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EX-32 - EXHIBIT 32.1 - MIKROS SYSTEMS CORPex32-1.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

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

For the quarterly period ended September 30, 2014

or

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from _____to_____.

 

Commission File Number: 000-14801

 

Mikros Systems Corporation

(Exact name of registrant as specified in its charter)

 

Delaware

14-1598200

(State or other jurisdiction of incorporation or organization)

(I.R.S. Employer Identification No.)

 

707 Alexander Road, Building Two, Suite 208, Princeton, New Jersey 08540

(Address of Principal Executive Offices)

 

(609) 987-1513

(Registrant’s Telephone Number, Including Area Code)

 

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 past 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     ☐ No

 

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

 

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 the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

 Large accelerated filer 

Accelerated filer

 Non-accelerated filer

Smaller reporting company

 (Do not check if a smaller reporting company) 

 

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

 

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date:  There were 32,018,753 issued and outstanding shares of the issuer’s common stock, $.01 par value per share, on November 14, 2014.

 

 

 
 

 

  

 

TABLE OF CONTENTS

 

 

 

PAGE #

PART I.

FINANCIAL INFORMATION

 

 

 

 

Item 1.

Financial Statements

 

 

 

 

 

Condensed Balance Sheets as of September 30, 2014 and December 31, 2013 (unaudited)

1

 

 

 

 

Condensed Statements of Operations and Comprehensive Income (Loss) for the Three and Nine Months Ended September 30, 2014 and 2013 (unaudited)

2

 

 

 

 

Condensed Statements of Cash Flows for the Nine Months Ended September 30, 2014 and 2013 (unaudited)

3

 

 

 

 

Notes to Condensed Financial Statements (unaudited)

4

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

9

 

 

 

Item 4.

Controls and Procedures

15

 

 

 

PART II.

OTHER INFORMATION

 

 

 

 

Item 6.

Exhibits

16

 

 

 

 

Signatures

17

  

 

 
 

 

  

 

PART I.  FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

Mikros Systems Corporation

Condensed Balance Sheets

(unaudited)

 

   

September 30,

2014

   

December 31,

2013

 

Assets

               

Current assets:

               

Cash and cash equivalents

  $ 1,286,937     $ 1,028,146  

Receivables on government contracts

    631,261       419,440  

Prepaid expenses and other current assets

    71,637       69,058  

Total current assets

    1,989,835       1,516,644  

Property and equipment:

               

Equipment

    51,583       45,157  

Furniture & fixtures

    14,728       9,264  

Less: accumulated depreciation

    (52,300

)

    (47,697

)

Property and equipment, net

    14,011       6,724  

Patents and trademarks

    1,383       1,383  

Less: accumulated amortization

    (1,139

)

    (1,035

)

Intangible assets, net

    244       348  

Deferred tax assets

    116,000       82,000  

Total assets

  $ 2,120,090     $ 1,605,716  

Liabilities and shareholders' equity

               

Current liabilities:

               

Accrued payroll and payroll taxes

  $ 383,547     $ 165,543  

Accounts payable and accrued expenses

    172,817       131,072  

Accrued warranty expense

    33,500       35,190  

Total current liabilities

    589,864       331,805  

Long-term liabilities

    9,054       12,476  

Total liabilities

    598,918       344,281  

Commitments and contingencies (Note 8)

               

Redeemable series C preferred stock par value $.01 per share, authorized 150,000 shares, issued and outstanding 5,000 shares (involuntary liquidation value - $80,450)

    80,450       80,450  

Shareholders' equity:

               

Preferred stock, series B convertible, par value $.01 per share, authorized 1,200,000 shares, issued and outstanding 1,102,433 shares (involuntary liquidation value - $1,102,433)

    11,024       11,024  

Preferred stock, convertible, par value $.01 per share, authorized 2,000,000 shares, issued and outstanding 255,000 shares (involuntary liquidation value - $255,000)

    2,550       2,550  

Preferred stock, series D, par value $.01 per share, 690,000 shares authorized, issued and outstanding (involuntary liquidation value - $1,518,000)

    6,900       6,900  

Common stock, par value $.01 per share, authorized 60,000,000 shares, issued and outstanding 32,018,753 shares and 32,011,753 shares at September 30, 2014 and December 31, 2013, respectively

    320,188       320,118  

Capital in excess of par value

    11,630,470       11,620,487  

Accumulated deficit

    (10,530,410

)

    (10,780,094

)

Total shareholders' equity

    1,440,722       1,180,985  

Total liabilities and shareholders' equity

  $ 2,120,090     $ 1,605,716  

 

See Notes to Unaudited Condensed Financial Statements 

 

 
1

 

  

Mikros Systems Corporation

Condensed Statements of Operations and Comprehensive Income (Loss)

 (unaudited)

 

   

Three Months Ended,

   

Nine Months Ended,

 
   

September 30,

2014

   

September 30,

2013

   

September 30,

2014

   

September 30,

2013

 
                                 

Contract revenues

  $ 1,057,442     $ 904,908     $ 3,150,584     $ 2,174,662  
                                 

Cost of sales

    431,701       433,316       1,284,081       1,110,709  
                                 

Gross margin

    625,741       471,592       1,866,503       1,063,953  
                                 

Expenses:

                               

Engineering

    329,864       214,461       832,517       619,468  

General and administrative

    213,956       236,030       806,591       784,426  
                                 

Total expenses

    543,820       450,491       1,639,108       1,403,894  
                                 

Income (loss) from operations

    81,921       21,101       227,395       (339,941

)

                                 

Interest income

    95       -       316       16  
                                 

Net income (loss) before income taxes

    82,016       21,101       227,711       (339,925

)

                                 

Income tax expense (benefit)

    (45,419 )     130,729       (21,973 )     (29,485

)

                                 

Net income (loss)

  $ 127,435     $ (109,628

)

  $ 249,684     $ (310,440

)

                                 

Other comprehensive income (loss)

    -       -       -       -  
                                 

Comprehensive income (loss)

  $ 127,435     $ (109,628

)

  $ 249,684     $ (310,440

)

                                 

Income (Loss) per common share - basic

  $ -     $ -     $ 0.01     $ (0.01

)

                                 

Basic weighted average number of shares outstanding

    31,904,786       31,840,970       31,892,694       31,830,881  
                                 

Income (Loss) per common share - diluted

  $ -     $ -     $ 0.01     $ (0.01

)

                                 

Diluted weighted average number of shares outstanding

    31,947,008       31,840,970       31,926,408       31,830,881  

 

See Notes to Unaudited Condensed Financial Statements

 

 
2

 

  

Mikros Systems Corporation

Condensed Statements of Cash Flows

(unaudited)

 

   

Nine Months Ended

 
   

September 30,

2014

   

September 30,

2013

 
                 

Cash flows from operating activities

               

Net income (loss)

  $ 249,684     $ (310,440

)

Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities:

               

Depreciation and amortization

    4,707       4,400  

Deferred tax benefit

    (34,000 )     (30,600

)

Share-based compensation expense

    9,703       10,220  

Changes in operating assets and liabilities:

               

(Increase) decrease in receivables on government contracts

    (211,821

)

    565,425  

Increase in prepaid expenses and other current assets

    (2,579

)

    (15,509

)

Increase (decrease) in accrued payroll and payroll taxes

    218,004       (144,134

)

Increase (decrease) in accounts payable and accrued expenses

    41,745       (136,924

)

(Decrease) increase in accrued warranty expense

    (1,690

)

    13,894  

Decrease in long-term liabilities

    (3,422

)

    (2,127

)

Net cash provided by (used in) by operating activities

    270,331       (45,795

)

Cash flows from investing activities:

               

Purchase of property and equipment

    (11,890

)

    (4,741

)

Net cash used in investing activities:

    (11,890

)

    (4,741

)

Cash flows from financing activities:

               

Proceeds received upon the exercise of stock options

    350       -  

Net cash provided by financing activities

    350       -  

Net increase (decrease) in cash and cash equivalents

    258,791       (50,536

)

Cash and cash equivalents, beginning of period

    1,028,146       887,140  

Cash and cash equivalents, end of period

  $ 1,286,937     $ 836,604  

Supplemental cash flow information:

               

Cash paid during the period for income taxes

  $ 558     $ 10,065  

 

See Notes to Unaudited Condensed Financial Statements

  

 
3

 

  

Mikros Systems Corporation

Notes to Condensed Financial Statements

(unaudited)

 

Note 1 – Basis of Presentation

 

The financial statements included herein have been prepared by Mikros Systems Corporation (the “Company”) pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”).  Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations.  These condensed financial statements should be read in conjunction with the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013.

 

In the opinion of the Company’s management, the accompanying unaudited interim condensed financial statements contain all adjustments, consisting solely of those which are of a normal recurring nature, necessary to present fairly its financial position as of September 30, 2014, and the results of its operations for the three and nine months ended September 30, 2014 and 2013 and cash flows for the nine months ended September 30, 2014 and 2013. Changes in the Company’s stockholders’ equity from December 31, 2013 to September 30, 2014 are a result of share-based compensation expense of $9,703, proceeds received upon the exercise of options of $350, and net income of $249,684.

 

Interim results are not necessarily indicative of results for the full fiscal year.

 

Note 2 – Recent Accounting Pronouncements

 

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09 “Revenue from Contracts with Customers”. ASU 2014-09 is a comprehensive new revenue recognition model requiring a company to recognize revenue to depict the transfer of goods or services to a customer at an amount reflecting the consideration it expects to receive in exchange for those goods or services. ASU 2014-09 may be applied using either a full retrospective or a modified retrospective approach and is effective for fiscal years, and interim periods within those years, beginning after December 15, 2016, and early adoption is not permitted. The Company is currently evaluating the impact of this amendment on its financial position and results of operations.

 

In June 2014, the FASB issued ASU No. 2014-12, "Compensation - Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide that a Performance Target Could be Achieved after the Requisite Service Period," ("ASU 2014-12"). ASU 2014-12 requires that a performance target that affects vesting, and that could be achieved after the requisite service period, be treated as a performance condition. As such, the performance target should not be reflected in estimating the grant date fair value of the award. This update further clarifies that compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the period(s) for which the requisite service has already been rendered. This ASU is effective for annual and interim periods beginning after December 15, 2015, and early adoption is permitted. The Company does not anticipate that the adoption of this standard will have a material impact on its financial statements.

 

In August 2014, the FABS issued ASU No. 2014-15, Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern (“ASU 2014-15”). ASU 2014-15 will explicitly require management to assess an entity’s ability to continue as a going concern, and to provide related footnote disclosure in certain circumstances. The new standard will be effective for all entities in the first annual period ending after December 15, 2016. Earlier adoption is permitted. The Company is currently evaluating the impact of the adoption of ASU 2014-15.

   

 
4

 

  

Mikros Systems Corporation

Notes to Condensed Financial Statements

(unaudited)

 

Note 3 – Significant Accounting Policies

 

Revenue Recognition

 

The Company is engaged in research and development contracts with the federal government to develop certain technology to be utilized by the U.S. Department of Defense (“DoD”). The contracts are cost plus fixed fee contracts and revenue is recognized on the basis of such measurement of partial performance as will reflect reasonably assured realization or delivery of completed articles. Fees earned under the Company’s contracts may also be accrued as they are billable, under the terms of the agreements, unless such accrual is not reasonably related to the proportionate performance of the total work or services to be performed by the Company from inception to completion. Under the terms of certain contracts, fixed fees are not recognized until the receipt of full payment has become unconditional, that is, when the product has been delivered and accepted by the Federal government.  Backlog represents the estimated amount of future revenues to be recognized under negotiated contracts as work is performed.  The Company’s backlog includes future Adaptive Diagnostic Electronic Portable Testset (“ADEPT”) units to be developed and delivered to the Federal government. 

 

Unbilled revenue reflects work performed, but not billed at the time, per contractual requirements. The Company had unbilled revenues of $24,586 and $16,130 included in receivables on government contracts as of September 30, 2014 and December 31, 2013, respectively.  Billings to customers in excess of revenue earned are classified as advanced billings, and shown as a liability.  As of September 30, 2014 and December 31, 2013, the Company had no advanced billings.  

  

Warranty Expense

 

The Company provides a limited warranty, as defined by the related warranty agreements, for its production units.  The Company’s warranties require the Company to repair or replace defective products during such warranty period. The Company estimates the costs that may be incurred under its warranty and records a liability in the amount of such costs at the time product revenue is recognized. Factors that affect the Company’s warranty liability include the number of units sold, expected and anticipated rates of warranty claims, and cost per claim. The Company periodically assesses the adequacy of its recorded warranty liability and adjusts the amount as necessary. During the three months ended September 30, 2014 and 2013, the Company recognized warranty (recoveries) expense of $(10,744) and $(3,901), respectively, and $(1,690) and $13,894 for the nine months ended September 30, 2014 and 2013, respectively.  Since the inception of the IDIQ contract in March 2010, the Company has delivered 125 ADEPT units.  As of September 30, 2014, there are 11 ADEPT units that remain under the limited warranty coverage.  As of September 30, 2014 and December 31, 2013, the Company had an accrued warranty expense of $33,500 and $35,190, respectively.

 

The following table reflects the reserve for product warranty activity as of September 30, 2014 and December 31, 2013:

 

   

2014

   

2013

 
                 

Reserve for product warranty, beginning of period

  $ 35,190     $ 69,655  

Provision for product warranty

    23,400       42,300  

Product warranty expirations

    (52,900 )     (57,800

)

Product warranty costs paid

    27,810       (18,965

)

Reserve for product warranty, end of period

  $ 33,500     $ 35,190  

  

Research and Development Costs

 

Research and Development expenditures for research and development of the Company's products are expensed when incurred, and are included in general and administrative expenses. The Company recognized research and development costs of $1,724 and $3,188 for the three months ended September 30, 2014 and 2013, respectively, and $5,021 and $78,672, for the nine months ended September 30, 2014 and 2013, respectively.

  

 
5

 

  

Mikros Systems Corporation

Notes to Condensed Financial Statements

(unaudited)

 

Note 4 – Income (Loss) Per Share

 

For periods with net income, net income per common share information is computed using the two-class method. Under the two-class method, basic net income per common share is computed by dividing the net income attributable to common stockholders by the weighted average number of shares of common stock outstanding during the period. Basic net loss attributable to common stockholders is computed by an adjustment to subtract from net income the portion of current period earnings that the preferred shareholders would have been entitled to receive pursuant to their dividend rights had all of the period’s earnings been distributed. No such adjustment to earnings is made during periods with a net loss, as the holders of the convertible preferred shares have no obligation to fund losses.

 

The table below sets forth the calculation of the percentage of net earnings (loss) allocable to common shareholders under the two-class method:

 

   

Three Months Ended,

   

Nine Months Ended,

 
   

September 30,

   

September 30,

   

September 30,

   

September 30,

 
   

2014

   

2013

   

2014

   

2013

 

Basic Income (Loss) Per Share:

                               

Net income (loss) applicable to common shareholders - basic

  $ 127,435     $ (109,628

)

  $ 249,684     $ (310,440

)

Portion allocable to common shareholders

    100

%

    100.0

%

    100

%

    100.0

%

Net earnings (losses) allocable to common shareholders

    127,435       (109,628

)

    249,684       (310,440

)

Weighted average basic shares outstanding

    31,904,786       31,840,970       31,892,694       31,830,881  

Basic income (loss) per share

  $ -     $ -     $ 0.01     $ (0.01

)

                                 

Dilutive Income (Loss) Per Share:

                               

Net income (loss) applicable to common shareholders

    127,435       (109,628

)

    249,684       (310,440

)

Numerator for diluted income (loss) per share

    127,435       (109,628

)

    249,684       (310,440

)

                                 

Weighted average shares outstanding - basic

    31,904,786       31,840,970       31,892,694       31,830,881  

Diluted effect:

                               

Stock options

    20,222       -       18,000       -  

Restricted stock options

    22,000       -       15,714       -  

Weighted average dilutive shares outstanding

    31,947,008       31,840,970       31,926,408       31,830,881  

Dilutive income (loss) per share

  $ -     $ -     $ 0.01     $ (0.01

)

  

 
6

 

  

Mikros Systems Corporation

Notes to Condensed Financial Statements

(unaudited)

 

   

Three Months Ended

September 30,

   

Nine Months Ended

September 30,

 
   

2014

   

2013

   

2014

   

2013

 

Numerator:

                               

Weighted average participating common shares

    31,904,786       31,840,970       31,892,694       31,830,881  

Denominator:

                               

Weighted average participating common shares

    31,904,786       31,840,970       31,892,694       31,830,881  

Portion allocable to common shareholders

    100

%

    100.0

%

    100

%

    100.0

%

 

Diluted net income (loss) per share for the three and nine months ended September 30, 2014 and 2013 does not reflect the following potential common shares, as the effect would be antidilutive.

 

   

September 30,

2014

   

September 30,

2013

 

Stock options

    610,000       645,000  

Unvested portion of restricted stock

    -       103,000  

Convertible preferred stock

    3,562,299       3,562,299  
      4,172,299       4,310,299  

  

Note 5 – Income Tax Matters

 

The Company conducts an on-going analysis to review the deferred tax assets and the related valuation allowance that it has recorded against deferred tax assets, primarily associated with Federal net operating loss carryforwards.  As a result of this analysis and the actual results of operations, the Company has increased its net deferred tax assets by $34,000 during the nine months ended September 30, 2014. The net deferred tax assets increased by $30,600 during the nine months ended September 30, 2013.   The change in deferred tax assets is attributable to the change in the valuation allowance as the Company anticipates annual earnings from operations to continue.  

 

Note 6 – Share-Based Compensation

 

A summary of the status of the Company’s 2007 Stock Incentive Plan as of September 30, 2014 is presented below.

 

   

Options

   

Weighted Exercise

Price

   

Weighted Life

(in years)

 
                         

Options outstanding - December 31, 2013

    645,000     $ 0.38       4.79  

Granted

    -       -          

Exercised

    (7,000

)

    0.05          

Forfeited

    -       -          

Options outstanding – September 30, 2014

    638,000     $ 0.38       4.01  

Options exercisable – September 30, 2014

    567,000     $ 0.33       3.74  

 

During the nine months ended September 30, 2014 and 2013, the Company issued 0 and 35,000 stock option awards, respectively. In accordance with the recognition provisions of the FASB’s Accounting Standards Codification 718, Share-Based Payments, the Company recorded the fair value of the options issued in 2013 at $0.02 per share. The fair value of the options was determined using the Black-Scholes option pricing model with the following assumptions: no dividend yield, risk-free interest rate of 0.75%, volatility of 123.3%, and an expected term of 6.5 years. The Company recognized stock-based compensation expense for stock options of $969 and $2,140 for the three months ended September 30, 2014 and 2013, respectively. The Company recognized stock-based compensation expense for stock options of $6,649 and $6,603 for the nine months ended September 30, 2014 and 2013, respectively. The intrinsic value of the options as of September 30, 2014 is $3,920. 

 

 
7

 

  

Mikros Systems Corporation

Notes to Condensed Financial Statements

(unaudited)

 

There were 44,000 and 103,000 restricted stock awards outstanding at September 30, 2014 and 2013, respectively.  The Company recognized stock-based compensation expense for restricted stock of $1,018 and $1,206 for the three months ended September 30, 2014 and 2013, respectively. The Company recognized stock-based compensation expense for restricted stock of $3,054 and $3,616 for the nine months ended September 30, 2014 and 2013, respectively.  

 

As of September 30, 2014, there was $2,900 of unrecognized stock-based compensation expense related to all outstanding equity awards that will be recognized in a future weighted average period of 1.46 years.

 

Note 7 – Related Party Transactions

 

Paul Casner, the chairman of the Company’s board of directors, also serves as the executive chairman and CEO of Atair Aerospace Incorporation.  Atair provided subcontracting services to the Company relating to the design of the chassis component within the ADEPT units.  During the three months ended September 30, 2014 and 2013, the Company incurred subcontracting service costs from Atair of $6,779 and $0, respectively. During the nine months ended September 30, 2014 and 2013, the Company incurred subcontracting service costs from Atair of $33,468 and $70,670, respectively.

 

 Note 8 – Commitments and Contingencies

 

The Company had a $500,000 line of credit agreement with Sun National Bank. The facility expired on June 30, 2014. There were no borrowings or payments related to this facility through the expiration date and the Company was in compliance with all the customary affirmative and negative covenants including its net worth financial covenant. The Company is not currently pursuing a new credit facility.

  

 
8

 

  

CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING STATEMENTS

 

This report contains “forward-looking statements” – that is, statements related to future, not past, events. In this context, forward-looking statements often address our expected future business and financial performance and financial condition, and often contain words such as “expect,” “anticipate,” “intend,” “plan,” “believe,” “seek,” “see,” or “will.” These forward-looking statements are not guarantees and are subject to known and unknown risks, uncertainties and assumptions about us that may cause our actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by such forward-looking statements.  For us, particular uncertainties that could cause our actual results to be materially different than those expressed in our forward-looking statements include: changes in business conditions; a decline or redirection of the U.S. defense budget; the termination of any contracts with the U.S. Government; continuation of the Federal automatic sequestration cuts; changes in our sales strategy and product development plans; changes in the marketplace; continued services of our executive management team; our limited marketing experience; competition between us and other companies seeking Small Business Innovative Research (“SBIR”) grants; competitive pricing pressures; market acceptance of our products under development; delays in the development of products; and statements of assumption underlying any of the foregoing, as well as other factors set forth under the caption “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2013 filed with the Securities and Exchange Commission.

 

All subsequent written and oral forward-looking statements attributable to us, or persons acting on our behalf, are expressly qualified in their entirety by the foregoing.  Except as required by law, we assume no duty to update or revise our forward-looking statements based on changes in internal estimates or expectations or otherwise.

 

Item 2.   Management’s Discussion and Analysis of Financial Position and Results of Operations.

 

Mikros Systems Corporation (“Mikros,” the “Company,” “we” or “us”) is an advanced technology company specializing in the research, development and production of electronic systems, primarily for military applications.  Classified by the Department of Defense (“DoD”) as a small business, our capabilities include technology management, electronic systems engineering and integration, radar systems engineering, command, control, communications, computers and intelligence (“C4I”) systems engineering, and communications engineering.

 

Overview

 

Our primary business focus is to pursue SBIR and other research and development programs from the DoD, Department of Homeland Security, and other governmental authorities, and to expand this government funded research and development into products and services.  Since 2002, we have been awarded several Phase I, II, and III SBIR contracts.

 

Revenues from our government contracts represented 100% of our revenues for the three and nine months ended September 30, 2014 and 2013.  We believe that we can utilize the intellectual property developed under our various SBIR awards to develop proprietary products for both the government and commercial marketplace.

 

ADEPT® 

 

Our primary source of revenue is sales of our Adaptive Diagnostic Electronic Portable Testset, or ADEPT, to the United States Navy. ADEPT is an automated maintenance workstation designed to significantly reduce the man-hours required to align the AN/SPY-1 Radar System aboard U.S. Navy AEGIS cruisers and destroyers, while optimizing system performance and readiness. ADEPT represents a new approach to Navy shipboard maintenance, integrating modular instrumentation cards in a rugged enclosure with an onboard computer, input and output devices, networking hardware, removable hard drives, and a touch screen display. A custom software application provides the user interface and integrates the hardware with a database that stores user information, instrument readings, maintenance requirements, and training aids. ADEPT is designed to be adapted to other complex shipboard system, and to provide integrated distance support capabilities for remote diagnostics and troubleshooting by shore-based Navy experts. We are currently extending the ADEPT system to a second Navy radar system. 

 

 
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ADSSS 

 

In 2013, we developed a second-generation of our ADEPT Distance Support Sensor Suite, or ADSSS, for the Littoral Combat Ship (LCS).  ADSSS is a network-enabled system which can be configured to monitor multiple shipboard systems and report maintenance data onshore for further analysis to detect trends and predict failures. This development program remains on schedule in-house and initial shipboard testing is planned for Summer 2015. We expect ADSSS to be used on both variants of the LCS which is currently planned to be at least 32 ships. ADSSS, with its remote monitoring and prognostics capabilities, has also generated interest in other ship classes, including Aegis, and we are currently pursuing several related opportunities.

 

Contracts

  

On March 18, 2010, we were awarded and entered into a multi-year Indefinite Delivery, Indefinite Quantity (“IDIQ”) contract with the Naval Surface Warfare Center, Crane IN related to our ADEPT product.  The contract is for a term of five years and provides for the purchase and sale of up to $26 million of ADEPT units and related engineering and logistics support.   We realized revenues related to the ADEPT production and support services of $1.1 million and $0.9 million during the three months ended September 30, 2014 and 2013, respectively, and $3.2 million and $2.1 million during the nine months ended September 30, 2014 and 2013, respectively.  The ADEPT contracts drive all revenue.  In the past, we were generating revenues primarily from the production and delivery of ADEPT units.   After executing the ADEPT program for four years, we now have contracts to do further R&D on ADEPT units to enhance functionality as well as provide other forms of support.  We expect additional delivery orders during the remaining term of the contract.  It should be noted that contracting with the Federal government is a lengthy and complex process and that many factors could materialize that would negatively impact our ability to secure future ADEPT orders.

  

In June 2013, we were awarded a $2.8 million service contract to develop Condition-Based Maintenance (“CBM”) for Littoral Combat Ship (LCS) Systems using the ADEPT Distance Support Sensor Suite, or ADSSS. This project will extend the development of the ADEPT to better facilitate the integration of multiple distributed sensors and portable data collection units, provide enhanced automated data collection and processing capabilities, and support hosting of prognostics modeling tools that use the collected data to predict remaining end of life for equipment under test components.

 

In August 2013, we were awarded a $5.5 million service contract under our IDIQ contract to provide necessary research, development, and program management and implementation of improvements to ADEPT units. We received an initial commitment of $0.8 million under this service contract which was increased to $2.1 million in the first quarter of 2014.

 

In January 2014, we were awarded a $0.5 million contract by the U.S. Navy that will extend the ADEPT system to a second Navy radar system.

 

During the second quarter of 2014, we were awarded four contracts valued at approximately $1.0 million to be funded over the next two years. Two of the awards are to support and improve our ADEPT product line by providing funding for continued training of Navy personnel and a new development effort to upgrade ADEPT instrumentation functions for data acquisition. The remaining two awards are to upgrade the ADSSS system for the Navy's new Littoral Combat Ship (“LCS”). Under the first ADSSS contract, we will design a new portable maintenance device for shipboard use, working closely with the Naval Ship Systems Engineering Station (“NAVSSES”) office in Philadelphia, PA. The second ADSSS award funds the installation of Condition Based Maintenance (“CBM”) equipment on the USS Fort Worth and continued shipboard testing.  This "Pilot Program" extends our pilot installation of ADSSS on the USS Freedom.

 

In July 2014, we were awarded additional funding of $0.3 million under the current IDIQ contract to upgrade the capabilities of the first 66 ADEPT units currently deployed in the fleet.  This effort involves installing a faster and more capable controller module and upgrading the Operating System software from Windows XP to Windows 7, and will be executed at our Largo, FL facility as units are returned for routine calibration.

 

In August 2014, we were awarded a major new production contract valued at $5 million for additional ADEPT® units. The Navy plans to purchase fifty-four (54) ADEPT units over the next year. These systems will be deployed on Navy “Aegis” destroyers and cruisers to support the AN/SPY-1 radar in air defense and ballistic missile defense missions. These systems will join the 125 ADEPT units already deployed and in everyday use by the Navy. Also, in August and September 2014, we were awarded two contracts for approximately $0.2 million for ADEPT training and calibration of 34 ADEPT units.

 

In November 2014, we were awarded a contract valued at $0.1 million for technical support on the USS Fort Worth (LCS3) using the latest version of our ADSSS (ADEPT Distance Support Sensor Suite) which will provide the SPS-75 Air Search Radar and Rolling Airframe (RAM) systems with Combat Systems (CS) Condition Based Monitoring (CBM) and Distance Support (DS) capability.

 

 
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It should be noted that contracting with the Federal government is a lengthy and complex process and that many factors could materialize that would negatively impact our ability to secure future contracts. In addition, our contracts with the Federal government contain unfavorable termination provisions and are subject to audit and modification.

 

Key Performance Indicator

 

As substantially all of our revenue is derived from contracts with the Federal government, our key performance indicator is the dollar volume of contracts awarded to us.  Increases in the number and value of contracts awarded will generally result in increased revenues in future periods and, assuming relatively stable variable costs associated with our fulfilling such contracts, increased profits in future periods.  The timing of such awards is uncertain as we sell to Federal government agencies where the process of obtaining such awards can be lengthy and at times uncertain.  As the majority of our revenue in 2014, and expected revenue over the next twelve months, is or will be from sales of ADEPT units under our IDIQ contract and releated R&D and support, continued generation of task orders and our ability to expand the market and potential customer base for ADEPT units will be a key indicator of future revenue. ADEPT units must be serviced and calibrated every two years. Accordingly, as we continue to increase the installed base of ADEPT units and expand the units to other radar systems, we expect to continue to generate future recurring maintenance and service revenue.

 

Outlook

 

Our strategy for continued growth is three-fold.  First, we expect to continue expanding our technology base, backlog and revenue by continuing our active participation in the DoD SBIR program and bidding on projects that fall within our areas of expertise.  These areas include electronic systems engineering and integration, radar systems engineering, C4I (Command, Control, Communications, Computers & Intelligence) systems engineering, and communications engineering.  We believe that we can utilize the intellectual property developed under our various SBIR awards to develop proprietary products, such as the ADEPT described above, with broad appeal in both the government and commercial marketplace. Our state-of-the-art test equipment could be used by many commercial and governmental customers such as the FAA, radio and television stations, cellular phone service providers and airlines.  Second, we will continue to pursue SBIR projects with the Department of Homeland Security, the U.S. Navy, and other government agencies.  Third, we believe that through our marketing of products such as ADEPT, we will develop key relationships with prime defense contractors.  Our strategy is to develop these relationships into longer-term, key subcontractor roles on future major defense programs awarded to these prime contractors.

 

In 2014, our primary strategic focus is to continue to: (i) establish ourselves as a premium provider of research and development and product development services to the defense industry; and (ii) grow our business, generate profits and increase our cash reserves through obtaining additional SBIR contracts and positioning ourselves to obtain future SBIR contracts.  From an operational prospective, we expect to focus substantial resources on generating purchase orders under the IDIQ contract for ADEPT units, expanding ADEPT to support other radar systems, and exploring commercialization opportunities.  We intend to capitalize on the Navy modernization program which could result in two or three ADEPT units being placed on each destroyer and cruiser in the U.S. Navy, with the potential to install multiple units on additional U.S. Navy ships and submarines. As the installed base increases, we expect additional and recurring revenue for calibration and other maintenance and support. In January 2014, we were awarded a contract to extend the ADEPT system to a second U.S. Navy radar system, the SBS-49, which is expected to assist in optimizing performance for the Ballistic Missile Defense Mission.

 

Over the longer term, we expect to further develop technology based on existing and additional SBIR contracts and to develop these technologies into products for wide deployment to DoD customers and contractors as well as developing potential commercial applications.  We believe that many of our core capabilities, remote monitoring, rugged systems, predictive maintenance and communications expertise, are applicable to other industries that work with complex distributed systems, such as utilities, communications and transportation systems. We are currently in discussions with certain industry participants regarding this initiative.

 

 
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During the past two fiscal years, the combination of spending caps, discretionary spending cuts, sequestration and further proposed reductions in defense spending has caused, and may in the future continue to cause, delays in funding certain projects. This has and may continue to adversely impact our revenues and profits. 

 

Changes to Critical Accounting Policies and Estimates

 

Our critical accounting policies and estimates are set forth in our Annual Report on Form 10-K for the fiscal year ended December 31, 2013. As of September 30, 2014, there have been no changes to such critical accounting policies and estimates.  

 

Results of Operations

 

 

Three Months Ended September 30, 2014 and 2013

 

Revenues earned are based upon the labor, subcontracting services, materials and other direct costs that we incur. Generally, labor and other direct costs generate higher revenues compared to subcontracting services and material costs. We generated revenues of $1,057,442 during the three months ended September 30, 2014 compared to $904,908 during the three months ended September 30, 2013, an increase of $152,534, or 17%.  The increase was primarily due to increased service revenue related to ADEPT units.  While production and delivery of ADEPT units was delayed period over period, contact services for the ADEPT units outpaced such delay.  During the three months ended September 30, 2014, revenues derived from labor hours completed outpaced subcontracting services and materials, resulting in higher revenues earned in 2014. While we experienced a delay in new delivery orders for ADEPT units during the three months ended September 30, 2014, we added fifteen new labor contracts.

 

Cost of sales consists of direct contract costs including labor, material, subcontracts, and warranty expense for ADEPT units that have been delivered, travel and other direct costs.   Cost of sales for the three months ended September 30, 2014 was $431,701 compared to $433,316 for the three months ended September 30, 2013, a decrease of $1,615 or 0.4%.  The increase in 2014 was primarily attributable to increases in direct labor of $105,715 and travel of $3,079 due to fifteen additional labor contracts offset by a reduction in material purchases of $15,479 and other direct costs including subcontractors of $85,429. Our warranty reserve decreased during the three months ended September 30, 2014 by $9,500 due to expiration of the warranty period applicable to 33 ADEPT units in 2014 as compared to 0 units in 2013.

 

The majority of our engineering costs consist of (i) salary, wages and related fringe benefits paid to engineering employees, (ii) rent-related costs, and (iii) consulting fees paid to engineering consultants.  As the nature of these costs benefit the entire organization and all research and development efforts, and their benefits cannot be identified with a specific project or contract, these engineering costs are classified as part of “engineering overhead” and included in operating expenses.  Engineering costs for the three months ended September 30, 2014 were $329,864 compared to $214,461 for the three months ended September 30, 2013, an increase of $115,403, or 54%. There were increases of $35,488 in fringe benefits incurred in connection with the addition of six new employees to the engineering staff, increased incentive compensation of $50,000, computer & software maintenance expenses of $7,594 and other miscellaneous engineering net costs of $22,321.

  

General and administrative expenses consist primarily of salary, intellectual property, consulting fees and related costs, professional fees, business insurance, franchise tax, SEC compliance costs, travel, and unallowable expenses (representing those expenses for which the government will not reimburse us).  General and administrative costs for the three months ended September 30, 2014 were $213,956 compared to $236,030 for the three months ended September 30, 2013, a decrease of $22,074, or 9%.   The decrease was primarily due to decreases in professional fees of $16,931, bid and proposal costs of $2,016, general, administrative salaries of $4,915, and other decreases of $212. These decreases were offset by a slight increase in incentive compensation of $2,000.

 

At September 30, 2014, we estimated our annual effective tax rate for 2014 to be 5.3%.  We recognized a tax benefit of $45,419 for the three months ended September 30, 2014 primarily due to expected net income for the remainder of 2014.  At September 30, 2014, the difference from the expected federal income tax rate is attributable to state income taxes, certain permanent book-tax differences and the income tax benefit related to the tax benefit recognized from the decrease in valuation allowance established for net deferred tax assets.  As of September 30, 2014, we had net operating loss carryforwards of $713,846, which will begin expiring in 2019 if not utilized.

 

 
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We realized net income of $127,435 during the three months ended September 30, 2014 as compared to a net loss of $109,628 during the three months ended September 30, 2013.  The increase in net income was primarily attributable to the award of fifteen additional labor contracts and receipt of orders for the purchase of 54 ADEPT units.

 

Nine Months Ended September 30, 2014 and 2013

 

We generated revenues of $3,150,584 during the nine months ended September 30, 2014 compared to $2,174,662 during the nine months ended September 30, 2013, an increase of $975,922, or 45%.  The increase was primarily due to the timing of the production and delivery of three ADEPT units offset by the change in the revenue mix between 2014 and 2013. While we experienced a delay in new delivery orders for ADEPT units during the nine months ended September 30, 2014, we added fifteen additional labor contracts and generated additional revenue related to the servicing of ADEPT units. During the nine months ended September 30, 2014, revenues derived from labor hours completed outpaced subcontracting services and materials, resulting in higher revenues earned in 2014.

 

Cost of sales for the nine months ended September 30, 2014 was $1,284,081 compared to $1,110,709 for the nine months ended September 30, 2013, an increase of $173,372, or 16%.  The increase in 2014 was primarily due to increases in direct labor of $369,524 due to fifteen additional labor contracts and receipt of orders for the purchase of 54 ADEPT units. Our cost of sales during the nine months ended September 30, 2014 was comprised of increased material costs of $58,244 reduced by subcontract services of $211,030 and other direct costs of $12,266. Labor costs were significantly lower during the comparable period in 2013. Our warranty reserve decreased during the nine months ended September 30, 2014 by $31,100 due to the addition of 3 and removal of 33 ADEPT units in 2014 as compared to the addition of 35 units in 2013.

 

Engineering costs for the nine months ended September 30, 2014 were $832,517 compared to $619,468 for the nine months ended September 30, 2013, an increase of $213,049, or 34%.  The increase was primarily due to the change in the mix of costs incurred. There were increases in fringe benefits of $94,944 due to the addition of six new employees to the engineering staff, incentive compensation of $79,135, additional rent due to the Florida office expansion of $6,998, computer, tools and equipment of $17,031, recruiting costs of $8,610, engineering tools and equipment of $11,562, office supplies of $6,870, consulting of $8,353 and other engineering cost fluctuations of $11,697. The increases were offset by reductions in engineering travel and salaries of $22,051 and $10,100, respectively.

 

General and administrative expenses for the nine months ended September 30, 2014 were $806,591 compared to $784,426 for the nine months ended September 30, 2013, an increase of $22,165, or 3%.  The increase was primarily due to the increases in bid and proposal costs of $27,296, incentive compensation of $63,530, professional fees of $9,785 and other general and administrative cost fluctuations of $9,280. These increases were offset by reductions in research and development and general and administrative salaries of $73,650 and $14,076, respectively.

 

At September 30, 2014, we estimated our annual effective tax rate for 2014 to be 5.3%.  We recognized a tax benefit of $21,973 for the nine months ended September 30, 2014 primarily due to expected net income for the remainder of 2014.  At September 30, 2014, the difference from the expected federal income tax rate is attributable to state income taxes, certain permanent book-tax differences and the income tax benefit related to the tax benefit recognized from the decrease in valuation allowance established for net deferred tax assets.  As of September 30, 2014, we had net operating loss carryforwards of $713,846, which will begin expiring in 2019 if not utilized.

 

We realized net income of $249,684 during the nine months ended September 30, 2014 as compared to a net loss of $310,440 during the nine months ended September 30, 2013.  The increase in net income was primarily attributable to the award of fifteen additional labor contracts and timing as we completed delivery order contracts for three ADEPT units.

 

Liquidity and Capital Resources

 

Since our inception, we have financed our operations through debt, private and public offerings of equity securities, and cash generated by operations.

 

During the nine months ended September 30, 2014, net cash provided by operations was $270,331 compared to net cash used in operations of $45,795 during the nine months ended September 30, 2013. The increase was due primarily to us having net income of $249,684 during the nine months ended September 30, 2014 compared to a net loss of $310,440 during the nine months ended September 30, 2013 and the timing of payments related to our operating assets and liabilities. Specifically, we had increases in accounts payable due to the timing of our vendor payments and accrued payroll and payroll taxes due to additional employees. These amounts were offset by increases in accounts receivable as a result of less payments being received than revenue billed.  We had working capital of $1,399,971 as of September 30, 2014 as compared to $1,184,839 as of December 31, 2013.  

 

 
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During the nine months ended September 30, 2014, net cash used in investing activities was $11,890 compared to $4,741 during the nine months ended September 30, 2013.  The increase was due to capital expenditures related to the expansion of our Florida office.

 

During the nine months ended September 30, 2014, net cash provided by financing activities of $350 was attributable to cash proceeds received due to the exercise of stock options.   

 

We believe our available cash resources and expected cash flows from operations will be sufficient to fund operations for the next twelve months.  We do not expect to incur any material capital expenditures during the next twelve months.

 

In order to pursue strategic opportunities, obtain additional SBIR contracts, or acquire strategic assets or businesses, we may need to obtain additional financing or seek strategic alliances or other partnership agreements with other entities.   In order to raise any such financing, we anticipate considering the sale of additional debt or equity securities under appropriate market conditions.  There can be no assurance, assuming we successfully raise additional funds or enter into business alliances, that we will remain profitable or continue to generate positive cash flow.

 

Off-Balance Sheet Arrangements

 

As of September 30, 2014, we did not have any relationships with unconsolidated entities or financial partners, such as entities often referred to as structured finance or special purpose entities, established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.  As such, we are not materially exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in such relationships.

 

Recent accounting pronouncements

 

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09 Revenue from Contracts with Customers. ASU 2014-09 is a comprehensive new revenue recognition model requiring a company to recognize revenue to depict the transfer of goods or services to a customer at an amount reflecting the consideration it expects to receive in exchange for those goods or services. ASU 2014-09 may be applied using either a full retrospective or a modified retrospective approach and is effective for fiscal years, and interim periods within those years, beginning after December 15, 2016, and early adoption is not permitted. We are currently evaluating the impact of this amendment on our financial position and results of operations.

 

In June 2014, the FASB issued Accounting Stands Update No. 2014-12, "Compensation - Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide that a Performance Target Could be Achieved after the Requisite Service Period," ("ASU 2014-12"). ASU 2014-12 requires that a performance target that affects vesting, and that could be achieved after the requisite service period, be treated as a performance condition. As such, the performance target should not be reflected in estimating the grant date fair value of the award. This update further clarifies that compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the period(s) for which the requisite service has already been rendered. This ASU is effective for annual and interim periods beginning after December 15, 2015, and early adoption is permitted. We do not anticipate that the adoption of this standard will have a material impact on our financial statements.

 

In August 2014, the FABS issued ASU No. 2014-15, Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern (“ASU 2014-15”). ASU 2014-15 will explicitly require management to assess an entity’s ability to continue as a going concern, and to provide related footnote disclosure in certain circumstances. The new standard will be effective for all entities in the first annual period ending after December 15, 2016. Earlier adoption is permitted. We are currently evaluating the impact of the adoption of ASU 2014-15.

  

 
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Item 4.  Controls and Procedures.

 

An evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934) was carried out by us under the supervision and with the participation of our president, who serves as our principal executive officer and principal financial officer.  Based upon that evaluation, our president concluded that as of September 30, 2014, our disclosure controls and procedures were effective to ensure (i) that information we are required to disclose in reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and (ii) that such information is accumulated and communicated to management, including our president, in order to allow timely decisions regarding required disclosure.

 

There were no changes in our internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) or 15d-15(f)) that occurred during the fiscal quarter ended September 30, 2014 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

  

 
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PART II.  OTHER INFORMATION

 

Item 6.   Exhibits

 

No.

Description

 

 

31.1

Certification of principal executive officer and principal financial officer pursuant to Rules 13a-14(a) or 15d-14(a) of the Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes Oxley Act of 2002.

 

 

32.1

Certification of principal executive officer and principal financial officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes Oxley Act of 2002.

 

 

101.INS

XBRL Instance

 

 

101.SCH

XBRL Taxonomy Extension Schema

 

 

101.CAL

XBRL Taxonomy Extension Calculation

 

 

101.DEF

XBRL Taxonomy Extension Definition

 

 

101.LAB

XBRL Taxonomy Extension Labels

 

 

101.PRE

XBRL Taxonomy Extension Presentation

  

 
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 SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

 

MIKROS SYSTEMS CORPORATION

 

 

 

 

 

November 14, 2014

By:

/s/ Thomas J. Meaney

 

 

 

 

 

 

 

 

 

 

 

Thomas J. Meaney

President and Chief Financial Officer

 

 

 

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