event (as defined under the Series A Convertible Preferred Stock Certification of Designations) resulting from such breach. The Series A Preferred Stockholder has demanded that we immediately redeem 14,025 shares of our Series A Convertible Preferred Stock, which constitutes all of the shares of such preferred stock held by the stockholder, at an aggregate price of $15,427,500.00. The Series A Preferred Stockholder has also demanded that we pay $470,317.81 as dividends it asserts have accrued from January 1, 2009 through April 13, 2009, on its preferred stock at the cash dividend rate of 12%, as well as $70,000.00 in legal fees and expenses the stockholder states that it has incurred in connection with the negotiations relating to the breach of the financial covenants pursuant to the forbearance letter dated February 13, 2009. Due to restrictions on the payment of dividends under our revolving line of credit with TD Bank, we have not paid dividends on the Series A Preferred for 2009.  We continue to negotiate with the holders of our Series A Convertible Preferred Stock to resolve the foregoing matters.

In May 2007, we entered into a loan agreement with Commerce Bank, N.A. (now known as TD Bank) pursuant to which we have access to a revolving credit facility up to a maximum of $12.0 million depending upon the periodic balance of our qualified accounts receivable.  As of March 31, 2009 and 2008, $591,000 and $0, respectively, was outstanding under the revolving credit facility.  As part of the same loan facility, we borrowed approximately $68,000 under a term loan due July 1, 2010, which is payable in equal monthly installments.  As of March 31, 2009 and March 31, 2008, approximately $68,000 and $120,000 was outstanding under the term loan, respectively.  The credit facility is secured by all of our assets, and bears interest at a variable rate equal to LIBOR plus a margin of between 1.75% and 2.45%.

 On April 1, 2009, we received a Notice of Default from our primary lender, TD Bank, resulting from the violation of certain financial covenants. The bank has stated that it is not presently taking action to enforce its rights and remedies under our existing revolving line of credit with the bank, however they are not waiving their rights under any exiting or future defaults or events of default. The bank has indicated that it will continue to make advances under the credit line, but it has no obligation to do so and may refuse an advance request in its sole discretion without notice. In the event the bank does refuse to make one or more advances, we may unexpectedly be unable to meet our working capital obligations which could harm our reputation and our business. The bank has demanded that we provide unaudited consolidated financial statements and a cash flow forecast within 20 days after each month end. We currently are evaluating alternative financing sources.

Subsequently, on April 27, 2009, we entered into a Forbearance Agreement and Amendment to Loan Agreement with the bank, pursuant to which the bank has agreed to forbear from exercising its default-related rights and remedies with respect to the defaults specified in the Notice of Default, including without limitation acceleration and foreclosure, and continue to provide advances and other financial accommodations under the Loan Agreement until June 15, 2009 (or Forbearance Period) unless such Forbearance Period is earlier terminated as a result of any Forbearance Default (as such term is defined in the Forbearance Agreement).  Notwithstanding the foregoing, the bank will have no obligation to make any advance if, after giving effect thereto, the aggregate principal amount of the Advances plus outstanding letters of audit issued by the lender for the account of our company and subsidiaries would exceed $2,000,000 prior to May 15, 2009 and $1,000,000 as of May 15, 2009 and thereafter.  Under the

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Forbearance Agreement, we have agreed, among other things, (i) not to make any Restricted Payment (as such term is defined in the Loan Agreement), other than a stock dividend payable in our common stock and approved by the Lender in its sole discretion, (ii) to use their best efforts to obtain a refinancing, (iii) to provide certain monthly financial information as set forth in the Forbearance Agreement and (iv) to pay the Advances, the Term Loan (as such term is defined in the Loan Agreement) and all other obligations in full by June 15, 2009.  Our failure to comply with any of the foregoing shall constitute a Forbearance Default under the Forbearance Agreement, which can result in termination of the Forbearance Agreement.

We believe that our current cash, cash equivalents, net accounts receivable and costs in excess of billings together with our expected cash flows from operations will be sufficient to meet our anticipated cash requirements for working capital and capital expenditures for at least the next 12 months, subject to the matters concerning TD Bank and the Series A redemptions.

Cash Flows from Operating Activities. Net cash used in operating activities was approximately $807,000 for the three months ended March 31, 2009 compared to net cash used in operating activities of approximately $2.0 million for the three months ended March 31, 2008.  Net cash used in operating activities in 2009 consisted primarily of changes in our operating assets and liabilities of approximately $400,000, 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 $1.5 million and $580,000, respectively, reflects the increases in projects in process as of March 31, 2009.  Our prepaid expenses and other current assets decreased approximately $43,000 due to amounts paid in advance in connection with the prepayment of legal expense and marketing expenses.  Net cash used in operating activities for the three months ended March 31, 2008 consisted primarily of changes in operating assets and liabilities of approximately $1.3 million, including changes in accounts receivable, cost in excess of billing, accounts payable and accrued liabilities.  These changes in accounts receivable and cost in excess of billing resulted from the increase in projects completed and invoiced to customers.  In addition, the changes in accounts payable and accrued liabilities reflect the related increase in expenses incurred, with no funds paid out.

As of March 31, 2009, we had net operating loss carryforwards of approximately $4.6 million available to reduce future taxable income. In the future, we may utilize our net operating loss carryforwards and would begin making cash tax payments at that time. In addition, the limitations on utilizing net operating loss carryforwards and other minimum taxes may also increase our overall tax obligations. We expect that if we generate taxable income and/or we are not allowed to use net operating loss carryforwards, our cash generated from operations will be adequate to meet our income tax obligations.

Net Cash Used In Investing Activities.  Net cash used in investing activities for the three months ended March 31, 2009 and 2008 was approximately $66,000 and $488,000, respectively.  Net cash used in investing activities during these periods 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.

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Net Cash Provided by Financing Activities.  Net cash provided by financing for the three months ended March 31, 2009 and 2008 was approximately $583,000 and $10.7 million, respectively. Net cash provided by financing activities during 2009 consisted of proceeds from the line of credit of approximately $583,000.  Net cash provided by financing activities during 2008 consisted primarily of proceeds of $11.3 million received from the sale of the Series A Preferred Stock, net of deferred financing costs of $658,500, and approximately $70,000 received from the term loan, offset by repayments of short term financing of approximately $6,300.

Item 4.    Controls and Procedure

Evaluation of Disclosure Controls and Procedures

        An evaluation was carried out under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this report. Based on the evaluation of our disclosure controls and procedures, our Chief Executive Officer and our Chief Financial Officer determined that a material weakness exists with respect to our reporting of complex and non-routine transactions. As a result of this material weakness, on November 20, 2009 we determined that restatements were required for our financial statements in our Annual Report for the year ended December 31, 2008 and our Quarterly Reports for the quarters ended March 31, 2009 and June 30, 2009.  

        To address this material weakness, we have engaged outside experts to provide counsel and guidance in areas where we cannot economically maintain the required expertise internally (e.g., with the appropriate classifications and treatments of complex and non-routine transactions).

        As a result of the material weakness identified with respect to our reporting of complex transactions, 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.

Changes in Internal Controls

        There were no changes in our internal controls over financial reporting during the quarter ended March 31, 2009 that have materially affected, or are reasonably likely to affect, our internal control over financial reporting.

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 error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the 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 July 10, 2007, we filed a lawsuit against a former subcontractor, Southern California Gold Products d/b/a Gypsy Rack, the subcontractor’s President and owner, Glenn Harris, and a designer, James McAvoy in the United States District Court, Eastern District of New York. Defendants moved to change venue to the Central District of California based upon insufficient contacts to the State of New York and on October 12, 2007 the matter was transferred to the United States District Court for the Central District of California, Case Number 07-CV-02779. On February 21, 2008, pursuant to the court’s order, we filed an amended complaint. The amended complaint names only Southern California Gold Products and James McAvoy as defendants and asserts six counts as follows: misappropriation of trade secrets and confidential information; breach of contract; unfair competition; conversion; violation of the Lanham Act; and interference with prospective economic advantage. The amended complaint seeks to enjoin the defendants from misappropriating, disclosing, or using our confidential information and trade secrets, and recall and surrender all products and trade secrets wrongfully misappropriated or converted by the defendants. It also seeks compensatory damages in an amount to be established at trial together with prejudgment and post judgment interest, exemplary damages, disgorgement,

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restitution with interest, attorney’s fees and the costs of suit. Defendants filed an answer to the amended complaint on April 16, 2008. Shortly after the filing of the amended answer, defendants made a motion for summary judgment on, among others, the grounds of collateral estoppel and res judicata. We filed opposition to the motion. The defendants motion and a subsequent application for an immediate interlocutory appeal were denied. A mediation settlement conference was held on October 31, 2008, which was unsuccessful. The discovery process is continuing and oral arguments on motion for summary judgment are scheduled for May 18, 2009.   Trial is currently set for August 25, 2009.

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. 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. 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 have commenced documentary discovery, which will be followed by depositions. 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 are material. 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.

Risks Relating to Our Company

We depend on the U.S. Government for a substantial amount of our sales and 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 significantly, our

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business may be harmed; and if we do not continue to experience demand for our products within the U.S. Government, our business may fail.

        We serve primarily 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 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.

        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 within the U.S. Department of Defense.

Our revenues in 2008 and the first three months of 2009 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.

        During 2008 and the first three months of 2009, two contracts with the U.S. Department of Defense represented approximately 75% 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 these two contracts were canceled, there are significant reductions in expected orders under any of the 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 currently in breach of certain financial covenants relating to our Series A Convertible Preferred Stock, and the holder of approximately 94% of our Series A Convertible Preferred Stock has exercised its right to cause us to redeem such shares of stock, which right purportedly has been triggered because of such breach. If we are required to redeem such

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Series A Convertible Preferred Stock, we will need to secure additional financing. If we are unable to obtain such financing or the cost of obtaining such financing is prohibitive, our business would be significantly harmed.

        In connection with our application to list shares of our common stock on the American Stock Exchange (now known as the NYSE Amex), we entered into a consent agreement with the holders of our Series A Convertible Preferred Stock. We did not meet the financial performance targets set forth in the consent agreement, which was filed as an exhibit to our Current Report on Form 8-K filed with the SEC on March 27, 2008. Our breach purportedly gives the holders of the Series A Convertible Preferred Stock the right to require us to redeem all or a portion of their shares of such stock. We have filed Current Reports on Form 8-K with the SEC on February 17, 2009 and March 4, 2009 regarding the foregoing. On April 14, 2009, we received a notice from the holder of approximately 94% of our Series A Convertible Preferred Stock that it is exercising such redemption right. The Series A Convertible Preferred Stockholder has also demanded that we pay them 12% dividends they assert accrued from January 1, 2009 to April 13, 2009, on its Series A Convertible Preferred Stock, in cash, as well as certain of their legal fees in connection with related matters. We currently do not have sufficient surplus as such term is defined under Delaware law to effect the redemption sought by the stockholder described above, and restrictions under our revolving line of credit with our primary lender would nevertheless prohibit any such redemption. Although we continue to negotiate with our Series A Preferred Stockholders to resolve the foregoing, if we are required to redeem such Series A Convertible Preferred Stock, we will need to secure additional financing. If we are unable to obtain such financing or the cost of obtaining such financing were prohibitive, our business would be significantly harmed. See “Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources” for additional information.

We are required to comply with complex procurement laws and regulations, 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;

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

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· 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, or operating results could be materially harmed. In addition, 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 release or access to classified information by foreign nationals.

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, or IDIQ contracts, General Services Administration, or GSA schedule contracts and other government-wide acquisition contracts, or GWACs. These contracts, some of which are awarded to multiple

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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 award; 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.

        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

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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.

        U.S. government agencies, including the Defense Contract Audit Agency, or the 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 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 (or 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 the contract 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.

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        A facility security clearance (or 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 facility security clearances 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 ability 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.

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, 2009, our backlog was approximately $60 million, of which $45 million is estimated to be realized in 2009. 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.

We have breached certain financial covenants under our revolving line of credit with TD Bank and the partial or complete loss of such revolving line may impact our ability to timely meet our working capital requirements.

        On April 1, 2009, we received a Notice of Default from our primary lender, TD Bank, resulting from the violation of certain financial covenants under the Loan Agreement, dated May 2, 2007, as amended, and as assumed by one of our subsidiaries. The bank has stated that it is not presently taking action to enforce its rights and remedies under our existing revolving line of credit with the bank, however they are not waiving their rights under any exiting or future defaults or events of default. The bank has indicated that it will continue to make advances under the Loan Agreement, but it has no obligation to do so and may refuse an advance request in its sole discretion without notice.

Subsequently, on April 27, 2009, we entered into a Forbearance Agreement and Amendment to Loan Agreement with the bank, pursuant to which the bank has agreed to forbear

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from exercising its default-related rights and remedies with respect to the defaults specified in the Notice of Default, including without limitation acceleration and foreclosure, and continue to provide advances and other financial accommodations under the Loan Agreement until June 15, 2009 (or Forbearance Period) unless such Forbearance Period is earlier terminated as a result of any Forbearance Default (as such term is defined in the Forbearance Agreement).  Notwithstanding the foregoing, the bank will have no obligation to make any advance if, after giving effect thereto, the aggregate principal amount of the Advances plus outstanding letters of audit issued by the lender for the account of our company and subsidiaries would exceed $2,000,000 prior to May 15, 2009 and $1,000,000 as of May 15, 2009 and thereafter.  Under the Forbearance Agreement, we have agreed, among other things, (i) not to make any Restricted Payment (as such term is defined in the Loan Agreement), other than a stock dividend payable in our common stock and approved by the Lender in its sole discretion, (ii) to use their best efforts to obtain a refinancing, (iii) to provide certain monthly financial information as set forth in the Forbearance Agreement and (iv) to pay the Advances, the Term Loan (as such term is defined in the Loan Agreement) and all other obligations in full by June 15, 2009.  Our failure to comply with any of the foregoing shall constitute a Forbearance Default under the Forbearance Agreement, which can result in termination of the Forbearance Agreement.  The Forbearance Agreement has been filed as an exhibit to the Form 8-K filed with the SEC on May 1, 2009.

        In the event we violate any covenants in the Loan Agreement or fail to comply with additional covenants set forth in the Forbearance Agreement during the Forbearance Period, the bank can refuse to make one or more advances and terminate the Forbearance Agreement, and we may unexpectedly be unable to meet our working capital obligations which could harm our reputation and our business.

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;

· 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;

· claim intellectual property rights in products provided by us; and

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· suspend or bar us from doing business with the federal government or with a governmental agency.

The ownership, control or influence of our company by foreigners 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.

        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 three, in particular, currently provide us with approximately 55% to 65% of our supply needs. If we can not obtain certain components for our products or we lost our key supplier, we might 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 supplies approximately 35% and Standard Bent Glass and Red Dot each supply between 10% and 15% of our overall supply needs. Moreover, Action Group supplies all of our steel pieces and hardware, Standard Bent Glass supplies all of our glass requirements and Red Dot supplies all of our vehicle air conditioning and heating equipment for our CPKs. 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 may 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.

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

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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 significant 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. We may be subject to personal liability claims and 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 the products. Any future claim against us for personal injury or property damage could materially adversely affect the 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 SAFETY Act certification for our products where we deem appropriate. However, even if we do purchase insurance, 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 and we must continue research and development to remain competitive.

        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, larger customer bases and significantly greater financial, sales and marketing, manufacturing, distribution, technical and other resources. As a result, these

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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.

        We rely on a combination of patents, 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 a number of U.S. pending patent applications.

         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.

        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 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

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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 attract and retain them.

We depend on the use of our operating facilities, which currently are nearing capacity. To the extent our growth strategy is successful, our operations could require additional space by the end of 2009 which, if not obtained on a cost-effective basis, could adversely affect our results of operations and financial conditions.

        Our success depends on the use of current operating facilities. However, the use of our facilities is quickly becoming maximized. To the extent our growth strategy is successful, we may require the acquisition or lease of additional property by the end of 2009 in order to effectively increase operating capabilities. Obtaining additional space may result in the investment of substantial time and capital and may not prove cost-effective, which could harm our results of operations and financial condition.

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

        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 may ineffectively use our resources which may affect our profitability and the costs associated with such work may preclude us from pursuing alternative opportunities.

        If 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

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the 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 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 that may be required under a specific contract.

We intend to pursue international sales opportunities which may require export licenses and controls.

        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

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internal compliance program for international sales will require the commitment of significant resources and capital.

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.

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.

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        Effective internal controls are necessary for us to provide accurate financial reports. We are beginning to evaluate how to document and test 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. During the course of this documentation and testing, we may identify significant deficiencies or material weaknesses that we may be unable to remediate before the deadline for those reports.

        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;

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

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

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

        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. Further, our credit facility restricts our ability to pay cash dividends. 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 our company will be if the market price of our common stock appreciates and you sell your common stock at a profit.

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;

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· prohibit stockholder action by written consent, which requires all 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.

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

On January 12, 2009, we issued options to purchase an aggregate of 100,000 shares of our common stock to consultants for services rendered.  The exercise price for each option is $2.00 per share and each option vested immediately upon the issuance.

The foregoing grants were exempt from registration under the Securities Act, pursuant to Section 4(2) and Rule 506 promulgated thereunder as transactions with accredited investors by an issuer not involving a public offering.

Item 3.Defaults Upon Senior Securities

               None.

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

None.

Item 5.           Other Information

   None.

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Item 6.           Exhibits

Exhibit Number	Exhibit
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.*

*      Filed herewith.

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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: April 15, 2010	By:	/s/ Gary Sidorsky
		Chief Financial Officer

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Index to Exhibits

Exhibit Number	Exhibit
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.

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