MIKROS SYSTEMS CORP - FORM 10-Q

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EXCEL - IDEA: XBRL DOCUMENT - MIKROS SYSTEMS CORP	Financial_Report.xls
EX-32.1 - EXHIBIT 32.1 - MIKROS SYSTEMS CORP	ex32-1.htm
EX-31.1 - EXHIBIT 31.1 - MIKROS SYSTEMS CORP	ex31-1.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

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

For the quarterly period ended September 30, 2012

o 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. x Yes o 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). x Yes o 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	o	Accelerated filer	o
Non-accelerated filer	o	Smaller reporting company	x

(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). o Yes x 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 32,016,753 issued and outstanding shares of the issuer’s common stock, $.01 par value per share, on November 14, 2012.

TABLE OF CONTENTS

		PAGE #
PART I.	FINANCIAL INFORMATION

Item 1.	Financial Statements

	Condensed Balance Sheets as of September 30, 2012 and December 31, 2011 (unaudited)	1

	Condensed Statements of Operations for the Three and Nine Months Ended September 30, 2012 and 2011 (unaudited)	2

	Condensed Statements of Cash Flows for the Three and Nine Months Ended September 30, 2012 and 2011 (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	13

PART II.	OTHER INFORMATION

Item 6.	Exhibits	14

	Signatures	14

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

Mikros Systems Corporation

Condensed Balance Sheets

(unaudited)

	September 30, 2012			December 31, 2011

Assets
Current assets:
Cash and cash equivalents	$	871,878		$	963,556
Receivables on government contracts		784,055			1,478,103
Prepaid expenses and other current assets		85,062			30,846
Total current assets		1,740,995			2,472,505
Property and equipment
Equipment		38,172			37,070
Furniture & fixtures		9,264			9,264
Less: accumulated depreciation		(40,640	)		(35,167	)
Property and equipment, net		6,796			11,167
Patents and trademarks		1,383			5,383
Less: accumulated amortization		(862	)		(1,775	)
Intangible assets, net		521			3,608
Deferred tax assets		102,000			21,000
Total assets	$	1,850,312		$	2,508,280
Liabilities and shareholders' equity
Current liabilities:
Accrued payroll and payroll taxes	$	125,783		$	364,148
Accounts payable and accrued expenses		479,298			904,217
Accrued warranty expense		52,338			86,400
Total current liabilities		657,419			1,354,765
Long-term liabilities		15,877			16,708
Total liabilities		673,296			1,371,473

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 32,016,753 shares		320,168			320,168
Capital in excess of par value		11,602,894			11,575,436
Accumulated deficit		(10,846,970	)		(10,859,721	)
Total shareholders' equity		1,096,566			1,056,357
Total liabilities and shareholders' equity	$	1,850,312		$	2,508,280

See Notes to Unaudited Condensed Financial Statements

Mikros Systems Corporation

Condensed Statements of Operations

(unaudited)

	Three Months Ended,						Nine Months Ended,
	September 30, 2012			September 30, 2011			September 30, 2012			September 30, 2011

Contract Revenues	$	1,124,211		$	1,098,430		$	2,362,703		$	3,057,406

Cost of sales		662,812			641,865			1,119,994			1,639,322

Gross margin		461,399			456,565			1,242,709			1,418,084

Expenses:
Engineering		174,203			211,977			480,956			621,220
General and administrative		251,712			247,796			854,100			778,875

Total expenses		425,915			459,773			1,335,056			1,400,095

(Loss) income from operations		35,484			(3,208	)		(92,347	)		17,989

Other income:
Interest		0			-			98			816

Net income (loss) before income taxes		35,484			(3,208	)		(92,249	)		18,805

Income tax (benefit) expense		(83,000	)		(4,100	)		(105,000	)		1,400

Net income	$	118,484		$	892		$	12,751		$	17,405

Income per common share - basic and diluted	$	-		$	-		$	-		$	-

Basic weighted average number of shares outstanding		31,782,786			31,766,753			31,772,136			31,766,753

Diluted weighted average number of shares outstanding		35,345,085			35,329,052			35,334,435			35,329,052

See Notes to Unaudited Condensed Financial Statements

Mikros Systems Corporation

Condensed Statements of Cash Flows

(unaudited)

	Nine Months Ended
	September 30, 2012			September 30, 2011

Cash flows from operating activities
Net (loss) income	$	12,751		$	17,405
Adjustments to reconcile net (loss) income to net cash provided by operating activities:
Depreciation and amortization		8,560			6,292
Deferred tax benefit		(81,000	)		(1,600	)
Share-based compensation expense		27,458			19,812
Changes in assets and liabilities:
Decrease in certificate of deposit, securing line of credit		-			50,000
Decrease (increase) in receivables on government contracts		694,048			(61,869	)
Increase in prepaid expenses and other current assets		(54,216	)		(16,141	)
Decrease in accrued payroll and payroll taxes		(238,365	)		(32,685	)
(Decrease) increase in accounts payable and accrued expenses		(424,919	)		195,052
(Decrease) increase in accrued warranty expense		(34,062	)		33,750
(Decrease) increase in long-term liabilities		(831	)		13,983
Net cash (used in) provided by operating activities		(90,576	)		223,999
Cash flows from investing activities:
Purchase of property and equipment		(1,102	)		(2,428	)
Net cash used in investing activities:		(1,102	)		(2,428	)
Net increase (decrease) in cash and cash equivalents		(91,678	)		221,571
Cash and cash equivalents, beginning of period		963,556			638,106
Cash and cash equivalents, end of period	$	871,878		$	859,677
Supplement cash flow information:
Cash paid during the period for income taxes	$	31,000		$	20,635

See Notes to Unaudited Condensed Financial Statements

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. 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, 2011.

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, 2012, and the results of its operations for the three and nine months ended September 30, 2012 and 2011, and cash flows for the nine months ended September 30, 2012 and 2011. Certain amounts for the prior period have been reclassified to conform to the current presentation. The Company has evaluated the impact of subsequent events through the date the condensed financial statements were issued and filed with the Securities and Exchange Commission (the “SEC”).

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

Note 2 – Recent Accounting Pronouncements

There have been no developments to recently issued accounting standards that would apply to the Company, including the expected dates of adoption and estimated effects on the Company’s condensed financial statements, from those disclosed in the Company’s 2011 Annual Report on Form 10-K.

Mikros Systems Corporation

Notes to Condensed Financial Statements

(unaudited)

Note 3 – Significant Accounting Policies

Revenue Recognition

The Company is a party to research and development contracts with the Federal government to develop certain technology to be utilized by the US Department of Defense. The contracts are cost plus fixed fee contracts and revenue is recognized based on the extent of progress towards completion of the long term contract.

The Company generally uses a variation of the cost to cost method to measure progress for all long term contracts unless it believes another method more clearly measures progress towards completion of the contract.

Revenues are recognized as costs are incurred and include estimated earned fees, or profit, calculated on the basis of the relationship between costs incurred and total estimated costs at 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 primarily consists of future Adaptive Diagnostic Electronic Portable Testset (“ADEPT”) units to be developed and delivered to the Federal government. The estimated value of the ADEPT® units and the Small Business Innovative Research (“SBIR”) program backlog was $3,292,568 as of September 30, 2012.

Unbilled revenue reflects work performed, but not billed at the time, per contractual requirements. As of September 30, 2012 and December 31, 2011, the Company had no unbilled revenues. Billings to customers in excess of revenue earned are classified as advanced billings, and shown as a liability. As of September 30, 2012 and December 31, 2011, the Company had no advanced billings. Under the Indefinite-Delivery, Indefinite-Quantity (“IDIQ”) agreement, the Company delivered 36 units for the nine months ended September 30, 2012.

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 and nine months ended September 30, 2012, the Company reversed warranty expenses of $24,500 and $32,400, respectively. Since the inception of the IDIQ contract in March 2010, the Company has delivered 81 ADEPT units. As of September 30, 2012, there are 38 ADEPT units that remain under the limited warranty coverage. As of September 30, 2012 and December 31, 2011, the Company had an accrued warranty expense of $52,338 and $86,400, respectively.

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 $21,809 and $8,794 for the three months ended September 30, 2012 and 2011, respectively, and $49,547 and $34,761 for the nine months ended September 30, 2012 and 2011, respectively.

Patents and Trademarks

The Company has developed and continues to develop intellectual property (technology and data) under SBIR and other contracts. The request for a trademark for the product name “ADEPT” has been approved by the U.S. Patent and Trademark Office, and ADEPT® is now a registered trademark of the Company.

Under SBIR data rights, the Company is protected from unauthorized use of SBIR-developed technology and data for a period of five years after acceptance of all items to be delivered under a particular SBIR contract or any follow-on contract.

During the nine months ended September 30, 2012, the Company discontinued the use of certain technology and related patents. The Company removed the historical carrying value of these patents of $4,000 from its condensed balance sheet as of September 30, 2012 and immediately recognized $2,933 of unamortized balance as amortization expense for the nine months ended September 30, 2012.

Mikros Systems Corporation

Notes to Condensed Financial Statements

(unaudited)

Note 4 – Earnings Per Share

The Company’s calculation of weighted average shares outstanding for the three and nine months ended September 30, 2012 and 2011 is set forth below:

	Three Months Ended September 30,						Nine Months Ended September 30,
	2012			2011			2012			2011
Basic earnings per common share:
Net income	$	118,484		$	892		$	12,751		$	17,405
Portion allocable to common shareholders		99.2	%		99.2	%		99.2	%		99.2	%
Net income allocable to common shareholders		117,536			885			12,649			17,266
Weighted average basic shares outstanding		31,782,786			31,766,753			31,772,136			31,766,753
Basic income per common share	$	-		$	-		$	-		$	-

Dilutive earnings per common share:
Net income allocable to common shareholders		117,536			885			12,649			17,266
Add: undistributed earnings allocated to participating securities		948			7			102			139
Numerator for diluted earnings per common share		118,484			892			12,751			17,405

Weighted average shares outstanding - basic		31,782,786			31,766,753			31,772,136			31,766,753
Diluted effect:
Stock options		-			-			-			-
Conversion equivalent of dilutive Series B Convertible Preferred Stock		3,307,299			3,307,299			3,307,299			3,307,299
Conversion equivalent of dilutive Convertible Preferred Stock		255,000			255,000			255,000			255,000
Weighted average dilutive shares outstanding		35,345,085			35,329,052			35,334,435			35,329,052
Dilutive income per common share	$	-		$	-		$	-		$	-

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

	Three Months Ended September 30,						Nine Months Ended September 30,
	2012			2011			2012			2011
Numerator:
Weighted average participating common shares		31,782,786			31,766,753			31,772,136			31,766,753
Denominator:
Weighted average participating common shares		31,782,786			31,766,753			31,772,136			31,766,753
Add: Weighted average shares of Convertible Preferred Stock		255,000			255,000			255,000			255,000
Weighted average participating shares		32,037,786			32,021,753			32,027,136			32,021,753
Portion allocable to common shareholders		99.2	%		99.2	%		99.2	%		99.2	%

As of September 30, 2012 and 2011, there were 690,000 shares issuable upon exercise of options and 186,000 unvested restricted shares excluded from the computation of dilutive earnings per share due to their anti-dilutive effect.

Mikros Systems Corporation

Notes to Condensed Financial Statements

(unaudited)

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 $81,000 and $1,600 during the nine months ended September 30, 2012 and 2011, respectively. The change in deferred tax assets is attributable to the change in the valuation allowance based on the Company’s forecasts of future earnings from operations.

Note 6 – Share Based Compensation

During the three and nine months ended September 30, 2012, the Company did not issue any stock options. The Company recognized stock-based compensation expense of $7,837 and $8,799 for the three months ended September 30, 2012 and 2011, respectively. The Company recognized stock-based compensation expense of $23,512 and $19,812 for the nine months ended September 30, 2012 and 2011, respectively. As of September 30, 2012, there were 690,000 outstanding options, of which 478,000 were exercisable. As of September 30, 2012, there was $16,726 of unrecognized stock-based compensation expense that will be recognized in future periods.

During the three and nine months ended September 30, 2012, the Company did not issue any shares of restricted stock. The Company recognized stock-based compensation expense of $1,328 and $0 for the three months ended September 30, 2012 and 2011, respectively. The Company recognized stock-based compensation expense of $3,946 and $0 for the nine months ended September 30, 2012 and 2011, respectively. As of September 30, 2012, there was $16,414 of unrecognized stock-based compensation expense that will be recognized in future periods. There were 186,000 unvested restricted shares of common stock as of September 30, 2012.

Note 7 – Related Party Transactions

Thomas Meaney, the Company’s president and member of the Company’s board of directors, also serves as a director of Ocean Power Technologies, Inc (“OPT”). Through the third quarter of 2011, the Company was a subcontractor to OPT under a four-year program to develop and deploy a Vessel Detection System based on the Littoral Expeditionary Autonomous Power Buoy (LEAP) technology. For the three months ended September 30, 2012 and 2011, the Company recognized revenues of $0 and $6,884 respectively, in connection with the subcontracting agreement with OPT. For the nine months ended September 30, 2012 and 2011, the Company recognized revenues of $0 and $115,861, respectively.

Under certain SBIR contracts, OPT operates as a subcontractor to the Company. During the three months ended September 30, 2012 and 2011, the Company incurred subcontractor expenses of $12,731 and $15,001, respectively. During the nine months ended September 30, 2012 and 2011, the Company incurred subcontractor expenses of $31,588 and $77,508, respectively.

Note 8 – Commitments and Contingencies

In May 2012, the Company renewed its 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 the Company’s 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 September 30, 2012 and December 31 2011, there were no amounts outstanding under the facility.

In August 2012, the Company renewed the lease for its facility at 8076 114th Ave N., Largo, Florida 33777 which supports production of the ADEPT product line and quality assurance, field support, and life cycle management.

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; the failure of Congress to avoid “sequestration” under the Budget Control Act of 2011; changes in our sales strategy and product development plans; changes in the marketplace; continued services of our executive management team; our limited marketing experience; security breaches; 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, 2011 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”) 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.

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, as amended (the “Exchange Act”)) 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, 2012, 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 Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’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, 2012 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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

** XBRL information is furnished and not filed or a part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, is deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise is not subject to liability under these sections.

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, 2012	By:	/s/ Thomas J. Meaney
		Thomas J. Meaney President (Principal Executive Officer and Principal Financial Officer)

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