UNITED STATES

SECURITIESANDEXCHANGECOMMISSION

Washington,D.C. 20549

☒QUARTERLYREPORTPURSUANTTOSECTION13OR15(d)OFTHESECURITIESEXCHANGEACTOF1934

Forthequarterlyperiodended June 30, 20162017

or

☐ TRANSITIONREPORTPURSUANTTOSECTION13OR15(d)OFTHESECURITIESEXCHANGEACTOF1934

Forthetransitionperiodfrom_____to_____.

Commission File Number: 000-14801

Mikros Systems Corporation

(Exact name of registrant as specified in its charter)

707AlexanderRoad,BuildingTwo,Suite208, Princeton,NewJersey08540

(Address of Principal Executive Offices)

(609) 987-1513

(Registrant’s Telephone Number, Including Area Code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

☒Yes ☒Yes    ☐No

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company, or emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company” and “smaller reporting“emerging growth company” in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ☐Yes☐

Yes ☒No

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: There were 34,747,16735,551,775 issued and outstanding shares of the issuer’s common stock, $.01 par value per share, on August 15, 2016.14, 2017.

TABLE OF CONTENTS

See Notes to Unaudited Condensed Financial Statements

See Notes to Unaudited Condensed Financial Statements

Mikros Systems Corporation

Statements of Shareholders' Equity (unaudited)

Mikros Systems Corporation

Condensed Statements of Cash Flows (unaudited)

See Notes to Unaudited Condensed Financial Statements 

See Notes to Unaudited Condensed Financial Statements(“ADEPT”) units to be developed and delivered to the federal government.

The Company recognizes revenue as it relates to the license of software when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the price is fixed or determinable, and collection is probable. The sale and/or license of software products and technology is deemed to have occurred when a customer either has taken possession of or has access to take immediate possession of the software or technology. Software license agreements include post-contract customer support ("PCS"). For the Company’s software and software-related multiple element arrangements, where customers purchase both software related products and software related services, the Company uses vendor-specific objective evidence (“VSOE”) of fair value for software and software-related services to separate the elements and account for them separately. VSOE exists when a company can support what the fair value of its software and/or software-related services is based on evidence of the prices charged when the same elements are sold separately. VSOE of fair value is required, generally, in order to separate the accounting for various elements in a software and related services arrangement. The Company has established VSOE of fair value for the majority of the PCS, professional services, and training. Given the limited number of sales related to this software, and the fact that the Company does not sell the PCS element separately, there is no VSOE currently available to bifurcate the PCS element from the contract.  In accordance with ASC 985-605-25-10a, the fees earned from sale of licenses to which the only undelivered element is the PCS, are recognized ratably over the life of the contract. Revenues from the sale of software licenses for the three and six months ended June 30, 2016 and 2015 were $33,751 and $0 and $61,501 and $0, respectively. At June 30, 2016 and December 31, 2015, deferred revenues amounted to $30,000 and $24,000, respectively.

See Notes to Unaudited Condensed Financial Statements

Mikros Systems Corporation

Notes to Condensed Financial Statements

(unaudited)

Note1–BasisofPresentation

The financial statements included herein have been prepared by Mikros Systems Corporation (the “Company”) pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted pursuant to such rules and regulations. These condensed financial statements should be read in conjunction with the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016.

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 June 30, 2017, the results of its operations for the three and six months ended June 30, 2017 and 2016, changes in stockholders’ equity from January 1, 2017 to June 30, 2017and cash flows for the six months ended June 30, 2017 and 2016.

Note2–RecentAccountingPronouncements

There have been no developments to recently issued accounting standards, including the expected dates of adoption and estimated effects on the Company’s condensed financial statements, from those disclosed in the Company’s 2016 Annual Report on Form 10-K.

Note3–SignificantAccountingPolicies

RevenueRecognition

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

The Company recognizes revenue as it relates to the license of software when persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the price is fixed or determinable, and collection is probable. The sale and/or license of software products and technology is deemed to have occurred when a customer either has taken possession of or has access to take immediate possession of the software or technology. Software license agreements include post-contract customer support ("PCS"). For the Company’s software and software-related multiple element arrangements, where customers purchase both software related products and software related services, the Company uses vendor-specific objective evidence (“VSOE”) of fair value for software and software-related services to separate the elements and account for them separately. VSOE exists when a company can support what the fair value of its software and/or software-related services is based on evidence of the prices charged when the same elements are sold separately. VSOE of fair value is required, generally, in order to separate the accounting for various elements in a software and related services arrangement. The Company has established VSOE of fair value for the majority of the PCS, professional services, and training. Given the limited number of sales related to this software, and the fact that the Company does not sell the PCS element separately, there is no VSOE currently available to bifurcate the PCS element from the contract.  In accordance with Accounting Standards Codification Topic 985-605-25-10a, the fees earned from sale of licenses to which the only undelivered element is the PCS, are recognized ratably over the life of the contract. Revenues from the sale of software licenses and maintenance for the three and six months ended June 30, 2017 and 2016 were $5,000 and $33,751 and $12,500 and $61,501, respectively. At June 30, 2017 and December 31, 2016, deferred revenues amounted to $25,000 and $7,500, respectively.

Mikros Systems Corporation

Notes to Condensed Financial Statements 

(unaudited)

Unbilled revenue reflects work performed, but not billed at the time, per contractual requirements. As of June 30, 2017 and December 31, 2016, the Company had unbilled revenues of $103,136 and $235,421, respectively which are recorded within receivables on government contracts in the Company’s balance sheet. Billings to customers in excess of revenue earned are classified as advanced billings, and shown as a liability. As of June 30, 2017 and December 31, 2016, there were no advanced billings.

WarrantyExpense

The Company provides a limited warranty, as defined by the related warranty agreements, for its production units. The Company’s warranties require the Company to repair or replace defective products during such warranty period. The Company estimates the costs that may be incurred under its warranty and records a liability in the amount of such costs at the time product revenue is recognized. Factors that affect the Company’s warranty liability include the number of units sold, expected and anticipated rates of warranty claims, and cost per claim. The Company periodically assesses the adequacy of its recorded warranty liability and adjusts the amount as necessary. During the three months ended June 30, 2017 and 2016, the Company recognized a warranty benefit of $97,560 and $0, respectively, and for the six months ended June 30, 2017 and 2016, the Company recognized a warranty benefit of $238,967 and $20,801, respectively. Since the inception of the ADEPT IDIQ contract in March 2010, the Company has delivered 189 ADEPT units. As of June 30, 2017, no ADEPT units remain under the limited warranty coverage.

The following table reflects the reserve for product warranty activity for:

Research and Development Expense

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 as follows:

Mikros Systems Corporation

Notes to Condensed Financial Statements

(unaudited)

Intangible Assets

The majority of the Company’s intangible assets is a license acquired during 2015. In July 2015, the Company purchased certain software products, intellectual property and related assets from VSE Corporation. The primary software programs purchased were the Prognostics Framework (PF) and Diagnostic Profiler (DP) programs. The Diagnostic Profiler software is used worldwide by several multinational companies for optimized maintenance of diverse product lines. The Diagnostic Profiler is also used by the US Air Force for depot test programs, and Prognostics Framework is used by the US Army for several missile defense systems.

Licenses are amortized using a straight-line method over their estimated life of six years. For the three and six months ended June 30, 2017 and 2016, amortization expense related to the Company’s license amounted to $5,250 and $5,250 and $10,500 and $10,500, respectively, and are included in general and administrative expenses on the Statements of Operations and Comprehensive Income.

Note 4–IncomePerShare

Net income per common share information is as follows:

MikrosSystemsCorporation

Notes to Condensed Financial Statements 

(unaudited)

The table below sets forth the calculation of the percentage of net earnings allocable to common shareholders under the two-class method in 2016.

Diluted net income per share for the three and nine months ended June 30, 2017 and 2016 does not reflect the following potential common shares, as the effect would be antidilutive.

Note 5 – Income Tax Matters

The Company conducts an on-going analysis to review its net deferred tax asset and the need for a related valuation allowance. As a result of this analysis and the actual results of operations, the net deferred tax assets changeddecreased by $(7,637)$63,159 and $54,000increased by $7,637 during the six months ended June 30, 20162017 and 2015,2016, respectively. The change in deferred tax assets is attributable to the reversal of various book/tax differences. utilization of income tax attributes, primarily federal net operating losses, as the Company anticipates annual earnings from operations to continue.

Note 6 – Share-BasedStock-Based Compensation

During 2017, the Company issued 60,000 shares of restricted stock with a weighted average fair value of $0.46 per share. As of June 30, 2017, there was $26,375 of unrecognized stock-based compensation expense related to the restricted stock issued during 2017, which will be recognized in future periods. During the six months ended June 30, 2017, 62,000 options were exercised for proceeds amounting to $11,350. The intrinsic value of the options as of June 30, 2017 is $63,250.

During the three and six months ended June 30, 2017 and 2016, the Company did not issue stock awards. During the six months ended June 30, 2016, 7,000 shares were exercised for proceeds in the amount of $350. The Company recognized stock-based compensation expense for stock options of $34$3,572 and $37 for the three months ended June 30, 2015$636 and 2014,$6,211 and $1,250, respectively. The Company recognized stock-based compensation expense for stock options of $69 and $74 for the six months ended June 30, 2016 and 2015, respectively. The intrinsic value of the options as of June 30, 2016 is $840.

As of June 30, 2016 and 2015, there were 44,000 and 103,000 restricted stock awards outstanding, respectively. The Company recognized stock-based compensation expense for restricted stock of $580 and $644 for the three months ended June 30, 2016 and 2015, respectively. The Company recognized stock-based compensation expense for restricted stock of $1,181 and $1,288 for the six months ended June 30, 2016 and 2015, respectively.

Note 7 – Recapitalization

During the second quarter 2016, the Company executed a series of Exchange Agreements with holders of a majority of its outstanding shares of preferred stock. Under the terms of the agreements, each series of preferred stock held by such holders was exchanged for a combination of cash and shares of common stock in the amounts set forth in the table below.

Mikros Systems Corporation

Notes to Condensed Financial Statements

(unaudited)

The Company entered into a separate exchange agreement (the “SBA Exchange Agreement”) with the United States Small Business Administration (“SBA”), pursuant to which it agreed to pay $250,000 to the SBA in exchange for all shares of preferred stock, all 2,084,167 shares of common stock then owned by the SBA, and the 1,658,540 shares of common stock which would have been issuable to the SBA if it had participated in the Exchange Agreements on the same terms as the other holders of the Company’s preferred stock. On June 16, 2016, the Company conducted closings under the Exchange Agreements and the SBA Exchange Agreement, pursuant to which it issued an aggregate of 4,427,498 shares of common stock and made aggregate cash payments of $509,664. In connection with the closings, the Company issued notices of redemption to holders of the 208,971 remaining issued and outstanding shares of Series B Preferred Stock and the 46,092 remaining issued and outstanding share of Series D Preferred Stock for a combination of cash and shares of common stock on the same terms as the Exchange Agreements (the “Redemption”). We anticipate that the redemption will be completed by the end of the third quarter in 2016.

The Company determined the difference between the fair value of the Company’s common stock and the cash paid to the holders of the preferred stock and the carrying amount of the preferred stock (net of issuance costs of $46,090) which amounted to $1,103,597 and added this amount to net income in the calculation of earnings per share (see Note 4 above). In addition, the discount upon exchange of the preferred stock, net of the related fees, was recorded in accumulated deficit since the discount represents a return from the preferred shareholders. The Company accounted for the purchase and subsequent retirement of the common stock from the SBA as the purchase of treasury stock and was recorded in the amount of $147,451 based on the amount paid to repurchase such shares.

As a result of the approval of the Redemption by the holders of requisite majorities of the Series B Preferred Stock and Series D Preferred Stock, the Company has recorded the discount upon exchange of the preferred stock as of June 30, 2016. Upon redemption of the 208,971 remaining issued and outstanding shares of Series B Preferred Stock and the 46,092 remaining issued and outstanding shares of Series D Preferred Stock, the Company will issue 741,600 additional shares of Common Stock and make aggregate cash payments of $33,941. At June 30, 2016, the Company has recorded an extinguishment liability of $33,941, which is included in accounts payable and accrued expenses on the balance sheet and represents the cash to be paid upon redemption of the remaining preferred stock.

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; changes in our sales strategy and product development plans; changes in the marketplace; continued services of our executive management team; our limited marketing experience; competition between us and other companies seeking Small Business Innovative Research (“SBIR”) grants; competitive pricing pressures; market acceptance of our products under development; delays in the development of products; our ability to adequately integrate our new software offerings into our business model;model, our ability to develop and market solutions for commercial customers, numerous other matters of national, regional and global scale, including those of a political, economic, business and competitive nature; 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, 20152016 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. WeExcept as required by law, we assume no duty to update or revise our forward-looking statements.

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

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 and utility systems, and Federal Aviation Administration (“FAA”) systems.

Over the past decade, our principal customer has been the U.S. Department of Defense, primarily the U.S. Navy. We provide the following two key systems to the Navy for maintenance of radars and combat systems:

More recently, we acquired certainhave developed and marketed software and related assets from VSE Corporation. The software is used in our Prognostics Framework® (PF) and Diagnostic Profiler® (DP) products to analyze maintenance data collected from target systems, optimize maintenance procedures, and predict failures. TheseOur Prognostics Framework® (PF) and Diagnostic Profiler® (DP) products provide software capabilities which complement our maintenance hardware products (ADEPT and 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.

Product Portfolio

Adaptive Diagnostic Electronic Portable Testset (ADEPT®).ADEPT is an automated maintenance workstation designed to significantly reduce the time required to align the AN/SPY-1 Radar System aboard U.S. Navy Aegis cruisers and destroyers, while optimizing system performance and readiness. ADEPT Systems are currently deploying on all Aegis CG and DDG platforms to support the AN/SPY1 radar system. ADEPT represents an innovative 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 provide integrated distance support capabilities for remote diagnostics and troubleshooting by shore-based Navy experts.

Since the system uses commercial instrument case and modules, ADEPT units can be modified to support both preventative maintenance and condition-based maintenance of other radars and complex electronic systems in military or commercial applications. In that regard, we have a service contract with the U.S. Navy to extend ADEPT to a second U.S. Navy radar system, the SPS-49. These services are expected to assist in optimizing performance for the Ballistic Missile Defense Mission. As of June 30, 2016,the date of this report, we have delivered a total of 189 ADEPT units.

Adaptive Distance Support Sensor Suite (ADSSS).In 2013, we started development of ADSSthe ADEPT Distance Support Sensor Suite, or ADSSS, for the Navy’s Littoral Combat Ship (“LCS”). The LCS is the U.S. Navy’s latest combat warship. ADSSS 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. ADSSS provides an open architecture approach with industry standard hardware, and cybersecurity compliant software to acquire and process system operational and maintenance data. ADSSS 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.

A pilot version of ADSSS has been deployed on the LCS Class since 2014. Development of the production system is ongoing and initial shipboard testing is planned for late 2016.was completed in 2016. In July, 2017, we installed the first ADSSS system on the LCS Class. We expect ADSSS to be used on both variants of the LCS, currently planned to be at least 32 ships. ADSSS, with its remote monitoring and prognostics capabilities, has also generated interest in other ship classes, including Aegis, and we are currently pursuing several related opportunities.

Diagnostic Profiler®. Profiler.The Diagnostic Profiler®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 call-outs, suggested “next best” test to further isolate faults, and direct maintenance actions. When additional faults are identified, the software prioritizes the fault call-outs 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 and over the life of the system, could result in significant cost savings.

Prognostics Framework®. Framework.Prognostics Framework®Framework is an analysis software for framework that implements 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 and environmental systems.

Government Contracts

On March 18, 2010,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 the 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 February 2017 we were awarded a follow-on multi-year Small Business Innovation Research (SBIR) Phase III IDIQ contract with the Naval Surface Warfare Center, Crane Division, for our ADEPT product.program. The contract provides for the purchase and sale of up to $26$35.1 million of ADEPT units and related engineering, such as calibration, repair, training and logistics support.other sustainment services. The initial term of the contractfirst delivery order for $1.1 million was five years, andalso awarded in March 2015, the period of performance was extended through August 11, 2016. It has been extended again until February 13, 2017 to conclude some development programs. Substantiallybuild eleven ADEPT systems for continuing fleet support on all of our revenue is attributable to our ADEPT product. Aegis cruisers and destroyers.

In the past,March 2017 we were generating revenues primarily fromawarded the productionsecond and third delivery orders for engineering services in the amount of ADEPT units. After executing$11.5 million which will be funded incrementally and facilitate the engineering and technical support for the ADEPT program during the next three years. The third delivery order contract for six years, we now have contracts$0.6 million is to do further R&D onprovide sustainment services, such as calibration, repair, evaluations, and screenings of ADEPT units to enhance functionality as well as provide other forms of support. We expect additional contract awards during the remaining term of the contract.be performed in our Manufacturing and Depot (M&D) Center in Largo, Florida.

In August 2013,April 2017 we were awardedreceived contract awards totaling $2.0 million from the U.S. Navy to extend the capabilities of the ADSSS Condition-Based Maintenance (CBM) system to support a $5.5fourth Navy radar system, the MK 99. The Small Business Innovation Research (SBIR) office in Dahlgren, VA provided $0.5 million service contractof the total funding to support this effort. Along with those awards, we received the fourth delivery order for $0.1 million under ourthe existing ADEPT IDIQ contract, to provide necessary research, development, and program management and implementationtraining of improvementsthe ADEPT maintenance automation workstation to ADEPT units. We received an initial commitment of $0.8 million under this service contract which was increased to $2.1 millionsailors in the first quarter of 2014.

In January 2014, we were awarded a $0.5 million contract by the U.S. Navy that will extend the ADEPT system to a second Navy radar, the SPS-49 long-range air surveillance radar.

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

In July 2014,2017 we were awarded additionalreceived a modification which added funding to our ADEPT IDIQ Contract, Delivery Order 02, for Engineering Services in the amount of $0.3 million under the current IDIQ$0.4 million. This contract award will allow us to upgrade the capabilitiescontinue support of the first 66 ADEPT units currently deployedproduct line in the fleet.  This effort involves installing a fasterfleet, implement necessary software enhancements, and more capable controller module and upgradinggeneral support of the Operating System software from Windows XP to Windows 7, and will be executed at our Largo, FL facility as units are returned for routine calibration.

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

In March 2015, the Navy also issued an additional contract for ADEPT General Engineering and Support, with initial funding of $0.1 million. This contract covers various technical tasking for deployed ADEPT systems, including logistics support, customer consultation and regularly scheduled team review meetings.

In May 2015, we received a study contract valued at $30 thousand from Lockheed Martin Corporation, to start work with Lockheed Martin on Condition Based Maintenance for Aegis systems.

In August 2015, we received contract award valued at approximately $0.2 million for the calibration of 45 additional ADEPT units. This is the seventh contract award of this type that we have received in support of the calibration effort. We also received two contracts in September 2015, for software development on the SLA-10B and SPQ-9B radars, totaling approximately $0.25 million. We have been tasked to define how the ADEPT tool can help support testing of the SPQ-9B system on Self Defense Test Ships (SDTS).

In September 2015, we entered into a contract modification for our current service contract for LCS systems using the ADSSS, which added an additional $1.5 million for ongoing development. This funding will extend the program until September 30, 2016, and allow us to perform installations and support for the LCS classes.

In March 2016, we received a contract award valued at approximately $0.15 million to provide Initial System Familiarization Training of the ADEPT system on all CG-47 and DDG-51 Class ships. Two events in Norfolk, VA and San Diego, CA have already occurred, and a third is scheduled in San Diego, CA in the month of August.

In April 2016, we received three contracts to continue logistics support of the ADEPT maintenance automation workstation. A contract valued at approximately $0.3 million to provide ADEPT General Engineering and Support was awarded, along with two other logistics contracts to perform necessary updates, repair and calibration on the ADEPT units, totaling $0.25 million. Along with the contracts received for our ADEPT product, we received a follow on contract in the amount of $0.1 million, for technical support on the USS Fort Worth (LCS3) using the latest version of our ADSSS.

In July 2016, we received two (2) additional contract modifications for our current service contract for LCS systems using the ADSSS, which added an additional $4.65 million for ongoing development. This funding will extend the program until June 2018, and allow us to perform installations and support for the LCS classes.

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

Key Performance Indicator

As substantially all of our revenue is derived from contracts with the Federalfederal government, our key performance indicator is the dollar volume of contracts and delivery orders awarded to us.us under our IDIQ contracts. 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,awards, increased profits in future periods. The timing of such awards is uncertain as we sell to Federalfederal government agencies where the process of obtaining such awards can be lengthy and at times uncertain. As the majority of our revenue in 2015,2016, and expected revenue over the next nine months,in 2017, is or will be from sales of ADEPT units and ADSSS systems under our IDIQ contract,contracts, continued generation of taskdelivery orders and our ability to expand the market and potential customer base for ADEPT units will be a key indicator of future revenue. ADEPT units must be serviced and calibrated every two years. Accordingly, as we continue to increase the installed base of ADEPT units and expand the units to other radar systems, we expect to generate future recurring maintenance and service revenue.

Outlook

Our strategy for continued growth is based on continuing expansion of our defense business, plus new initiatives to marketapply our advanced maintenance technology toin commercial markets. First,With regard to the defense industry, 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 utilizeuse the technology and 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. Our state-of-the-art test equipment cancould be used by many commercial and governmental customers such as the Federal Aviation Administration,FAA, radio and television stations, cell phone stations, and airlines. Second, we will continue to pursue SBIR projects with the Department of Homeland Security, the U.S. Navy, and other government agencies. Third, we believe that through our marketing of products, such as ADEPT, we will develop key relationships with prime defense contractors. Our strategy is to develop these relationships into long-term, key subcontractor roles on future major defense programs awarded to these prime contractors.

In addition,With regard to commercial markets, our new commercialDiagnostics 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. We have received several repeat orders from these customers and continue to support their applications. Most recently we extended our Diagnostic Profiler software support with HP for a fifth year. We plan to provide “condition-based maintenance” systems for applications such as FAA radar surveillance and support systems, power distribution and utilities infrastructure, commercial shipping, cooling and environmental systems, and other “complex distributed systems.” Customers for these systems include major multinational corporations. We have received several repeat orders from these customers and continuesystems” to support their applications.commercial customers.

In 2016,2017, our primary strategic focus is to continue as a premium provider of R&D and product development services to the defense industry, generate multiple delivery orders under our two IDIQ contracts, extend ADEPT and ADSSS to additional combat systems and ship classes, and expand our commercial business through marketing and sales of our Prognostics Framework and Diagnostic Profiler software products. From an operational prospective, we expectWe will also seek to focus substantial resources on generating purchase orders for ADEPT units, expanding ADEPTgenerate incremental revenue through providing light assembly and production services to support other radar systems, including theSPS-49,commercial customers at our manufacturing and exploring commercialization opportunities. As the installed base increases, we expect additional and recurring revenue for calibration and other maintenance and support. In January 2014, we were awarded a contract to extend the ADEPT system to a second U.S. Navy radar system, the SPS-49, which is expected to assistdepot center in optimizing performance for the Ballistic Missile Defense Mission.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 additional 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.systems, and building maintenance. We are currently in discussions with certain industry participants regarding this initiative.

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

Changes to Critical Accounting Policies and Estimates

Our critical accounting policies and estimates are set forth in our Annual Report on Form 10-K for the fiscal year ended December 31, 2015.2016. As of June 30, 2016,2017, there have been no changes to such critical accounting policies and estimates.

Results of Operations

ThreeMonthsEnded June 30,2016 2017and20152016

We generated revenues of $1,740,863 during the three months ended June 30, 2017 compared to $978,372 during the three months ended June 30, 2016, compared to $1,734,382 during the three months ended June 30, 2015, a decreasean increase of $756,010,$762,491, or 44%78%. The decreaseincrease was due primarily due to the completion of thea production contractsorder for 6411 ADEPT units in 2015February 2017 and significant delays in the awardreceipt of several new Navy contracts. We expect thesefour additional contracts for engineering services, support and repairs and calibration services amounting to be awarded later in 2016. Such delays are not uncommon in the current defense contracting environment and we may experience similar delays in future periods.$843,457.

Cost of sales consists of direct contract costs including labor, material, subcontracts, warranty expense for ADEPT units that have been delivered, travel, and other direct costs. Cost of sales for the three months ended June 30, 20162017 was $349,526$621,582 compared to $877,168$349,526 for the three months ended June 30, 2015, a decrease2016, an increase of $527,642$272,056 or 60%78%. The decreaseincrease was due primarily due to the completionreceipt of thea production contractsorder for 6411 ADEPT units in 2015.February 2017 and the receipt of four additional contracts for engineering services, support and repairs and calibration services. As a percentage of revenue, cost of sales decreased towas 36% of revenues for the three months ended June 30, 2017 and 2016, as compared to 51% of revenues for the three months ended June 30, 2015. The decrease was primarily due to the change of the mix of costs incurred in 2016. There were significant decreases in material purchases due to delays in receiving production contracts. There were slight increases in direct labor and subcontract costs related to engineering service contracts awarded in the first quarter of 2016.respectively.

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 June 30,201630, 2017 were $312,849$539,412 compared to $326,521$312,849 for the three months ended June 30, 2015, a decrease2016, an increase of $13,672,$226,563, or 4%72%. The decreaseincrease was primarily due to a decreasesignificant increases in fringe benefits and engineering salaries due to the hiring of six additional employees, recruiting costs, travel and subsistence expenses, engineering consulting feescosts and incentive compensation expense.compensation.

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)us, including independent research and development (IR&D) which consists of research and development expenses unrelated to our defense contracts). General and administrative costs for the three months ended June 30, 20162017 were $296,754$430,384 compared to $300,574$296,754 for the three months ended June 30, 2015,2016, an increase of $133,630, or 45%. The increase was due primarily to increases in salaries, incentive compensation, and professional fees offset by a decrease of $3,820, or 1%.in unallowable and bid and proposal costs.

At June 30, 2016,2017, we estimated our annual effective tax rate for 20162017 to be 61.0%49%. We recognized a tax expense of $12,512$73,985 for the three months ended June 30, 20162017 primarily due to expected net income for the remainder of 2016.2017. At June 30, 2016,2017, the difference from the expected federal income tax rate is attributable to state income taxes and certain permanent book-tax differences.

We reported net income of $7,987 for the three months ended June 30, 2016 as compared to net income of $120,712 for the three months ended June 30, 2015. The decrease is primarily attributable to the decrease in revenues during the three months ended June 30, 2016.

SixMonthsEnded June 30,2016 2017and20152016

We generated revenues of $3,495,836 during the six months ended June 30, 2017 compared to $1,966,301 during the six months ended June 30, 2016, compared to $4,210,421 during the six months ended June 30, 2015, a decreasean increase of $2,244,120,$1,529,535, or 53%78%. The decreaseincrease was due primarily due to the completion of thea production contractsorder for 6411 ADEPT units in 2015February 2017 and significant delays in the awardreceipt of several new Navy contracts. We expect theseten additional contracts for engineering services, support and repairs and calibration services amounting to be awarded later in 2016. Such delays are not uncommon in the current defense contracting environment and we may experience similar delays in future periods.$1,488,131.

Cost of sales consists of direct contract costs including labor, material, subcontracts, warranty expense for ADEPT units that have been delivered, travel, and other direct costs. Cost of sales for the six months ended June 30, 20162017 was $673,854$1,273,118 compared to $2,339,073$673,854 for the six months ended June 30, 2015, a decrease2016, an increase of $1,665,219$599,264 or 71%89%. The decreaseincrease was due primarily due to the completionreceipt of thea production contractsorder for 6411 ADEPT units in 2015.February 2017 and the receipt of ten additional contracts for engineering services, support and repairs and calibration services. As a percentage of revenue, cost of sales decreasedwas 36% for the six months ended June 30, 2017 as compared to 34% of revenues for the six months ended June 30, 2016 as compared to 56% of revenues for the six months ended June 30, 2015.2016. The decrease was primarilyincrease is due to the change of the mix ofan increase in production costs incurred in 2016. There were significant decreases in material purchases due to delays in receiving production contracts. There were slight increases inand other direct labor and subcontract costs related to engineering service contracts awarded in the first quarter of 2016.costs.

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 six months ended June 30,201630, 2017 were $636,762$1,056,592 compared to $748,936$636,762 for the six months ended June 30, 2015, a decrease2016, an increase of $112,174,$419,830, or 15%66%. The decreaseincrease was primarily due to a decreasesignificant increases in consulting feesfringe benefits and incentive compensation expense.

General and administrative expenses consist primarilyengineering salaries due to the hiring of salary, intellectual property, consulting fees and related costs, professional fees, business insurance, franchise tax, SEC compliancesix additional employees, recruiting costs, travel and unallowablesubsistence expenses, (representing those expenses for which the government will not reimburse us). engineering consulting costs and incentive compensation.

General and administrative costs for the six months ended June 30, 20162017 were $632,902$839,287 compared to $622,597$632,902 for the six months ended June 30, 2015,2016, an increase of $10,305,$206,385, or 2%33%. The increase was due primarily to increases in salaries, incentive compensation, and professional fees offset by a decrease in unallowable and bid and proposal costs.

At June 30, 2016,2017, we estimated our annual effective tax rate for 20162017 to be 61.0%49%. We recognized a tax expense of $15,655$161,760 for the six months ended June 30, 20162017 primarily due to expected net income for the remainder of 2016.2017. At June 30, 2016,2017, the difference from the expected federal income tax rate is attributable to state income taxes and certain permanent book-tax differences.

We reported net income of $9,833 for the six months ended June 30, 2016 as compared to net income of $261,501 for the six months ended June 30, 2015. The decrease is primarily attributable to the decrease in revenues during the six months ended June 30, 2016.

LiquidityandCapitalResources

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, 2016,2017, net cash provided by operations was $188,986 compared to net cash used in operations was $666,117 compared to net cash provided by operations of $643$667,117 during the six months ended June 30, 2015.2016. The decreaseincrease was primarily due a decreasean increase in net income of $251,668$156,699 and the timing of receipts and payments related to our operating assets and liabilities.

We currently do not have any outstanding loan or line of credit with any bank or financial institution. 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.

By the end of the third quarter 2016, we expect to complete a recapitalization transaction (the “Recapitalization Transaction”) pursuant to which all issued and outstanding shares of our preferred stock will be exchanged or redeemed for a combination of cash and shares of our common stock in the amounts set forth in the table below.

As part of the Recapitalization Transaction, we also repurchased 2,084,167 shares of common stock owned by the United States Small Business Administration. Pursuant to the Recapitalization Transaction, we will make cash payments of $544,017 and issue 5,173,973 shares of common stock which will result in the net issuance of 3,089,806 additional shares of common stock, and eliminated $2,955,433 of aggregate liquidation preferences applicable to our previously outstanding shares of preferred stock.

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

Off-BalanceSheetArrangements

As of June 30, 2016,2017, 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.

Item4.ControlsandProcedures.

An evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) or 15d-15(e) under the Securities Exchange Act of 1934) was carried out by us under the supervision and with the participation of our president, who serves as our principal executive officer and principal financial officer. Based upon that evaluation, our president concluded that as of March 31, 2016,June 30, 2017, our disclosure controls and procedures were effective to ensure (i) that information we are required to disclose in reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and (ii) that such information is accumulated and communicated to management, including our president, in order to allow timely decisions regarding required disclosure.

There were no changes in our internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) or 15d- 15(f)) that occurred during the fiscal quarter ended June 30, 20162017 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II. OTHER INFORMATION

Item6.Exhibits

No.Description

Item 2.Unregistered Sales of Equity Securities and Use of ProceedsProceeds.

In connection withDuring the Recapitalization Transaction described above, onquarter ended June 16, 201630, 2017, we repurchased 2,084,167 issued and outstanding40,000 shares of common stock to an officer upon exercise of options in consideration of cash payment of $8,000. The forgoing shares were issued pursuant to a privately negotiated transaction with the holderexemption from registration provided by Section 4(a)(2) of such sharesthe Securities Act of 1933, as set forth in the table below.amended.

(1) This amount does not give effectDuring the quarter ended June 30, 2017, we issued 30,000 shares of restricted common stock to a new employee which vest in equal installments over a five year period. The forgoing shares were issued pursuant to the 1,658,540 sharesexemption from registration provided by Section 4(a)(2) of common stock that would have been issued to the holderSecurities Act of such shares if it had participated in the Recapitalization Transaction on the same terms1933, as the other holders of our preferred stock. Including these shares in the amount repurchased results in a per share purchase price of $0.0394.

amended.

Item6.Exhibits

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.

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