Table of Contents
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 June 30, 2008
Commission
File Number 000-53092
American
Defense Systems, Inc.
(
Exact Name of Registrant as
Specified in Its Charter)
Delaware
|
|
83-0357690
|
(State or Other
Jurisdiction of Incorporation or
Organization)
|
|
(I.R.S. Employer
Identification No.)
|
230 Duffy Avenue
Hicksville, NY 11801
(516) 390-5300
(Address including zip
code, and telephone number, including area code, of principal executive
offices)
Indicate by check
mark whether the registrant (1) has filed all reports required to be filed
by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes
x
No
o
Indicate by check
mark whether the registrant is a large accelerated filer, an accelerated filer,
a non-accelerated filer, or a smaller reporting company. See definition of accelerated filer, large
accelerated filer and smaller reporting company in Rule 12b-2 of the
Exchange Act. (Check one):
Large Accelerated Filer
o
Accelerated Filer
o
Non-Accelerated
Filer
o
Smaller
Reporting Company
x
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act).
Yes
o
No
x
As of August 11, 2008, 39,358,202 shares of common stock, par
value $0.001 per share, of the registrant were outstanding.
Table of Contents
PART I
Item 1. Consolidated Financial Statements
AMERICAN DEFENSE SYSTEMS,
INC. AND SUBSIDIARIES
CONSOLIDATED
BALANCE SHEETS
|
|
June 30,
|
|
December 31,
|
|
|
|
2008
|
|
2007
|
|
|
|
(Unaudited)
|
|
(Audited)
|
|
ASSETS
|
|
|
|
|
|
Current Assets:
|
|
|
|
|
|
Cash
|
|
$
|
6,613,517
|
|
$
|
1,479,886
|
|
Accounts receivable, net
|
|
5,491,623
|
|
6,711,161
|
|
Inventory
|
|
1,271,365
|
|
737,458
|
|
Prepaid expenses and other current assets
|
|
2,940,532
|
|
1,856,236
|
|
Deferred tax asset
|
|
4,136,982
|
|
4,136,982
|
|
Costs in excess of billings on uncompleted contracts
|
|
8,462,308
|
|
5,011,974
|
|
Deposits
|
|
656,430
|
|
608,020
|
|
Total current assets
|
|
29,572,757
|
|
20,541,718
|
|
|
|
|
|
|
|
Property and equipment, net
|
|
3,151,815
|
|
1,194,676
|
|
|
|
|
|
|
|
Deferred financing cost
|
|
1,721,131
|
|
|
|
|
|
|
|
|
|
Goodwill
|
|
1,950,000
|
|
1,680,361
|
|
|
|
|
|
|
|
Advances for future acquisitions
|
|
525,350
|
|
138,000
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
36,921,053
|
|
$
|
23,554,754
|
|
|
|
|
|
|
|
LIABILITIES AND STOCKHOLDERS EQUITY
|
|
|
|
|
|
Current liabilities:
|
|
|
|
|
|
Accounts payable
|
|
$
|
3,827,283
|
|
$
|
4,381,930
|
|
Accrued payroll
|
|
374,847
|
|
205,230
|
|
Accrued expenses
|
|
329,914
|
|
599,258
|
|
Dividends payable
|
|
401,252
|
|
|
|
Due to Tactical Applications Group
|
|
250,000
|
|
1,512,741
|
|
Deferred tax liability
|
|
3,965,150
|
|
3,965,150
|
|
Short term notes payable
|
|
142,903
|
|
64,947
|
|
Total current liabilities
|
|
9,291,349
|
|
10,729,256
|
|
|
|
|
|
|
|
Long term notes payable
|
|
|
|
27,670
|
|
|
|
|
|
|
|
Mandatorily redeemable Series A Convertible
Preferred Stock (cumulative). 5,000,000 shares authorized, 15,000 shares
issued and outstanding
|
|
12,437,584
|
|
|
|
|
|
|
|
|
|
Investor warrant liability
|
|
265,604
|
|
|
|
|
|
|
|
|
|
Total liabilities
|
|
21,994,537
|
|
10,756,926
|
|
|
|
|
|
|
|
Stockholders equity:
|
|
|
|
|
|
Common stock, $0.001 par value, 100,000,000 shares
authorized, 39,349,050 and 38,957,950 shares issued and outstanding as of
June 30, 2008 and December 31, 2007
|
|
49,055
|
|
48,379
|
|
Additional paid-in capital
|
|
10,219,832
|
|
9,765,432
|
|
Retained earnings
|
|
4,657,629
|
|
2,984,017
|
|
Total stockholders equity
|
|
14,926,516
|
|
12,797,828
|
|
Total liabilities and stockholders equity
|
|
$
|
36,921,053
|
|
$
|
23,554,754
|
|
The accompanying notes
are an integral part of these consolidated financial statements.
3
Table of Contents
AMERICAN DEFENSE SYSTEMS,
INC. AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF OPERATIONS
|
|
For the three months ended June 30,
|
|
For the six months ended June 30,
|
|
|
|
2008
|
|
2007
|
|
2008
|
|
2007
|
|
|
|
(Unaudited)
|
|
(Unaudited)
|
|
(Unaudited)
|
|
(Unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
Contract revenues earned
|
|
$
|
9,136,078
|
|
$
|
10,403,510
|
|
$
|
18,556,198
|
|
$
|
16,567,366
|
|
|
|
|
|
|
|
|
|
|
|
Cost of revenues earned
|
|
6,301,895
|
|
6,303,969
|
|
11,768,573
|
|
9,612,296
|
|
|
|
|
|
|
|
|
|
|
|
Gross profit
|
|
2,834,183
|
|
4,099,541
|
|
6,787,625
|
|
6,955,070
|
|
|
|
|
|
|
|
|
|
|
|
Operating expenses
|
|
|
|
|
|
|
|
|
|
Research and development expense
|
|
203,956
|
|
97,972
|
|
369,152
|
|
235,625
|
|
Marketing expense
|
|
727,260
|
|
609,488
|
|
1,359,567
|
|
1,279,683
|
|
General and administrative expense
|
|
728,099
|
|
828,101
|
|
2,656,407
|
|
1,419,234
|
|
General and administrative salaries expense
|
|
1,097,243
|
|
747,147
|
|
2,254,651
|
|
1,473,569
|
|
Depreciation
|
|
147,666
|
|
91,008
|
|
282,435
|
|
174,979
|
|
Settlement of litigation
|
|
|
|
2,400
|
|
57,377
|
|
85,587
|
|
Loss on disposal of fixed assets
|
|
|
|
|
|
|
|
136
|
|
Total operating expenses
|
|
2,904,224
|
|
2,376,116
|
|
6,979,589
|
|
4,668,813
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) from operations
|
|
(70,041
|
)
|
1,723,425
|
|
(191,964
|
)
|
2,286,257
|
|
|
|
|
|
|
|
|
|
|
|
Other income and (expense):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gain on adjustment of fair value Series A
convertible preferred stock classified as a liability
|
|
2,605,159
|
|
|
|
1,176,494
|
|
|
|
Gain on investor warrant liability
|
|
1,421,432
|
|
|
|
1,313,843
|
|
|
|
Other income (expense)
|
|
10,159
|
|
33,387
|
|
(3,423
|
)
|
33,387
|
|
Interest expense
|
|
(243,780
|
)
|
(3,716
|
)
|
(310,167
|
)
|
3,716
|
|
Interest income
|
|
48,305
|
|
65,542
|
|
90,081
|
|
(65,542
|
)
|
Total other income (expense)
|
|
3,841,275
|
|
95,213
|
|
2,266,828
|
|
(28,439
|
)
|
Net income before income taxes
|
|
3,771,234
|
|
1,818,638
|
|
2,074,864
|
|
2,257,818
|
|
|
|
|
|
|
|
|
|
|
|
Provision for income taxes
|
|
|
|
283,638
|
|
|
|
283,638
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
3,771,234
|
|
$
|
1,535,000
|
|
$
|
2,074,864
|
|
$
|
1,974,180
|
|
|
|
|
|
|
|
|
|
|
|
Preferred stock dividend payable
|
|
(401,252
|
)
|
|
|
(401,252
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income allocated to common stock shareholders
|
|
3,369,982
|
|
1,535,000
|
|
1,673,612
|
|
1,974,180
|
|
|
|
|
|
|
|
|
|
|
|
Net income per share basic and diluted
|
|
$
|
0.09
|
|
$
|
0.04
|
|
$
|
0.04
|
|
$
|
0.05
|
|
Weighted average number of shares outstanding during
the year basic and diluted
|
|
39,204,753
|
|
37,300,000
|
|
39,069,337
|
|
37,300,000
|
|
The accompanying notes
are an integral part of these consolidated financial statements.
4
Table of Contents
AMERICAN DEFENSE SYSTEMS,
INC.
AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF CASH FLOWS
For the six months ended
June 30,
|
|
2008
|
|
2007
|
|
|
|
(Unaudited)
|
|
(Unaudited)
|
|
|
|
|
|
|
|
Cash flows from operating activities:
|
|
|
|
|
|
Net income
|
|
$
|
2,074,864
|
|
$
|
1,974,180
|
|
|
|
|
|
|
|
Adjustments to reconcile net income to net cash used
in operating activities:
|
|
|
|
|
|
Change in fair value associated with preferred stock
and warrants
|
|
(2,490,337
|
)
|
|
|
Stock based compensation expense
|
|
54,297
|
|
|
|
Amortization of deferred financing costs
|
|
147,747
|
|
|
|
Discount on Series A preferred stock
|
|
154,604
|
|
|
|
Depreciation and amortization
|
|
282,435
|
|
145,986
|
|
|
|
|
|
|
|
Changes in operating assets and liabilities:
|
|
|
|
|
|
Restricted cash
|
|
|
|
216,101
|
|
Accounts receivable
|
|
1,219,538
|
|
(2,119,473
|
)
|
Inventories
|
|
(533,907
|
)
|
18,050
|
|
Deposits and other assets
|
|
(48,410
|
)
|
|
|
Cost in excess of billing on uncompleted contracts
|
|
(3,450,334
|
)
|
(1,747,650
|
)
|
Prepaid expenses and other assets
|
|
(1,485,548
|
)
|
(725,324
|
)
|
Deferred financing costs
|
|
(416,886
|
)
|
|
|
Advances for future acquisitions
|
|
(387,350
|
)
|
|
|
Investment in affiliate
|
|
(1,669,350
|
)
|
(40,000
|
)
|
Accounts payable and accrued expenses
|
|
(604,801
|
)
|
(515,308
|
)
|
Accrued liabilities
|
|
169,617
|
|
617,114
|
|
Due to related party
|
|
262,741
|
|
|
|
|
|
|
|
|
|
Net cash used in operating activities
|
|
(6,721,080
|
)
|
(2,176,324
|
)
|
|
|
|
|
|
|
Cash flows from investing activities:
|
|
|
|
|
|
Purchase of equipment
|
|
(2,239,575
|
)
|
(436,067
|
)
|
Cash paid for acquisition in excess of cash received
|
|
(100,000
|
)
|
|
|
|
|
|
|
|
|
Net cash used in investing activities
|
|
(2,339,575
|
)
|
(436,067
|
)
|
|
|
|
|
|
|
Cash flows from financing activities:
|
|
|
|
|
|
Proceeds from notes payable
|
|
62,970
|
|
140,859
|
|
Repayments of short term financing
|
|
(12,684
|
)
|
(11,396
|
)
|
Proceeds from the sale of common stock
|
|
194,000
|
|
260,000
|
|
Proceeds from sale of Series A Convertible Preferred
Shares, net of of capitalization costs of $1,050,000
|
|
13,950,000
|
|
|
|
|
|
|
|
|
|
Net cash provided by financing activities
|
|
14,194,286
|
|
389,463
|
|
|
|
|
|
|
|
NET INCREASE (DECREASE) IN CASH
|
|
5,133,631
|
|
(2,222,928
|
)
|
|
|
|
|
|
|
CASH AT BEGINNING OF YEAR
|
|
1,479,886
|
|
4,951,302
|
|
|
|
|
|
|
|
CASH AT END OF PERIOD
|
|
$
|
6,613,517
|
|
$
|
2,728,374
|
|
|
|
|
|
|
|
Supplemental disclosure of cash flow information:
|
|
|
|
|
|
Cash paid during the year for interest
|
|
$
|
7,816
|
|
$
|
787
|
|
Cash paid for taxes
|
|
$
|
|
|
$
|
|
|
|
|
|
|
|
|
Supplemental disclosure of non-cash financing
activities
|
|
|
|
|
|
Stock options issued in lieu of compensation
|
|
$
|
54,297
|
|
$
|
|
|
Dividends payable
|
|
$
|
401,252
|
|
$
|
|
|
Fair value of placement agent warrants
|
|
$
|
374,933
|
|
$
|
|
|
|
|
|
|
|
|
Assets and liabilities received in acquisition of
American Anti-Ram, Inc.
|
|
|
|
|
|
Fixed assets
|
|
$
|
30,000
|
|
$
|
|
|
Inventory
|
|
$
|
120,000
|
|
$
|
|
|
Goodwill
|
|
$
|
280,000
|
|
$
|
|
|
Accounts payable and accrued expense
|
|
$
|
(30,000
|
)
|
$
|
|
|
Shares issuable in connection with acquisition
|
|
$
|
(200,000
|
)
|
$
|
|
|
Cash paid to American Anti-Ram, Inc.
|
|
$
|
(100,000
|
)
|
$
|
|
|
Amounts due to American Anti-Ram, Inc.
|
|
$
|
(100,000
|
)
|
$
|
|
|
Amounts due to American Anti-Ram, Inc.
|
|
$
|
(100,000
|
)
|
$
|
|
|
The accompanying notes
are an integral part of these consolidated financial statements.
5
Table of
Contents
AMERICAN
DEFENSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. NATURE OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES
Organization
On
May 1, 2003, the stockholder of A. J. Piscitelli &
Associates, Inc. exchanged all his issued and outstanding shares for
shares of American Defense Systems, Inc. (the Company). American Defense
Systems, Inc. was incorporated under the laws of the State of Delaware on
December 6, 2002. The exchange was accounted for as a recapitalization of
the Company, wherein the stockholder retained all the outstanding stock of
American Defense Systems, Inc. At the time of the acquisition American
Defense Systems, Inc. was substantially inactive.
On
November 15, 2007, the Company entered into an Asset Purchase Agreement
with Tactical Applications Group (TAG), a North Carolina based sole
proprietorship, and its owner. TAG has
a retail establishment located in Jacksonville, North Carolina that supplies
tactical equipment to military and security personnel.
In
January 2008, American Physical Security Group, LLC (APSG), a wholly owned
subsidiary of the Company, acquired the assets of American Anti-Ram, Inc.,
a manufacturer of crash tested vehicle barricades. APSG is located in North Carolina.
Nature of
Business
The Company designs and supplies transparent and
opaque armor solutions for both military and commercial applications. 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 develops solutions,
integrates and installs detention and security hardware, entry control and
monitoring systems, intrusion detection systems, and security glass. In
addition, the Company provides engineering and consulting services to the
detention and security industry. The primary customers of the Company are United
States government agencies, general contractors who have contracts with
governmental entities, and private industry.
The Company also
supplies tactical equipment to military and security personnel, as well as
vehicle anti-ram barriers.
The accompanying interim
unaudited condensed financial statements have been prepared in accordance with
generally accepted accounting principles for interim financial information and
with the instructions to Form 10-Q and Article 8 of Regulation S-X.
Accordingly, they do not include all of the information and footnotes required
by generally accepted accounting principles for complete financial statements.
In our opinion, all adjustments (consisting of normal recurring accruals)
considered necessary for a fair presentation have been included. Operating
results for the six-month period ended June 30, 2008 are not necessarily
indicative of the results that may be expected for the year ending
December 31, 2008. For further information, refer to the financial
statements and footnotes thereto included in the Companys Form 10 registration
statement filed with the SEC on April 22, 2008.
Principles
of Consolidation
The consolidated financial statements
include the accounts of American Defense Systems, Inc. and its
wholly-owned subsidiaries, A.J Piscitelli & Associates, Inc. and
American Physical Security Group, LLC. All significant intercompany accounts
and transactions have been eliminated in consolidation.
6
Table of
Contents
AMERICAN
DEFENSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
Use of
Estimates
The preparation of financial statements and related
disclosures in conformity with accounting principles generally accepted in the
United States requires management to make estimates and assumptions that affect
the amounts reported in the consolidated financial statements and accompanying
notes. Estimates are used for revenue recognition, income taxes and accrued
liabilities among others. Actual results could differ materially from those
estimates.
Significant
estimates for all periods presented include cost in excess of billings and
accrued contingency losses in connection with litigation.
Cash and
Cash Equivalents
The Company considers all highly liquid
investments with maturities of three months or less at the time of purchase to
be cash equivalents.
Concentrations
Cash
and cash equivalents are maintained in financial institutions. Deposits held
with banks may exceed the amount of insurance provided on such deposits.
Generally, these deposits may be redeemed upon demand and therefore bear
minimal risk.
The Company
received certain of its components from sole suppliers. Additionally, the
Company relies on a limited number of contract manufacturers and suppliers to
provide manufacturing services for its products. The inability of any contract
manufacturer or supplier to fulfill supply requirements of the Company could
materially impact future operating results.
For the six months
ended June 30, 2008 and 2007, the Company derived 99% of its revenues from
various U. S. government entities.
Inventories
Inventories
are stated at the lower of cost or market, with cost determined using the
first-in, first-out method.
Equipment
Equipment
is stated at cost less accumulated depreciation. Depreciation is provided using
a straight-line method over an estimated useful life of three to five years.
Expenditures for repairs and maintenance are charged to expense as incurred.
Goodwill
and Indefinite-Lived Intangible Assets
In accordance with SFAS No. 142,
Goodwill and Other Intangible Assets, goodwill, represents the excess
of the purchase price and related costs over the value assigned to net tangible
and identifiable intangible assets of businesses acquired and accounted for
under the purchase method, acquired in
business combinations is assigned to reporting units that are expected to
benefit from the synergies of the combination as of the acquisition date. Under
this standard, goodwill and intangibles with indefinite useful lives are no
longer amortized. The Company assesses
goodwill and indefinite-lived intangible assets for impairment annually during
the fourth quarter, or more frequently if events and circumstances indicate
impairment may have occurred in accordance with SFAS No. 142. If the
carrying value of a reporting units goodwill exceeds its implied fair value,
the Company records an impairment loss equal to the difference. SFAS
No. 142 also requires that the fair value of indefinite-lived purchased
intangible assets be estimated and compared to the carrying value. The Company
recognizes an impairment loss when the estimated fair value of the
indefinite-lived purchased intangible assets is less than the carrying value. The Company has recorded goodwill associated
with the asset purchase agreements with TAG and APSG in the amount of
$1,950,000 and $1,680,361 as of June 30, 2008 and December 31, 2007. No impairment loss was recognized as of
June 30, 2008 or December 31, 2007.
7
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Contents
AMERICAN
DEFENSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
Long-Lived
Assets
The Company reviews long-lived assets and certain
identifiable assets related to those assets for impairment whenever
circumstances and situations change, such that there is an indication that the
carrying amounts may not be recoverable. If the undiscounted cash flows of the
long-lived assets are less than the carrying amount, their carrying amounts are
reduced to fair value, and an impairment loss is recognized.
Revenue and Cost Recognition
The Company recognizes revenue in accordance with the provisions of Staff
Accounting Board (SAB) No. 104,
Revenue Recognition
,
which states that revenue is realized and earned when all of the following
criteria are met: (a) persuasive evidence of the arrangement exists,
(b) delivery has occurred or services have been rendered, (c) the
sellers price to the buyer is fixed and determinable and
(d) collectibility is reasonably assured.
Under this provision, revenue is recognized upon delivery and acceptance
of the order.
Contract Revenue
- The Company recognizes revenues and reports profits from long-term
construction equipment contracts, its principal business, under the completed
contract method. These contracts generally extend for periods in excess of one
year. Contract costs are accumulated as deferred assets and billings and/or
cash received are charged to a deferred revenue account, during the periods of
construction, but no revenues, costs or profits are recognized in operations
until the period upon completion of the contract. Costs include direct
material, direct labor, and project-related overhead. A contract is considered
complete, when all costs except insignificant items have been incurred, and the
installation is operating according to specifications, or has been accepted by
the customer. Corporate general and administrative expenses are charged to the
periods as incurred. Provisions for estimated contract losses, if any, are made
in the period that such losses are determined. Claims are included in revenues when
received and claims related to unpaid amounts recorded as accounts payable to
subcontractors are included in revenues if the dispute is resolved to the
benefit of the Company.
All costs associated with uncompleted purchase orders
under contract are recorded on the balance sheet as a deferred current asset
called Costs in Excess of Billings on Uncompleted Contracts. Upon completion of purchase order, costs are
then reclassified from the balance sheet to the statement of operations as
costs of revenue. All billings
associated with uncompleted purchase orders under contract are recorded on the
balance sheet as a deferred current liability called Billings in Excess of
Costs on Uncompleted Contracts. Upon
completion of the purchase order, all such billings would be reclassified from
the balance sheet to the statement of operations as revenues. Due to the structure of the Companys
contracts, billing is not done until the purchase order is complete, therefore
there are no amounts recorded as deferred liabilities as of June 30, 2008
or 2007. Contract retentions are
included in accounts receivable.
Retail revenue
- The Company
recognizes revenue from its retail location upon point of sale. Due to the nature of the merchandise sold,
the Company does not accept returns and, therefore, no provision for returns
has been recorded as of June 30, 2008 or 2007.
8
Table of
Contents
AMERICAN
DEFENSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
Advertising
Costs
The Company
expenses all advertising costs as incurred.
Earnings
per Share
Basic earnings (loss) per share is computed using
the weighted-average number of common shares outstanding during the period.
Diluted net income per share is computed using the weighted-average number of
common shares and dilutive potential common shares outstanding during the
period. Diluted net earnings loss per share is computed using the
weighted-average number of common shares and excludes dilutive potential common
shares outstanding, as their effect is anti-dilutive. Dilutive potential common
shares would primarily consist of employee stock options and restricted common
stock.
Income
Taxes
The Company accounts for income taxes according to
Statement of Financial Accounting Standard (SFAS) 109 Accounting for Income
Taxes which requires an asset and liability approach to financial accounting
for income taxes. Deferred income tax assets and liabilities are computed
annually for the difference between the financial statement and tax bases of
assets and liabilities that will result in taxable or deductible amounts in the
future, based on enacted tax laws and rates applicable to the periods in which
the differences are expected to affect taxable income. Valuation allowances are
established when necessary to reduce deferred tax assets to the amount expected
to be realized. Income tax expense is the tax payable or refundable for the
period, plus or minus the change during the period in deferred tax assets and
liabilities.
The Corporation
adopted the provisions of FASB Interpretation (FIN) No. 48, Accounting
for Uncertainty in Income Taxes, an interpretation of FASB Statement 109,
effective January 1, 2007. FIN 48 prescribes a recognition threshold and a
measurement attribute for the financial statement recognition and measurement
of a tax position taken or expected to be taken in a tax return. Benefits from
tax positions should be recognized in the financial statements only when it is
more likely than not that the tax position will be sustained upon examination
by the appropriate taxing authority that would have full knowledge of all
relevant information. A tax position that meets the more-likely-than-not
recognition threshold is measured at the largest amount of benefit that is
greater than fifty percent likely of being realized upon ultimate settlement.
Tax positions that previously failed to meet the more-likely-than-not recognition
threshold should be recognized in the first subsequent financial reporting
period in which that threshold is met. Previously recognized tax positions that
no longer meet the more-likely-than-not recognition threshold should be
derecognized in the first subsequent financial reporting period in which that
threshold is no longer met. FIN 48 also provides guidance on the accounting for
and disclosure of unrecognized tax benefits, interest and penalties. Adoption
of FIN 48 did not have a significant impact on the Companys financial
statements.
The Company files
income tax returns in the U.S. federal jurisdiction and various states. The
Company has not been subject to U.S. federal income tax examinations by tax
authorities nor state authorities since its inception in 2000.
Fair
Value of Financial Instruments
Fair value of certain of the
Companys financial instruments including cash and cash equivalents, accounts
receivable, accrued compensation, and other accrued liabilities approximate
cost because of their short maturities.
9
Table of Contents
AMERICAN
DEFENSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
Recent
accounting pronouncements
Business Combinations
In December, 2007,
the Financial Accounting Standards Board (FASB) issued Statement of Financial
Accounting Standards (SFAS) No. 141 (revised 2007), Business
Combinations (hereinafter SFAS No. 141 (revised 2007)). This statement
establishes principles and requirements for how an acquirer a) recognizes and
measures in its financial statements the identifiable assets acquired, the
liabilities assumed and any noncontrolling interest in the acquiree, b)
recognizes and measures the goodwill acquired in the business combination or a
gain from a bargain purchase and c) determines what information to disclose to
enable users of the financial statements to evaluate the nature and financial
effects of the business combination. The scope of SFAS No. 141 (revised
2007) is broader than the scope of SFAS No. 141, which it replaces. The
effective date of SFAS No. 141 (revised 2007) is for all acquisitions in
which the acquisition date is on or after the beginning of the first annual
reporting period beginning on or after December 15, 2008. The adoption of
this statement is not expected to have an immediate material effect on the
Companys consolidated financial condition or results of operations.
Noncontrolling
Interests in Consolidated Financial Statements an amendment of ARB 51
In December, 2007,
the FASB issued SFAS No. 160, Noncontrolling Interests in Consolidated
Financial Statements an amendment of ARB No. 51 (hereinafter SFAS
No. 160). This statement establishes accounting and reporting standards
that require a) the ownership interests in subsidiaries held by parties other
than the parent be clearly identified, labeled and presented in the
consolidated statement of financial position with equity, but separate from the
parents equity, b) the amount of consolidated net income attributable to the
parent and to the noncontrolling interest be clearly identified and presented
on the face of the consolidated statement of income, c) changes in a parents ownership
interest while the parent retains its controlling financial interest in its
subsidiary be accounted for consistently, d) when a subsidiary is
deconsolidated, any retained noncontrolling equity investment in the former
subsidiary be initially measured at fair value and e) entities provide
sufficient disclosures that clearly identify and distinguish between the
interests of the parent and the interests of the noncontrolling owners. The
effective date of this standard is for fiscal years and interim periods
beginning on or after December 15, 2008. The adoption of this statement is
not expected to have an immediate material effect on the Companys consolidated
financial condition or results of operations.
Disclosure
about Derivative Instruments and Hedging Activities
In
March 2008, the FASB issued SFAS No. 161,
Disclosure about Derivative Instruments and Hedging
Activities
,
an amendment of FASB
Statement No. 133, (SFAS 161). This statement requires that objectives for
using derivative instruments be disclosed in terms of underlying risk and
accounting designation. The Company is required to adopt SFAS 161 on
January 1, 2009. The Company is currently evaluating the potential impact
of SFAS No. 161 on the Companys consolidated financial statements.
10
Table of
Contents
AMERICAN
DEFENSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
Determination
of the Useful Life of Intangible Assets
In
April 2008, the FASB issued FSP FAS 142-3, Determination of the Useful
Life of Intangible Assets,, which amends the factors that should be considered
in developing renewal or extension assumptions used to determine the useful
life of intangible assets under FASB 142 Goodwill and Other Intangible
Assets. The intent of this FSP is to improve the consistency between the
useful life of a recognized intangible asset under SFAS 142 and the period of
the expected cash flows used to measure the fair value of the asset under FASB
141 (revised 2007) Business Combinations and other U.S. generally accepted
accounting principles. The Company is currently evaluating
the potential impact of FSP FAS 142-3 on its consolidated financial statements.
The
Hierarchy of Generally Accepted Accounting Principles
In May 2008, the FASB issued SFAS No. 162, The Hierarchy of
Generally Accepted Accounting Principles (FAS No.162). SFAS No. 162 identifies the sources of
accounting principles and the framework for selecting the principles used in
the preparation of financial statements.
SFAS No. 162 is effective 60 days following the SECs approval of
the Public Company Accounting Oversight Board amendments to AU
Section 411, The Meaning of Present Fairly in Conformity with Generally
Accepted Accounting Principles. The
implementation of this standard will not have a material impact on the
Companys consolidated financial position and results of operations.
Accounting for Convertible Debt Instruments That May Be Settled in
Cash upon Conversion (Including Partial Cash Settlement)
In
May 2008, the FASB issued FSP Accounting Principles Board (APB) Opinion
No. 14-1, Accounting for Convertible Debt Instruments That May Be
Settled in Cash upon Conversion (Including Partial Cash Settlement). The FSP
clarifies the accounting for convertible debt instruments that may be settled
in cash (including partial cash settlement) upon conversion. The FSP requires issuers to account
separately for the liability and equity components of certain convertible debt
instruments in a manner that reflects the issuers nonconvertible debt
(unsecured debt) borrowing rate when interest cost is recognized. The FSP requires bifurcation of a component
of the debt, classification of that component in equity and the accretion of
the resulting discount on the debt to be recognized as part of interest expense
in our consolidated statement of operations.
The FSP requires retrospective application to the terms of instruments
as they existed for all periods presented.
The FSP is effective for us as of January 1, 2009 and early
adoption is not permitted. The Company
is currently evaluating the potential impact of FSP APB 14-1 upon its
consolidated financial statements.
Determining Whether an Instrument (or an Embedded Feature) Is Indexed
to an entitys Own Stock
In
June 2008, the FASB ratified EITF Issue No. 07-5, Determining
Whether an Instrument (or an Embedded Feature) Is Indexed to an Entitys Own
Stock (EITF 07-5). EITF 07-5 provides
that an entity should use a two step approach to evaluate whether an
equity-linked financial instrument (or embedded feature) is indexed to its own
stock, including evaluating the instruments contingent exercise and settlement
provisions. It also clarifies on the
impact of foreign currency denominated strike prices and market-based employee
stock option valuation instruments on the evaluation. EITF 07-5 is effective for fiscal years
beginning after December 15, 2008.
The Company is currently assessing the impact of EITF 07-5 on its
consolidated financial position and results of operations.
11
Table of
Contents
AMERICAN
DEFENSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
Determining Whether Instruments Granted in
Share-Based Payment Transactions Are Participating Securities
In
June 2008, the FASB issued FSP Emerging Issues Task Force (EITF) Issue
No. 03-6-1, Determining Whether Instruments Granted in Share-Based
Payment Transactions Are Participating Securities. The FSP addresses whether
instruments granted in share-based payment transactions are participating
securities prior to vesting and, therefore, need to be included in the earnings
allocation in computing earnings per share under the two-class method. The FSP
affects entities that accrue dividends on share-based payment awards during the
awards service period when the dividends do not need to be returned if the
employees forfeit the award. This FSP is effective for fiscal years beginning
after December 15, 2008. The Company is currently assessing the impact of
FSP EITF 03-6-1 on its consolidated financial position and results of
operations.
2.
COSTS
IN EXCESS OF BILLINGS (BILLINGS IN EXCESS OF COSTS) ON UNCOMPLETED CONTRACTS
AND CONTRACTS RECEIVABLE
Costs in excess of
billings on uncompleted contracts represent accumulated contract costs that
exceeded billings and/or cash received on uncompleted contracts at
June 30, 2008 and 2007.
For the periods
presented, the cost in excess of billings on uncompleted contracts consisted of
the following as of June 30, 2008 and December 31, 2007
|
|
2008
|
|
2007
|
|
Uncompleted
contract costs
|
|
$
|
8,462,308
|
|
$
|
5,011,974
|
|
Billings and /
or receipts on uncompleted contracts
|
|
|
|
|
|
Cost in excess
of billings on uncompleted contracts
|
|
$
|
8,462,308
|
|
$
|
5,011,974
|
|
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 long-term contracts and
progress billings on uncompleted contracts. Allowance for doubtful accounts is
based upon a review of outstanding receivables, historical collection
information, and existing economic conditions. Any amounts considered
recoverable under the customers 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 June 30, 2008 and
December 31, 2007, the Company had $5,491,623 and $6,711,161,
respectively, of accounts receivable, of which the Company considers all to be
fully collectible.
There was no bad
debt expense recorded for the six months ended June 30, 2008 and 2007.
12
Table of
Contents
AMERICAN
DEFENSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
3. COMMITMENTS AND CONTINGENCIES
Legal Proceedings
On
July 10, 2007, the Company filed a lawsuit against a former subcontractor,
Southern California Gold Products d/b/a Gypsy Rack, the subcontractors
President and owner, Glenn Harris, and a designer, James McAvoy in the United
States District Court, Eastern District of New York. Defendants moved to change
venue to the Central District of California based upon insufficient contacts to
the State of New York and on October 12, 2007 the matter was transferred
to the United States District Court for the Central District of California,
Case Number 07-CV-02779. On February 21, 2008, pursuant to the courts order,
we filed an amended complaint. The amended complaint names only Southern
California Gold Products and James McAvoy as defendants and asserts six counts
as follows: misappropriation of trade secrets and confidential information;
breach of contract; unfair competition; conversion; violation of the Lanham
Act; and interference with prospective economic advantage. The amended
complaint seeks to enjoin the defendants from misappropriating, disclosing, or
using our confidential information and trade secrets, and recall and surrender
all products and trade secrets wrongfully misappropriated or converted by the
defendants. It also seeks compensatory damages in an amount to be established
at trial together with prejudgment and post judgment interest, exemplary damages,
disgorgement, restitution with interest, attorneys fees and the costs of suit.
Defendants filed an answer to the amended complaint on April 16, 2008. Shortly
after the filing of the amended answer, defendants made a motion for summary
judgment on, among others, the grounds of collateral estoppel and res
judicata. The Company filed opposition
to the motion. The motion for summary judgment is scheduled for argument before
the court on August 25, 2008.
On
December 6, 2006, the former Chief Financial Officer commenced an
action against the Company for breach of contract arising from his termination
of employment in the Eastern District of Ohio. The matter was transferred on
defendants motion to the United States District Court, Eastern District of New
York. The Complaint seeks damages in
excess of $500,000 inclusive of interest. In April 2008, the parties
reached a settlement of $200,000 in this matter.
On
February 29, 2008, a former employee commenced an action against the
Company for breach of contract arising from his termination of employment in
the Supreme Court of the State of New York, Nassau County. The Complaint seeks
damages of approximately $87,000. The Company filed an answer to the complaint
and will be commencing discovery. Meritorious defenses to the claims
exist and the Company intends to vigorously defend this action.
On
March 4, 2008, the Companys former General Counsel, commenced an action
with the United States Department of Labor, Occupational Safety and Health and
Safety Administration, alleging retaliation in contravention of the
Sarbanes-Oxley Act. The Complaint seeks damages in excess of $3,000,000. The
Company believe the allegations to be without merit and intend to vigorously
defend against the action. On March 7, 2008, a second action was commenced
against the Company for breach of contract and related issues arising from his
termination of employment in New York State Supreme Court, Nassau County. On May
7, 2008, the Company served
a motion to dismiss the complaint, which is fully submitted to the Court.
No amounts have been accrued for damages as
the Company believes meritorious defenses to the claims exist. The Company
intends to vigorously defend this action.
13
Table of
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AMERICAN
DEFENSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
4. STOCKHOLDERS EQUITY
Warrants
- As an inducement to the February 2005 private offering, the Company also
issued 2,778,950 warrants to purchase stock at $1.00 per share to these
subscribers. These warrants expired on August 31, 2006. In addition,
purchase warrants for up to 555,790 shares of common stock at the purchase
price of $1.10 per share were issued to the placement agent in such offering.
These warrants will expire September 1, 2010.
The following is a
summary of stock warrants outstanding at June 30, 2008 and
December 31, 2007.
|
|
|
|
Exercise
|
|
Value
|
|
|
|
Warrants
|
|
Price
|
|
If Exercised
|
|
Beginning Balance,
December 31, 2007
|
|
808,462
|
|
1.00
|
|
808,462
|
|
|
|
|
|
|
|
|
|
Exercised
|
|
(25,630
|
)
|
1.00
|
|
(25,630
|
)
|
|
|
|
|
|
|
|
|
Ending Balance,
June 30, 2008
|
|
782,832
|
|
1.00
|
|
782,832
|
|
In accordance with
Statement of Financial Accounting Standards (SFAS) No. 123 Accounting for
Stock-Based Compensation, and SFAS No. 148 Accounting for Stock-Based
Compensation Transition and Disclosure, the Company accounts for the stock
warrants using the fair value method.
The Black-Scholes method
option pricing model was used to estimate fair value as of the date of grant
using the following assumptions:
Risk-Free
|
|
3.22%
|
|
Expected
volatility
|
|
10 20%
|
|
Expected life
|
|
1.5 Years 5.5 Years
|
|
Expected
dividends
|
|
|
|
Based on the
assumptions noted above, the fair market value of the warrants was valued at
$330,475, which has been reflected in the Statement of Stockholders Equity as
of December 31, 2005. No value was
attributed to warrants in 2006 or 2007.
Stock
Option Plan
On December 3, 2007, the Company adopted
the American Defense Systems, Inc. 2007 Incentive Compensation Plan. Under this plan, stock options may be granted
to employees, officers, consultants or others who provide services to the Company. On December 14, 2007, 1,645,000 stock options
were granted to officers and employees of the Company. An additional 72,500 stock options were
granted to employees of the Company on February 20, 2008.
14
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AMERICAN
DEFENSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
The Black-Scholes method
option pricing model was used to estimate fair value as of the date of grant
using the following assumptions:
Risk-Free
|
|
4.23
|
%
|
Expected
volatility
|
|
45
|
%
|
Forfeiture rate
|
|
10
|
%
|
Expected life
|
|
5 Years
|
|
Expected
dividends
|
|
|
|
Based on the
assumptions noted above, the fair market value of the options issued was valued
at $430,472, of which $54,297 and $0 has been expensed in the Statement of
Operations as of June 30, 2008 and 2007, respectively.
Shares
issued in connection with Asset Purchase Agreement
In
January 2008, the Company acquired the assets of American Physical
Security Group., a manufacturer of crash tested vehicle barricades. The purchase price for this acquisition is
expected to be $600,000. Of this amount,
$100,000 has been paid in cash and 100,000 shares of stock were issued, valued
at $2 per share. The Company will pay
another $100,000 by the end of 2008. The
remaining purchase price will be negotiated based on performance. The Company acquired approximately $120,000
in net assets in this acquisition.
5. ACQUISITION
In January 2008,
the Company acquired the assets of American Anti-Ram, Inc., a manufacturer
of crash tested vehicle barricades. The
purchase price for this acquisition is expected to be $600,000. Of this amount, $100,000 has been paid in
cash and 100,000 shares of stock were issued, valued at $2 per share. The Company will pay another $100,000 by the
end of 2008. The remaining purchase
price will be negotiated based on performance.
The Company
acquired approximately $120,000 in net assets in this acquisition. As of June 30, 2008, the Company has
paid $300,000 toward the anticipated purchase price. The remaining balance due of $100,000 under
agreement has been accrued as of June 30, 2008.
The consideration had been allocated to assets and liabilities based internal assessments with $280,000 initially allocated to goodwill.
6. SERIES A CONVERTIBLE PREFERRED
STOCK, INVESTOR WARRANTS AND PLACEMENT WARRANTS
The
Company entered into a Securities Purchase Agreement (Purchase Agreement) on
March 7, 2008 to sell shares of its Series A Convertible Preferred
Stock (Series A Preferred) and warrants (Investor Warrants) to
purchase shares of its common stock, and to conditionally sell shares of the
Companys common stock, to three investors. The investors have agreed to
purchase an aggregate of 15,000 shares of Series A Preferred and Investor
Warrants to purchase up to 3,750,000 shares of common stock, and to
conditionally purchase 100,000 shares of common stock. The aggregate purchase
price for the Series A Preferred and Investor Warrants is $15,000,000 and
the aggregate purchase price for the common stock is $500,000.
15
Table of Contents
AMERICAN
DEFENSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
An
initial closing under the Purchase Agreement was held on March 7, 2008 in
which an aggregate of 10,975 shares of Series A Preferred and Investor
Warrants to purchase up to 2,743,706 shares of Common Stock were issued for an
aggregate purchase price of $10,975,000. After the payment of investor expenses
of $60,000 and the $658,500 cash portion of the placement agent fee described
below, the Company received net proceeds of $10,256,500.
A
second closing occurred on April 4, 2008, in which an aggregate of 4,025
shares of Series A Preferred and Investor Warrants to purchase up to
1,006,250 shares of Common Stock were issued for a total price of $4,025,000. The Company received net proceeds of
$3,743,250, which is net of fees paid to the placement agent and investor
expenses of $281,750. The Company agreed with the investors in the Series A Preferred
that the conditional sale of the 100,000 shares of Common Stock would not be
consummated.
In
connection with sale of the Series A Preferred and Investor Warrants under
the Securities Purchase Agreement described above, the Companys placement
agent for the transaction is entitled to a cash fee equal to 6.0% of the gross
proceeds and warrants to purchase that number of shares of common stock equal
to 6.0% of the number of shares of common stock issued in the financing. For
the initial closing above, the placement agent received a cash payment of
$658,500 (6.0% of $10,975,000) and warrants to purchase 493,872 shares of
Common Stock (6.0% of the sum of (i) 5,487,500, the initial number of
shares of Common Stock into which the Series A Preferred issued in the
March 7, 2008 closing may be converted and (ii) 2,743,706, the
initial number of shares of common stock that may be purchased under the
Investor Warrants issued in the March 7, 2008 closing). At the
April 4, 2008 closing, the placement agent received an additional cash
payment of $281,750 (7.0% of $4,025,000) and warrants to purchase up to 181,128
shares of Common Stock (6.0% of the sum of (1) 2,012,500, the initial
number of shares of Common Stock into which the Series A Preferred issued
in the April 4, 2008 closing may be converted and (2) 1,006,294, the
initial number of shares of common stock that may be purchased under the
Investor Warrants issued in the April 4, 2008 closing).
Series A
Convertible Preferred Stock
The
provisions for the Series A Preferred are as follows:
Dividends
on Series A Preferred
The shares of Series A Preferred accrue a
cumulative dividend at a rate of 9% per annum of the Conversion Amount, as
defined below. Dividends on the Series A Preferred shall be cumulative,
shall accrue, whether or not declared, and be payable quarterly in cash or, at
the Companys option, payable in common stock at 10%. As of June 30, 2008, the Company has
accrued $401,252 for dividends payable.
Liquidation
Preference
In the event of the liquidation, dissolution or
winding up of the affairs of the Company, whether voluntary or involuntary (a
Liquidation), the holders of shares of the Series A Preferred then
outstanding shall be entitled to receive an amount per Series A Preferred
equal to 110% of the Conversion Amount.
16
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Contents
AMERICAN
DEFENSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
Voting Rights
Holders of Series A Preferred are entitled
to vote on an as if converted basis and vote with the common stockholders as
required. Voting rights are subject to
the maximum ownership percentage of 9.99%.
Holders Right to Convert
At any time the holder of any such shares of
Series A Preferred may, at such holders option, elect to convert all or
any portion of their whole number of shares of Series A Preferred held by
such person into Common stock at the Conversion Rate, which is equal to the
Conversion Amount divided by the Conversion Price. The Conversion Amount shall initially be
equal to the Stated Value ($1,000 per share) times the number of shares subject
to conversion. The Conversion Price is
the Initial Conversion Price ($2.00).
The conversion Price shall be reduced by (i) 4% of the Initial
Conversion Price on or after May 30, 2008 if the Companys common stock is
not listed on an Eligible Market and (ii) a further 1.5% of the Initial
Conversion Price on each 30
th
day thereafter until the Companys common
stock is so listed; provided, however, that all decreases shall in no event be
more than 10% of the Initial Conversion Price.
The Conversion Price is also subject to certain standard anti-dilution
adjustment provisions.
Redemption at Option of Holders
Triggering Event Upon the occurrence of a
Triggering Event, each Holder may, at such Holders option, subject to the
Limitation on Damages, require the Company to redeem all or a portion of such
Holders Series A Stock shares at a price per Preferred Share equal to the
greater of (i) 110% of the Conversion Amount (or, in the case of the
Triggering Events set forth in Sections 3(a)(v) and 3(a)(vi), 100% of the
Conversion Amount) and (ii) the product of (A) the Conversion Rate in
effect at such time and (B) the Closing Sale Price of the Companys common
stock on the trading day immediately preceding such Triggering Event (the
Triggering Event Redemption Price).
Failure to Satisfy Equity Condition - If the
Equity Conditions are not satisfied as of December 31, 2008, then on any
date thereafter that any Equity Condition (as defined in the Series A
Preferred Certificate) is not satisfied the Holders shall have the right, in
its sole discretion, to require that the Company redeem all of or any portion
of such Holders Series A Preferred shares in case at a price equal to
100% of the Conversion Amount.
Redemption
by Company
Mandatory redemption If any Series A
Preferred shares remain outstanding on the Maturity Date, which is
December 31, 2010, the Company shall redeem all such Series A Preferred
shares on the Maturity Date for an amount in cash per Preferred Share equal to
the Conversion Amount.
Optional redemption At any time on or after the
(i) 2
nd
anniversary of the Public Company Date (the date on
which the Companys securities are initially registered under the Exchange
Act), (A) the median price of the Weighted Average Price of the Companys
common stock over any consecutive 30 Trading Day period is greater than $3.00
per share, (B) the median trading
17
Table of
Contents
AMERICAN
DEFENSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
volume for such period is greater than 75,000 shares
and (C) there shall not have been any Equity Conditions Failure or
(ii) 6-month anniversary of a Qualified Public Offering and there shall
not have been any Equity Conditions Failure, the Company shall have the right
to redeem any or all of the Series A Preferred shares to cash in an amount
equal to 100% of the Conversion Amount.
Accounting
for the Series A Preferred
The Company accounted for the transaction in
accordance with SFAS 150 Accounting for Certain Financial Instrument with
Characteristics of both Liabilities and Equity. SFAS 150 provides guidance on how financial
instruments should be classified and measured when characteristics of both
liabilities and equity exist and requires that an entity classify a financial
instrument that is within its scope as a liability because the financial
instrument embodies an obligation of the issuer. The mandatory redemption provision
incorporated into the Series A Preferred causes the stock to fall within
the scope of SFAS 150 since the Company must redeem the stock by
December 31, 2010 by transferring cash to the Holders.
The proceeds from the issuance of the
Series A Preferred and accompanying common stock warrants, net of direct
costs including the fair value of warrants issued to placement agent in connection
with the transaction, must be allocated to the instruments based upon relative
fair value upon issuance. In addition,
under SFAS 150, paragraph 20, mandatorily redeemable instruments must be
measured initially at fair value.
Therefore, after the initial recording of the Series A Stock based
upon net proceeds received, the carrying value of the Series A Preferred
must be adjusted to the fair value at the date of issuance, with the difference
recorded as a loss. The initial
valuation of the Series A Preferred is as follows:
Security
|
|
Face Value
|
|
Fair Value
|
|
Allocation of
proceeds
|
|
Proceeds in excess
of fair value
|
|
Series A
|
|
$
|
15,000,000
|
|
$
|
12,437,584
|
|
$
|
13,459,474
|
|
$
|
1,021,890
|
|
Preferred
|
|
|
|
|
|
|
|
|
|
Warrants
|
|
|
|
265,604
|
|
1,540,526
|
|
1,274,922
|
|
|
|
$
|
15,000,000
|
|
$
|
12,703,188
|
|
$
|
15,000,000
|
|
$
|
2,296,812
|
|
The Series A Preferred has been included as a
noncurrent liability until December 31, 2009, at which time it will be
included as a current liability.
For the three months ended June 30, 2008, the
Company has recorded a net gain on adjustment of fair value of their
Series A Preferred of $2,605,159.
The total net gain on adjustment as of June 30, 2008 is $1,176,494.
18
Table of Contents
AMERICAN
DEFENSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
Investor Warrants
In
connection with the closings under the Purchase Agreement, Investor Warrants to
purchase up to 3,750,000 shares of Common Stock at $2.40 per share were issued
in addition to the 15,000 shares of Series A Preferred.
The
terms of the investor warrants provide the following:
(a)
Exercise price of $2.40 per share. If not listed on an eligible market on or
before May 30, 2008, the exercise price shall be reduced $.10 and shall be
further decreased by $.04 on each 30
th
day thereafter until such
listing occurs, subject to a maximum of $.24
(b)
The investor warrants are immediately
exercisable upon issuance through the date that is 36 months after the Public
Company date.
(c)
A cashless exercise is available at the
option of the Holders as of the Public Company date.
(d)
In the event of a Fundamental Transaction,
the Holders may request that the Company repurchase the Warrant from the
Holders by paying a cash amount equal to the Black-Scholes Value of the
remaining unexercised portion on the date of the Fundamental Transaction. Fundamental Transactions are defined within
the terms of the Investor Warrant Agreement.
(e)
The Company, at its option, has the right to
require that the Holder exercise all or a portion of their Investor Warrants
under terms that are defined within the Investor Warrant Agreement.
The
Investor Warrants were accounted for as follows:
(a) The warrants meet the
criteria under SFAS 133 Accounting for Derivative Instruments and Hedging
Activities. Under SFAS 133, the
warrants are recorded at fair value upon the date of issuance, with changes in
the value fair value recognized as a gain or loss as they occur. At the initial date of issuance, the Company
recorded a derivative liability of $1,142,503, which represents the fair value
of the Investor Warrants and a loss on Investor Warrants of $146,510. Upon the second closing, the Company recorded
a derivative liability of an additional $398,023 and a loss on Investor
Warrants of $51,836. This liability was
subsequently adjusted to fair value as of June 30, 2008 and a
corresponding fair value adjustment of $1,473,268 reduced the derivative
liability. The total net gain on
Investor Warrants as of June 30, 2008 was $1,313,843.
(b) The warrants meet the
criteria under EITF 01-6 The Meaning of Indexed to a Companys Own Stock,
which provides guidance as to whether a contract is indexed to a Companys own
stock. However, since the warrants do
not meet the criteria for reporting as an equity instruments under EITF 00-19
Accounting for Derivative Financial Instruments Indexed to, and Potentially
Settled in, a Companys Own Stock, the fair value of the Investor Warrants is
included as a noncurrent liability.
19
Table of
Contents
AMERICAN
DEFENSE SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
In valuing the Investor Warrants associated with the Series A
Preferred Stock the Company used the Black-Scholes option pricing model with
the following range of assumptions:
|
|
March 7, 2008
|
|
April 4, 2008
|
|
Expected Life
|
|
3.10 Years
|
|
2.78 Years
|
|
Risk-Free Rate
|
|
2.13
|
%
|
2.85
|
%
|
Expected Volatility
|
|
40
|
%
|
40
|
%
|
Dividend Rate
|
|
0
|
%
|
0
|
%
|
The resulting values per warrant for the March 7, 2008 and the
April 4, 2008 issuances were $.47 and $.07, respectively. The resulting fair value associated with the
3,750,000 Investor Warrants as of June 30, 2008 was $265,604.
Placement Agent Warrants
In
connection with the sale of the Series A Preferred and Investor Warrants,
the placement agent was entitled to receive warrants (Placement Agent Warrants)
to purchase a total of 6% of the number of common stock issued in the financing
or 675,000 shares. The Placement Agent
Warrants were accounted for as a transaction cost associated with the issuance
of the Series A Preferred. The
Placement Agent Warrants recorded at fair value at the date of issuance. Under EITF 00-19 Accounting for Derivative
Financial Instruments Indexed to, and Potentially Settled in, a Companys Own
Stock, the Company satisfies the criteria for classification of the Placement
Agent Warrants as equity. The Company
has recorded the corresponding amount recorded as a Deferred Financing Cost. Since the Series A Preferred and
Investor Warrants are classified as liabilities, the carrying value of the
Placement Agent Warrants has been recorded as an other asset and is amortized
as additional financing costs over the term of the Series A Preferred
using the interest method. At the date
of each issuance, the Company recorded $1,033,433 and $418,559 in deferred
financing costs and amortized $147,747 as interest expense as of June 30,
2008.
In valuing the Placement Agent Warrants associated with the Series A
Preferred the Company used the Black-Scholes option pricing model with the
following range of assumptions:
|
|
March 7, 2008
|
|
April 4, 2008
|
|
Expected Life
|
|
4 Years
|
|
4 Years
|
|
Risk-Free Rate
|
|
2.45
|
%
|
2.31
|
%
|
Expected Volatility
|
|
45
|
%
|
45
|
%
|
Dividend Rate
|
|
0
|
%
|
0
|
%
|
The resulting value per warrant for both issuances was approximately
$.76. The fair value associated with the
675,000 Placement Agent Warrants was $511,742.
20
Table of Contents
Item 2. Managements 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 repor
t and in our registration statement on Form 10 (SEC
No. 0-53092) filed with the SEC on April 22, 2008.
Except for statements of historical fact, certain
information described in this report contains forward-looking statements that
involve substantial risks and uncertainties. You can identify these statements
by forward-looking words such as anticipate, believe, could, estimate,
expect, intend, may, should, will, would or similar words. The
statements that contain these or similar words should be read carefully because
these statements discuss our future expectations, contain projections of our
future results of operations or of our financial position, or state other
forward-looking information. We believe that it is important to communicate
our future expectations to our investors. However, there may be events in the
future that we are not able accurately to predict or control. Further, we urge
you to be cautious of the forward-looking statements which are contained in
this report because they involve risks, uncertainties and other factors
affecting our operations, market growth, service and products. The factors
listed in the section captioned Risk Factors within Item 1A, Description of
Business, in our Form 10 Registration Statement filed with the SEC on
April 22, 2008, as well as other cautionary language in such
Form 10, describe such risks,
uncertainties and events that may cause our actual results and achievements,
whether expressed or implied, to differ materially from the expectations we
describe in our forward-looking statements. The occurrence of any of the events
described as risk factors could have a material adverse effect on our business,
results of operations and financial position.
Overview
We are a provider of
customized transparent and opaque armor solutions for tactical and non-tactical
transport vehicles and construction equipment used by the military. We focus
primarily on research and development, design and engineering, fabrication and
providing component integration. Our armor solutions are used in retrofit
applications for equipment already in service, and we work with original
equipment manufacturers to provide armor solutions for new equipment purchased
by the military.
We also sell physical
security products consisting primarily of vehicle anti-ram barriers such as
bollards, steel gates and steel wedges that deploy out of the ground. In addition, we sell tactical products such as
body armor, nylon holsters, vests and packs, weapons, ammunition, weapons parts
and accessories through a retail outlet.
In May 2008, we launched
our new live-fire interactive T2 Tactical Training System and have begun active
marketing of the system. T2 provides law
enforcement officers, SWAT team members, tactical specialists and military
operators with the opportunity to hone their firearms and combat skills, with
their own weapons and ammunition, in conjunction with realistic video scenarios
broadcast on a large screen, incorporating environmental factors such as heat,
cold, sound and light effects. In
addition to installation fees for T2 systems, we anticipate additional revenue
opportunities for service and support of T2 facilities once installed.
Our technical expertise is in
the development of lightweight composite ballistic, blast and bullet mitigating
materials used to fortify and enhance capabilities of existing and in-service
equipment and structures. We serve primarily the defense market and our sale
are highly concentrated within the U.S. government. Our customers include
various branches of the U.S. military through the U.S. Department of Defense
(or DoD) and to a much lesser extent other government, law enforcement and
correctional agencies as well as private sector customers.
21
Table of Contents
We have experienced
significant growth, with revenues of $4.8 million, $25.3 million and $36.5
million in 2005, 2006 and 2007, respectively, and $18.6 million for the six
months ended June 30, 2008. The principal factor contributing to our
recent growth has been increased demand by the U.S. military for lightweight
ballistic and blast resistant transparent and opaque armor that protects
soldiers, sailors and marines.
Our recent historical
revenues have been generated primarily from three large contracts. To continue
expanding our business, we are seeking to broaden our customer base and to
diversify our product and service offerings. Our strategy to increase our
revenue, grow our company and increase stockholder value involves the following
key elements:
·
increase exposure to
military platforms in the U.S. and internationally;
·
form strategic partnerships
with original equipment manufacturers (OEMs);
·
develop strategic alliances;
·
capitalize on increased
homeland security requirements and non-military platforms; and
·
focus on an advanced
research and development program to capitalize on increased demand for new
armor materials.
We are pursuing each of these
growth strategies simultaneously, and expect one or more of them to result in
additional revenue opportunities within the next 12 months. Please see
BusinessOur Growth Strategy in our Form 10 filed April 22, 2008
for additional information.
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. Under these contracts, we provide customized
transparent and opaque armor products for transport and construction vehicles
used by the military, group protection kits and spare parts. We also
derive revenues from sales of our physical security products and retail sales
of our tactical products.
Our contract backlog as of
June 30, 2008 and 2007 was $45 million and $32 million,
respectively. Of our $45 million contract backlog at June 30, 2008,
we estimate that $30 million, $10 million and $5 million will be filled during
the remainder of 2008 and in 2009 and 2010, respectively. Accordingly, in order
to maintain our current growth rate or even our current revenue levels, 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 OEMs 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 2006 and 2007.
Cost of Revenues and Operating Expenses
Cost of Revenues.
Cost of revenues consists of parts, direct labor and
overhead expense incurred for the fulfillment of orders under contract. These
costs are charged to expense upon completion and acceptance of an
22
Table of Contents
order. Costs of revenue also includes the costs of protyping
and engineering, which are expensed upon completion of an order as well. These
costs are included as costs of revenue because they are incurred to modify
products based upon government specifications and are reimbursable costs within
the contract. These costs for the production of goods under contract are
expensed when they are complete. We allocate overhead expenses such as employee
benefits, computer supplies, depreciation for computer equipment and office
supplies based on personnel assigned to the job. As a result, indirect overhead
expenses are included in cost of revenues and each operating expense category.
Sales and Marketing.
Expenses related to sales and marketing consist primarily
of compensation for our sales and marketing personnel, sales commissions and
incentives, trade shows and related travel.
As our revenues increase, we
plan to continue to invest heavily in sales and marketing by increasing the
number of direct sales personnel in order to add new customers and increase
sales to our existing customers. We also plan to expand our marketing
activities in order to build brand awareness and generate additional leads for
our growing sales personnel. We expect that in the remainder of 2008, sales and
marketing expenses will increase in absolute dollars but will decrease as a
percentage of revenues.
Research and Development.
Research and development expenses are incurred as we
perform ongoing evaluations of materials and processes for existing products,
as well as the development of new products and processes. Such expenses
typically include compensation and employee benefits of engineering and testing
personnel, materials, travel and costs associated with design and required
testing procedures associated with our product line. We expect that in the remainder
of 2008, research and development expenses will increase in absolute dollars as
we upgrade and extend our service offerings and develop new protections
products, but will remain relatively consistent or decrease slightly as a
percentage of revenues. Research and development costs are charged to expense
as incurred.
General and Administrative.
General and administrative expenses consist of compensation
and related expenses for executive, finance, accounting, administrative, legal,
professional fees, other corporate expenses and allocated overhead. We expect
that in the remainder of 2008, general and administrative expenses will
increase in absolute dollars but decrease as a percentage of revenues.
Critical Accounting Policies
Our consolidated financial
statements are prepared in accordance with accounting principles generally
accepted in the United States. The preparation of these consolidated financial
statements requires us to make estimates and assumptions that affect the
reported amounts of assets, liabilities, revenues, costs and expenses and
related disclosures. On an ongoing basis, we evaluate our estimates and
assumptions. Our actual results may differ from these estimates under different
assumptions or conditions.
We believe that of our
significant accounting policies, which are described in Note 1 to the
consolidated financial statements, the following accounting policies involve a
greater degree of judgment and complexity. Accordingly, these are the policies we
believe are the most critical to aid in fully understanding and evaluating our
consolidated financial condition and results of operations.
Revenue and Cost Recognition.
We recognize revenue in accordance with the provisions of
the Securities and Exchange Commission (SEC) Staff Accounting Board (SAB)
No. 104,
Revenue Recognition
,
which states that revenue is realized and earned when all of the following
criteria are met: (a) persuasive evidence of the arrangement exists,
(b) delivery has occurred or services have been rendered, (c) the
sellers price to the buyer is fixed and determinable and
(d) collectability is reasonably assured. Under this provision, revenue is
recognized upon delivery and acceptance of the order.
We recognize revenue and
report profits from purchases orders filled under master contracts under the
completed contract method. Purchase orders received under master contracts may
extend for periods in excess of one year. Contract costs are accumulated as
deferred assets and 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
23
Table of Contents
insignificant items, have been incurred, installation 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 June 30, 2008 and December 31,
2007, there were no such provisions made.
All costs associated with
uncompleted purchase orders under contract are recorded on the balance sheet as
a deferred asset called Costs in Excess of Billings on Uncompleted Contracts.
Upon completion of a purchase order, such associated costs are then
reclassified from the balance sheet to the statement of operations as costs of
revenue.
All billings associated with
uncompleted purchase orders under contract are recorded on the balance sheet as
a deferred liability called Billings in Excess of Costs on Uncompleted
Contracts. Upon completion of a purchase order, all such associated billings
would be reclassified from the balance sheet to the statement of operations as
revenues. Due to the structure of our contracts, billing is not done until the
purchase order is complete, therefore there are no amounts recorded as deferred
liabilities as of June 30, 2008 or December 31, 2007.
Stock-Based Compensation.
Stock based compensation consists of stock issued to
employees and contractors for services rendered. We accounted for the stock
issued using the estimated current market price per share at the date of
issuance. Such cost was recorded as compensation in our statement of operations
at the date of issuance.
In December 2007, we adopted
our 2007 Incentive Compensation Plan pursuant to which we have issued and intend
to issue stock-based compensation from time to time, in the form of stock,
stock options and other equity based awards. Our policy for accounting for such
compensation in the form of stock options is as follows:
We have adopted the
provisions of Statement of Financial Accounting Standard No. 123(R),
Share-Based Payment
(SFAS No. 123R).
In accordance with SFAS No. 123R, we will use the Black-Scholes option
pricing model to measure the fair value of our option awards granted after June 15,
2005. The Black-Scholes model requires the input of highly subjective
assumptions including volatility, expected term, risk-free interest rate and
dividend yield. In 2005, the SEC issued Staff Accounting Bulletin (SAB)
No. 107 (SAB No. 107) which provides supplemental implementation
guidance for SFAS No. 123R.
Because we have only recently
become a public entity, we will have a limited trading history. The expected
term of an award is based on the simplified method allowed by SAB
No. 107, whereby the expected term is equal to the midpoint between the
vesting date and the end of the contractual term of the award. The risk-free
interest rate will be based on the rate on U.S. Treasury zero coupon issues
with maturities consistent with the estimated expected term of the awards. We
have not paid and do not anticipate paying a dividend in the foreseeable future
and accordingly, use an expected dividend yield of zero. Changes in these
assumptions can affect the estimated fair value of options granted and the
related compensation expense which may significantly impact our results of
operations in future periods.
Stock-based compensation
expense recognized will be based on the estimated portion of the awards that
are expected to vest. We will apply estimated forfeiture rates based on
analyses of historical data, including termination patterns and other factors.
We recognized $54,297 and
$6,800 in stock compensation expense as of June 30, 2008 and
December 31, 2007, respectively.
Series A Convertible Preferred Stock,
Investor Warrants and Placement Agent Warrants
Series A Preferred Stock
. We accounted for our Series A Convertible
Preferred Stock (or Series A Preferred) in accordance with SFAS 150
Accounting for Certain Financial Instrument with Characteristics of both
Liabilities and Equity. SFAS 150 provides guidance on how financial
instruments should be classified and measured when characteristics of both
liabilities and equity exist and requires that an entity classify a financial
instrument that is within its scope as a liability because the financial
instrument embodies an obligation of the issuer. The mandatory redemption
provision incorporated into the Series A Preferred causes the stock to
fall within
24
Table of Contents
the scope of SFAS 150 since we must redeem the stock by
December 31, 2010 by transferring cash to the holders of the Series A
Preferred.
The proceeds from the
issuance of the Series A Preferred and accompanying common stock warrants,
net of direct costs including the fair value of warrants issued to the
Placement Agent in connection with the transaction, must be allocated to the
instruments based upon relative fair value upon issuance. In addition,
under SFAS 150, paragraph 20, mandatorily redeemable instruments must be
measured initially at fair value. Therefore, after the initial
recording of the Series A Preferred based upon net proceeds received, the
carrying value of the Series A Preferred must be adjusted to the fair
value at the date of issuance, with the difference recorded as a loss.
Investor Warrants.
The warrants issued with the Series A Preferred
(or Investor Warrants) meet the criteria under SFAS 133 Accounting for
Derivative Instruments and Hedging Activities. Under SFAS 133, the
warrants are recorded at fair value upon the date of issuance, with changes in
the value fair value recognized as a gain or loss as they occur. On March 7,
2007, the date of initial issuance, we recorded a derivative liability of
$1,142,503. On April 4, 2008, the
date of the second issuance, we recorded a derivative liablity of
$398,023. These liabilities were
subsequently adjusted to fair value as of June 30, 2008, which resulted in
a net gain of $1,313,843. As of
June 30, 2008, the Investor Warrant liability was $265,604.
The Investor Warrants meet
the criteria under EITF 01-6 The Meaning of Indexed to a Companys Own Stock,
which provides guidance as to whether a contract is indexed to a companys own
stock. However, since the warrants do not meet the criteria
for reporting as an equity instruments under EITF 00-19 Accounting for
Derivative Financial Instruments Indexed to, and Potentially Settled in, a
Companys Own Stock, the fair value of the Investor Warrants is included as a
noncurrent liability.
Placement Agent Warrants.
The warrants issued to the Placement Agent with
respect to the sale of the Series A Preferred and Investor Warrants (or Placement
Agent Warrants) were accounted for as a transaction cost associated with the
issuance of the Series A Preferred. The Placement Agent Warrants are
recorded at fair value at the date of issuance. Under EITF 00-19
Accounting for Derivative Financial Instruments Indexed to, and Potentially
Settled in, a Companys Own Stock, we satisfy the criteria for classification
of the Placement Agent Warrants as equity. We have recorded the
corresponding amount recorded as a Deferred Financing Cost. Since the
Series A Preferred and Investor Warrants are classified as liabilities,
the carrying value of the Placement Agent Warrants has been recorded as an
other asset and is amortized as additional financing costs over the term of the
Series A Preferred using the interest method. At the date of each issuance,
we recorded $1,033,433 and $418,559 in deferred financing costs and amortized
$147,747 as interest expense as of June 30, 2008.
Comparison of the Three Months Ended
June 30, 2008 versus June 30, 2007
Revenues.
Revenues for the three months ended
June 30, 2008 were approximately $9.1 million, a decrease of approximately
$1.3 million, or 12.5%, over revenues of approximately $10.4 million in the
comparable period in 2007. This decrease was due primarily to a higher
volume of orders completed under our U.S. Marine Corp. sole source contract
(no. M6785407D5023) during the second quarter of 2007 versus the same quarter
in 2008.
Cost of
Revenues.
Cost
of revenues for the three months ended June 30, 2008 and June 30,
2007 were approximately $6.3 million for each period. As a percentage of revenue, the cost of
revenue was 69% for the three months ended June 30, 2008 versus 61% for
the three months ended June 30, 2007.
This increase was due primarily to additional costs of sales included
from the tactical application retail outlet and physical security product
business, both of which were not in existence in 2007. In addition, the increase was related to our
increased production costs under the Marine Corp. sales contract mentioned
above. Cost of sales for the three months ended June 30, 2007 also
included costs related to orders filled for spare parts, which have a much
lower cost.
Gross
profit margin
.
The gross profit margin for the three months ended June 30, 2008 and
June 30, 2007 was approximately $2.8 million and $4.1 million,
respectively. The gross profit margin percentage was 31% and 39% for the
three months ended June 30, 2008 and June 30, 2007,
respectively. The decrease in gross profit margin percentage was due
to higher costs associated with production associated with the Marine
Corp. sales contract and lower gross profit margins associated with our
tactical application retail outlet and our physical security product
25
Table of Contents
business. Gross profit margin
for the three months ended June 30, 2007 also includes sales related to
orders filled for spare parts, which have higher gross profit margins.
Sales and
Marketing Expenses.
Sales
and marketing expenses for the three months ended June 30, 2008 and
June 30, 2007 were approximately $727,000 and $609,000, respectively,
representing an increase of $118,000, or 19%. We increased our sales and
marketing department from 7 employees as of June 30, 2007 to 15 employees
as of June 30, 2008. This increase
in personnel resulted in approximately $120,000 in additional salaries and
employee benefits expense.
Research and
Development Expenses.
Research
and development expenses for the three months ended June 30, 2008 and
June 30, 2007 were approximately $204,000 and $98,000, respectively.
The increase of $106,000 or 108% from 2007 to 2008 was the result of additional
testing and improvements of existing products.
General
and Administrative Expenses.
General and administrative expenses for the three months
ended June 30, 2008 and June 30, 2007 were approximately $728,000 and
$828,000, respectively. The decrease of $100,000, or 12%, was primarily
due primarily to expansion expenses incurred during the three months ended
June 30, 2007 that were not incurred during the three months ended
June 30, 2008.
General
and Administrative Salaries Expense .
General and
administrative salaries expense for the three months ended June 30, 2008
and June 30, 2007 were approximately $1.1 million and $747,000,
respectively. The increase of $353,000, or 47%, was primarily due to the
increase in personnel associated with our expansion and our acquisition of the
our tactical application retail outlet and our physical security product
business. As of June 30, 2008,
there were 41 employees that were classified as general and administrative
personnel, versus 27 employees as of June 30, 2007.
Depreciation
expense.
Depreciation expense was approximately $148,000 and $91,000 for the three
months ended June 30, 2008 and June 30, 2007, respectively. The
increase of $57,000, or 63%, resulted from the expansion of our headquarters
during 2008, which resulted in higher depreciation expense. For the three
months ended June 30, 2008, we acquired additional property and equipment
associated with our tactical application retail outlet and our physical
security product business and, as a result, incurred higher depreciation
costs. No such property or equipment
was acquired during the three months ended June 30, 2007.
Other (income) and expense.
We experienced a gain on adjustment of
fair value with respect to our Series A Convertible Preferred Stock, which
was classified as a liability, of approximately $2.6 million and a gain on the
related investor warrants of approximately $1.4 million for the three months
ended June 30, 2008. These securities were not outstanding during
the three months ended June 30, 2007 and accordingly there was no such
gain or loss recorded. As a result of our agreement to sell our
Series A Convertible Preferred Stock and warrants to purchase common
stock, we incurred gains which occurred upon the valuation of the stock. Such
valuation took into account the features, rights and obligations of the
convertible preferred stock, which ultimately resulted in a lower fair value
than the proceeds received. Since the Series A Convertible
Preferred Stock and related Investor Warrants are required to be recorded at
fair value, we recorded a gain on such securities. Interest expense for the three months ended
June 30, 2008 and June 30, 2007 was $243,000 and $3,700, respectively. The increase of $239,300 or 6467% for the
three months ended June 30, 2008 was the result of interest expense
associated with the amortization of the deferred financing costs and related
discounts on the Series A preferred stock of approximately $240,000. We had no such interest expense associated
with amortization of deferred financing costs for the three months ended
June 30, 2007.
Comparison of the Six Months Ended
June 30, 2008 versus June 30, 2007
Revenues.
Revenues for the six months ended
June 30, 2008 was approximately $18.6 million, an increase of
approximately $2 million, or 12%, over revenues of approximately $16.6 million
in the comparable period in 2007. This increase was due primarily to a
higher volume of orders completed under the Marine Corp. sole source contract
mentioned above for the six months ended June 30, 2008 versus
June 30, 2007. In addition, we recorded
approximately $1 million dollars in sales relating to the tactical application
retail outlet and physical
26
Table of Contents
security product business for the six months ended June 30,
2008. No such revenue was recorded for
the six months ended June 30, 2007.
Cost of
Revenues.
Cost
of revenues for the six months ended June 30, 2008 and June 30, 2007
was approximately $11.8 million and $9.6 million, respectively. This resulted in an increase of approximately
$2.2 million or 23%. This increase was
due to additional costs of revenue associated with the tactical application
retail outlet and physical security product business, both of which were not in
existence in 2007. In addition, the
increase was related to our increased production costs under the Marine Corp.
sales contract mentioned above. Cost of sales for the six months ended
June 30, 2007 also included costs related to orders filled for spare
parts, which have a much lower cost.
Gross
profit margin
.
The gross profit margin for the six months ended June 30, 2008 and
June 30, 2007 was approximately $6.8 million and $7.0 million,
respectively. The gross profit margin percentage was 37% and 42% for the
six months ended June 30, 2008 and June 30, 2007, respectively.
The decrease in gross profit margin percentage was due to higher costs associated
with production associated with the Marine Corp. sales contract and lower gross
profit margins associated with our tactical application retail outlet and our
physical security product business.
Gross profit margin for the six months ended June 30, 2007 also
include sales related to orders filled for spare parts, which have higher gross
profit margins.
Sales and Marketing Expenses.
Sales
and marketing expenses for the six months ended June 30, 2008 and
June 30, 2007 were approximately $1.36 million and $1.28 million,
respectively, representing an increase of $80,000, or 6%. We increased our
sales and marketing department from 7 employees as of June 30, 2007 to 15
employees as of June 30, 2008.
This increase in personnel resulted in approximately $120,000 in
additional salaries and employee benefits expense for the six months ended
June 30, 2008. For the six months
ended June 30, 2007, we incurred an additional $40,000 in travel expenses
related to tradeshows and commissions, over the corresponding six months ended
June 30, 2008.
Research
and Development Expenses.
Research and development expenses for the six months ended
June 30, 2008 and June 30, 2007 were approximately $370,000 and
$236,000, respectively. The increase of $134,000 or 57% from 2007 to 2008
was the result of additional testing and improvements of existing products.
General
and Administrative Expenses.
General and administrative expenses for the six months
ended June 30, 2008 and June 30, 2007 were approximately $2.7 million
and $1.4 million, respectively. The increase of $1.3 million, or 93%, was
primarily due to expansion expenses incurred during the six months ended
June 30, 2008, primarily during the first three months of 2008. Due to our expansion, we also incurred
increases in other expenses, such as general and liability insurance, rent and
general supplies, which approximated $420,000. We also incurred
additional general and administrative expenses associated with the facilities
for our tactical application retail outlet and our physical security product
business of approximately $600,000. We also incurred significant legal,
merger and acquisition, and accounting costs associated with the registration
of our common stock with the SEC under the Securities Exchange Act of 1934 and
our asset acquisition during the first quarter of 2008, which were
approximately $200,000.
General
and Administrative Salaries Expense.
General and
administrative salaries expense for the six months ended June 30, 2008 and
June 30, 2007 were approximately $2.3 million and $1.5 million,
respectively. The increase of $800,000, or 53%, was due to the increase
in personnel associated with our expansion and our acquisition of our tactical
application retail outlet and our physical security product business. As of June 30, 2008, there were 41
employees that were classified as general and administrative personnel, versus
27 employees as of June 30, 2007.
Depreciation
expense.
Depreciation expense was approximately $282,000 and $175,000 for the six months
ended June 30, 2008 and June 30, 2007, respectively. The
increase of $107,000, or 61%, was the result the expansion of our headquarters
during 2008, which resulted in higher depreciation expense. For the six
months ended June 30, 2008, we acquired additional property and equipment
associated with our tactical application retail outlet and our physical
security product business and, as a result, incurred higher depreciation
costs. No such property or equipment was
acquired as of June 30, 2007.
27
Table of Contents
Other (income) and expense.
We experienced a gain on adjustment of
fair value with respect to our Series A Convertible Preferred Stock, which
was classified as a liability, of approximately $1.2 million and a gain on the
related investor warrants of approximately $1.3 million for the six months
ended June 30, 2008. These securities were not outstanding as of
June 30, 2007 and accordingly there was no such gain or loss recorded for
the six months then ended. As a result of our agreement to sell our
Series A Convertible Preferred Stock and warrants to purchase common
stock, we incurred gains which occurred upon the valuation of the stock.
Such valuation took into account the features, rights and obligations of the
convertible preferred stock, which ultimately resulted in a lower fair value
than the proceeds received. Since the Series A Convertible
Preferred Stock and related Investor Warrants are required to be recorded at
fair value, we recorded a gain on such securities. Interest expense for the six months ended
June 30, 2008 and June 30, 2007 was $310,000 versus $3,700. The increase of $306,300 or 8278% for the six
months ended June 30, 2008 was the result of interest expense associated
with the amortization of the deferred financing costs and related discounts on
the Series A preferred stock of approximately $303,000. There was no such interest expense associated
with amortization of deferred financing costs for the six months ended
June 30, 2007.
Liquidity and Capital Resources
As June 30, 2008, our principal sources of liquidity were cash and
cash equivalents totaling approximately $6.6 million, net accounts receivable
of approximately $5.5 million and costs in excess of billings of approximately
$8.5 million. The primary sources of our liquidity during 2008 have come
from operations and proceeds received from the sale of our shares of
Series A Convertible Preferred Stock and warrants to purchase our common
stock.
On March 7, 2008, we entered into an agreement to sell shares of
our Series A Convertible Preferred Stock and warrants to purchase our
common stock, and to conditionally sell shares of our common stock, to three
investors. The aggregate purchase price of the preferred stock and warrants was
$15.0 million and the aggregate purchase price of the common stock was
$0.5 million. An initial closing on the sale of the preferred stock
and warrants was held on March 7, 2008 in which we received gross proceeds
of $10,975,000. A second closing took place on April 4, 2008 in which we
received gross proceeds of $4,025,000.
The conditional closing of the $500,000 common stock sale was not, and
will not be, completed.
In May 2007, we entered into a loan agreement
with Commerce Bank, N.A. pursuant to which we have access to a $12.0 million
revolving credit facility, and had access to a term loan of up to $3.0 million
through October 2007. As of the end of June 30, 2008,
approximately $143,000 was outstanding under the term loan. There were
no other draws upon the term loan. The credit facility is secured by all
of our assets, and bears interest at a variable rate equal to LIBOR plus a
margin of between 1.75% and 2.45%. We have not yet drawn on any funds available
under the revolving credit facility.
As of June 30, 2007, our principal
sources of liquidity were cash and cash equivalents totaling approximately
$2.7 million, net accounts receivable of approximately $6.4 million
and costs in excess of billings of approximately $3.2 million. The
primary source of our liquidity and capital resources during the first six
months of 2007 came from operations.
We believe that our current cash, cash equivalents and short-term
investments together with our expected cash flows from operations will be
sufficient to meet our anticipated cash requirements for working capital and
capital expenditures for at least the next 12 months.
It is possible, however, that implementation
of our growth strategy could result in additional business requiring us to
expand our operations, including our operating facilities, equipment and
employees. These facility and resource requirements could necessitate
additional funding beyond our operating cash flow and available credit.
We are exploring a number of capital raising alternatives to plan for this
28
Table of Contents
possibility. There can be no assurances that any outside funding
will be available to us or, if available, on reasonably acceptable terms.
Cash Flows
from Operating Activities.
Net cash used in operating activities was approximately $6.7 million
for the six months ended June 30, 2008 compared to net cash used in
operating activities of approximately $2.2 million as of June 30,
2007. Net cash used in operating activities in 2008 consisted primarily
of changes in our operating assets and liabilities of approximately $(2.7)
million, including changes in accounts receivable, cost in excess of billing,
prepaid expense, accounts payable and accrued liabilities. The changes in
accounts receivable and costs in excess of billing of $1.2 million and $(3.5)
million, respectively, reflects the increased payments received from our
customers and increases in projects in process as of June 30,
2008. Our prepaid expenses increased approximately $1.5 million due
to amounts paid in advance in connection with our intent to enter the public market
and obtain outside financing. In addition, the changes in accounts
payable and accrued liabilities reflect the related increase in expenses
incurred, with no funds paid out. Net
cash used in operating activities for the six months ended June 30, 2007
consisted primarily of changes in operating assets and liabilities of
approximately $(4.3) million, including changes in accounts receivable, cost in
excess of billing, accounts payable and accrued liabilities. These
changes in accounts receivable and cost in excess of billing resulted from the
increase in projects completed and invoices issued to customers.
As of June 30, 2008, we had net
operating loss carryforwards of approximately $5.0 million available to
reduce future taxable income. In the future, we may utilize our net operating
loss carryforwards and would begin making cash tax payments at that time. In
addition, the limitations on utilizing net operating loss carryforwards and
other minimum taxes may also increase our overall tax obligations. We expect
that if we generate taxable income and/or we are not allowed to use net
operating loss carryforwards, our cash generated from operations will be
adequate to meet our income tax obligations.
Net Cash
Used In Investing
Activities.
Net cash used in
investing activities for the six months ended June 30, 2008 and 2007 was
approximately $2.3 million and $436,000, respectively. Net cash used in
investing activities during these periods consisted primarily of cash paid for
the acquisition of equipment, leasehold
improvements related to the expansion of
the office and cash paid out for the acquisition of assets in excess of cash
received.
Net Cash
Provided by Financing
Activities.
Net cash
provided by financing for the six months ended June 30, 2008 and 2007 was
approximately $14 million and $389,000 respectively. Net cash provided by
financing activities during 2008 consisted primarily of proceeds of $13.9
million received from the sale of Series A Preferred Stock, $194,000
received from the sale of our common stock and approximately $65,000 received
from the term loan, offset by repayments of short term financing of
approximately $13,000. Net cash used in financing activities during 2007
consisted of proceeds from the sale of our common stock of $260,000 and proceeds
from short term financing of $141,000, which were offset by repayments of short
term financing of approximately $12,000.
Item 4. Controls and Procedure
Evaluation of Disclosure Controls and Procedures
Our
management carried out an
evaluation required by Rule 13a-15 under the Securities Exchange Act of
1934, as amended (the Exchange Act), under the supervision and with the
participation of our President and Chief Executive Officer (CEO) and Chief
Financial Officer (CFO), of the effectiveness of our disclosure controls and
procedures as defined in Rule 13a-15 and 15d-15 under the Exchange Act
(Disclosure Controls). Based on the evaluation, our CEO and CFO concluded
that, subject to the limitations noted herein, as of June 30, 2008, our
Disclosure Controls are effective in timely alerting them to material
information required to be included in our reports filed with the SEC.
Managements Assessment of the Effectiveness of Internal
Controls
This quarterly report does not include a report of managements assessment
regarding internal controls over financial reporting or an attestation report
of our registered independent public accounting firm due to a transition period
established by rules of the Securities and Exchange Commission for newly
formed public companies.
29
Table of Contents
Limitations on the Effectiveness of Controls
Our management, including our CEO and CFO, does not expect that our
Disclosure Controls and internal controls will prevent all error and all fraud.
A control system, no matter how well conceived and operated, can provide only
reasonable, not absolute, assurance that the objectives of the control system
are met. Further, the design of a control system must reflect the fact that
there are resource constraints, and the benefits of controls must be considered
relative to their costs. Because of the inherent limitations in all control
systems, no evaluation of controls can provide absolute assurance that all
control issues and instances of fraud, if any, with American Defense Systems
have been detected. These inherent limitations include the realities that
judgments in decision-making can be faulty and that breakdowns can occur
because of simple error or mistake. Additionally, controls can be circumvented
by the individual acts of some persons, by collusion of two or more people or
by management override of the controls.
The design of any system of controls also is based in part upon certain
assumptions about the likelihood of future events, and there can be no
assurance that any design will succeed in achieving its stated goals under all
potential future conditions; over time, a control may become inadequate because
of changes in conditions or the degree of compliance with the policies or
procedures may deteriorate. Because of the inherent limitations in a
cost-effective control system, misstatements due to error or fraud may occur
and may not be detected.
PART II
Item 1. Legal Proceedings
On July 10, 2007, we filed a lawsuit against a
former subcontractor, Southern California Gold Products d/b/a Gypsy Rack, the
subcontractors President and owner, Glenn Harris, and a designer, James McAvoy
in the United States District Court, Eastern District of New York. Defendants
moved to change venue to the Central District of California based upon
insufficient contacts to the State of New York and on October 12, 2007 the
matter was transferred to the United States District Court for the Central
District of California, Case Number 07-CV-02779. On February 21, 2008,
pursuant to the courts order, we filed an amended complaint. The amended
complaint names only Southern California Gold Products and James McAvoy as
defendants and asserts six counts as follows: misappropriation of trade secrets
and confidential information; breach of contract; unfair competition;
conversion; violation of the Lanham Act; and interference with prospective
economic advantage. The amended complaint seeks to enjoin the defendants from
misappropriating, disclosing, or using our confidential information and trade
secrets, and recall and surrender all products and trade secrets wrongfully
misappropriated or converted by the defendants. It also seeks compensatory
damages in an amount to be established at trial together with prejudgment and
post judgment interest, exemplary damages, disgorgement, restitution with
interest, attorneys fees and the costs of suit. Defendants filed an answer to
the amended complaint on April 16, 2008. Shortly after the filing of the
amended answer, defendants made a motion for summary judgment on, among others,
the grounds of collateral estoppel and res judicata. We filed opposition to the motion. The motion
for summary judgment is scheduled for argument before the court on August 25,
2008.
On
December 6, 2006, Stephen Lassak, our former Chief Financial Officer
commenced an action for breach of contract arising from his termination of
employment, which was in the United States District Court, Eastern District of
New York. The parties have reached a
settlement in this matter.
On
February 29, 2008, Roy Elfers, a former employee commenced an action
against us for breach of contract arising from his termination of employment in
the Supreme Court of the State of New York, Nassau County. The Complaint seeks
damages of approximately $87,000. We filed an answer to the complaint and will
be commencing discovery. Meritorious defenses to the claims exist and we
intend to vigorously defend this action.
On
March 4, 2008, Thomas Cusack, our former General Counsel, commenced an
action with the United States Department of Labor, Occupational Safety and
Health and Safety Administration, alleging retaliation in contravention of the
Sarbanes-Oxley Act. Mr. Cusack seeks damages in excess of $3,000,000. On April 2, 2008, we filed a response to
the charges. We believe the allegations
to be without merit and intend to vigorously defend against the action. On March 7, 2008, Mr. Cusack also
commenced a second action against 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, we served a motion to dismiss the complaint, which is fully
submitted before the Court. Meritorious
defenses to the claims exist and we intend to vigorously defend this action.
Item 2. Unregistered Sales of Equity
Securities and Use of Proceeds
On March 7, 2008, we entered into an
agreement to sell shares of our Series A Convertible Preferred Stock
(Series A Preferred) and warrants (Investor Warrants) to purchase our
common stock, and to conditionally sell shares of our common stock, to three
investors. The investors agreed to
purchase an aggregate of 15,000 shares of Series A Preferred and Investor
Warrants to purchase up to 3,750,000 shares of common stock, and to
conditionally purchase 100,000 shares of common stock. The aggregate purchase price of the preferred
stock and warrants is $15.0 million and the aggregate purchase price of
the common stock is $0.5 million.
Each share of Series A Preferred is initially convertible into 500
shares of common stock at a conversion price of $2.00 per share (Conversion
Price).
The holders of Investor Warrants may purchase
shares of our common stock at an exercise price of $2.40 per share until the
date that is 36 months after the date we become a reporting company under the
1934 Act. We have the right to require holders of the warrants to
exercise such warrants at any time after the 2
nd
anniversary of the date we become a public
reporting company under the 1934 Act if the trading price and volume of our
common
30
Table of Contents
stock achieves certain benchmarks or at any time after the six month
anniversary of a qualified public offering, in each case provided certain other
conditions are satisfied.
An initial closing on the sale of the preferred
stock and warrants was held on March 7, 2008 in which we received gross
proceeds of $10,975,000. A subsequent
closing took place on April 4, 2008 in which we received gross proceeds of
$4,025,000. In addition, the three
investors in our Series A Preferred were obligated to purchase 100,000
shares of our common stock for an aggregate purchase price of $500,000 if we
successfully listed our common stock on an eligible market on or prior to
June 30, 2008. We have agreed with
the investors that the conditional purchase would not be consummated.
In connection with the foregoing financing, we
also paid a portion of the related placement agent fees in the form of warrants
to purchase 675,000 shares of our common stock.
The warrants issued to the placement agent are exercisable for 5
years from the date of issue at an exercise price of $2.00 per share.
With respect to the sales of our
securities described above, we relied on the exemption provided by
Section 4(2) of the Securities Act and Regulation D promulgated
thereunder. The purchasers of securities are accredited investors and
acquired securities for their own account for investment purposes only and not
for resale unless registered under the Securities Act or pursuant an exemption
from such registration.
Item 5. Other Information
None.
Item 6. Exhibits
Exhibit Number
|
|
Exhibit
|
|
|
|
10.1
|
|
Consent and Agreement of Series A Convertible
Preferred Stockholders, dated May 23, 2008 (1)
|
10.2
|
|
Form of Voting Agreement for Anthony Piscitelli, Gary
Sidorsky and Curtis Taufman (1)
|
10.3
|
|
Letter
Agreement, dated May 29, 2008, between American Defense Systems, Inc. and
West Coast Opportunity Fund, LLC (2)
|
10.4
|
|
Letter Agreement, dated May 29, 2008, between
American
Defense Systems, Inc.
and Centaur
Value Fund, LP and United Centaur Master Fund (2)
|
10.5
|
|
Amendment No.1 to Independent Consulting Agreement, effective
July 23, 2008, between Richard Torykian and American Defense
Systems, Inc.(3)
|
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.
(1) Incorporated by reference to an exhibit to
the Registrants current report on Form 8-K filed with the SEC on
May 27, 2008.
(2) Incorporated by reference to an exhibit to
the Registrants current report on Form 8-K filed with the SEC on
May 30, 2008.
(3) Incorporated by reference to
Exhibit 99.1 to the Registrants current report on Form 8-K filed
with the SEC on August 8, 2008.
31
Table of Contents
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:
August 14, 2008
|
By:
|
/s/ Gary
Sidorsky
|
|
|
Chief Financial
Officer
|
|
|
|
|
32
Table of Contents
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.
|
33
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