10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

FORM 10-Q

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

For the Quarter Ended March 31, 2010

Commission File Number 001-33888

American Defense Systems, Inc.

(Exact Name of Registrant as Specified in Its Charter)

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

230 Duffy Avenue

Hicksville, NY 11801

(516) 390-5300

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

offices)

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

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

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

Large Accelerated Filer   o	Accelerated Filer   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 14, 2010, 47,876,318 shares of common stock, par value $0.001 per share, of the registrant were outstanding.

TABLE OF CONTENTS

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

PART I

Item 1.    Condensed Consolidated Financial Statements

AMERICAN DEFENSE SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

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

* Condensed from audited financial statements

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

3

AMERICAN DEFENSE SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

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

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

4

AMERICAN DEFENSE SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

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

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

5

AMERICAN DEFENSE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Organization

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

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

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

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

Interim Review Reporting

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

Nature of Business

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

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

Principles of Consolidation

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

Terms and Definitions

ADSI	American Defense Systems, Inc. (or, the “Company”)
AJP	A.J. Piscitelli & Associates, Inc., a subsidiary
APSG	American Physical Security Group, LLC, a subsidiary
ASC	FASB Accounting Standards Codification
FASB	Financial Accounting Standards Board
GAAP	Generally Accepted Accounting Principles
PCAOB	Public Companies Accounting Oversight Board
SEC	Securities Exchange Commission
SFAS or FAS	Statement of Financial Accounting Standards
TAG	Tactical Applications Group, a subsidiary

6

AMERICAN DEFENSE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Management Liquidity Plans

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

 Use of Estimates

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

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

Subsequent Events

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

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

Revenue and Cost Recognition

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

           (a) persuasive evidence of the arrangement exists,

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

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

           (d) collectibility is reasonably assured.

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

7

AMERICAN DEFENSE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Contract Revenue

Cost in Excess of Billing

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

Retail Revenue

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

Concentrations

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

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

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

Allowance For Doubtful Accounts

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

Loss per Share

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

8

AMERICAN DEFENSE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

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

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

Fair Value of Financial Instruments

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

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

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

Level 1

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

Level 2

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

Level 3

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

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

9

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

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

	Fair Value Measurements at Reporting Date Using
			Quoted Prices
			in Active
	Balance as of		Markets for			Significant Other			Significant
	March		Identical			Observable			Unobservable
	31,		Assets			Inputs			Inputs
Description	2010		(Level 1)			(Level 2)			(Level 3)
Liabilities
Series A Preferred (1)	$	13,330,189		$	—		$	—		$	13,330,189
2005 Warrants (1)		82			—			—			82
2006 Warrants (1)		28			—			—			28
Placement Agent Warrants (1)		59,732			—			—			59,732
Total Liabilities	$	13,390,031		$	—		$	—		$	13,390,031

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

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

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

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

Reclassification

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

10

AMERICAN DEFENSE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Recent Accounting Pronouncements

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

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

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

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

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

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AMERICAN DEFENSE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

Costs in Excess of Billings and Billing in Excess of Costs

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

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

Backlog

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

Accounts Receivable

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

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

3.  COMMITMENTS AND CONTINGENCIES

Legal Proceedings

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

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

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

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4. SHAREHOLDERS’ DEFICIENCY

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

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

Warrants

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

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

Stock Option Plan

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

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

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

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

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

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

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

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

Stock Grants

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

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

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

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

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

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5.  SERIES A CONVERTIBLE PREFERRED STOCK AND WARRANT LIABILITIES

Features of the Series A Preferred and Warrants Liabilities

2005 Warrants

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

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

2006 Warrants

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

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

Series A Preferred and Investor Warrants and Placement Agent Warrants

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

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

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

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

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Settlement Agreement

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

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

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

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

Investor Warrants

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

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Placement Agent Warrants

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

Accounting for the Series A Preferred and Warrant Liabilities

2005 Warrants, 2006 Warrants, and Placement Agent Warrants

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

Series A Preferred

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

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

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

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

Valuation – Methodology and Significant Inputs Assumptions

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

2005 and 2006 Warrants

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

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

Placement Agent Warrants

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

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

Series A Preferred

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

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

The following are significant assumptions utilized in developing the inputs

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

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

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

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

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

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

6. DISPOSAL OF TAG

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

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

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

2009	$	100,000
2010	$	100,000
2011	$	200,000
2012	$	300,000
2013	$	300,000
Total	$	1,000,000

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

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

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

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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 for the year ended December 31, 2009.

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

Overview

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

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

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

· increase exposure to military platforms in the U.S. and internationally;

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

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

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

· pursue strategic acquisitions.

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

Sources of Revenues

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

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

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

Cost of Revenues and Operating Expenses

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

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

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

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

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

Critical Accounting Policies

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

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

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

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

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

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

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

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

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

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

Fair Value Measurements

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

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

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

· Level 1 Inputs:  These inputs come from quoted prices (unadjusted) in active markets for identical assets or liabilities.

· Level 2 Inputs:  These inputs are other than quoted prices that are observable, for an asset or liability. This includes: quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; inputs other than quoted prices that are observable for the asset or liability; and inputs that are derived principally from or corroborated by observable market data by correlation or other means.

· Level 3 Inputs:  These are unobservable inputs for the asset or liability which require the company’s own assumptions.

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

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

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

Derivative Warrants

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

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

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

Placement Agent Warrants .     

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

2005 Warrants and 2006 Warrants

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

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Consolidated Results of Operations

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

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

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

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

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

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

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

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

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

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

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

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

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

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Liquidity and Capital Resources

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

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

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

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

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

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

Accounts Receivable Purchase Agreement

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

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

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

 Series A Convertible Preferred Stock

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

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

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

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

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

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

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

Item 3.    Quantitative and Qualitative Disclosure About Market Risk

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

Item 4.    Controls and Procedure

Evaluation of Disclosure Controls and Procedures

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

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

Financial Reporting

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

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

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

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

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º Inaccurate accounting and disclosure.  We did not maintain adequate procedures or effective controls over accounting, communication, and disclosure of compensation expense related to awards. Specifically, we lacked a process of financial and administrative oversight over the stock-based compensation process.

º Inadequate administration of awards.  We did not maintain effective controls as it related to the reconciliation of grants to source data.

º Insufficient tracking of employee data.  We did not maintain adequate procedures or effective controls over tracking awards that ultimately impacted the timely accounting for compensation expense.

General Computing Controls

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

• Inadequate system access controls.  System access controls over our accounting information system were not in place to appropriately prohibit or limit user access in areas including journal entries, invoice processing, master-file maintenance.

• Inadequate general computing controls.  Overall general user and system administration were inadequate in the following areas where procedures were in place but not formalized or documented;

º Backup and recovery of financial data

º Systems development and change management

º Incident management

º Security monitoring

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

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

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

• engage external subject matter experts to:

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

º develop and implement formal remediation plans;

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

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

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

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

Changes in Internal Controls

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

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Limitations on the Effectiveness of Controls

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

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

PART II

Item 1.    Legal Proceedings

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

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

Item 1A.  Risk Factors

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

Risks Relating to Our Company

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

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

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

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

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

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

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

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

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

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

· The Federal Acquisition Regulations: Along with agency regulations supplemental to the Federal Acquisition Regulations, comprehensively regulate the formation, administration and performance of federal government contracts;

· The Truth in Negotiations Act: Requires certification and disclosure of all cost and pricing data in connection with contract negotiations;

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

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

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

·       Termination of contracts;

·       Forfeiture of profits;

·       Cost associated with triggering of price reduction clauses;

·       Suspension of payments;

·       Fines; and

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

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

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

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

· the need to bid on programs in advance of the completion of their design, which may result in unforeseen technological difficulties and cost overruns;

· the substantial cost and managerial time and effort that we may spend to prepare bids and proposals for contracts that may not be awarded to us;

· the need to estimate accurately the resources and cost structure that will be required to service any contract we are awarded; and

· the expense and delay that may arise if our or our partners’ competitors protest or challenge contract awards made to us or our partners pursuant to competitive bidding, and the risk that any such protest or challenge could result in the resubmission of bids on modified specifications, or in the termination, reduction or modification of the awarded contract.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

· reduce or modify contracts or subcontracts;

· decline to make orders under existing contracts;

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

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

· claim intellectual property rights in products provided by us.

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

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

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

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

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

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

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

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

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

We are subject to substantial competition.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Risks Relating to Our Common Stock

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

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

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

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

Volatility of our stock price could adversely affect stockholders.

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

· quarterly variations in our operating results;

· cyclical nature of defense spending;

· interest rate changes;

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

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

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

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

· news reports relating to trends in our markets;

· changes in laws and regulations affecting our business;

· material announcements by us or our competitors;

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

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

· other matters discussed in the Risk Factors.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Item 3.         Defaults Upon Senior Securities

None.

Item 4.         (Removed and Reserved)

Item 5.           Other Information

None.

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Item 6.           Exhibits

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

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

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

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

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

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

*      Filed herewith.

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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: May 14, 2010	By:	/s/ Gary Sidorsky
		Chief Financial Officer

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Index to Exhibits

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

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EX-10.5

AMENDMENT TO EMPLOYMENT AGREEMENT

THIS AMENDMENT TO EMPLOYMENT AGREEMENT (this “Amendment”) is made effective as of January 25, 2010 (the “Effective Date”) by and between Robert Aldrich (“Aldrich” or the “Executive”) and American Defense Systems, Inc. (“ADSI” or the “Company”).

WHEREAS, ADSI and Aldrich have previously entered into an employment agreement dated August 1, 2008 (the “Employment Agreement”); and

WHEREAS, ADSI and Aldrich desire to amend the Employment Agreement between the parties.

NOW THEREFORE, in consideration of the foregoing and for other good and valuable consideration, the receipt and adequacy of which is hereby acknowledged, ADSI and Aldrich hereby agree as follows:

1.           Section 3.4 of the Employment Agreement (Stock), is hereby amended and restated as follows:

Stock Options.  Subject to approval by the Company’s Board of Directors (the “Board”) and its Compensation Committee (“Committee”), as further compensation for Executive’s services hereunder, the Company shall grant to Executive, effective as of the date of the Amendment, a nonqualified option to purchase 100,000 shares of the Company’s common stock, the terms of which shall be set forth in a stock option agreement issued pursuant to, and subject to, the terms of the Company’s 2007 Incentive Compensation Plan (as amended from time to time, the “Plan”).  The option will become exercisable according to a vesting schedule pursuant to which forty percent (40%) of the option shall be immediately vested as of the option grant date and twenty percent (20%) of the option shall vest annually commencing on the first one-year anniversary of the option grant date.  The initial per share exercise price of the option shall equal the fair market value of a share of the Company’s common stock on the date of the grant, as determined by the Committee in accordance with terms of the Plan.

2.           Confirmation of the Employment Agreement.  Except as amended hereby, all of the terms of the Employment Agreement shall remain and continue in full force and effect and are hereby confirmed in all respects, and all references to the Employment Agreement and the Amendment To Employment Agreement shall be deemed to refer to the Employment Agreement as amended hereby.

[THE REMAINDER OF THIS PAGE LEFT BLANK INTENTIONALLY]

IN WITNESS WHEREOF, the parties have executed this Amendment effective as of the date set forth above.

American Defense Systems, Inc.
By:	/s/ Anthony Piscitelli
	Name:  Anthony Piscitelli
	Title:    CEO

By:	/s/ Robert Aldrich
	Robert Aldrich

EX-10.6

EMPLOYMENT AGREEMENT

This EMPLOYMENT AGREEMENT (“Agreement”) is effective this 1st day of January 2009, between American Defense Systems, Inc. (“the Company”) and Russell Scales (“Executive”) (sometimes referred to herein individually as “Party” or collectively as “Parties”).

WHEREAS, the Company desires to retain the services of Executive as Senior Vice President of Business Development; and

WHEREAS, Company and Employee desire to enter into this Agreement to set forth the terms and conditions of the employment relationship between Company and Employee;

NOW THEREFORE, in consideration of the promises and the mutual agreements herein contained, the Parties hereto, intending to be legally bound, hereby agree as follows:

1.          Definitions. Those words and terms that have special meanings for purposes of this Agreement are specially defined through the use of parenthetical quotations and upper-lower case lettering.

2.          Employment.

2.1           Position and Term. The Company hereby employs Executive and Executive hereby accepts said employment and agrees to render such services to the Company on the terms and conditions set forth in this Agreement. Unless terminated in accordance with Section 5 below, the term of this Agreement will be for a term of three (3) years commencing on the Effective Date of this Agreement (the “Initial Term”); and following the Initial Term the Agreement will automatically renew for an additional term of one (1) year (“Renewal Term”) on each one-year anniversary of the Agreement (the “Annual Renewal Date”), unless one of the Parties gives the other Party written notice of non-renewal in accordance with Section 6.2 below) at least thirty (30) days before the impending Annual Renewal Date, in which event this Agreement shall terminate at the end of the then current Term. Reference herein to “Term” shall refer both to the Initial Term and any successive Renewal Term, as the context requires.

2.2           Duties.   During theTerm, Executive shall devote his full working time, attention and best efforts to further the interests of the Company and shall perform such services for the Company as are consistent with his position.

3.          Compensation and Benefits.

3.1           Base Salary. For services rendered by Executive under this Agreement, the Company shall pay Executive a minimum base salary of $211,230.50 per year (“Base Salary”). The Company shall review Executive’s Base Salary on an annual basis and may, in its sole discretion modify the Base Salary from time to time in such amounts as may determined by the Board. Said Base Salary shall be payable in accordance with the Company’s regular payroll practices for executive employees.

3.2           Bonus. Executive shall be entitled to receive a bonus in the amount of 1.0%of all American Physical Safety Group (“APSG”) sales. The Bonus shall be calculated on an annual basis. If otherwise eligible, Executive need not be employed by the Company at the time that the Bonus is calculated and/or paid in order to receive the Bonus. Withholding. All payments required to be made by the Company to Executive under this Agreement shall be subject to the withholding of such amounts, if any, relating to tax and other payroll deductions as must be withheld pursuant to any applicable law or regulation.

3.3           Stock Options. Executive shall be eligible to participate in the Company’s Stock Option Plan as it may be amended from time to time. All grants under the Stock Option Plan shall be made in accordance with and subject to the terms thereof.

3.4           Benefits.

 3.4.1 Participation in Benefit Plans. Except as otherwise provided in this Agreement, Executive shall be entitled to participate in and receive the benefits of any benefit plans, benefits and privileges given to similar level employees of the Company, to the extent commensurate with his then duties and responsibilities (“Benefit Plans”) when and if such Benefit Plans are established by the Company. The Company shall not make any changes in such Benefit Plans that would adversely affect Executive’s rights or benefits thereunder unless such change occurs pursuant to a program applicable to all similar level employees of the Company and does not result in a proportionately greater adverse change in the rights of or benefits to Executive as compared with any other similar level employee of the Company.

 3.4.2 Vacation. Executive shall be entitled to four (4) weeks of paid vacation each calendar year.

4.          Expenses

4.1Expenses. The Company shall reimburse Executive or otherwise provide for or pay for all reasonable expenses incurred by Executive in furtherance of, or in connection with, the Company’s business, including, but not by way of limitation, traveling expenses, communication expenses, and all reasonable entertainment expenses (whether incurred at Executive’s residence, while traveling or otherwise), subject to such reasonable documentation and other limitations as may be established by the Company.

5.          Termination.

5.1           Termination Due to Death. The Company shall have the right to terminate Executive’s employment by reason of his death, in which event the Company shall promptly pay his spouse or estate, as applicable, all compensation, expenses and other amounts owed to him as of the Date of Termination (as defined in Section 5.10 below) and thereafter shall have no further obligation to pay compensation to his spouse or estate (unless required by applicable law).

5.2           Termination Due to Disability. The Company shall have the right to terminate Executive’s employment hereunder, if the Executive shall, as the result of mental and physical incapacity, illness, or disability become unable to perform his duties hereunder for in excess of ninety (90) days in any 12-month period.

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5.3           Termination by Executive by Resignation. Executive shall have the right to resign his employment upon thirty (30) days notice, in which event the Company shall promptly pay him all compensation, expenses and other amounts owed to him as of the Date of Termination (as defined in Section 5.10 below) and thereafter shall have no further obligation to pay him compensation (unless required by applicable law).

5.4           Termination by the Company Without Cause. The Company shall have the right to terminate Executive’s employment without Cause with thirty (30) days written notice (subject to and in accordance with Sections 5.10 and 6.2 below), in which event the Company:

 (a)shall, on the Date of Termination, pay Executive all compensation, expenses and other amounts owed to him as of the Date of Termination (as defined in Section 5.10 below);

 (b)shall continue to pay Executive’s Base Salary (in effect as of the Date of Termination) for six months from the Date of Termination.

5.5           Termination by the Company for Cause. The Company shall have the right to terminate Executive’s employment for Cause subject to the conditions set forth herein. If the Company terminates Executive’s employment for Cause, the Company shall promptly pay Executive all compensation, expenses and other amounts owed to him as of the Date of Termination (as defined in Section 5.10 below) and thereafter shall have no further obligation to pay him compensation. As used in this Agreement, “Cause” shall mean any of the following: (i) Executive’s repeated failure or refusal to perform reasonably assigned duties; (ii) Executive’s commission of fraud or theft, conviction of a felony or crime involving moral turpitude, or substance abuse; (iii) Executive’s disclosure of Confidential Information (as defined herein) or trade secrets, except in connection with his duties to Company; (iv) the association, directly or indirectly, of Executive, for his profit or financial benefit, with any person firm, partnership, association, entity, or corporation that competes in any material way, with the Company; (v) Executive’s willful misconduct or gross negligence in the performance of his duties or obligations to the Company; or (vi) Executive’s material breach of the Agreement.

5.6           Benefits Upon Termination. Except as otherwise provided in this Agreement, in the event of termination of Executive’s employment under Sections 5.1 through 5.6 above, Executive’s entitlement to benefits under any Benefit Plan (as defined in Section 3.5 above) shall be determined in accordance with applicable law and the provisions of such Benefit Plan.

5.7           Termination by Mutual Consent. Notwithstanding any of the foregoing provisions of this Section 5, if, at any time during the Term, the Parties by mutual consent decide to terminate this Agreement, they may and shall do so by separate agreement setting forth the terms and conditions of such termination.

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5.8           Withholding. All payments required to be made by the Company to Executive under Section 5 of this Agreement shall be subject to the withholding of such amounts, if any, relating to tax and other payroll deductions as must be withheld pursuant to any applicable law or regulation.

5.9           Notice of Termination. Any termination of Executive’s employment by the Company for any reason, or by Executive for any reason, shall be communicated by a written “Notice of Termination” to the other Party and shall include a “Date of Termination”.

6.         Nondisclosure of Confidential and Proprietary Information

6.1           The Executive acknowledges that during the period of employment, Executive will have access to and possession of trade secret, confidential information, and proprietary information (collectively, as defined more extensively below, “Confidential Information”) of the Company, its parents, subsidiaries, and affiliates and their respective clients. The Executive recognizes and acknowledges that this Confidential Information is valuable, special, and unique to the Company’s business, and that access to and knowledge thereof are essential to the performance of the Executive’s duties to the Company. During the Employment Period and thereafter, Executive will keep secret and will not use or disclose to any person or entity other than the Company, in any fashion or for any purpose whatsoever, any Confidential Information relating to the Company, its parents, subsidiaries, affiliates, or its clients, except at the request or the Company. To the extent that Executive has signed any other confidentiality agreement, such agreement continues in full force and effect.

6.2           The term “Confidential Information” means confidential data and confidential information relating to the business of the Company, its parents, subsidiaries, and affiliates and their respective clients, that is or has been disclosed to Executive or of which Executive became aware as a consequence of or through Executive’s employment with the Company and that has value to the Company and is not generally known to the competitors of the Company and includes but is not limited to information written, in digital form, in graphic form, electronically stored, orally transmitted or memorized concerning the Company’s business or operations plans, strategies, portfolio, prospects or objectives, structure, products, product development, technology, distribution, sales, services, support and marketing plans, practices, and operations; research and development, financial records and information, and client lists.

6.3           The Executive further recognizes that the Company has received and in the future will receive from third parties confidential or proprietary information (“Third Party Information”) subject to a duty on the Company’s part to maintain the confidentiality of such information and to use it only for certain limited purposes. During the Employment Period and thereafter, Executive will hold Third Party Information in the strictest confidence and will not disclose to anyone (other than Company personnel who need to know such information in connection with their work for the Company) or use, except in connection with work for the Company, Third Party Information unless expressly authorized by the Company in writing.

6.4           The Executive further agrees to store and maintain all Confidential Information in a secure place. On the termination of the relationship, Executive agrees to deliver all records, data, information, and other documents produced or acquired during the period of employment, and all copies thereof, to the Company. Such material at all times will remain the exclusive property of the Company, unless otherwise agreed to in writing by the Company. Upon termination of the relationship, Executive agrees to make no further use of any Confidential Information on his or her own behalf or on behalf of any other person or entity other than the Company.

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7.          Assignment Of Inventions and Intellectual Property

In consideration of Executive’s employment, Executive acknowledges and agrees that the Company shall have exclusive, unlimited ownership rights to all materials, information and other items created, prepared, derived or developed in connection with or arising from Executive’s employment relationship with the Company, whether individually or jointly with others, whether original or considered enhancements, improvement or modifications, whether or not completed, and whether or not protectable as trade secrets, service or trademarks, or through patent, copyright, mask work or any other intellectual, industrial or other form of property protection or proprietary rights (“Inventions”). Executive further agrees that all Inventions shall be deemed made in the course and scope of Executive’s employment with the Company and shall belong exclusively to the Company, with the Company having the sole right to obtain, hold and renew, in its own name and for its own benefit, all registrations and other protections that may be available by contract, license, law, equity and/or regulation. To the extent that exclusive title or ownership rights do not originally vest in the Company as contemplated, Executive hereby irrevocably assigns, transfers and conveys (and agrees to assign, transfer and convey in the future) to the Company all such rights. Executive agrees to give the Company all reasonable assistance and execute all documents reasonably necessary to assist and enable the Company to perfect, preserve, enforce, register and record its rights. To the extent that Executive has signed any other assignment of inventions agreement, such agreement continues in full force and effect.

8.          Agreement Not to Compete

8.1           The Executive agrees with the Company that the services which the Executive will render during the Employment Period are unique, special and of extraordinary character, that the Company will be substantially dependent upon such services to develop and market its products and to earn a profit, and that the application of the Executive’s knowledge and services to any competitive business would be substantially detrimental to the Company. Accordingly, in consideration for employment by the Company and compensation and other benefits pursuant to this Agreement, and any compensation the Executive may receive after her employment is terminated, the Executive will not compete or interfere with the Company or any affiliate of the Company (or any of their successors or assigns), directly or indirectly during the Employment Period or for the six (6) month period following termination of Executive’s employment the “Restricted Period”).

The term “compete” as used herein means to engage in, assist, or have any interest in, including without limitation as a principal, consultant, employee, owner, shareholder, director, officer, partner, member, advisor, agent, or financier, any entity that is, or that is about to become engaged in, any activity that is in competition with, or competes with the Company, provided that the Executive shall not be deemed to “compete” with the Company if he does not perform any duties or services for the competing entity that relate, directly or indirectly, to managing, producing, soliciting or selling services, programs or products that provide similar functions to any of the Company’s services, programs or proposed products .

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8.2           Furthermore, during the Restricted Period, Executive shall not, directly or indirectly, with respect to the Company (including any parents, subsidiaries or affiliates of the Company), or any successors or assigns:

(a)Solicit any of the Company’s customers except on the Company’s behalf, or direct any current or prospective customer to anyone other than the Company for goods or services that the Company provides;

(b)Directly or indirectly influence any of the Company’s employees to terminate their employment with the Company or accept employment with any of the Company’s competitors; or

(c)Interfere with any of the Company’s business relationships, including without limitation those with customers, suppliers, consultants, attorneys, or other agents, whether or not evidenced by written or oral agreements.

8.3           The Executive agrees that any breach of this Section 8 shall cause the Company substantial and irrevocable damage and therefore, in the event of any such breach, the Executive agrees that (i) the Executive shall not be entitled to any further payments due under the terms of this Agreement, and (ii) any stock option granted but not exercised shall be void and have no further force or effect. Furthermore, in addition to any other remedies that may be available, the Company shall have the right to seek specific performance and injunctive relief as set forth in this Agreement, without the need to post a bond or other security.

8.4           The Executive further acknowledges that the covenants contained in this Section are a material part of this Agreement and if this Agreement is terminated for any reason, the Executive will be able to earn a livelihood without violating these provisions.

9.          Return of Company Property

When the Executive leaves the employ of the Company, the Executive will deliver to the Company (and will not keep in his possession, recreate or deliver to anyone else) any and all devices, records, recordings, data, notes, reports, proposals, lists, correspondence, specifications, drawings, blueprints, sketches, materials, computer materials, equipment, other documents or property, together with all copies thereof (in whatever medium recorded), belonging to the Company, its successors or assigns. The Executive further agrees that any property situated on the Company’s premises and owned by the Company, including computer disks and other digital, analog or hard copy storage media, filing cabinets or other work areas, is subject to inspection by Company personnel at any time with or without notice.

10.          Legal and Equitable Remedies

Because the Executive’s services are personal and unique and because the Executive may have access to and become acquainted with the Proprietary Information of the Company, and because the parties agree that irrepressible harm would result in the event of a breach of Sections 6, 7, 8, and 9 by the Executive, the Company may not have an adequate remedy at law, the Company will have the right to enforce Sections 6, 7, 8, and 9 and any of their provisions by injunction, restraining order, specific performance or other injunction relief, without bond, and without prejudice to any other rights and remedies that the Company may have for a breach of this Agreement. The Company’s remedies under this Section 10 are not exclusive and shall not prejudice or prohibit any other rights or remedies under this Agreement or otherwise.

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11.          General Provisions.

11.1         Assignment. The Company shall assign this Agreement and its rights and obligations hereunder in whole, but not in part, to any corporation or other entity with or into which the Company may hereafter merge or consolidate or to which the Company may transfer all or substantially all of its assets, if in any such ease said corporation or other entity shall by operation of law or expressly in writing assume all obligations of the Company hereunder as fully as if it had been originally made a party hereto; the Company may not otherwise assign this Agreement or its rights and obligations hereunder. Executive may not assign or transfer this Agreement or any rights or obligations hereunder.

11.2         Notice. All Notices of Termination and other communications provided for in this Agreement shall be in writing and shall be deemed to have been duly given when delivered or mailed by certified or registered mail, return receipt requested, postage prepaid, addressed to the respective addresses set forth below:

To the Company:	American Defense Systems, Inc.
	230 Duffy Ave., Unit C
	Hicksville, NY 11801
To Executive:	Russell Scales
	10509 Old Coast Guard Rd
	Emerald Isle, NC 28594

Either Party may change the address to which Notices of Termination and other communications provided for in this Agreement shall be sent to that Party, by giving the other Party notice in the manner provided in this Section.

11.3         Indemnification. The Company shall indemnify Executive and hold him harmless for any and all liabilities arising from the performance of his duties under this Agreement and services for the Company, subject to and in accordance with applicable law and any applicable indemnification provisions in the Company’s Articles of Incorporation and/or Bylaws.

11.4         Tax Treatment of Payments and/or Benefits. Each payment made pursuant to the terms and Agreement is intended as a separate payment within the meaning of Code Section 409A and Department of Treasury regulations and other interpretive guidance issued thereunder. To the extent applicable and notwithstanding any other provisions of this Agreement, this Agreement and payments and benefits hereunder shall be administered, operated and interpreted in accordance with Code Section 409A and Department of Treasury regulations and other interpretive guidance issued thereunder, including without limitation any such regulation or other guidance that may be issued after the Effective Date of this agreement; provided however, in the event that the Company determines that any payments or benefits hereunder may be taxable to Executive under Code 409A and related Treasury guidance prior to the payment and/or delivery of such amount, the Company, may adopt such amendments to the Agreement that the Company reasonably and in good faith determines necessary or appropriate to preserve the intended tax treatment of the benefits provided under this Agreement and/or (ii) take such other actions, including delaying the payment or delivery hereunder, as the Company determines necessary or appropriate to comply with or exempt the payments or benefits from the requirements of Code Section 409A including but not limited to delaying any separation payments under this Agreement to the sixth month anniversary of the date of Executive’s separation from service.

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11.5         Amendment and Waiver. No amendment or modification of this Agreement shall be valid or binding upon the Parties unless made in writing and signed by each of the Parties for that express purpose.

11.6         Non-Waiver of Breach. No failure by either Party to declare a default due to any breach of any obligation under this Agreement by the other, nor failure by either Party to act with regard thereto, shall be considered to be a waiver of any such obligation, or of any future breach.

11.7         Severability. In the event that any provision or portion of this Agreement, shall be determined to be invalid or unenforceable for any reason, the remaining provisions of this Agreement shall be unaffected thereby and shall remain in full force and effect.

11.8         Governing Law. The validity and effect of this Agreement and the rights and obligations of the Parties hereto shall be construed and determined accordance with the law of the State of New York without regard to its conflicts of laws or principles.

11.9         Dispute Resolution. Any controversy, dispute or claim arising out of or relating to this Agreement or breach thereof shall first be resolved through good faith negotiation between the Parties. If the Parties are unsuccessful at resolving the dispute through such negotiation, the Parties agree to attempt in good faith to resolve the dispute by mediation in New York City, New York (or such other location agreed upon between the Parties), administered by JAMS. Either Party may commence such mediation by providing the other Party (in accordance with Section 6.2 above) and JAMS a written request for mediation, setting forth the subject of the dispute and the relief requested. The Parties covenant that they will cooperate in good faith with JAMS and one another in selecting a mediator from JAMS panel of neutrals and in scheduling and participating in the mediation proceedings. If the Parties are unsuccessful at resolving the dispute through such mediation, the Parties agree to final and binding arbitration in New York City, New York (or such other location agreed upon between the Parties), administered by JAMS pursuant to its Employment Arbitration Rules & Procedures (except insofar as they conflict with the express provisions of this Section) and subject to JAMS Policy on Employment Arbitration Minimum Standards of Procedural Fairness. Either Party initiating such arbitration must do so by filing a written demand for arbitration (and giving the other Party notice in accordance with Section 6.2 above) at any time following the initial mediation session or 45 days after the date of filing the written request for mediation, whichever occurs first. The mediation may continue after the commencement of arbitration if the Parties so agree. Unless otherwise agreed by the Parties, the mediator shall be disqualified from serving as arbitrator. The arbitrator may, in the award, allocate all or part of the costs, fees and expenses of the arbitration. Judgment on the arbitration award may be entered in any court having jurisdiction. The provisions of this Section may be enforced by any court of competent jurisdiction, and the Party seeking enforcement shall be entitled to an award of all costs, fees and expenses, including attorneys’ fees, to be paid by the Party against whom enforcement is ordered.

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11.10      Entire Agreement. Unless otherwise specified this Agreement contains all of the terms agreed upon by the Company and Executive with respect to the subject matter hereof and supersedes all prior agreements, arrangements and communications between the Parties dealing with such subject matter, whether oral or written.

11.11      Binding Effect. This Agreement shall be binding upon and shall inure to the benefit of the transferees, successors and assigns of the Company, including any corporation or entity with which the Company may merge or consolidate.

11.12      Headings. Numbers and titles to Sections hereof are for information purposes only and, where inconsistent with the text, are to be disregarded.

11.13      Counterparts. This Agreement may be executed in counterparts, each of which shall be deemed an original, but all of which when taken together, shall be and constitute one and the same instrument.

11.14      Executive’s Warranties. Executive expressly warrants that he has carefully read and filly understands all the provisions of this Agreement and is hereby advised by the Company to consult an attorney of his own choosing in deciding whether to sign this Agreement

IN WITNESS WHEREOF, the Parties hereto have caused this Agreement to be duly executed as of the date and year first written above.

The Company:	AMERICAN DEFENSE SYSTEMS, INC.
	By:	/s/ Anthony J. Piscitelli
		Anthony J. Piscitelli
		Chief Executive Officer

Executive:       By: /s/ Russell Scales

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EX-31.1

Exhibit 31.1

CERTIFICATION OF CHIEF EXECUTIVE OFFICER

PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002

I, Anthony Piscitelli, certify that:

1. I have reviewed this quarterly report on Form 10-Q of American Defense Systems, Inc.;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

(a) designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b)  designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c) evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d) disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

(a) all significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date:  May 14, 2010

/s/ Anthony Piscitelli

Anthony Piscitelli

Chief Executive Officer, President and Chairman

EX-31.2

  
    Unassociated Document
    
    
    
    
    
    

EX-32.1

  
    Unassociated Document