ADFS American Defense Systems Inc (CE)

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 favorably resolved all outstanding litigation against the Company including the cases involving Thomas Cusack, Action Group Inc., and the Scales Group, as more fully discussed in PART II, Item 1, Legal Proceedings.

·         We have decreased general and administrative expenses for the nine months ended September 30, 2012 by approximately $2.3 million or 75% compared to the nine months ended September 30, 2011. The decrease included approximately $1.2 million in rent expense for the termination of the Hicksville lease which was recorded in the third quarter of 2011 and reversed in the fourth quarter of 2011. Excluding that, general and administrative expenses decreased approximately $1.1 million or 58%. The decrease was due primarily to lower overhead costs resulting from the Company’s relocation to Lillington, NC in July 2011, a reduction in employee benefits related to reduced headcount, and an overall cost cutting program initiated by the Board of Directors. These changes will enable us 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 September 30, 2012 was $3 million. We estimate that approximately $800,000 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 to pursue long-term government and commercial contracts, including with respect to Homeland Security. There can be no assurance that we will obtain a sufficient number of contracts or that any contracts obtained will be of significant value or duration.

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 revenues 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 September 30, 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 $40,864 and $115,310 in stock compensation expense for the nine months ended September 30, 2012 and 2011, respectively, and $3,644 and $40,203 for the three months ended September 30, 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 Nine Months Ended September 30, 2012 and 2011

Revenues. Revenues for the nine months ended September 30, 2012 were $5,225,489, a decrease of $1,768,157, or 25%, as compared to revenues of $6,993,646 in the comparable period in 2011. This decrease was due primarily to a ship armoring project completed during the nine months ended September 30, 2011 and a reduction in the number of Field Service Representatives under contract from 3 in 2011 to 1 in 2012.

Cost of Revenues. Cost of revenues for the nine months ended September 30, 2012 was $2,988,400, a decrease of $1,149,871, or 28%, over cost of revenues of $4,138,271 in the comparable period in 2011. This decrease resulted primarily from the decline in revenue.

Gross Profit . Gross profits for the nine months ended September 30, 2012 and 2011 were $2,237,089 and $2,855,375, respectively. Gross profit margin was 43% and 41% for nine months ended September 30, 2012 and 2011, respectively. The increase in gross profit margin resulted primarily from a better product mix.

Sales and Marketing Expenses. Sales and marketing expenses for the nine months ended September 30, 2012 and 2011 were $111,881 and $343,357, respectively, representing a decrease of $231,476, or 67%. The decrease was due primarily to a decrease in trade show expenses and related expenses from selling and marketing including use of outside consultants of approximately $116,000, as well as a reduction in headcount of approximately $107,000.

Research and Development Expenses. Research and development expenses for the nine months ended September 30, 2012 and 2011 were $53,776 and $206,815, respectively, a decrease of $153,039, or 74%, 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 nine months ended September 30, 2012 and 2011 were $779,883 and $3,080,834, respectively. The decrease of $2,300,951, or 75%, was due primarily to lower overhead costs resulting from the Company’s relocation to Lillington, NC in July 2011 of approximately $307,000, lower general liability insurance due to decreased sales of approximately $97,000, reduction in employee benefits related to reduced headcount of approximately $260,000, and an overall cost cutting program initiated by the Board of Directors of approximately $326,000. In addition, approximately $1.2 million in rent expense for the termination of the Hicksville lease which was reversed in the fourth quarter of 2011.

General and Administrative Salaries Expense. General and administrative salaries expenses for the nine months ended September 30, 2012 and 2011 were $1,072,156 and $1,798,914, respectively. The decrease of $726,758, or 40%, was due primarily to a reduction in headcount of 12 employees, as well as salary reductions for remaining employees.

Depreciation and Amortization Expense. Depreciation and amortization expense was $179,918 and $530,483 for the nine months ended September 30, 2012 and 2011, respectively, a decrease of $350,565, or 66%, due to the absence of depreciation on leasehold improvements on the Company’s Hicksville, NY facility which was vacated in July 2011.

Impairment of Fixed Assets. We recorded an impairment on the leasehold improvements of our Hicksville facility of $204,846 for the nine months ended September 30, 2011.

Professional Fees. Professional fees for the nine months ended September 30, 2012 and 2011 were $536,153 and $705,326, respectively. The decrease of $169,173, or 24%, was primarily the result of a negotiated reduction in previously billed fees from our prior outside legal counsel that was recognized in the third quarter of 2012.

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 nine months ended September 30, 2011. In addition, we incurred interest expense associated with the amortization of the deferred financing costs and discount on the Series A Preferred of $236,373 for the nine months ended September 30, 2011. We recorded a gain on the redemption of our Series A Preferred of $12,786,969 for the nine months ended September 30, 2011.

(Loss) Income from Discontinued Operations. We recorded a loss from discontinued operations of $26,669 for the nine months ended September 30, 2012 related to the impairment of the remaining assets of T2. We recorded income from discontinued operations of $2,510,766 for the nine months ended September 30, 2011, including a gain on the disposal of APSG of $2,910,565. See Note 5 of the accompanying condensed consolidated financial statements.

Comparison of the Three Months Ended September 30, 2012 and 2011

Revenues. Revenues for the three months ended September 30, 2012 were $1,601,032, a decrease of $1,017,512, or 39%, as compared to revenues of $2,618,544 in the comparable period in 2011. This decrease was due primarily to a slow-down in government orders and a reduction in the number of Field Service Representatives under contract from three in the third quarter of 2011 to none in the third quarter of 2012.

Cost of Revenues. Cost of revenues for the three months ended September 30, 2012 was $907,923, a decrease of $714,238, or 44%, over cost of revenues of $1,622,161 in the comparable period in 2011. This decrease resulted primarily from the decline in revenue.

Gross Profit . Gross profits for the three months ended September 30, 2012 and 2011 were $693,109 and $996,383, respectively. Gross profit margin was 43% and 38% for three months ended September 30, 2012 and 2011, respectively. The increase in gross profit margin resulted primarily from the Company working with the government to close out existing contracts that resulted in additional billings.

Sales and Marketing Expenses. Sales and marketing expenses for the three months ended September 30, 2012 and 2011 were $39,347 and $70,443, respectively, representing a decrease of $31,096, or 44%. 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 September 30, 2012 and 2011 were $16,910 and $22,800, respectively, a decrease of $5,890, or 26%, due to a reduction in the number of employees from three full-time employees to one part-time employee.

General and Administrative Expenses. General and administrative expenses for the three months ended September 30, 2012 and 2011 were $262,853 and $1,490,077, respectively. The decrease of $1,227,224, or 82%, was due primarily to approximately $1.2 million in rent expense for the termination of the Hicksville lease which was reversed in the fourth quarter of 2011.

General and Administrative Salaries Expense. General and administrative salaries expenses for the three months ended September 30, 2012 and 2011 were $366,655 and $445,965, respectively. The decrease of $79,310, or 18%, was due primarily to salary reductions for remaining employees.

Depreciation and Amortization Expense. Depreciation and amortization expense was $49,124 and $96,887 for the three months ended September 30, 2012 and 2011, respectively, a decrease of $47,763, or 49%, due to the absence of depreciation on leasehold improvements on the Company’s Hicksville, NY facility which was vacated in July 2011.

Impairment of Fixed Assets. We recorded an impairment on the leasehold improvements of our Hicksville facility of $204,846 for the three months ended September 30, 2011.

Professional Fees. Professional fees for the three months ended September 30, 2012 and 2011 were $25,795 and $204,269, respectively. The decrease of $178,474, or 87%, was primarily the result of a negotiated reduction in previously billed fees from our prior outside legal counsel that was recognized in the third quarter of 2012.

Loss from Discontinued Operations. We recorded losses from discontinued operations of $0 and $14,270 for the three months ended September 30, 2012 September 30, 2011, respectively, related to T2. See Note 5 of the accompanying condensed consolidated financial statements.

Liquidity and Capital Resources

The primary sources of our liquidity during the nine months ended September 30, 2012 were net accounts receivable of $305,272 and costs in excess of billings of $696,912 as well as our ability to sell future accounts receivable under an accounts receivable purchase agreement with Republic Capital Access (RCA).

As of September 30, 2012, the Company had a working capital deficit of $1,232,939, an accumulated deficit of $17,557,452, shareholders’ deficiency of $796,413 and cash on hand of $150,740. The Company has experienced substantial historical losses. The Company had net cash used in operations of $43,545 and $1,725,258 for the nine months ended September 30, 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 beyond December 31, 2012. 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 $43,545 and $1,725,258 for the nine months ended September 30, 2012 and 2011, respectively. Net cash used in operating activities during the nine months ended September 30, 2012 consisted primarily of changes in our operating assets and liabilities of $183,023, 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 $546,678. Net cash used in operating activities during the nine months ended September 30, 2011 consisted primarily of changes in our operating assets and liabilities of $199,804 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 $4,060,200.

Net Cash Provided By Investing Activities. Net cash provided by investing activities for the nine months ended September 30, 2012 was $62,000 and consisted of proceeds from the sale of a fixed asset. Net cash provided by investing activities for the nine months ended September 30, 2011 was $1,422,441 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 nine months ended September 30, 2012 and 2011. Cash flows from discontinued operations were $154,800 for the nine months ended September 30, 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 September 30, 2012, there was $0 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, as amended (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 September 30, 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 September 30, 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 September 30, 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 September 30, 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, which was dismissed on May 12, 2011. On March 7, 2008, Mr. Cusack also commenced an action against the Company in New York State Supreme Court, Nassau County, for breach of contract and conversion of stock arising from his termination of employment, and on November 5, 2008, the Company filed counterclaims against Mr. Cusack for fraud and rescission. On June 4, 2012, the parties reached a settlement, which the parties are finalizing. The Company recorded $50,000 in settlement costs which are included in accrued expenses in the condensed consolidated balance sheet as of September 30, 2012.

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 sought an award of compensatory damages in an unspecified amount. On May 9, 2012, the Company filed an answer to the complaint. During the nine months ended September 30, 2012, the Company incurred approximately $133,000 in legal fees associated with this matter. On June 4, 2012, the plaintiffs dismissed the action with prejudice.

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.

* 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.