This Management's Discussion and Analysis of Financial Condition and Results of
Operations summarizes the significant factors affecting the operating results,
financial condition, liquidity and cash flows of the Company as of and for the
periods presented below. The following discussion and analysis should be read in
conjunction with our unaudited condensed financial statements and related
information contained herein and our audited financial statements as of December
31, 2019.
Overview
Mikros Systems Corporation (the "Company", "we", or "us") designs and
manufactures software, hardware and electronic systems used to maintain complex
distributed systems. Examples of such systems include defense equipment such as
radars and combat systems, and commercial and industrial applications such as
printing presses, power distribution, utility systems, and Federal Aviation
Administration systems.
Our primary business focus is to (i) provide engineering services, products,
software and related maintenance under contracts with the United States
Department of Defense (DoD), primarily the United States Navy and (ii) pursue
Small Business Innovation Research (SBIR) programs from the DoD, Department of
Homeland Security, and other governmental authorities, with a view to expanding
this government funded research and development into government contracts. Since
2002, we have been awarded several Phase I, II, and III SBIR contracts, and
several IDIQ contracts for our ADEPT and ADSSS products.
Revenues from our government contracts represented substantially all of our
revenues for the three months ended March 31, 2020 and 2019. Over the past
decade, our principal customer has been the U.S. Department of Defense,
primarily the U.S. Navy ("Navy"). We provide the following key system to the
Navy for maintenance of radars and combat systems:
? ADSSS, the ADEPT Distance Support Sensor Suite, a Condition-Based
Maintenance (CBM) system used to monitor Combat System Elements (CSEs)
onboard the Littoral Combat Ship (LCS).
More recently, we have developed and marketed software products to analyze
maintenance data collected from target systems, optimize maintenance procedures,
and predict failures. Our Prognostics Framework (PF) and Diagnostic
Profiler (DP) products provide software capabilities which complement our
maintenance hardware products (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.
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Our Products
Adaptive Diagnostic Electronic Portable Testset (ADEPT). ADEPT®, also known as
the AN/PSM-132, is an automated maintenance workstation designed to
significantly reduce the time required to align all variants of the AN/SPY-1
Radar System aboard U.S. Navy Aegis cruisers and destroyers, while optimizing
system performance and readiness. Manufacturing, selling and servicing ADEPT
units was a substantial part of our business over the past decade. During the
life of the program, we delivered a total of 226 ADEPT units to our Navy
customers. Effective October 1, 2019, the US Navy determined to stop funding the
ADEPT program in fiscal year 2020.
ADEPT Distance Support Sensor Suite (ADSSS). In 2013, we started development of
ADSSS for the Navy's LCS. Our system has now matured and has earned the official
Navy nomenclature AN/SYM-3. The LCS is the U.S. Navy's latest combat warship.
AN/SYM-3 is a network-enabled system that can be configured to monitor multiple
shipboard systems and report maintenance data onshore for further analysis to
detect trends and predict failures. AN/SYM-3 provides an open architecture
approach with industry-standard hardware, and cybersecurity compliant software
to acquire and process system operational and maintenance data. The AN/SYM-3
system fully automates the capture of system operation, environment and
maintenance data to provide unattended operation. The system monitors key
parameters and sends alert notifications when parameters move out of tolerance.
The first full AN/SYM-3 system was successfully completed on LCS 2 and onshore
installation of prognostics software has been completed at Port Hueneme
Division. The ADSSS is used on both variants of the LCS, currently planned to be
at least 32 ships. In 2019, we completed installations on four additional LCS
ships that are being deployed allowing for data collection while operational at
sea. During 2020, we expect to install systems on two or three additional ships.
We are working with the government to have their virtual data transport system
installed on two deploying ships, allowing for near real-time data to be sent
back to shore and processed through our prognostics framework models. During
2020, we expect to add several new combat system elements to our LCS platform
which is expected to expand our footprint and bring condition-based maintenance
plus (CBM +) to additional mission-critical systems. We are also working to
maintain SYM-3 for modernization systems that are being planned in the next 3-5
years
Through our NSSMS contract awarded in the fourth quarter of 2019, we plan to
develop a new variant of the AN/SYM-3 system for the NATO Seasparrow Surface
Missile System. NSSMS is installed on Navy Aircraft Carriers (CVN class) and
"Big Deck" Amphibious Assault Ships (LHD/LHA class), so the new variant could be
installed on these two new ship classes. We have started the software, hardware,
and systems engineering tasks needed to move this CBM capability to land based
test events and then to a long-term pilot installation for four systems on the
NSSMS platform.
The SYM-3 has also generated interest from other ship classes, Aegis and
unmanned systems, and for use to monitor shipboard hull, mechanical and
electrical (HME) systems, additional combat systems, and navigational radars.
This is part of the Navy's continued effort to increase operational,
sustainability and lethality for many different ship classes. We are also
working to maintain SYM-3 for modernization systems that are being planned in
the next three to five years.
Diagnostic Profiler. The Diagnostic Profiler is an integrated development
environment for developing diagnostic capabilities used in maintenance, embedded
diagnostics, and troubleshooting applications. The software provides diagnostic
services to its host application, including fault callouts, suggested "next
best" test to further isolate faults, and direct maintenance actions. When
additional faults are identified, the software prioritizes the fault callouts by
probability. The use of the Diagnostic Profiler eliminates the need for the
development and maintenance of diagnostic flow charts and hard-coded text
sequences. This reduces the effort required to correct bugs and design
changes. Over the life of the system, this could result in significant cost
savings. This system is used by clients and has also generated yearly support
contracts for service. Mikros has also been upgrading and customizing the system
to the client needs.
Prognostics Framework. Prognostics Framework is an analytic software framework
for implementing real-time prognostics, diagnostics, and status monitoring to
support embedded prognostic applications, health management systems and
condition-based maintenance applications. The Prognostics Framework software
institutes an information framework that organizes relevant data related to: (i)
the condition of the system; (ii) the system's ability to perform required
functions over specific time intervals; and (iii) the need for maintenance
actions and repair parts. The Prognostics Framework has been used to implement a
complete health management system on one of the first radar systems to require
prognostics as a key element of its overall solutions. Other potential
applications include complex computer networks, power generators, power supply,
cooling, C4I (Command, Control, Communications, Computers & Intelligence),
environmental and imaging systems.
Government Contracts
In September 2016, we were awarded and entered into a multi-year IDIQ contract
with the Naval Surface Warfare Center, Port Hueneme Division, relating to our
ADSSS product. The contract has a term of five years and provides for the
purchase and sale of up to $48 million of ADSSS units and related engineering
and logistics support. The first delivery order in the amount of $3.0 million
was awarded on September 15, 2016 to perform installations, support and
logistics for the LCS class.
In February 2017, we were awarded a follow-on multi-year Small Business
Innovation Research Phase III IDIQ contract with the Naval Surface Warfare
Center, Crane Division, for our ADEPT program. The contract provided for the
purchase and sale of up to $35.1 million of ADEPT units and related engineering,
such as calibration, repair, training and other logistics services. We have been
awarded several delivery orders under the ADEPT IDIQ Contract. In October 2019,
we received notice from Program Executive Office Integrated Warfare Systems that
the ADEPT program will not be funded in fiscal year 2020. We will continue to
fulfill our current obligations under outstanding engineering services task
orders previously issued under the program. As of the date of this report, we
have one open task order for general engineering services.
In April 2017, we received contract awards totaling $2.0 million from the U.S.
Navy to extend the capabilities of the ADSSS CBM system to support a fourth Navy
radar system, the MK 99. The Small Business Innovation Research office in
Dahlgren, VA provided $0.5 million of the total funding to support this effort.
In June 2018, we received the second delivery order under our multi-year IDIQ
relating to our ADSSS product. This $2.5 million order provides for further MK
99 Fire Control System (FCS) development, test and installation.
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In September 2019, we received the third delivery order under our multi-year
IDIQ relating to our ADSSS product. The award covers the installation of
condition-based maintenance systems for the Littoral Combat Ship and has a
ceiling of $15 million. As of the date of this report, approximately $4.0
million of incremental funding has been awarded for work to be executed in
government fiscal year (FY) 2020.
In October 2019, we received an additional contract award under our multi-year
IDIQ relating to our ADSSS product. This incremental funding with a ceiling up
to $6 million, under the third delivery order, covers the development of a new
variant of the AN/SYM-3 system and installation of the new CBM system on two
additional ship classes; the Aircraft Carriers (CVN class) and the "Big Deck"
Amphibious Assault Ships (LHD/LHA class). As of the date of this report, $3.0
million of incremental funding has been awarded for work to be executed in FY
2020.
In November 2019, we were awarded a five (5) year Basic Ordering Agreement (BOA)
from Naval Air Warfare Center Aircraft Division, to begin a Phase I SBIR effort
entitled "Unmanned Surface Vehicle and Unmanned Underwater Vehicle Autonomous
Behavior Development". The amount of this Phase I effort was approximately
$150,000.
In April 2020, we received $4.9 million of additional funding from the U.S. Navy
to expand its flagship AN/SYM-3 program to additional LCS systems, new combat
systems, and two new ship classes. The new funding was part of the third
Delivery Order awarded under our multi-year IDIQ relating to our ADSSS product.
The funding will provide for continuing installations on the LCS class and
development of CBM solutions for aircraft carriers and "big deck" amphibious
ships.
In April 2020, we received notification of a Phase I SBIR contract entitled
"ADAPT - Naval Depot Modernization and Sustainment" This program seeks to
develop an integrated solution to allow facility managers to monitor the status
of a wide range of infrastructure systems, identify areas of concern, and
predict future areas of concern. The Phase I objective is to demonstrate
proposed solution feasibility. We will develop a solution to collect data from
critical building infrastructure systems including HVAC, mechanical systems,
communication systems, chillers, pumps, electrical switchgear, seismometers and
surveillance systems, as well as monitor energy usage data, water level data,
and data from other critical infrastructure systems. This work will include
developing a limited scale system to illustrate the concept. The amount of this
Phase I effort was approximately $200,000.
Commercial Contracts
In 2019 and 2020, HP Indigo, Saab Grintek Defense and Northrop Grumman renewed
their annual contracts for Diagnostic Profiler and Diagnostician Software
Maintenance and Support. We have also increased our capabilities to provide
online support at one of the client's facility.
The Mikros MindR™ system is a vendor-agnostic facility health status monitoring
solution which provides the ability to collect data from critical building
infrastructure systems including HVAC, mechanical systems, communication
systems, chillers, pumps, electrical switchgear, seismometers and surveillance
systems, as well as monitor energy usage data, water level data, and data from
any other systems. Data collected can be aggregated on a centralized physical or
secure cloud-based server where Mikros MindR Enterprise software can perform
analysis to determine status, diagnose existing failures, and predict future
failures. We are currently piloting our Mikros MindR system at a client facility
to collect and distribute data from the HVAC units to the client.
Key Performance Indicator
As substantially all of our revenue is derived from contracts with the U.S.
Federal government, our key performance indicators are (i) the dollar volume of
contracts and task orders awarded to us under our IDIQ contract, and (ii) the
number and dollar amount of new contracts and SBIR grants awarded to us.
Increases in the number and value of contracts and delivery orders awarded will
generally result in increased revenues in future periods and, assuming
relatively stable variable costs associated with our fulfilling such awards,
increased profits in future periods. The timing of such awards is uncertain as
we sell to Federal government agencies where the process of obtaining such
awards can be lengthy and at times uncertain. As the substantial majority of our
revenue in 2019, and expected revenue in 2020, is or will be from sales of
AN/SYM-3 systems under our IDIQ contract, continued generation of task orders
and our ability to expand the market and potential customer base for this
technology is our primary focus.
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Outlook
Our strategy for continued growth is based on continuing expansion of our
defense business and executing new initiatives to apply our advanced maintenance
technology in commercial markets. With regard to the defense industry, we expect
to continue expanding our technology base, backlog and revenue by continuing to
bid on projects that fall within our areas of expertise. These areas include
electronic systems engineering and integration, radar systems engineering,
combat/C4I (Command, Control, Communications, Computers & Intelligence) systems
engineering, communications engineering, remote monitoring and augmented
reality. We believe that we can utilize the intellectual property developed
under our various SBIR awards to develop proprietary products, such as ADEPT and
ADSSS, with broad appeal in both the government and commercial marketplace. Our
state of the art test equipment can be used by many commercial and governmental
customers such as the FAA, radio and television stations, cell phone stations,
and airlines. Second, we will continue to actively participate in the SBIR
program and pursue SBIR projects with the DoD, Department of Homeland Security,
U.S. Navy, and other government agencies. Third, we believe that through our
marketing of products, we will develop key relationships with prime defense
contractors. Our strategy is to develop these relationships into long-term, key
subcontractor roles on future major defense programs awarded to these prime
contractors.
With regard to commercial markets, our Diagnostics Profiler and Prognostics
Framework software offerings complement our hardware products and allow us to
provide complete hardware/software solutions for advanced maintenance
applications. Current customers for these systems include major multinational
corporations such as HP, which recently extended our Diagnostic Profiler
software support for a seventh year. We continue to receive repeat orders from
these customers to support their applications. We plan to provide
"condition-based maintenance" systems for "complex distributed systems" to
commercial customers. In that regard, we are developing a condition-based
maintenance solution for HVAC equipment based on our proprietary Prognostics
Framework solution which we call Mikros Mindr. We have deployed two active pilot
systems that are providing key maintenance data on a daily basis to service
technicians. We are also working with an energy consulting business in Florida
to remotely monitor energy use and required maintenance for its customers. We
are in discussions with additional commercial companies regarding the use of our
condition based maintenance applications.
In 2020, our primary strategic focus is to continue as a premium provider of R&D
and product development services to the defense industry, generate multiple task
orders under our ADSSS IDIQ and BOA contracts, additional Phase I and Phase II
SBIR grants with a view to obtaining additional government contracts, and expand
our commercial business through marketing and sales of our Prognostics Framework
and Diagnostic Profiler software products. In furtherance of this strategy, we
have made material investments in our engineering and technical staffs to
provide broader and deeper expertise to our customers. We will also seek to
generate incremental revenue through providing light assembly and production
services to commercial customers at our M&D Center in Largo, Florida.
Over the longer term, we intend to further develop advanced maintenance
technologies and implement these technologies in products for deployment in
defense applications and to expand into more commercial applications. We believe
that many of our core capabilities, remote monitoring, rugged systems,
predictive maintenance and communications expertise, are applicable to other
industries that work with complex distributed systems, such as utilities,
communications and transportation systems. We are currently in discussions with
certain industry participants regarding this initiative.
Recent Developments
An outbreak of a novel strain of the coronavirus, COVID-19, has been recognized
as a pandemic by the World Health Organization. This outbreak has severely
restricted the level of economic activity around the world. In response to this
coronavirus outbreak the governments of many countries, states, cities and other
geographic regions have taken preventative or protective actions, such as
imposing restrictions on travel and business operations and advising or
requiring individuals to limit or forego their time outside of their homes. The
Governor of Pennsylvania has ordered the closure of all non-life sustaining
businesses in Pennsylvania where the majority of our employees work. Further,
individuals' ability to travel has been curtailed through mandated travel
restrictions and may be further limited through additional voluntary or mandated
closures of travel-related businesses. Although our employees are able to work
remotely, this coronavirus outbreak has had a negative impact on our
productivity and revenues to date in 2020.
In addition, the pandemic and resulting closures has negatively impacted our
supply chain for component parts necessary to timely deliver AN/SYM-3 systems to
our Government customer. Non-essential travel bans and quarantine protocols
imposed to access US Navy ships have and are expected to continue to materially
delay our ability to complete on-ship installations, result in excessive
down-time for our engineering personnel, and increase travel costs. The pandemic
has also resulted in delays in contract awards, task orders, and contract
modifications to fund our projects. All of the forgoing has and will continue to
adversely impact our financial condition and results of operation. Given the
uncertainty regarding the spread of this coronavirus, the related financial
impact cannot be reasonably estimated at this time.
During recent years, the combination of spending caps, discretionary spending
cuts, sequestration and further changes in defense spending and priorities have
caused, and may in the future continue to cause, delays in funding certain
projects. This may negatively impact our revenues and profits.
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Changes to Critical Accounting Policies and Estimates
We reviewed all of the recently issued accounting pronouncement through May 2020
which are not yet effective and we do not believe the future adoption of any
such pronouncements may be expected to cause a material impact on our financial
condition or the results of its operations.
Results of Operations
Three Months Ended March 31, 2020 and March 31, 2019
We generated revenues of $1,081,163 during the three months ended March 31, 2020
compared to $2,020,265 during the three months ended March 31, 2019, a decrease
of $939,102, or 46%. This resulted primarily from the delay of follow-on funding
and the delivery of direct components. Revenues in the first quarter of 2020 and
2019 consisted entirely of engineering support services contracts.
Cost of sales consists of direct contract costs including labor, material,
subcontracts, travel, and other direct costs. Cost of sales for the three months
ended March 31, 2020 was $357,473 compared to $778,542 for the three months
ended March 31, 2019, a decrease of $421,069 or 54%. The reduction resulted from
the delay of follow-on funding and the delivery of direct components.
The majority of our engineering costs consist of (i) salary, wages and related
fringe benefits paid to engineering employees, (ii) rent-related costs, and
(iii) consulting fees paid to engineering consultants. As the nature of these
costs benefit the entire organization, and their benefit cannot be identified
with a specific project or contract, these engineering costs are classified as
part of "engineering overhead" and included in operating expenses. Engineering
costs for the three months ended March 31, 2020 were $609,961 compared to
$662,250 for the three months ended March 31, 2019, a decrease of $52,289, or
8%.
General and administrative expenses consist primarily of salary, intellectual
property, consulting fees and related costs, professional fees, business
insurance, franchise tax, SEC compliance costs, travel, and unallowable expenses
(representing those expenses for which the government will not reimburse us,
including independent research and development which consists of research and
development expenses unrelated to our defense contracts). General and
administrative costs for the three months ended March 31, 2020 were $445,319 as
compared to $463,565 for the three months ended March 31, 2019, a decrease of
$18,246, or 4%.
We estimated our annual effective tax rate for 2020 and 2019 to be 35% and 31%.
As a result, we recognized a tax benefit of $114,503 for the three months ended
March 31, 2020, as compared to tax expense of $(36,835) for the three months
ended March 31, 2019. The differences from the statutory federal income tax rate
were attributable to state income taxes and certain permanent book-tax
differences.
We reported a net loss of $216,285 in the three months ended March 31, 2020 as
compared to net income of $80,805 in three months ended March 31, 2019. The
decrease was attributable primarily to the decrease in revenues in the first
quarter of 2020.
Liquidity and Capital Resources
Since our inception, we have financed our operations through debt, private and
public offerings of equity securities, and cash generated by operations.
During the three months ended March 31, 2020, net cash used in operations was
$411,374 compared to net cash used in operations of $559,073 during the three
months ended March 31, 2019. The decrease in cash used in operations of
$147,699 was due to a $404,259 decrease in cash used in operations resulting
from the timing of receipts and payments related to our operating assets and
liabilities. The decrease in cash used in operations related to noncash charges
of $40,530 which amounts were offset by an increase in cash used in operations
of $297,090 which represents the increase in our net loss of $216,285 for the
three months ended March 31, 2020 as compared to net income of $80,805 for the
three months ended March 31, 2019.
Net cash used in investing activities was $0 in the three months ended March 31,
2020 as compared to $30,842 in the three months ended March 31, 2019, a decrease
of $30,842. The decrease was related to the completion of an expansion of our
offices in Pennsylvania in 2019.
On January 31, 2018, we entered into a $550,000 credit facility with PNC Bank.
The facility initially matured on January 31, 2020 and has been extended to
January 31, 2021. The facility accrues interest at a variable rate equal to the
Daily LIBOR Rate plus 250 basis points. Interest is paid monthly. Principal
borrowings may be prepaid at any time without penalty and the facility is
secured by substantially all of our assets. The facility contains customary
affirmative and negative nonfinancial covenants. As of March 31, 2020, no
amounts were outstanding under the facility.
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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.
Off-Balance Sheet Arrangements
As of March 31, 2020, we did not have any relationships with unconsolidated
entities or financial partners, such as entities often referred to as structured
finance or special purpose entities, established for the purpose of facilitating
off- balance sheet arrangements or other contractually narrow or limited
purposes. As such, we are not materially exposed to any financing, liquidity,
market or credit risk that could arise if we had engaged in such relationships.
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