UNITED STATES

SECURITIESANDEXCHANGECOMMISSION

Washington,D.C. 20549

Commission File Number: 000-14801

Mikros Systems Corporation

(Exact name of registrant as specified in its charter)

(609) 987-1513

(Registrant’s Telephone Number, Including Area Code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. ☒Yes    ☐No

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company” and “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 ☒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 35,494,77535,551,775 issued and outstanding shares of the issuer’s common stock, $.01 par value per share, on May 11,August 14, 2017.

TABLE OF CONTENTS

See Notes to Unaudited Condensed Financial Statements

See Notes to Unaudited Condensed Financial Statements

Mikros Systems Corporation

Condensed Statements of Shareholders' Equity

See Notes to Unaudited Condensed Financial Statements

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 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 months ended March 31, 2017 and 2016 were $7,500 and $27,750, respectively. At March 31, 2017 and December 31, 2016, deferred revenues amounted to $0 and $7,500, 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 Company has decreased its net deferred tax assets decreased by $35,169$63,159 and $1,381increased by $7,637 during the threesix months ended March 31,June 30, 2017 and 2016, respectively. The change in deferred tax assets is attributable to the reversal of various book/tax differences.

At March 31, 2017, utilization of income tax attributes, primarily federal net operating losses, as the Company estimated itsanticipates annual effective tax rate for 2017earnings from operations to be 49.3%. The Company recognized a tax expense of $87,775 for the three months ended March 31, 2017 primarily due to expected net income for the remainder of 2017. At March 31, 2017, the difference from the expected federal income tax rate is attributable to state income taxes and certain permanent book-tax differences.continue.

Note 6 – Stock-Based Compensation

On January 30,During 2017, the Company issued 30,00060,000 shares of restricted stock with a weighted average fair value of $0.37$0.46 per share. As of March 31,June 30, 2017, there was $11,100$26,375 of unrecognized stock-based compensation expense related to the restricted stock issued in Januaryduring 2017, which will be recognized in future periods. During the threesix months ended March 31,June 30, 2017, 22,00062,000 options were exercised for proceeds amounting to $3,350.$11,350. The intrinsic value of the options as of March 31,June 30, 2017 is $40,530.$63,250.

TheDuring the three and six months ended June 30, 2017 and 2016, the Company recognized stock-based compensation expense for restricted stock of $2,639$3,572 and $636 for the three months ended March 31, 2017 and 2016,$6,211 and $1,250, respectively.

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, 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, 2016 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.

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 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 (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 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 the 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 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.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 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.Prognostics 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, we were awarded and entered into a multi-year IDIQ contract with the Naval Surface Warfare Center related to our ADEPT product. The contract provided for the purchase and sale of up to $26 million of ADEPT units and related engineering and logistics support. The initial term of the contract was five years, but the period of performance was extended through February 13, 2017, to conclude some development programs.

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. The first event in Norfolk has already occurred, and a second event in San Diego is currently scheduled for May.

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 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.

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 September 2016, we also received multiple contracts totaling approximately $0.4 million to continue logistics support of the ADEPT maintenance workstation. These contracts include general engineering support, repair, calibration and training.

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 program. The contract provides for the purchase and sale of up to $35.1 million of ADEPT units and related engineering, such as calibration, repair, training and other logisticssustainment services. The first delivery order for $1.1 million was also awarded in February 2017 to build eleven ADEPT systems for continuing fleet support on all Aegis cruisers and destroyers.

In March 2017 we were awarded the second and third delivery orders for engineering services in the amount of $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 $0.6 million is to provide logisticsustainment services, such as calibration, repair, evaluations, and screenings of ADEPT units to be performed in our Manufacturing and Depot (M&D) Center in Largo, Florida.

In April 2017 we received 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 fourth Navy radar system, the MK 99. The Small Business Innovation Research (SBIR) office in Dahlgren, VA provided $0.5 million of the total funding to support this effort. Along with those awards, we received the fourth delivery order for $0.1 million under the existing ADEPT IDIQ contract, to provide training of the ADEPT maintenance automation workstation to sailors in the fleet.

In July 2017 we received a modification which added funding to our ADEPT IDIQ Contract, Delivery Order 02, for Engineering Services in the amount of $0.4 million. This contract award will allow us to continue support of the ADEPT product line in the fleet, implement necessary software enhancements, and general support of the program.

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 and delivery orders awarded to 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 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 majority of our revenue for the three months ended March 31, 2017,in 2016, and expected revenue for the next nine months ofin 2017, is or will be from sales of ADEPT units and ADSSS systems under our IDIQ contracts, continued generation of delivery 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 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 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 and ADSSS, 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 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.

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. 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” to commercial customers. Customers for these systems, include major multinational corporations. We have received several repeat orders from these customers and continue to support their applications.

In 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. We will also seek to generate incremental revenue through providing light assembly and production services to commercial customers at our manufacturing and depot 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 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, 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, 2016. As of March 31,June 30, 2017, there have been no changes to such critical accounting policies and estimates.

Results of Operations

ThreeMonthsEnded March 31,June 30, 2017and2016

We generated revenues of $1,754,973$1,740,863 during the three months ended March 31,June 30, 2017 compared to $987,929$978,372 during the three months ended March 31,June 30, 2016, an increase of $767,044,$762,491, or 78%. The increase was due primarily due to a production order for 11 ADEPT units in February 2017 and the receipt of sixfour additional contracts for engineering services, support and repairs and calibration services amounting to $584,537.$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 March 31,June 30, 2017 was $651,536$621,582 compared to $324,328$349,526 for the three months ended March 31,June 30, 2016, an increase of $327,208$272,056 or 101%78%. The increase was due primarily due to the receipt of a production order for 11 ADEPT units in February 2017 in addition toand the receipt of sixfour additional contracts for engineering services, support and repairs and calibration services. As a percentage of revenue, cost of sales increased to 37%was 36% of revenues for the three months ended March 31,June 30, 2017 as compared to 33% of revenues for the three months ended March 31, 2016. The increase was primarily due to the change of the mix of costs incurred in 2017 specifically, increases in direct labor, material and subcontract costs related to engineering service contracts awarded in the first quarter of 2017 which were offset by the expiration of warranty reserves.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 March 31,June 30, 2017 were $517,180$539,412 compared to $323,913$312,849 for the three months ended March 31,June 30, 2016, an increase of $193,267,$226,563, or 60%72%. The increase was due to significant increases in fringe benefits and engineering salaries due to the hiring of six additional employees, recruiting costs, travel and subsistence expenses, engineering consulting costs and incentive 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 March 31,June 30, 2017 were $408,903$430,384 compared to $336,148$296,754 for the three months ended March 31,June 30, 2016, an increase of $72,755,$133,630, or 22%45%. The increase was due primarily to increases in Independent Research & Development (IR&D) salaries, incentive compensation, and professional fees.fees offset by a decrease in unallowable and bid and proposal costs.

At March 31,June 30, 2017, we estimated our annual effective tax rate for 2017 to be 49%. We recognized a tax expense of $87,775$73,985 for the three months ended March 31,June 30, 2017 primarily due to expected net income for the remainder of 2017. At March 31,June 30, 2017, the difference from the expected federal income tax rate is attributable to state income taxes and certain permanent book-tax differences.

SixMonthsEnded June 30, 2017and2016

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, an increase of $1,529,535, or 78%. The increase was due primarily to a production order for 11 ADEPT units in February 2017 and the receipt of ten additional contracts for engineering services, support and repairs and calibration services amounting to $1,488,131.

Cost of sales for the six months ended June 30, 2017 was $1,273,118 compared to $673,854 for the six months ended June 30, 2016, an increase of $599,264 or 89%. The increase was due primarily to the receipt of a production order for 11 ADEPT units in 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 was 36% for the six months ended June 30, 2017 as compared to 34% of revenues for the six months ended June 30, 2016. The increase is due to an increase in production costs and other direct costs.

Engineering costs for the six months ended June 30, 2017 were $1,056,592 compared to $636,762 for the six months ended June 30, 2016, an increase of $419,830, or 66%. The increase was due to significant increases in fringe benefits and engineering salaries due to the hiring of six additional employees, recruiting costs, travel and subsistence expenses, engineering consulting costs and incentive compensation.

General and administrative costs for the six months ended June 30, 2017 were $839,287 compared to $632,902 for the six months ended June 30, 2016, an increase of $206,385, or 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, 2017, we estimated our annual effective tax rate for 2017 to be 49%. We recognized a tax expense of $161,760 for the six months ended June 30, 2017 primarily due to expected net income for the remainder of 2017. At June 30, 2017, the difference from the expected federal income tax rate is attributable to state income taxes and certain permanent book-tax differences.

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 threesix months ended March 31,June 30, 2017, net cash provided by operations was $497,615$188,986 compared to net cash used in operations of $609,580$667,117 during the threesix months ended March 31,June 30, 2016. The increase was primarily due to an increase in net income of $88,461$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.

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 March 31,June 30, 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,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 March 31,June 30, 2017 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 Proceeds.

During the quarter ended March 31,June 30, 2017, we issued 22,00040,000 shares of common stock to certain employees and consultantsan officer upon exercise of options in consideration of cash payment of $3,350.$8,000. The forgoing shares were issued pursuant to the exemption from registration provided by Section 4(a)(2) of the Securities Act of 1933, as amended.

ItemDuring 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 exemption from registration provided by Section 4(a)(2) of the Securities Act of 1933, as 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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