This Management's Discussion and Analysis of Financial Condition and Results of
Operations summarizes the significant factors affecting the operating results,
financial condition, liquidity and cash flows of the Company as of and for the
periods presented below. The following discussion and analysis should be read in
conjunction with our unaudited condensed financial statements and related
information contained herein and our audited financial statements as of December
31, 2019.
Mikros Systems Corporation (the "Company", "we", or "us") designs and
manufactures software, hardware and electronic systems used to maintain complex
distributed systems. Examples of such systems include defense equipment such as
radars and combat systems, and commercial and industrial applications such as
printing presses, power distribution, utility systems, and Federal Aviation
Administration systems.
Our primary business focus is to (i) provide engineering services, products,
software and related maintenance under contracts with the United States
Department of Defense (DoD), primarily the United States Navy and (ii) pursue
Small Business Innovation Research (SBIR) programs from the DoD, Department of
Homeland Security, and other governmental authorities, with a view to expanding
this government funded research and development into government contracts. Since
2002, we have been awarded several Phase I, II, and III SBIR contracts, and
several IDIQ contracts for our ADEPT® and ADSSS® products.
Revenues from our government contracts represented substantially all of our
revenues for the six months ended June 30, 2020 and 2019. Over the past decade,
our principal customer has been the U.S. Department of Defense, primarily the
U.S. Navy ("Navy"). We provide the following key system to the Navy for
maintenance of radars and combat systems:
? ADSSS, the ADEPT Distance Support Sensor Suite, a Condition-Based
Maintenance (CBM) system used to monitor Combat System Elements (CSEs)
onboard the Littoral Combat Ship (LCS).
More recently, we have developed and marketed software products to analyze
maintenance data collected from target systems, optimize maintenance procedures,
and predict failures. Our Prognostics Framework® (PF) and Diagnostic
Profiler® (DP) products provide software capabilities which complement our
maintenance hardware products (ADSSS) and allow us to provide complete
hardware/software solutions for advanced maintenance, particularly of complex
distributed systems. Now that we have a complete hardware/software solution for
advanced maintenance, we are expanding into commercial and industrial markets.
Our Products
Adaptive Diagnostic Electronic Portable Testset® (ADEPT). ADEPT, also known as
the AN/PSM-132, is an automated maintenance workstation designed to
significantly reduce the time required to align all variants of the AN/SPY-1
Radar System aboard U.S. Navy Aegis cruisers and destroyers, while optimizing
system performance and readiness. Manufacturing, selling and servicing ADEPT
units was a substantial part of our business over the past decade. During the
life of the program, we delivered a total of 226 ADEPT units to our Navy
customers. Effective October 1, 2019, the US Navy determined to stop funding the
ADEPT program in fiscal year 2020.
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ADEPT Distance Support Sensor Suite® (ADSSS). In 2013, we started development of
ADSSS for the Navy's LCS. Our system has now matured and has earned the official
Navy nomenclature AN/SYM-3. The LCS is the U.S. Navy's latest combat warship.
AN/SYM-3 is a network-enabled system that can be configured to monitor multiple
shipboard systems and report maintenance data onshore for further analysis to
detect trends and predict failures. AN/SYM-3 provides an open architecture
approach with industry-standard hardware, and cybersecurity compliant software
to acquire and process system operational and maintenance data. The AN/SYM-3
system fully automates the capture of system operation, environment and
maintenance data to provide unattended operation. The system monitors key
parameters and sends alert notifications when parameters move out of tolerance.
The first full AN/SYM-3 system was successfully completed on LCS 2 and onshore
installation of prognostics was completed at Port Hueneme Division. The ADSSS is
used on both variants of the LCS, currently planned to be at least 32 ships. In
2019, we completed installations on four additional LCS ships that are being
deployed allowing for data collection while operational at sea. During 2020, we
expect to install systems on two or three additional ships.
We are working with the government to have their virtual data transport system
installed on two deploying ships, allowing for near real-time data to be sent
back to shore and processed through our prognostics framework models. During
2020, we expect to add several new combat system elements to our LCS platform
which is expected to expand our footprint and bring condition-based maintenance
plus (CBM +) to additional mission-critical systems. We are also working to
maintain SYM-3 for modernization systems that are being planned in the next 3-5
years.
Through our NSSMS contract awarded in the fourth quarter of 2019, we plan to
develop a new variant of the AN/SYM-3 system for the NATO Seasparrow Surface
Missile System. NSSMS is installed on Navy Aircraft Carriers (CVN class) and
"Big Deck" Amphibious Assault Ships (LHD/LHA class), so the new variant could be
installed on these two new ship classes. We have started the software, hardware,
and systems engineering tasks needed to move this CBM capability to land based
test events and then to a long-term pilot installation for four systems on the
NSSMS platform.
The SYM-3 has also generated interest from other ship classes, Aegis and
unmanned systems, and for use to monitor shipboard hull, mechanical and
electrical (HME) systems, additional combat systems, and navigational radars.
This is part of the Navy's continued effort to increase operational,
sustainability and lethality for many different ship classes. We are also
working to maintain SYM-3 for modernization systems that are being planned in
the next three to five years.
Diagnostic Profiler. The Diagnostic Profiler is an integrated development
environment for developing diagnostic capabilities used in maintenance, embedded
diagnostics, and troubleshooting applications. The software provides diagnostic
services to its host application, including fault callouts, suggested "next
best" test to further isolate faults, and direct maintenance actions. When
additional faults are identified, the software prioritizes the fault callouts by
probability. The use of the Diagnostic Profiler eliminates the need for the
development and maintenance of diagnostic flow charts and hard-coded text
sequences. This reduces the effort required to correct bugs and design
changes. Over the life of the system, this could result in significant cost
savings. This system is used by clients and has also generated yearly support
contracts for service. We have also been upgrading and customizing the system to
the client needs.
Prognostics Framework. Prognostics Framework is an analytic software framework
for implementing real-time prognostics, diagnostics, and status monitoring to
support embedded prognostic applications, health management systems and
condition-based maintenance applications. The Prognostics Framework software
institutes an information framework that organizes relevant data related to: (i)
the condition of the system; (ii) the system's ability to perform required
functions over specific time intervals; and (iii) the need for maintenance
actions and repair parts. The Prognostics Framework has been used to implement a
complete health management system on one of the first radar systems to require
prognostics as a key element of its overall solutions. Other potential
applications include complex computer networks, power generators, power supply,
cooling, C4I (Command, Control, Communications, Computers & Intelligence),
environmental and imaging systems.
Government Contracts
In September 2016, we were awarded and entered into a multi-year IDIQ contract
with the Naval Surface Warfare Center, Port Hueneme Division, relating to our
ADSSS product. The contract has a term of five years and provides for the
purchase and sale of up to $48 million of ADSSS units and related engineering
and logistics support. The first delivery order in the amount of $3.0 million
was awarded on September 15, 2016 to perform installations, support and
logistics for the LCS class.
In April 2017, we received contract awards totaling $2.0 million from the U.S.
Navy to extend the capabilities of the ADSSS CBM system to support a fourth Navy
radar system, the MK 99. The Small Business Innovation Research office in
Dahlgren, VA provided $0.5 million of the total funding to support this effort.
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In June 2018, we received the second delivery order under our multi-year IDIQ
relating to our ADSSS product. This $2.5 million order provides for further MK
99 Fire Control System (FCS) development, test and installation.
In September 2019, we received the third delivery order under our multi-year
IDIQ relating to our ADSSS product. The award covers the installation of
condition-based maintenance systems for the Littoral Combat Ship and has a
ceiling of $15 million. As of the date of this report, approximately $4.0
million of incremental funding has been awarded for work to be executed in
government fiscal year (FY) 2020.
In October 2019, we received an additional contract award under our multi-year
IDIQ relating to our ADSSS product. This incremental funding with a ceiling up
to $6 million, under the third delivery order, covers the development of a new
variant of the AN/SYM-3 system and installation of the new CBM system on two
additional ship classes; the Aircraft Carriers (CVN class) and the "Big Deck"
Amphibious Assault Ships (LHD/LHA class). As of the date of this report, $3.0
million of incremental funding has been awarded for work to be executed in FY
2020.
In February 2017, we were awarded a follow-on multi-year Small Business
Innovation Research Phase III IDIQ contract with the Naval Surface Warfare
Center, Crane Division, for our ADEPT program. The contract provided for the
purchase and sale of up to $35.1 million of ADEPT units and related engineering,
such as calibration, repair, training and other logistics services. We have been
awarded several delivery orders under the ADEPT IDIQ Contract. In October 2019,
we received notice from Program Executive Office Integrated Warfare Systems that
the ADEPT program will not be funded in fiscal year 2020. We will continue to
fulfill our current obligations under outstanding engineering services task
orders previously issued under the program. As of the date of this report, we
have one open task order for general engineering services.
In November 2019, we were awarded a five (5) year Basic Ordering Agreement (BOA)
from Naval Air Warfare Center Aircraft Division, to begin a Phase I SBIR effort
entitled "Unmanned Surface Vehicle and Unmanned Underwater Vehicle Autonomous
Behavior Development". The amount of this Phase I effort was approximately
$150,000.
In April 2020, we received $4.9 million of additional funding from the U.S. Navy
to expand its flagship AN/SYM-3 program to additional LCS systems, new combat
systems, and two new ship classes. The new funding was part of the third
Delivery Order awarded under our multi-year IDIQ relating to our ADSSS product.
The funding will provide for continuing installations on the LCS class and
development of CBM solutions for aircraft carriers and "big deck" amphibious
ships.
In April 2020, we received notification of a Phase I SBIR contract entitled
"ADAPT - Naval Depot Modernization and Sustainment" This program seeks to
develop an integrated solution to allow facility managers to monitor the status
of a wide range of infrastructure systems, identify areas of concern, and
predict future areas of concern. The Phase I objective is to demonstrate
proposed solution feasibility. We will develop a solution to collect data from
critical building infrastructure systems including HVAC, mechanical systems,
communication systems, chillers, pumps, electrical switchgear, seismometers and
surveillance systems, as well as monitor energy usage data, water level data,
and data from other critical infrastructure systems. This work will include
developing a limited scale system to illustrate the concept. The amount of this
Phase I effort was approximately $200,000.
In June 2020, we received $1.2 million of additional funding from the U.S. Navy
to expand its flagship AN/SYM-3 program to additional LCS systems and new combat
systems. The new funding was part of the third Delivery Order awarded under our
multi-year IDIQ relating to our ADSSS product. The funding will provide for
continuing installations on the LCS.
Commercial Contracts
In 2019 and 2020, HP Indigo, Saab Grintek Defense, and Northrop Grumman renewed
their annual contracts for Diagnostic Profiler and Diagnostician Software
Maintenance and Support. We have also increased our capabilities to provide
online support at one of the client's facility.
The Mikros MindR® system is a vendor-agnostic facility health status monitoring
solution which provides the ability to collect data from critical building
infrastructure systems including HVAC, mechanical systems, communication
systems, chillers, pumps, electrical switchgear, seismometers and surveillance
systems, as well as monitor energy usage data, water level data, and data from
any other systems. Data collected can be aggregated on a centralized physical or
secure cloud-based server where Mikros MindR Enterprise software can perform
analysis to determine status, diagnose existing failures, and predict future
failures. We are currently piloting our Mikros MindR system at a client facility
to collect and distribute data from the HVAC units to the client.
Key Performance Indicator
As substantially all of our revenue is derived from contracts with the U.S.
Federal government, our key performance indicators are (i) the dollar volume of
contracts and task orders awarded to us under our IDIQ contract, and (ii) the
number and dollar amount of new contracts and SBIR grants awarded to us.
Increases in the number and value of contracts and delivery orders awarded will
generally result in increased revenues in future periods and, assuming
relatively stable variable costs associated with our fulfilling such awards,
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 substantial majority of our
revenue in 2019, and expected revenue in 2020, is or will be from sales of
AN/SYM-3 systems under our IDIQ contract, continued generation of task orders
and our ability to expand the market and potential customer base for this
technology is our primary focus.
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Outlook
Our strategy for continued growth is based on continuing expansion of our
defense business and executing new initiatives to apply our advanced maintenance
technology in commercial markets. With regard to the defense industry, we expect
to continue expanding our technology base, backlog and revenue by continuing to
bid 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, communications engineering, remote monitoring and augmented
reality. We believe that we can utilize the intellectual property developed
under our various SBIR awards to develop proprietary products, such as ADEPT and
ADSSS, with broad appeal in both the government and commercial marketplace. Our
state-of-the-art test equipment can be used by many commercial and governmental
customers such as the FAA, radio and television stations, cell phone stations,
and airlines. Second, we will continue to actively participate in the SBIR
program and pursue SBIR projects with the DoD, Department of Homeland Security,
U.S. Navy, and other government agencies. Third, we believe that through our
marketing of products, we will develop key relationships with prime defense
contractors. Our strategy is to develop these relationships into long-term, key
subcontractor roles on future major defense programs awarded to these prime
contractors.
With regard to commercial markets, our Diagnostics Profiler and Prognostics
Framework software offerings complement our hardware products and allow us to
provide complete hardware/software solutions for advanced maintenance
applications. Current customers for these systems include major multinational
corporations such as HP, which recently extended our Diagnostic Profiler
software support for a seventh year. We continue to receive repeat orders from
these customers to support their applications. We plan to provide
"condition-based maintenance" systems for "complex distributed systems" to
commercial customers. In that regard, we are developing a condition-based
maintenance solution for HVAC equipment based on our proprietary Prognostics
Framework solution which we call Mikros MindR. We have deployed two active pilot
systems that are providing key maintenance data daily to service technicians. We
are also working with an energy consulting business in Florida to remotely
monitor energy use and required maintenance for its customers. We are in
discussions with additional commercial companies regarding the use of our
condition- based maintenance applications.
In 2020, our primary strategic focus is to continue as a premium provider of R&D
and product development services to the defense industry, generate multiple task
orders under our ADSSS IDIQ and BOA contracts, additional Phase I and Phase II
SBIR grants with a view to obtaining additional government contracts, and expand
our commercial business through marketing and sales of our Prognostics Framework
and Diagnostic Profiler software products. In furtherance of this strategy, we
have made material investments in our engineering and technical staffs to
provide broader and deeper expertise to our customers. We will also seek to
generate incremental revenue through providing light assembly and production
services to commercial customers at our M&D Center in Largo, Florida.
Over the longer term, we intend to further develop advanced maintenance
technologies and implement these technologies in products for deployment in
defense applications and to expand into more 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.
Recent Developments
An outbreak of a novel strain of the coronavirus, COVID-19, has been recognized
as a pandemic by the World Health Organization. This outbreak has severely
restricted the level of economic activity around the world. In response to this
coronavirus outbreak the governments of many countries, states, cities and other
geographic regions have taken preventative or protective actions, such as
imposing restrictions on travel and business operations and advising or
requiring individuals to limit or forego their time outside of their homes. In
March 2020, the Governor of Pennsylvania ordered the closure of all non-life
sustaining businesses in Pennsylvania where most of our employees work.
Further, individuals' ability to travel has been curtailed through mandated
travel restrictions and may be further limited through additional voluntary or
mandated closures of travel-related businesses. Although our employees are able
to work remotely, this coronavirus outbreak has had a negative impact on our
productivity and revenues to date in 2020.
In addition, the pandemic and resulting closures has negatively impacted our
supply chain for component parts necessary to timely deliver AN/SYM-3 systems to
our Government customer. Non-essential travel bans, quarantine protocols imposed
to access US Navy ships, and self-quarantine orders imposed by the Governor of
Pennsylvania on interstate travel have and are expected to continue to
materially delay our ability to complete on-ship installations, result in
excessive down-time for our engineering personnel, and increase travel costs.
The pandemic has also resulted in delays in contract awards, task orders, and
contract modifications to fund our projects. All of the forgoing has and will
continue to adversely impact our financial condition and results of operation.
Given the uncertainty regarding the spread of this coronavirus, the related
financial impact cannot be reasonably estimated at this time.
During recent years, the combination of spending caps, discretionary spending
cuts, sequestration and further changes in defense spending and priorities have
caused, and may in the future continue to cause, delays in funding certain
projects. This may negatively impact our revenues and profits.
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Changes to Critical Accounting Policies and Estimates
We reviewed all of the recently issued accounting pronouncement through August
2020 which are not yet effective and we do not believe the future adoption of
any such pronouncements may be expected to cause a material impact on our
financial condition or the results of its operations.
Results of Operations
Three Months Ended June 30, 2020 and June 30, 2019
We generated revenues of $1,844,923 during the three months ended June 30, 2020
as compared to $1,853,503 during the three months ended June 30, 2019. Revenues
in the second quarter of 2020 and 2019 consisted entirely of engineering support
services contracts which included direct components delivered during the second
quarter of 2020.
Cost of sales consists of direct contract costs including labor, material,
subcontracts, travel, and other direct costs. Cost of sales for the three months
ended June 30, 2020 was $734,223 compared to $792,151 for the three months ended
June 30, 2019, a decrease of $57,928 or 7%. The reduction resulted from timing
of delivery of direct components.
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 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 June 30, 2020 were $531,816 compared to
$695,838 for the three months ended June 30, 2019, a decrease of $164,022, or
24%. The decrease was due primarily to staff reduction and associated fringe
benefits and reduced third party consultant costs.
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,
including independent research and development which consists of research and
development expenses unrelated to our defense contracts). General and
administrative costs for the three months ended June 30, 2020 were $344,286 as
compared to $369,742 for the three months ended June 30, 2019, a decrease of
$25,456, or 7%.
We estimated our annual effective tax rate for 2020 and 2019 to be 35% and 33%.
As a result, we recognized a tax expense of $81,163 for the three months ended
June 30, 2020, as compared to tax expense of $432 for the three months ended
June 30, 2019. The differences from the statutory federal income tax rate were
attributable to state income taxes and certain permanent book-tax differences.
We reported net income of $154,030 in the three months ended June 30, 2020 as
compared to a net loss of $3,721 in three months ended June 30, 2019. The
increase was attributable primarily to the decrease in operating expenses in the
second quarter of 2020.
Six Months Ended June 30, 2020 and June 30, 2019
We generated revenues of $2,926,086 during the six months ended June 30, 2020
compared to $3,873,768 during the six months ended June 30, 2019, a decrease of
$947,682, or 32%. The decrease resulted primarily from the delay of follow-on
funding during the first quarter of 2020 and the delivery of direct components.
Revenues for the six months ended June 30, 2020 and 2019 consisted entirely of
engineering support services contracts.
Cost of sales for the six months ended June 30, 2020 was $1,091,696 compared to
$1,570,693 for the six months ended June 30, 2019, a decrease of $478,997, or
44%. The reduction resulted from the delay of follow-on funding and the delivery
of direct components.
Engineering costs for the six months ended June 30, 2020 were $1,141,777
compared to $1,358,088 for the six months ended June 30, 2019, a decrease of
$216,311, or 19%. The decrease was due primarily to staff reduction and
associated fringe benefits, and third party consultant costs.
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General and administrative costs for the six months ended June 30, 2020 were
$789,605 as compared to $833,307 for the six months ended June 30, 2019, a
decrease of $43,702, or 6%. The decrease was due primarily to staff reduction,
and third party consultant costs.
We recognized a tax benefit of $33,340 for the six months ended June 30, 2020
due primarily to expected net income for the remainder of 2020. At June 30,
2020, the difference from the expected federal statutory income tax rate is
attributable to state income taxes and certain permanent book-tax differences.
We reported a net loss of $ $62,255 for the six months ended June 30, 2020 as
compared to net income of $77,084 for the six months ended June 30, 2019. The
decrease was attributable primarily to the decrease in revenues in the first six
months of 2020.
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 six months ended June 30, 2020, net cash used in operations was
$103,027 compared to net cash used in operations of $531,106 during the six
months ended June 30, 2019. The $428,079 decrease in cash used in operations was
due to the timing of receipts and payments related to our operating assets and
liabilities and a $41,922 increase in noncash charges which were offset by a
decrease in net income (loss) of $139,339 during the six months ended June 30,
2019.
Net cash used in investing activities was $4,817 for the six months ended June
30, 2020 as compared to $28,216 for the six months ended June 30, 2019, a
decrease of $23,399. The decrease was related to the completion of an expansion
of our Pennsylvania office in 2019.
Net cash provided by financing activities was $260,000 for the six months ended
June 30, 2020 as compared to $4,000 for the six months ended June 30, 2019, an
increase of $256,000. The increase consisted primarily of $260,000 of borrowings
under our line of credit in 2020.
On January 31, 2018, we entered into a $550,000 credit facility with PNC Bank.
The facility initially matured on January 31, 2020 and has been extended to
January 31, 2021. The facility accrues interest at a variable rate equal to the
Daily LIBOR Rate plus 250 basis points. Interest is paid monthly. Principal
borrowings may be prepaid at any time without penalty and the facility is
secured by substantially all of our assets. The facility contains customary
affirmative and negative nonfinancial covenants. As of June 30, 2020, $260,000
was outstanding under the facility.
On April 14, 2020, we entered into a Term Note with PNC Bank pursuant to the
Paycheck Protection Program of the recently enacted Coronavirus Aid, Relief, and
Economic Security Act administered by the U.S. Small Business Administration. We
received total proceeds of $753,300 from the PNC Note. On May 12, 2020, the term
loan was repaid in full.
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 of success in such strategic
opportunities, assuming we successfully raise additional funds or enter into
business alliances.
Off-Balance Sheet Arrangements
As of June 30, 2020, 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.
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