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MKRS > SEC Filings for MKRS > Form 10-Q on 14-Nov-2012All Recent SEC Filings

Show all filings for MIKROS SYSTEMS CORP

Form 10-Q for MIKROS SYSTEMS CORP


14-Nov-2012

Quarterly Report


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

Mikros Systems Corporation ("Mikros," the "Company," "we" or "us") was incorporated in the State of Delaware in June 1978. We are an advanced technology company specializing in the research and development of electronic systems technology 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, combat/command, control, communications, computers and intelligence ("C4I") systems engineering, and communications engineering.

Overview

Our primary business is to pursue Small Business Innovative Research ("SBIR") programs from the DoD, Department of Homeland Security, and other governmental authorities, and to expand this government-funded research and development into products, services, and other business areas of the Company. Since 2002, we have been awarded a number of 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, 2012 and 2011. The majority of our revenue was generated by sales of Adaptive Diagnostic Electronic Portable Testset ("ADEPT") units. We believe that we can utilize the intellectual property developed under our various SBIR awards to create proprietary products for both the government and commercial marketplace.

Below is a brief description of certain of the material projects we are working on at this time.

(ADEPT®)

Originally designated as the Multiple Function Distributed Test and Analysis Tool, the ADEPT began as an SBIR investigation in 2002. Additional ADEPT development was completed through a series of SBIR grants and contracts. 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 an 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 systems, and to provide integrated distance support capabilities for remote diagnostics and troubleshooting by shore-based Navy experts.

Key benefits of ADEPT include:

• Distance support capability enabling "expert" remote (shore-based) system support and fleet-wide system analysis;

• Reduction in the amount of electronic test equipment required for organizational level support; and

• Modularity and programmability which aims to overcome obsolescence issues encountered with current test equipment and support capability enhancements in future systems.

The goal for ADEPT has been to obtain a multi-year Indefinite-Delivery, Indefinite-Quantity ("IDIQ") contract for production, engineering, and logistics support. On March 19, 2010, we were awarded and entered into an IDIQ contract with the Naval Surface Warfare Center. 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 support.


In September 2010 and July 2011, we were awarded significant task orders under the IDIQ contract. For the nine months ended September 30, 2012 and 2011, we realized revenues of $2,246,764 and $2,187,997, respectively, related to the ADEPT production orders received. 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 April, June, and July 2012, we received commitments of $385,000 $852,000 and $88,000, respectively, under the ADEPT contract to provide additional engineering and logistics support. In August and September 2012, we received new task orders under the ADEPT contract to produce and deliver 35 ADEPT units.

Wireless Local Area Network

Since June 2004, we have been working with the Office of Naval Research regarding emerging Wireless Local Area Network systems ("WLANs") and DoD radar systems to, among other things, evaluate and quantify the potential improvements which may be afforded by selected mitigation techniques. We continue to perform contracts in connection with this project and are working closely with engineers from the Naval Air Warfare Center, Weapons Division ("NAWCWD"). The technical objective of this effort is to develop simulation models that can be used to predict the performance of data links in a jamming environment.

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 during the first three quarters of 2012, and expected revenue over the next three months, is or will be from sales of ADEPT units under our IDIQ contract, 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.

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, combat/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 ADEPT, with broad appeal in both the government and commercial marketplace. This state-of-the-art test equipment can 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 system contractors. Our strategy is to develop these relationships into longer-term, key subcontractor roles on future major defense programs awarded to these prime contractors.

For the remainder of 2012, 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 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.

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.

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, 2011. As of September 30, 2012, there have been no changes to such critical accounting policies and estimates.


Results of Operations

The discussion and analysis of our financial condition and results of operations are based upon our financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles ("GAAP") and the requirements of the SEC. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our estimates, including those related to bad debts, recoverability of long-lived assets, warranties, income taxes and commitments. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. The accounting estimates and assumptions discussed in the notes to our condensed financial statements included herein are those that we consider to be the most critical to an understanding of our financial statements because they inherently involve significant judgments and uncertainties.

Three Months Ended September 30, 2012 and 2011

We generated revenues of $1,124,211 during the three months ended September 30, 2012 compared to $1,098,430 during the three months ended September 30, 2011, an increase of $25,781, or 2%. The increase is primarily due to the receipt of additional task orders for ADEPT units in August and September of 2012.

Cost of revenues consist of direct contract costs such as labor, material, subcontracts, travel, and other direct costs. Cost of revenues for the three months ended September 30, 2012 was $662,812 compared to $641,865 for the three months ended September 30, 2011, an increase of $20,947 or 3%. The increase is primarily due to the receipt of additional task orders for ADEPT units in August and September of 2012, offset by the reversal of warranty expense recorded in prior periods. Our estimates for future warranty costs are largely based on our historical experience of material usage and service delivery costs incurred in correcting product failures related to ADEPT units. Since the inception of the IDIQ contract in March 2010, we have delivered 81 ADEPT units. As of September 30, 2012, we have 38 ADEPT units that we continue to provide limited warranty coverage.

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 benefit 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, 2012 were $174,203 compared to $211,977 for the three months ended September 30, 2011, a decrease of $37,774, or 18%. The decrease is primarily attributable to the anticipated reductions in bonuses for 2012 and other fringe benefits that were offset by increases in time and travel costs related to product enhancements.

General and administrative expenses consist primarily of salary, 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, 2012 were $251,712 compared to $247,796 for the three months ended September 30, 2011, an increase of $3,916 or 2%. The increase was primarily attributable to an increased effort to obtain more government contracts as well as new task orders under our current programs with the Federal government offset by anticipated reductions in bonuses and related incentive compensation.

At September 30, 2012, we estimate our annual effective tax rate for 2012 to be 74.6% exclusive of discrete items. We are recognizing a tax benefit of $83,000 for the three months ended September 30, 2012 primarily due to the state tax benefit attributable to the loss generated in the quarter and changes in the valuation allowance established for net deferred tax assets. At September 30, 2012, the difference from the expected federal income tax rate is attributable to certain permanent book-tax differences, state income taxes and changes in the valuation allowance established for net deferred tax assets.

We reported a net income of $118,484 during the three months ended September 30, 2012 as compared to a net income $892 during the three months ended September 30, 2011. The increase was primarily attributable to a decrease in the valuation allowance for deferred tax assets the reversal of warranty expense recorded in prior periods, and the receipt of new task orders for ADEPT units in August and September 2012. Our forecasting of future earnings resulted in the decrease to our valuation allowance.


Nine Months Ended September 30, 2012 and 2011

We generated revenues of $2,362,703 during the nine months ended September 30, 2012 compared to $3,057,406 during the nine months ended September 30, 2011, a decrease of $694,703, or 23%. The decrease was primarily attributable to the delay in receiving additional task orders to produce ADEPT units and related developments and the completion of our role in the LEAP program and SBIR Phase II contract, and other projects that were completed in 2011.

Cost of revenues consist of direct contract costs such as labor, material, subcontracts, travel, and other direct costs. Cost of revenues for the nine months ended September 30, 2012 was $1,119,994 compared to $1,639,322 for the nine months ended September 30, 2011, a decrease of $519,328, or 32%. The decrease was primarily attributable to the reversal of warranty expense recorded in prior periods and the delay in receiving additional task orders to produce ADEPT units and related developments and the completion of our role in the LEAP program and SBIR Phase II contract, and other projects that were completed in 2011. We completed production and delivery of ADEPT units in May 2012 and did not receive new task orders for ADEPT units until August 2012.

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 benefit 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 nine months ended September 30, 2012 were $480,956 compared to $621,220 for the nine months ended September 30, 2011, a decrease of $140,264, or 23%. The decrease was primarily attributable to the anticipated reductions in bonuses for 2012 offset by an increase in amortization expense resulting from the discontinuance of certain patents and related technology.

General and administrative expenses consist primarily of salary, 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 nine months ended September 30, 2012 were $854,100 compared to $778,875 for the nine months ended September 30, 2011, an increase of $75,225, or 10%. The increase was primarily attributable to an increased effort to obtain more government contracts as well as new task orders under our current programs with the Federal government offset by anticipated reductions in bonuses and related incentive compensation.

At September 30, 2012, we estimate our annual effective tax rate for 2012 to be 74.6% exclusive of discrete items. We are recognizing a tax benefit of $105,000 for the nine months ended September 30, 2012 primarily due to the state tax benefit attributable to the loss generated in the period and changes in the valuation allowance established for net deferred tax assets. At September 30, 2012, the difference from the expected federal income tax rate is attributable to certain permanent book-tax differences, state income taxes and changes in the valuation allowance established for net deferred tax assets.

We reported net income of $12,751 during the nine months ended September 30, 2012 as compared to net income of $17,405 during the nine months ended September 30, 2011. The decrease was primarily attributable to the completion of production and development under our IDIQ, SBIR, and subcontracting arrangements and a delay in the award of additional task orders to produce ADEPT units. These decreases were offset by the reversal of warranty expense recorded in prior periods and the decease in our valuation allowance for our deferred tax assets.


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, 2012, net cash used in operations was $90,576 compared to net cash provided by operations of $223,999 during the nine months ended September 30, 2011. The decrease was due primarily to the completion of outstanding task orders under our IDIQ contract and a delay in the award of additional task orders in August and September 2012. We had working capital of $1,083,576 as of September 30, 2012 as compared to working capital of $1,117,740 at December 31, 2011.

During the nine months ended September 30, 2012, net cash used in investing activities was $1,102 compared to $2,428 during the nine months ended September 30, 2011. The decrease was due to fewer capital expenditures.

In May 2012, we renewed our line of credit agreement with Sun National Bank. The borrowing capacity remained unchanged at $200,000. The facility matures on May 31, 2013 and accrues interest at a variable rate equal to the bank's prime rate plus 300 basis points with a minimum interest rate of 5.25% per annum. Principal borrowings may be prepaid at any time without penalty, and the facility is secured by substantially all of our assets. Borrowings under the facility are limited to a percentage of aggregate outstanding receivables that are due within 90 days. The facility contains customary affirmative and negative covenants and a net worth financial covenant. As of the date of this report, there were no amounts outstanding under the facility.

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 any such transaction will achieve profitability or generate positive cash flow.

Off-Balance Sheet Arrangements

As of September 30, 2012, we did not have any relationships with unconsolidated entities or financial partners, such as entities often referred to as structured finance or variable interest 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.

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