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, 2012

 

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.)

 

420 McKinney Pkwy

Lillington, NC 27546

(910) 514-9701

(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 x No o

 

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

 

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

 

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

 

As of May 3, 2012, 55,087,192 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, 2012 (Unaudited) and December 31, 2011	3
	Condensed Consolidated Statements of Operations for the three months ended March 31, 2012 and 2011 (Unaudited)	5
	Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2012 and 2011 (Unaudited)	6
	Notes to Condensed Consolidated Financial Statements	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	17
Item 3.	Quantitative and Qualitative Disclosure About Market Risk	21
Item 4.	Controls and Procedures	22
PART II — OTHER INFORMATION
Item 1.	Legal Proceedings	23
Item 1A.	Risk Factors	24
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	24
Item 3.	Defaults Upon Senior Securities	24
Item 4.	(Removed and Reserved)	24
Item 5.	Other Information	24
Item 6.	Exhibits	25
SIGNATURES		26

 

  

PART I

 

Item 1. Condensed Consolidated Financial Statements

 

AMERICAN DEFENSE SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS 

 

		March 31, 2012				December 31,
ASSETS		(Unaudited)				2011*
CURRENT ASSETS
Cash		$	55,866			$	132,285
Accounts receivable, net of allowance for doubtful accounts of
$451,761 as of March 31, 2012 and December 31, 2011			458,360				891,033
Accounts receivable factoring			4,810				5,112
Tax receivable			101,641				101,641
Costs in excess of billings on uncompleted contracts, net			792,873				1,178,584
Prepaid expenses and other current assets			58,610				101,191
Assets held for sale			62,000				62,000
Assets of discontinued operations			10,774				10,774
TOTAL CURRENT ASSETS			1,544,934				2,482,620
Property and equipment, net			390,388				463,452
Deposits			151,016				151,016
Deferred tax assets			1,896				1,896
Assets of discontinued operations			15,895				15,895
TOTAL ASSETS		$	2,104,129			$	3,114,879

 

 

* Condensed from audited financial statements

 

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

 

 

AMERICAN DEFENSE SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

 

LIABILITIES AND SHAREHOLDERS' DEFICIENCY		March 31, 2012 (Unaudited)				December 31, 2011 *
CURRENT LIABILITIES
Accounts payable		$	2,506,605			$	3,059,708
Accrued expenses			200,132				288,287
Deferred tax liability			1,896				1,896
TOTAL CURRENT LIABILITIES			2,708,633				3,349,891
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS' DEFICIENCY
Common stock, $0.001 par value, 100,000,000 shares authorized, 55,087,192 and 54,987,192 shares issued and outstanding as of March 31, 2012 and December 31, 2011, respectively			55,087				54,987
Additional paid-in capital			16,690,865				16,665,188
Accumulated deficit			(17,350,456	)			(16,955,187	)
TOTAL SHAREHOLDERS' DEFICIENCY			(604,504	)			(235,012	)
TOTAL LIABILITIES AND SHAREHOLDERS' DEFICIENCY		$	2,104,129			$	3,114,879

 

 

* Condensed from audited financial statements

 

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

  

 

AMERICAN DEFENSE SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

  

			For the Three Months Ended
			March 31, 2012				March 31, 2011
CONTRACT REVENUES EARNED		$	1,889,610			$	2,515,652
COST OF REVENUES EARNED (exclusive of depreciation
and amortization shown separately below)			1,291,307				1,384,291
GROSS PROFIT			598,303				1,131,361
OPERATING EXPENSES
General and administrative expenses			275,290				817,018
General and administrative salaries			362,862				703,895
Sales and marketing			41,113				171,403
Research and development			19,731				115,159
Depreciation and amortization			73,144				222,643
Professional fees			211,152				238,864
TOTAL OPERATING EXPENSES			983,292				2,268,982
OPERATING LOSS			(384,989	)			(1,137,621	)
OTHER (EXPENSE) INCOME
Unrealized loss on adjustment of fair value Series A convertible preferred stock classified as a liability			-				(2,395,592	)
Unrealized gain on warrant liability			-				3,125
Gain on sale of fixed asset			-				54,475
Gain on redemption of mandatorily redeemable preferred stock			-				12,786,969
Interest expense			-				(236,118	)
Finance charge			(10,280	)			(20,211	)
TOTAL OTHER (EXPENSE) INCOME			(10,280	)			10,192,648
(LOSS) INCOME BEFORE INCOME TAXES FROM CONTINUING OPERATIONS			(395,269	)			9,055,027
INCOME TAX PROVISION			-				-
(LOSS) INCOME FROM CONTINUING OPERATIONS			(395,269	)			9,055,027
DISCONTINUED OPERATIONS (Note 6):
INCOME FROM DISCONTINED OPERATIONS, (including gain on disposal of $2,910,565 during the three months ended March 31, 2011), NET OF TAX of $0			-				2,905,858
NET (LOSS) INCOME		$	(395,269	)		$	11,960,885
Weighted Average Shares Outstanding (Basic and Diluted)			55,034,445				54,341,685
(Loss) Income per Share (Basic and Diluted)
(LOSS) INCOME FROM CONTINUING OPERATIONS		$	(0.01	)		$	0.17
INCOME FROM DISCONTINED OPERATIONS, NET OF TAX		$	-			$	0.05
NET (LOSS) INCOME		$	(0.01	)		$	0.22

 

 

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

 

 

AMERICAN DEFENSE SYSTEMS, INC. AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

 

		Three Months Ended March 31,
		2012				2011
CASH FLOWS FROM OPERATING ACTIVITIES:
NET (LOSS) INCOME		$	(395,269	)		$	11,960,885
Adjustments to reconcile net (loss) income to net cash used in
operating activities:
Stock based compensation expense			25,777				33,279
Depreciation and amortization			73,144				269,754
Gain on redemption of preferred stock			-				(12,786,969	)
Gain on disposal of subsidiary			-				(2,910,565	)
Gain on sale of fixed asset			-				(54,475	)
Change in fair value associated with preferred stock and warrants liabilities			-				2,392,467
Amortization of deferred financing costs			-				141,710
Amortization of discount on Series A preferred stock			-				94,408
Bad debt expense			-				2,805
Deferred rent			-				13,844
Changes in operating assets and liabilities:
Accounts receivable			432,673				(605,653	)
Accounts receivable factoring			302				81,504
Deposits and other assets			-				14,255
Cost in excess of billing on uncompleted contracts, net			385,711				60,330
Prepaid expenses and other current assets			42,581				(44,954	)
Accounts payable and accrued expenses			(641,338	)			256,308
NET CASH USED IN OPERATING ACTIVITIES			(76,419	)			(1,081,067	)
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sale of fixed asset			-				429,697
Proceeds from disposal of subsidiary/redemption of preferred stock			-				1,000,000
Purchase of equipment			-				(6,273	)
NET CASH PROVIDED BY INVESTING ACTIVITIES			-				1,423,424
NET (DECREASE) INCREASE IN CASH			(76,419	)			342,357
CHANGE IN CASH OF DISCONTINUED OPERATIONS, INCLUDING
CASH DISPOSED OF AT THE TRANSACTION DATES			-				153,477
CASH AT BEGINNING OF YEAR			132,285				249,855
CASH AT THE END OF PERIOD		$	55,866			$	745,689
Supplemental disclosure of cash flow information:
Cash paid during the period for interest		$	-			$	-
Cash paid during the period for taxes		$	-			$	-
Non cash investing and financing activities:
Redemption of mandatorily redeemable preferred stock		$	-			$	16,500,000

 

 

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

 

 

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.

 

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. On March 22, 2011, the Company entered into a Securities Redemption Agreement, as more fully discussed in Note 5, with the holders of its Series A convertible preferred stock (the “Series A Holders”), pursuant to which the Company sold to the Series A Holders all of the issued and outstanding membership interests in APSG. As such the results of APSG have been reflected in discontinued operations for all periods presented.

 

In July 2011, the Company relocated its corporate headquarters and operations from Hicksville, NY to Lillington, NC. The Company's new address is 420 McKinney Pkwy, Lillington, NC 27546, see Note 6.

 

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 the opinion of management, 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, 2012 are not necessarily indicative of the results that may be expected for the year ending December 31, 2012. 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, 2011 filed on April 16, 2012.

 

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.

 

Principles of Consolidation

 

The consolidated financial statements include the accounts of American Defense Systems, Inc. and its wholly-owned subsidiaries, AJP and American Institute for Defense and Tactical Studies, Inc. (“AI”). All significant intercompany accounts and transactions have been eliminated in consolidation.

  

 

AMERICAN DEFENSE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

Management Liquidity Plans

 

As of March 31, 2012, the Company had a working capital deficit of $1,163,699, an accumulated deficit of $17,350,456, shareholders’ deficiency of $604,504 and cash on hand of $55,866. The Company had operating losses of $384,989 and $1,137,621 for the three months ended March 31, 2012 and 2011, respectively. The Company had losses from continuing operations for the three months ended March 31, 2012 of $395,269. The Company had income from continuing operations for the three months ended March 31, 2011 of $9,055,027, including a gain of $12,786,969 on the redemption of mandatorily redeemable preferred stock. The Company had a net loss of $395,269 and net income of $11,960,885 for the three months ended March 31, 2012 and 2011, respectively. The Company had net cash used in operations of $76,419 and $1,081,067 for the three months ended March 31, 2012 and 2011, respectively. The Company continues to explore all sources of increasing revenue. If the Company is unable in the near term to raise capital on commercially reasonable terms or increase revenue, it will not have sufficient cash to sustain its operations for the next twelve months. As a result, the Company may be forced to further reduce or even curtail its operations. These factors raise substantial doubt about the Company’s ability to continue as a going concern. The accompanying financial statements do not include any adjustments that might be necessary if the Company is unable to continue as a going concern.

 

Reclassifications

 

Certain amounts in the prior year financial statements have been reclassified for comparative purposes to conform to the presentation in the current year financial statements. These reclassifications had no effect on previously reported income.

 

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 condensed 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, and valuation of deferred tax assets.

 

Subsequent Events

 

The Company has evaluated events that occurred subsequent to March 31, 2012 through the date these financial statements were issued. Management concluded that no subsequent events required disclosure in these financial statements except as discussed in Notes 3 and 6.

 

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. However, no revenues, costs or profits are recognized in operations until the period of 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, 2012 and December 31, 2011, there were no such provisions made.

 

 

 

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, net.” 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.

 

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 has two suppliers, including a former subsidiary, that provided 24% and 12%, respectively, of its supply needs during the three months ended March 31, 2012. The Company had one supplier that provided 10% of its supply needs during the three months ended March 31, 2011. 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, 2012, the Company derived 91% of its revenues from two customers. For the three months ended March 31, 2011, the Company derived 16% and 64%, respectively, of its revenues from various U.S. government entities, and two other customers.

 

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, 2012 and December 31, 2011, the allowance for doubtful accounts was $451,761.

 

Long-Lived Assets

 

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

 

(Loss) Income per Share

 

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

  

 

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,
		2012				2011
Warrants to purchase Common Stock			675,001				675,001
Options to purchase Common Stock			1,055,000				2,479,000
Total potential Common Stock			1,730,001				3,154,001

  

Fair Value of Financial Instruments

 

Fair value of certain of the Company’s financial instruments including cash, accounts receivable, accounts payable, 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 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.

 

The Company did not have any assets or liabilities categorized as Level 1, Level 2 or Level 3 as of March 31, 2012 or December 31, 2011. There were no transfers into or out of Level 1 or Level 2 during the quarters ended March 31, 2012 or 2011.

 

 

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, net were $792,873 and $1,178,584 as of March 31, 2012 and December 31, 2011, respectively.

 

Backlog

The estimated gross revenue on work to be performed on backlog was approximately $5 million and $10 million as of March 31, 2012 and 2011, respectively.

 

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, 2012 and December 31, 2011, the Company had accounts receivable of $458,360 and $891,033, respectively and an allowance for doubtful accounts of $451,761. The Company recorded bad debt expense of $0 and $2,805 for the three months ended March 31, 2012 and 2011, 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. 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. Legal fees are expensed as incurred and are included in general and administrative expenses in the condensed consolidated statements of operations.

  

 

AMERICAN DEFENSE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

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. On April 2, 2008, the Company filed a response to the charges. On May 12, 2011, the Department of Labor dismissed the complaint.  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, stock conversion claim, as well as one claim for conversion of his personal property which Mr. Cusack has also asserted against the Company’s executive officers. On 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 amended complaint and filed counterclaims against Mr. Cusack for fraud and rescission of his contract. The parties submitted motions for summary judgment, and on August 19, 2010, the Court granted Mr. Cusack’s motion as to his stock conversion claim and narrowed certain issues as to his breach of contract claims. On July 19, 2011, the Appellate Division upheld the stock conversion decision but reversed the decision to narrow the issues as to the breach of contract claims. The trial has been scheduled for early June 2012. Mr. Cusack seeks damages in excess of $3,000,000. The Company intends to vigorously defend this action. While it is reasonably possible that an unfavorable outcome may occur, management has concluded that it is not probable that a loss has been incurred and it is unable to estimate the possible loss or range of loss that could result from an unfavorable outcome and accordingly, has not provided any amounts in the condensed consolidated financial statements for an unfavorable outcome.

 

On January 7, 2011, Action Group, Inc. commenced an action in the United States District Court for the Eastern District of New York. The complaint sought $1,187,510, plus interest, for goods allegedly sold to the Company, for which payment was not received. This amount is included in accounts payable in the consolidated balance sheet as of December 31, 2011. While the parties were engaged in settlement discussions, plaintiff sought and was granted entry of a default on February 8, 2011. Plaintiff then filed a motion with the Court, dated March 7, 2011, seeking entry of a default judgment in the amount of $1,246,542, representing the original demand set forth in the complaint, plus interest, costs and disbursements. On March 16, 2011, the Court issued an Order, directing Defendants to respond to the Court in writing within seven days as to why default judgment should not be entered. On March 28, 2011, counsel for the Company sought and obtained an Order from the Court extending its time to respond to the Court's March 16, 2011 Order up to and including April 11, 2011. On April 11, 2011, Defendants served and filed a motion to set aside the default entered against them, and in opposition to plaintiff's motion for entry of a default judgment. The Court subsequently granted the Defendants' motion, over Plaintiff's objection, and permitted Defendants to interpose an answer. The answer to the complaint was filed on June 13, 2011, and Defendants asserted several affirmative defenses to payment, including a claim for offset of amounts expended by Defendant to resolve issues with non-conforming goods supplied by Plaintiff. Following document discovery, the parties entered into a settlement agreement obligating Defendant American Defense Systems, Inc. to pay $1,174,882 to Action Group over 117 weeks, and otherwise releasing all claims and defenses asserted in the action. The action has since been discontinued, with prejudice, by the parties.

 

On January 6, 2012, a group led by Dale Scales (the “Scales Group”) filed a Schedule 13D with the Securities and Exchange Commission stating that it intended to ask the Board of Directors to call a special meeting of the Company’s stockholders for the purpose of removing the Company’s directors for cause and replacing them with candidates chosen by the Scales Group. The Board of Directors believes that this filing misleads the Company’s stockholders because, among other things, it fails to disclose that the Scales Group is acting in concert with Anthony Piscitelli, the Company’s former chief executive officer. In November 2011, the Board demanded Mr. Piscitelli’s resignation as a result of mismanagement and misconduct that included providing confidential information belonging to the Company to Mr. Scales in violation of the Board’s express instructions. On January 9, 2012, the Board of Directors of the Company amended the Company’s bylaws to eliminate the ability of stockholders to request special meetings of stockholders. Subsequently, the Board has declined to call a special meeting of stockholders despite having received a request from the Scales Group purporting to have been signed by the holders of more than two thirds of the Company’s outstanding shares. On April 3, 2012, Mr. Scales and a company controlled by him filed a civil action in the Court of Chancery of the State of Delaware against the Company and the current members of its Board of Directors. The caption of the action is Armor Technologies LLC v. American Defense Systems, Inc., Civil Action No. 7394-CS. The plaintiffs allege that the Company’s current directors have breached their fiduciary duties by amending the bylaws and declining to schedule the special meeting requested by the Scales Group. The plaintiffs ask the Court to declare the bylaw amendment invalid and order the Board of Directors to call the special meeting requested by the Scales Group. The plaintiffs also seek an award of compensatory damages in an unspecified amount. The Company and the Board of Directors believe the action is without merit and intend to defend themselves vigorously but cannot reasonably predict the outcome at this time.

 

 

 

AMERICAN DEFENSE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

4.	SHAREHOLDERS’ DEFICIENCY

 

The following table summarizes the changes in shareholders' deficiency for the three months ended March 31, 2012:

 

Balance - January 1, 2012		$	(235,012	)
Stock based compensation			25,777
Net loss			(395,269	)
Balance - March 31, 2012		$	(604,504	)

 

Warrants

 

The following is a summary of stock warrants outstanding at March 31, 2012:

 

		Warrants				Weighted Average Exercise Price				Weighted Average Remaining Contractual Lives (in years)
Balance – January 1, 2012			675,001			$	2.00				1.18
Granted			-				n/a				-
Exercised			-				n/a				-
Cancelled, Forfeited or expired			-				n/a				-
Balance – March 31, 2012			675,001			$	2.00				0.93
Exercisable – March 31, 2012			675,001

 

The fair value of the stock warrants as of March 31, 2012 and December 31, 2011 was not material.

 

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) income before taxes for the three months ended March 31, 2012 and 2011 included $25,777 and $33,279 of stock based compensation expense, 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.

 

 

 

AMERICAN DEFENSE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

The following is a summary of stock options outstanding at March 31, 2012:

  

				Stock Options				Weighted-Average Exercise Price				Aggregate Intrinsic Value				Weighted Average Remaining Contractual Life (In years)
Outstanding, January 1, 2012				2,040,000			$	1.57				-				3.47
Granted				-				n/a				n/a				n/a
Exercised				-				n/a				n/a				n/a
Cancelled/forfeited				(985,000	)			1.27				n/a				n/a
Outstanding, March 31, 2012				1,055,000			$	1.85				-				2.87
Exercisable, March 31, 2012				854,000			$	1.85								2.84

 

As of March 31, 2012, there was a total of $42,705 of unrecognized compensation arrangements granted under the Company’s 2007 Incentive Compensation Plan (the “2007 Plan”). The cost is expected to be recognized through 2015.

 

The Company did not issue any options during the three months ended March 31, 2012.

 

The Company issued 100,000 shares of common stock to non-employee directors as compensation under the 2007 Plan during the three months ended March 31, 2012. The fair value on the date of grant was $5,000 based on the stock price on the date of issuance. These awards were fully vested on the date of grant.

 

5.	DISCONTINUED OPERATIONS

 

APSG

 

On March 22, 2011, the Company entered into a Securities Redemption Agreement (the "Redemption Agreement") with the Series A Holders, pursuant to which the Company sold to the Series A Holders all of the issued and outstanding membership interests in APSG, the Company’s wholly-owned subsidiary. The Series A Holders owned an aggregate of 15,000 shares of the Series A Preferred. In exchange for the sale of the APSG interests to the Series A Holders, the Series A Holders (i) paid the Company $1,000,000 in cash at the closing of the transactions and (ii) tendered to the Company the Series A Preferred, which had an aggregate redemption price of $16,500,000. Upon the closing of the transactions, the Series A Holders own 100% of the APSG interests and APSG is no longer be a subsidiary of the Company.

 

In connection with the Redemption Agreement, the Company and the Series A Holders entered into a Membership Interest Option Agreement (the "Option Agreement") pursuant to which the Series A Holders granted the Company an option (the “Option”) to repurchase the APSG interests within six months following the closing of the transactions contemplated by the Redemption Agreement at a cash purchase price equal to the sum of (i) $15,525,000, plus (ii) the amount of any net investment made in APSG concurrently with and following the closing of the Redemption Agreement and prior to the closing of the purchase of the APSG membership interests pursuant to exercise of the Option. An analysis of the Option was performed and its value was deemed to be immaterial.

  

AMERICAN DEFENSE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

The presentation herein of the results of continuing operations excludes APSG for all periods presented. The following APSG amounts have been segregated from continuing operations and are reflected as discontinued operations in the condensed consolidated statement of operations for the three months ended March 31, 2012 and 2011:

 

		2012				2011
Revenues		$	-			$	969,291
Income from discontinued operations before income taxes			-				126,518
Gain on disposal of APSG			-				2,910,565
Income tax expense			-				-
Income from discontinued operations, net of tax		$	-			$	3,037,083

 

The total consideration the Company received in connection with the Redemption Agreement was $1.0 million in cash and the return and extinguishment of the mandatorily redeemable Series A Preferred which had a redemption value of $16.5 million. The Company allocated $4.4 million of the consideration to the sale of APSG based on a calculation of the fair value of APSG with the residual amount of the consideration allocated to the redemption of the Series A Preferred. The Company recorded a gain on the sale of APSG of approximately $3 million for the three months ended March 31, 2011 based on the difference between the allocated consideration and the net book value of APSG, including goodwill.

 

T2

During the second quarter of 2011, management decided to establish a plan to sell and or discontinue the operations of a portion of AI’s business consisting of the operation of a live-fire interactive tactical training range located in Hicksville, NY, hereinafter referred to as “T2”, therefore, the presentation herein of the results of continuing operations excludes T2 for all periods presented.

 

The following T2 amounts have been segregated from continuing operations and are reflected as discontinued operations in the condensed consolidated statement of operations for the three months ended March 31, 2012 and 2011:

 

		2012				2011
Revenues		$	-			$	20,500
Loss from discontinued operations, net of tax		$	-			$	131,225

 

The following T2 amounts have been segregated from continuing operations and are reflected as discontinued operations in the condensed consolidated balance sheets at March 31, 2012 and December 31, 2011:

 

		March 31, 2012				December 31, 2011
Current Assets:
Accounts receivable, net		$	10,774			$	10,774
Long-term Assets:
Property and equipment, net		$	15,895			$	15,895

  

Cash flows from discontinued operations were not reported separately for the three months ended March 31, 2012 and 2011.

  

 

AMERICAN DEFENSE SYSTEMS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

6.	LEASE TERMINATION

 

In connection with the Company’s relocation of its corporate headquarters and operations from Hicksville, NY to Lillington, NC, the Company surrendered the Premises in the building designated as 230 Duffy Avenue, Hicksville, NY, the “Premises” on July 15, 2011. On April 9, 2012, the Company entered into a lease termination agreement (the “Agreement”) with the landlord of the Premises. The Agreement states that the Company’s remaining payment obligation under the Lease is $82,878 as of April 9, 2012. This represents the balance of rental arrears on the Premises. The balance due on these rental arrears was $92,878 at March 31, 2012 and is included in accounts payable in the Company’s condensed consolidated balance sheet at March 31, 2012.

 

7.	INCOME TAXES

 

In its interim financial statements the Company follows the guidance in ASC 270, “Interim Reporting” (“ASC 270”) and ASC 740, “Income Taxes” (“ASC 740”) whereby the Company utilizes the expected annual effective tax rate in determining its income tax provisions for the interim period’s income or loss. That rate differs from the U.S. statutory rate primarily as a result of certain net operating loss carryforwards and permanent differences between book and tax reporting.

 

The Company does not expect that its unrecognized tax benefits will significantly change within the next twelve months. The Company files a consolidated U.S. income tax return and tax returns in certain state and local jurisdictions. There are no current tax examinations in progress. As of March 31, 2012, the Company remains subject to examination in applicable tax jurisdictions for the relevant statute of limitations periods.

 

 

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, 2011.

 

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.

 

Overview

 

We are a defense and security products company engaged in two business areas: customized transparent and opaque armor solutions for construction equipment and tactical and non-tactical transport vehicles used by the military; and architectural hardening and perimeter defense, such as bullet and blast resistant transparent armor, walls and doors. We disposed of the portion of our business related to the operation of a live-fire interactive tactical training range located in Hicksville, NY, hereinafter referred to as T2, during the year ended December 31, 2011. The portion of our business related to vehicle anti-ram barriers such as bollards, steel gates and steel wedges that deploy out of the ground was sold as of March 22, 2011.

 

We primarily serve the defense market. Our customers include various branches of the U.S. military through the U.S. Department of Defense 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 two customers. 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 shareholder value involves the following key elements:

 

·	We have put a new leadership and management team in place effective November 2, 2011 to reform Company operations;

 

·	We have moved Company operations to North Carolina to better focus our efforts and to provide a more competitive business environment;

 

·	We will diversify by selectively pursuing commercial opportunities in addition to our unique military and government activities;

 

·	We will re-invigorate efforts to develop strategic alliances and form favorable partnerships with original equipment manufacturers (OEMs); and

 

·	We will diligently research programs and efforts to capitalize on future requirements and demands for new armor and related force protection materials.

 

We are pursuing each of these growth strategies simultaneously.

 

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.

 

Our contract backlog as of March 31, 2012 was $5 million. We estimate that approximately $5 million of the backlog will be filled during the remainder of 2012. Accordingly, in order to maintain our current revenue levels and to generate revenue growth, we will need to win more contracts with the U.S. government and other commercial entities, achieve significant penetration into critical infrastructure and public safety protection markets, and successfully further develop our relationships with OEM's and strategic partners. Notwithstanding the possible significant troop reductions in Afghanistan and Iraq, we expect that demand in those countries for armored military construction vehicles will continue in order to repair significant war damage and for nation-building purposes. In addition, we are exploring interest in armored construction equipment in other countries with mine-infested regions.

 

 

We continue to aggressively bid on projects and are in preliminary talks with a number of international firms to pursue long-term government and commercial contracts, including with respect to Homeland Security. While no assurances can be given that we will obtain a sufficient number of contracts or that any contracts we do obtain will be of significant value or duration, we are confident that we will continue to have the opportunity to bid and win contracts as we have in 2011.

 

Cost of Revenues and Operating Expenses

 

Cost of Revenues. Cost of revenues consists of parts, direct labor and overhead expenses 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. As we have implemented various cost cutting measures, including a decrease in trade show participation and a reduction in headcount, in 2011, we expect that in 2012, sales and marketing expenses will decrease.

 

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. We expect that in 2012, research and development expenses will decrease. Research and development costs are charged to expense as incurred.

 

General and Administrative. General and administrative expenses consist of compensation and related expenses for finance, accounting, administrative, legal, professional fees, other corporate expenses and allocated overhead. We expect that in 2012, general and administrative expenses will continue to decrease due to cost cutting measures implemented in 2011. Cost cutting measures implemented include the Company’s relocation to Lillington, NC in July 2011, lower employee benefits due to reduced headcount, and restrictions on travel.

 

General and Administrative Salaries. General and administrative salaries expenses consist of compensation for the officers, IT, accounting, and design and engineering personnel. We expect that in 2012, general and administrative salaries expenses will decrease due to the cost cutting measures, which include reductions in employee headcount as well as salary reductions for remaining employees, implemented in 2011.

 

 

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 condensed 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, 2011, 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, 2012, there were no such provisions made.

 

 

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

 

Stock-Based Compensation. Stock based compensation consists of stock or options issued to employees, directors, consultants and contractors for services rendered. We account for the stock issued using the estimated current market price per share at the date of issuance. Such cost is 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:

 

In accordance with ASC 718 “Compensation–Stock Compensation” we record stock based compensation at fair value. 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.

 

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 $25,777 and $33,279 in stock compensation expense for the three months ended March 31, 2012 and 2011, respectively.

 

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. The following discussion excludes results of discontinued operations.

 

Comparison of the Three Months Ended March 31, 2012 and 2011

 

Revenues. Revenues for the three months ended March 31, 2012 were $1,889,610, a decrease of $626,042, or 25%, as compared to revenues of $2,515,652 in the comparable period in 2011. This decrease was due primarily to a ship armoring project completed in the first quarter of 2011 and a reduction in the number of Field Service Representatives under contract from 3 in the first quarter of 2011 to 1 in the first quarter of 2012.

 

Cost of Revenues. Cost of revenues for the three months ended March 31, 2012 was $1,291,307, a decrease of $92,984, or 7%, over cost of revenues of $1,384,291 in the comparable period in 2011. This decrease resulted primarily from the decline in revenue.

 

Gross Profit. Gross profits for the three months ended March 31, 2012 and 2011 were $598,303 and $1,131,361, respectively. Gross profit margin was 32% and 45% for three months ended March 31, 2012 and 2011, respectively. The decrease in gross profit margin resulted primarily from an inventory overhead allocation adjustment in first quarter of 2012 due to lower levels of inventory.

 

Sales and Marketing Expenses. Sales and marketing expenses for the three months ended March 31, 2012 and 2011 were $41,113 and $171,403, respectively, representing a decrease of $130,290, or 76%. The decrease was due primarily to a decrease in trade show expenses and related expenses from selling and marketing including use of outside consultants.

 

Research and Development Expenses. Research and development expenses for the three months ended March 31, 2012 and 2011 were $19,731 and $115,159, respectively, a decrease of $95,428 or 83% due to a reduction in the number of employees from 3 full-time employees to 1 part-time employee.

 

General and Administrative Expenses. General and administrative expenses for the three months ended March 31, 2012 and 2011 were $275,290 and $817,018, respectively. The decrease of $541,728 or 66% was due primarily to lower overhead costs resulting from the Company’s relocation to Lillington, NC in July 2011, lower general liability insurance due to decreased sales, reduction in employee benefits related to reduced headcount, and a reduction in travel expenses.

  

 

General and Administrative Salaries Expense. General and administrative salaries expenses for the three months ended March 31, 2012 and 2011 were $362,862 and $703,895, respectively. The decrease of $341,033 or 48% was due primarily to a reduction in headcount of 8 employees, as well as salary reductions for remaining employees.

 

Depreciation and Amortization Expense. Depreciation and amortization expense was $73,144 and $222,643 for the three months ended March 31, 2012 and 2011, respectively, a decrease of $149,499, or 67% due to the absence of depreciation on leasehold improvements on the Company’s Hicksville, NY facility which was vacated in July 2011.

 

Professional Fees. Professional fees for the three months ended March 31, 2012 and 2011 were $211,152 and $238,864, respectively. The decrease of $27,712 or 12% was due primarily to a decrease in consulting fees.

 

Other (Income) and Expense. Our Series A Preferred was recorded at fair value through March 22, 2011 with changes in fair value recorded in the statement of operations. We experienced a loss on adjustment of fair value with respect to our Series A Preferred of $2,395,592 for the three months ended March 31, 2011. In addition, we incurred interest expense associated with the amortization of the deferred financing costs and discount on the Series A Preferred of $236,118 for the three months ended March 31, 2011. We recorded a gain on the redemption of our Series A Preferred of $12,786,969 for the three months ended March 31, 2011.

 

Income from Discontinued Operation. We recorded income from discontinued operations of $0 and $2,905,858 for the three months ended March 31, 2012 and 2011, respectively. See Note 5 of the accompanying condensed consolidated financial statements.

 

Liquidity and Capital Resources

 

The primary sources of our liquidity during the three months ended March 31, 2012 are net accounts receivable of $458,360 and costs in excess of billings of $792,873 as well as our ability to sell future accounts receivable under an accounts receivable purchase agreement with Republic Capital Access (RCA).

 

As of March 31, 2012, the Company had a working capital deficit of $1,163,699, an accumulated deficit of $17,350,456, shareholders’ deficiency of $604,504 and cash on hand of $55,866. The Company had operating losses of $384,989 and $1,137,621 for the three months ended March 31, 2012 and 2011, respectively. The Company had losses from continuing operations for the three months ended March 31, 2012 of $395,269. The Company had income from continuing operations for the three months ended March 31, 2011 of $9,055,027, including a gain of $12,786,969 on the redemption of mandatorily redeemable preferred stock. The Company had a net loss of $395,269 and net income of $11,960,885 for the three months ended March 31, 2012 and 2011, respectively. The Company had net cash used in operations of $76,419 and $1,081,067 for the three months ended March 31, 2012 and 2011, respectively. The Company continues to explore all sources of increasing revenue. If the Company is unable in the near term to raise capital on commercially reasonable terms or increase revenue, it will not have sufficient cash to sustain its operations for the next twelve months. As a result, the Company may be forced to further reduce or even curtail its operations. These factors raise substantial doubt about the Company’s ability to continue as a going concern. The accompanying financial statements do not include any adjustments that might be necessary if the Company is unable to continue as a going concern.

 

Net Cash Used In Operating Activities. Net cash used in operating activities was $76,419 and $1,081,067 for the three months ended March 31, 2012 and 2011, respectively. Net cash used in operating activities during the three months ended March 31, 2012 consisted primarily of changes in our operating assets and liabilities of $219,929, including changes in accounts receivable, cost in excess of billing, prepaid expenses and other current assets, and accounts payable and accrued expenses, as well as an operating loss of $384,989. Net cash used in operating activities during the three months ended March 31, 2011 consisted primarily of changes in our operating assets and liabilities of $238,210 including accounts receivable, cost in excess of billing, prepaid expenses and other current assets, and accounts payable and accrued expenses as well as an operating loss of $1,137,621.

 

Net Cash Provided By Investing Activities. Net cash provided by investing activities for the three months ended March 31, 2012 was $0. Net cash provided by investing activities for the three months ended March 31, 2011 was $1,423,424 and consisted of $1,000,000 of proceeds from the sale of APSG and the redemption of the Series A Preferred, as well as proceeds from the sale of a fixed asset of 429,697, partially offset by leasehold improvements and purchases of computer equipment.

 

Cash flows from discontinued operations were not reported separately for the three months ended March 31, 2012 and 2011. Cash flows from discontinued operations were $153,477 for the three months ended March 31, 2011. The absence of these cash flows is not expected to have a material effect on our future liquidity or capital resources.

  

 

Accounts Receivable Purchase Agreement

 

In July 2009, we entered into an accounts receivable purchase agreement with Republic Capital Access, LLC (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, (Program Continuance Fee), 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.

 

The initial term of the purchase agreement ended on December 31, 2009 and will renew annually after the initial term, unless earlier terminated by either of the parties. Pursuant to an amendment to the purchase agreement in October 2009, the term during which we may offer and sell eligible accounts receivable to RCA (Availability Period) was extended from December 31, 2009 to October 15, 2010, and the discount factor rate was reduced from 0.524% to 0.4075%. On November 12, 2010, the term was further extended to October 15, 2011. On November 9, 2011, we signed an amendment to the purchase agreement which extended the term to December 31, 2012, eliminated the Program Continuance Fee and added a Commitment Fee equal to 1% of the difference between the outstanding receivable balance and $1 million. As of March 31, 2012, there was $48,105 in accounts receivable for which RCA had not received payment from our customers.

 

Item 3. Quantitative and Qualitative Disclosure About Market Risk

 

We are a smaller reporting company as defined by Rule 12b-2 of the Securities Exchange Act of 1934 (or Exchange Act) and are not required to provide the information required under this Item 3.

 

 

 

Item 4. Controls and Procedures

 

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, 2012 because of the material weakness set forth below.

 

The following is a summary of the material weaknesses we identified as of December 31, 2011 which remain as of March 31, 2012:

 

Due to the reduction in accounting staff during 2011, we did not have a sufficient number of accounting personnel in order to have adequate segregation of duties. In addition, we did not have a sufficient number of trained accounting personnel with expertise in GAAP to ensure that complex, material and/or non-routine transactions were properly reflected in the consolidated financial statements. However, all such transactions have been properly disclosed in the accompanying condensed consolidated financial statements as of March 31, 2012 and December 31, 2011.

 

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.

 

Changes in Internal Controls

 

There were no changes in our internal controls over financial reporting during the quarter ended March 31, 2012 that have materially affected, or are reasonably likely to affect, our internal control over financial reporting.

 

Limitations on the Effectiveness of Controls

 

Our management, including our Chief Executive Officer and Chief Financial Officer, 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 our company 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 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. On April 2, 2008, the Company filed a response to the charges. On May 12, 2011, the Department of Labor dismissed the complaint.  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, stock conversion claim, as well as one claim for conversion of his personal property which Mr. Cusack has also asserted against the Company’s executive officers. On 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 amended complaint and filed counterclaims against Mr. Cusack for fraud and rescission of his contract. The parties submitted motions for summary judgment, and on August 19, 2010, the Court granted Mr. Cusack’s motion as to his stock conversion claim and narrowed certain issues as to his breach of contract claims. On July 19, 2011, the Appellate Division upheld the stock conversion decision but reversed the decision to narrow the issues as to the breach of contract claims. The trial has been scheduled for early June 2012. Mr. Cusack seeks damages in excess of $3,000,000. The Company intends to vigorously defend this action. While it is reasonably possible that an unfavorable outcome may occur, management has concluded that it is not probable that a loss has been incurred and it is unable to estimate the possible loss or range of loss that could result from an unfavorable outcome and accordingly, has not provided any amounts in the condensed consolidated financial statements for an unfavorable outcome.

 

On January 7, 2011, Action Group, Inc. commenced an action in the United States District Court for the Eastern District of New York. The complaint sought $1,187,510, plus interest, for goods allegedly sold to the Company, for which payment was not received. This amount is included in accounts payable in the consolidated balance sheet as of December 31, 2011. While the parties were engaged in settlement discussions, plaintiff sought and was granted entry of a default on February 8, 2011. Plaintiff then filed a motion with the Court, dated March 7, 2011, seeking entry of a default judgment in the amount of $1,246,542, representing the original demand set forth in the complaint, plus interest, costs and disbursements. On March 16, 2011, the Court issued an Order, directing Defendants to respond to the Court in writing within seven days as to why default judgment should not be entered. On March 28, 2011, counsel for the Company sought and obtained an Order from the Court extending its time to respond to the Court's March 16, 2011 Order up to and including April 11, 2011. On April 11, 2011, Defendants served and filed a motion to set aside the default entered against them, and in opposition to plaintiff's motion for entry of a default judgment. The Court subsequently granted the Defendants' motion, over Plaintiff's objection, and permitted Defendants to interpose an answer. The answer to the complaint was filed on June 13, 2011, and Defendants asserted several affirmative defenses to payment, including a claim for offset of amounts expended by Defendant to resolve issues with non-conforming goods supplied by Plaintiff. Following document discovery, the parties entered into a settlement agreement obligating Defendant American Defense Systems, Inc. to pay $1,174,882 to Action Group over 117 weeks, and otherwise releasing all claims and defenses asserted in the action. The action has since been discontinued, with prejudice, by the parties.

 

On January 6, 2012, a group led by Dale Scales (the “Scales Group”) filed a Schedule 13D with the Securities and Exchange Commission stating that it intended to ask the Board of Directors to call a special meeting of the Company’s stockholders for the purpose of removing the Company’s directors for cause and replacing them with candidates chosen by the Scales Group. The Board of Directors believes that this filing misleads the Company’s stockholders because, among other things, it fails to disclose that the Scales Group is acting in concert with Anthony Piscitelli, the Company’s former chief executive officer. In November 2011, the Board demanded Mr. Piscitelli’s resignation as a result of mismanagement and misconduct that included providing confidential information belonging to the Company to Mr. Scales in violation of the Board’s express instructions. On January 9, 2012, the Board of Directors of the Company amended the Company’s bylaws to eliminate the ability of stockholders to request special meetings of stockholders. Subsequently, the Board has declined to call a special meeting of stockholders despite having received a request from the Scales Group purporting to have been signed by the holders of more than two thirds of the Company’s outstanding shares. On April 3, 2012, Mr. Scales and a company controlled by him filed a civil action in the Court of Chancery of the State of Delaware against the Company and the current members of its Board of Directors. The caption of the action is Armor Technologies LLC v. American Defense Systems, Inc., Civil Action No. 7394-CS. The plaintiffs allege that the Company’s current directors have breached their fiduciary duties by amending the bylaws and declining to schedule the special meeting requested by the Scales Group. The plaintiffs ask the Court to declare the bylaw amendment invalid and order the Board of Directors to call the special meeting requested by the Scales Group. The plaintiffs also seek an award of compensatory damages in an unspecified amount. The Company and the Board of Directors believe the action is without merit and intend to defend themselves vigorously but cannot reasonably predict the outcome at this time.

 

 

 

Item 1A. Risk Factors

 

None.

 

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

 

None.

 

Item 3. Defaults Upon Senior Securities

 

None.

 

Item 4. (Removed and Reserved)

 

Item 5. Other Information

 

None.

 

 

 

Item 6. Exhibits

 

Exhibit

Number Exhibit

 

31.1*   Certification of Chairman and Chief Executive Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a), promulgated under the Securities Exchange Act of 1934, as amended.

 

31.2*   Certification of Chief Financial Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a), promulgated under the Securities Act of 1934, as amended.

 

32.1*   Certification of Chairman and Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

_________________

 

* Filed herewith.

  

 

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 15, 2012	By:	/s/ Gary Sidorsky
		Gary Sidorsky Chief Financial Officer

  

 

Index to Exhibits

  

Exhibit
Number		Exhibit
31.1		Certification of Chairman and Chief Executive Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a), promulgated under the Securities Exchange Act of 1934, as amended.
31.2		Certification of Chief Financial Officer pursuant to Rule 13a-14(a) and Rule 15d-14(a), promulgated under the Securities Act of 1934, as amended.
32.1		Certification of Chairman and Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.